March 2021 Issue
2020 saw a resurgence of private investment in public equities (PIPEs), which offer companies a way to raise a large amount of capital relatively quickly and easily. Last year, 1055 PIPE transactions were completed, raising over $53bn – the largest total since 2008, according to PrivateRaise. Healthcare and life sciences companies accounted for $15.2bn across 254 PIPEs, while industrials – such as chemicals, metals, mining and paper companies – led the market by number of deals with 323, but raised much less in aggregate, with $2.8bn.
PIPE deals are a faster, more bespoke source of financing which have proved popular in periods of economic turbulence. During the last economic crisis, for example, public companies used PIPE transactions to raise more than $123bn in 2008, an 86 percent increase over 2007’s then-record $66bn, according to PrivateRaise.
In 2020, the effects of the coronavirus (COVID-19) pandemic were sudden and devastating for many businesses. Companies endured a drop in demand, disrupted supply chains, location closures, a switch to remote working, and a rise in furloughed or laid-off workers. Many watched their cash flow dwindle and scrambled to access capital – even as traditional sources of financing dried up. While some turned to existing shareholders for support, others utilised the equity markets.
“PIPEs have allowed difficult credits to find liquidity in urgent and creative ways, particularly in light of the unanticipated need for capital and limited availability of credit at key times during 2020,” says Paul M. Tiger, a partner at Freshfields Bruckhaus Deringer US LLP. “PIPEs offer issuers a potentially faster path to fundraising, especially where they involve only a bilateral negotiation with a single investor.”
PIPE deals are particularly attractive during a relatively short-term crisis, such as the COVID-19 pandemic, as they provide companies with an alternative to taking on more debt or selling the company while the market is at a low. Furthermore, as any publicly-traded company can initiate a PIPE deal with an accredited investor, PIPEs undoubtedly make it easier for smaller and lesser-known companies to raise capital, which has been vital in the challenging economic climate brought about by COVID-19. Given the ongoing economic crisis, listed companies will continue to look at capital-raising options throughout 2021, and PIPE transactions are likely to remain popular.
Benefits for investors
Historically, the types of investor most willing to participate in PIPE transactions have been institutional, though investors differ depending on the particular situation, such as whether the company is distressed or healthy. “Generally, there will be investors that are committed sector investors, and these include mutual funds and other asset managers,” notes Anna T. Pinedo, a partner at Mayer Brown LLP. “There may be private equity (PE) and venture funds, and there may be financial or opportunistic investors, such as hedge funds.”
During periods of crisis or difficulty, PE funds may find that uncertainty around private company valuations makes such investments more difficult to execute. PIPE transactions offer them the opportunity to take a significant stake in a public company at a negotiated, discounted price, and in some cases even secure a seat on the target’s board. Through PIPEs, PE firms can also deploy capital quickly when activity in private markets slows or when deal pipelines are running dry. They can also support PE firms looking to fulfil certain fund mandates.
“While some PIPE investors have tended to be focused on short-term investment, more recently PE investors have shown an interest in acquiring substantial minority positions if the issuer is a strong company, established in one of the industries that the investor has experience in, and is one where the investor may be able to negotiate control rights,” points out Darrell Peterson, a partner at Bennett Jones LLP.
“PIPEs have already proved vital to the continued existence of many companies, particularly in industries most impacted by the economic upheaval and contraction caused by the COVID-19 pandemic.”
As Mr Peterson explains, for an investor there are a number of advantages of a PIPE transaction. “PIPEs offer investors the ability to receive a discount to the current market price in order to compensate for the initial statutory hold period imposed in Canadian PIPE transactions, the ability to negotiate additional governance rights and protections – such as board seats, anti-dilution protection, pre-emptive rights, registration rights or veto rights – and an upside if equity is bought at a discount based on broad market factors, such as a well-run company with a depressed price due to poor general market conditions,” he says.
To that end, a number of PE firms have turned to PIPE deals during the pandemic. Notable examples include Silver Lake’s $1bn investment in Twitter in March 2020, and Silver Lake and Apollo’s $1.2bn investment into Expedia Group in May 2020. In August, Bain Capital pledged $750m to Nutanix, a publicly traded developer of cloud-based enterprise software, while Blackstone agreed to take a stake worth roughly $300m in Tricon Residential, a publicly traded operator of single-family rental homes, in the same month.
Potential risks and drawbacks
Though PIPE deals do provide valuable opportunities for companies to access capital quickly, they are not without their critics. For shareholders, PIPEs can be problematic as the issuance of new stock for these sales dilutes the value of existing shares. In some instances, investors or companies with inside knowledge of the trade have shorted the issuing firm stock in anticipation. “PIPE transactions received negative press in the early 1990s at a period in time when death-spiral transactions, which were future-priced or adjustable-rate transactions, were being completed,” recalls Ms Pinedo.
Of course, there are other challenges and restrictions for issuers undertaking a PIPE transaction. “First, the offering would be restricted to those purchasers who meet prospectus exemption requirements, principally accredited investors,” says Mr Peterson. “Second, in order to compensate for the initial four-month statutory hold period in Canada, PIPE investors will require a discount to market on the purchase price. And third, generally a listed issuer cannot sell more than 20 percent of its outstanding stock at a discount without receiving prior shareholder approval.”
Investors, too, need to consider the potential downsides. “For an investor, disadvantages of a PIPE transaction include equity capital at higher risk than debt, and as a result, more exposure to the issuer’s downside risk, and reduced liquidity due to a limited ability under securities laws to exit a substantial or control position,” says Mr Peterson.
As Ms Pinedo explains, since a PIPE transaction is a private placement, the securities that are sold in the transaction are ‘restricted securities’ and cannot be freely resold. “As a result, the investors will demand some discount, often referred to as a ‘liquidity discount’,” she says. “This is a disadvantage compared to a Securities and Exchange Commission (SEC)-registered offering. In an SEC-registered offering that is undertaken as a firm commitment underwritten offering, the issuer would not have to worry about the stock exchange rules related to shareholder approval. This is another factor to take into account. That said, often an issuer will choose to undertake a PIPE transaction when it cannot undertake an SEC-registered offering.”
Regulatory considerations
Part of the appeal of PIPEs is that they are subject to fewer regulations, particularly from the applicable securities regulated authority, which also speeds up the process compared to other forms of secondary offerings. “Subject to consideration of required approvals, PIPEs can be completed in a condensed timeline and, if placed with an existing investor, can often be done with more limited due diligence than other financing alternatives,” says Mr Tiger. “These bilateral negotiations also create an environment where creative issuers and investors can structure around difficult economic, governance and diligence issues. Oftentimes however, that results in a security that becomes increasingly complex, which can be hard to explain to existing investors from a PR perspective and may result in unintended consequences down the road.”
The interest in speed of execution in PIPE transactions often leads to placements with an existing investor, which can generally conduct more limited diligence. But companies that effect successful PIPE transactions during turbulent times may be subject to 20/20 hindsight that make the transaction look problematic. “If a PIPE transaction involved an existing investor, the criticism may be that much more intense – with claims it amounts to a sweetheart deal to an insider,” points out Mr Tiger.
“This can be an unfair criticism, since companies do not usually turn to the PIPE market if other, more traditional financing sources are available,” he continues. “Nevertheless, issuers need to be cognisant of that risk and consider if there are ways to run their process to proactively address these potential criticisms, often by considering alternate sources of financing or allowing the public to participate in the offering on the back-end through a rights offering or similar mechanism.” Some regulators have called for more intensive regulations to prevent insider trading opportunities. They also argue that small offering firms may have little choice but to take bad deals with hedge funds to raise sorely needed capital.
In addition, most PIPEs involve voting securities, or securities convertible into voting securities, which means companies need to consider relevant thresholds for antitrust or other regulatory approvals. “For US public companies, that also means you need to be cognisant of stock exchange requirements to obtain shareholder votes,” says Mr Tiger. “There are some workarounds for this, but these can be expensive in light of potential uncertainty around the vote, and may in turn create interesting fiduciary issues for boards pushed to include sweeteners to compensate investors for that uncertainty.”
Both Nasdaq and the New York Stock Exchange (NYSE) require listed companies to obtain shareholder approval prior to certain issuances of common stock or securities convertible into common stock, generally in excess of 19.9 percent of the company’s outstanding shares pre-transaction, which could delay a company’s plans to raise capital. Listed companies that choose not to comply with shareholder approval rules may face delisting by the exchange.
Future of PIPEs
During the global financial crisis of 2007-2009, there was a notable uptick in PIPE transactions, with activity continuing steadily thereafter. In the current market conditions, PIPEs are set to remain a smart choice for those who fully understand their benefits, as well as their limitations.
“The speed to execution, which offers the ability to structure complex securities in challenging times, can often drive meaningful value, even if it comes at a price,” says Mr Tiger. “There may be some cyclicality in the market, but 2020 showed that PIPEs serve a meaningful role in the financing markets. And we are also seeing that they are increasingly playing an important role in de-SPAC transactions, giving special purpose acquisition companies (SPACs) the ability to target companies with greater cash needs than the SPAC can address on its own.”
SPAC transactions had a positive year in 2020. To September 2020, according to SPAC Insider, there were nearly $36.2bn in SPAC gross proceeds, far higher than the $13.6bn in 2019 and the $10.8bn in 2018. Such numbers suggest that SPAC transactions may become more of a permanent fixture in the dealmaking landscape over the coming months, or even years. In July, SPAC Pershing Square Tontine Holdings Ltd, raised $4bn as its initial public offering of 200 million shares priced at $20 a share. With other corporates looking to SPACs to help them acquire businesses that they could not otherwise afford, the future of SPACs looks positive.
There are, of course, risks with PIPE transactions, as there are with all deals. Particularly in the current climate, investors are betting on companies which may not survive the economic storm. But for an issuer, while the injection of capital is vital, having a large PE firm on board can also provide a level of prestige, and potentially attract other institutional investors, thereby boosting the company’s chances of survival. They also provide strategic guidance to the board.
PIPEs have already proved vital to the continued existence of many companies, particularly in industries most impacted by the economic upheaval and contraction caused by the COVID-19 pandemic. But they remain appealing even when conditions are calmer.
“PIPE transaction activity has always been fairly steady,” says Ms Pinedo. “PIPE transactions have a role to play, regardless of market cycles. For example, for companies in certain sectors, like life sciences, which must raise capital frequently, PIPE transactions remain important capital-raising alternatives.
“For companies of all sizes, PIPE transactions remain important capital-raising alternatives to finance significant acquisitions, because often, an SEC-registered offering will not be available,” she adds. “For SPACs, PIPE transactions have proven to be essential in order to mitigate the risks associated with potential shareholder redemptions. As a result, it is fair to say that PIPE transactions are here to stay.”
© Financier Worldwide
BY
Richard Summerfield