February 2014 Issue
The global economy is improving, and market sentiment is high and rising. At the same time, performance of PE-backed companies has improved, and the IPO pipeline has grown. Prior to 2013, the IPO market was effectively closed for many companies, with institutional investors weary of private equity backed companies that had come to market during the boom years, overly burdened with debt. Since June 2013, however, these attitudes have softened, and recent deals suggest the market for private equity backed IPOs has reopened. Furthermore, with many companies that were taken private pre-crisis yet to be exited, the IPO pipeline could stretch on for some time.
Current trends
The resurgence of PE backed IPOs follows two lean years in 2011 and 2012, when the appetite for new listings was hit by global economic uncertainty and a rash of poor secondary market performances. Those windows that did open for IPOs were very short, leading to a backlog of issuers hoping to go to market, which we’ve seen in recent months. Indeed, 2013 was a bumper year for PE backed IPOs, which, totalling $57bn, raised more than twice the amount seen in 2012. This figure also marked the second-largest total on record, coming in just short of 2007’s $58.5bn haul. In terms of volume, 181 deals had priced through to 12 December 2013, compared to 110 for the whole of 2012. “PE houses have considered IPOs as an exit route for their investments over the past few years, however they have been dissuaded by changeable market conditions and negative sentiment from investors,” says Mark Hughes capital markets partner at PwC. “The strong performance from these PE-backed IPOs will go a long way to restoring confidence and realigning the expectations of other sector players.”
From the outset, 2013 looked set to surpass the lacklustre performance of the previous year, and momentum built steadily between January and April. The first quarter made for a strong departure, with sponsored deals raising $7.1bn across 30 listings, up 31 percent on Q4 2012. Of the first three months, March was the most active, accounting for 62 percent of proceeds raised and more than two-thirds of IPOs. The largest IPO of the period saw Asiacell Communication float on the Iraq Stock Exchange, raising $1.4bn. The second quarter built on this success, and sponsored firms continued to file for IPOs. In the three months from April to July, $13.6bn was raised from 43 IPOs. Among these was the May debut of Quintiles Transnational, which raised $1.1bn on the NYSE.
“The resurgence of PE backed IPOs follows two lean years in 2011 and 2012, when the appetite for new listings was hit by global economic uncertainty and a rash of poor secondary market performances.”
As the global economy improved through the year, market sentiment grew with it. Although the third quarter was marked by investor caution over the US Federal Reserve’s quantitative easing program, this did not prevent $7.7bn being raised through 34 transactions, bringing total proceeds for the year to date to $29bn – an increase of 77 percent on the same period a year earlier. Rounding off the year, Q4 2013 was particularly active, and October and November alone saw PE backed flotations raise $20.4bn – the highest since Q2 2007.
Geographically, much of this activity was centred, predictably, on the Americas, which saw 60 percent of the year’s PE backed IPOs. This success was further boosted at the end of the year by the IPO of hotel chain Hilton Worldwide Holdings. Blackstone Group, which bought the company in October 2007, booked a paper profit of $8.5bn from the IPO, based on the $6.5bn that the firm and its partners invested in the business.
Activity in Europe, however, also picked up. Rising investor confidence and easing fears over regional economies saw PE-backed IPOs in the region increase from just six in 2012 to 34 in 2013. Correspondingly, deal value increased from $2.3bn to $17.6bn. Over half of all European deals took place in London, although Paris, Frankfurt, Milan and Brussels all saw PE firms raise more than $1bn. The IPO of Merlin Entertainments Group in November 2013 was the largest European IPO of 2013 at €3.8bn.
Activity elsewhere was more subdued, however. Falling valuations continued to challenge IPO issuance in the Asia-Pacific region. This is of particular concern as PE firms in the region have traditionally relied on stock market listings to exit their investments. The issue is particularly pronounced in China. The country’s markets have, until recently, been closed to new issues, and most PE-backed companies are looking at alternative exit routes. For several years, concerns have mounted about the governance and accounting practices of several newly traded Chinese companies. As a result, the China Securities Regulatory Commission (CSRC) imposed a halt to mainland listings in order to improve the quality of the country’s IPOs. Despite the shortfall of firms exiting, though IPO activity in Asia Pacific was limited, on the whole, those companies that did go public performed well.
By sector, financial services proved the most active, accounting for over 20 percent of PE backed IPOs. The real estate market also played a key role, with deals in the sector raising more than $5bn. “Having emerged from the global recession and its aftermath, the real estate private equity sector is finally positioned for growth in 2014. A number of related companies outside the real estate sector also benefited from rising real estate prices – 14 companies in the building industry collectively raised nearly US$4.5b during the year,” said Jeffrey Bunder, Global Private Equity Leader at EY. The healthcare and technology sectors also saw good returns.
Optimal exit environment
The growing strength of the IPO market has been welcomed by PE firms – this is unsurprising since 62 percent of companies acquired in 2006 and 73 percent of those acquired in 2007 remain un-exited, and investors are clamouring for returns. IPO exits have, for several years, been intermittent at best. The IPO window has been volatile – opening for short periods, then closing rapidly when a deal fails publicly, or in response to the latest macroeconomic challenge.
Indeed, PE exits as a whole have been muted since the financial crisis. In addition to the poor general market conditions, institutional investors also felt somewhat bruised that many private equity backed companies that had come to market during the boom years had been overly burdened with debt.
But since 2007, PE firms have waited patiently, continuing to operate and improve their portfolio companies until the time that exit conditions became optimal. Indeed, the environment since the crisis has altered the way PE firms operate to some extent, with investment periods stretched beyond historic norms. In 2010, the average PE investment period was 4.7 years, rising to 5.2 years in 2011, and 5.9 in 2012, according to research by the Australian Private Equity and Venture Capital Association. This strategy appears to have paid off – PE backed IPO performance has been robust through 2013, with flotations delivering, on average, a 13 percent first-day increase on their offer price. Through 12 December 2013, IPOs were 18.6 percent above their offer price on a weighted-average basis.
Recent activity, then, strongly suggests that the industry is once again ready to embrace IPO exits, and the strength of the market is encouraging more companies and PE owners to re-evaluate and accelerate their plans to go public. Indeed, surging investor confidence and improving economic fundamentals led to 2013 being one of the strongest markets on record for PE backed IPOs. The key question now is whether conditions will remain sufficiently stable in 2014 for this trend to continue.
Considerations
When the proper market conditions are available, IPOs can enable PE firms to realise the highest return on their investments. Notwithstanding this, IPOs also have a serious disadvantage compared to other exit methods: they do not represent a straightforward exit route for private equity. An IPO can take considerable time to come to complete, and considerable lead in time is necessary for appropriate preparation. Many private equity firms now commence pre-marketing much earlier to ensure successful debuts, typically initiating dialogue with institutional investors six to nine months before the IPO. Prior to the financial crisis, they would often only be contacted a few weeks before due date.
Before embarking on a potential IPO, PE owners must be confident that there is space for the business on the market, and be certain it will achieve an adequate valuation. Firms taking the IPO route may find it necessary to significantly de-lever a portfolio company prior to listing. In addition, the firm’s management team must have experience running a publicly-listed business. Furthermore, PE sponsors must be comfortable that a full exit will be realised over time. IPOs do not necessarily mean a full exit – PE firms can only exit an investment when their shares are actually sold on the stock market, which is very unlikely to happen simultaneously with the IPO. For a certain amount of time after the IPO is carried out, PE firms are therefore exposed to all the fluctuations and risks that come with playing the market. A further consideration for IPO exits is the strict regulatory requirements applicable to any firm listing on the stock exchange, which adds to the duration and expense of the exit process.
In the broader sense, PE sellers must consider the current strength of the IPO market, which, although healthy at present, has not yet emerged from its nascent stages of growth and could be impacted by ongoing issues. Further problems in the eurozone, for instance, could curtail confidence in the IPO market. And while investor confidence in PE backed IPOs is returning, it could potentially take only one poor performing listing to stir up negative sentiments.
Looking ahead
Going into 2014, the outlook for PE backed IPOs remains strong, with PE firms filing for IPOs at an accelerated rate. December 2013 saw $14bn of new deals in the pipeline, and by early January 2014, 60 PE backed firms had filed for IPO in the coming year. Major firms set to list include UK card maker The Card Factory, controlled by Charterhouse; Russian grocer Lenta, backed by TPG Capital; and Hong Kong meat producer Shuanghui International, backed by CDH China Holdings and New Horizon Capital. “PE and VC backers will continue to take advantage of improving market performance, generating good returns by taking their investees or portfolio companies public,” says Mr Bunder. “There is a strong appetite among institutional investors for these IPOs as they offer the prospect of higher returns.”
The situation in Asia also looks more promising. Following reform at the end of 2013, China’s IPO pipeline has reopened, and, with as many as 300 expected offerings, as much as $41bn could be raised in 2014. In November, the China Securities Regulatory Commission announced changes that would see more responsibility for pricing put in the hands of investors, and a move towards a disclosure-based system for filing IPOs, in line with procedures used in the US. Enthusiasm has been high, particularly in the country’s retail sector, which is heavily supported by PE backed firms. The $48m public float of babywear maker Miko International Holdings Ltd. in January was reportedly 1,125 times oversubscribed. However, the vast majority of Chinese firms will be looking to IPO on domestic stock markets, in part because of the poor performance over the last several years of many Chinese companies listed on international markets.
Assuming the macroeconomic picture continues to improve and equities markets continue to trend high, conditions should remain favourable for a sustained period of new IPOs, globally. But this does not mean that firms should lower their guard when embarking on such an exit. PE firms contemplating the IPO of a portfolio company are strongly recommended to consider the feasibility of an IPO and any potential red flag issues, the most suitable brokers for the proposed deal, as well as current trends in advisers’ fees and commissions.
The process is far from straightforward, and among the key issues for an IPO management team is running the process while minimising disruption to the business. But, given the drawn out nature of IPOs, care must also be taken to protect the PE firm’s interests beyond the IPO itself. Firms may consider including entrenched board seats and other rights as part of the transaction. However, while this exit strategy may be quite complex, the success of recent transactions and the growing pipeline of IPOs are grounds for PE firm optimism.
Along with the encouraging signs of economic recovery, the success of recent PE backed IPOs offer genuine reasons for optimism, however it may not be a panacea for the beleaguered private equity industry. Despite the boost that the IPO market has given to firms looking to offload assets, a surge in listings may reduce opportunities for PE firms to acquire assets. It may also result in PE firms paying more for deals. To counter any negative fallout from a burgeoning IPO market, PE firms must also consider secondary sales, sales to trade buyers and other routes to return profits to investors.
© Financier Worldwide
BY
Matt Atkins