The weak performance of several recent IPOs is casting a shadow on one of the market’s most fertile sources of dealflow: private equity firms. Private equity sponsors have leapt at the recent opportunity to exit investments via IPOs with robust enthusiasm, with, as Deutsche Bank’s Henrik Johnsson, European head of high-yield capital markets, told this magazine in April “every single private equity asset that has been owned for more than one year looking at an IPO”.
Recent research from EY seems to confirm this: by the end of March private equity backed firms had priced 46 IPOs in 2014 raising $17.4 billion – more than double the equivalent figure for 2013.
“All firms are lining up assets to IPO, and investment bankers are talking about the significant premium they can get from an IPO. Everyone wants to get things out there in an orderly rush – people are not expecting that appetite will be this frothy for very much longer”
Graham Elton, Bain & Co
“IPO appetite has a huge impact on PE on both the sell side and the buy side,” Graham Elton, head of private equity for Bain & Co in EMEA, tells Euromoney. “All firms are lining up assets to IPO, and investment bankers are talking about the significant premium they can get from an IPO. Everyone wants to get things out there in an orderly rush – people are not expecting that appetite will be this frothy for very much longer.”
Elton spoke to Euromoney in May, when there were already warning signs that the IPO window might not be open for private equity firms forever.
“We are seeing some signs of overheating now,” he said. “Deals are being done at very toppy prices. If you are buying in normal conditions there is some expectation that the forces of beta would be there to support you. But are you really going to get a better debt package in two or three years’ time? No, you aren’t. People buying assets now will really have to work to make a return.”
In its Global Private Equity Report for 2014 Bain & Co calculates that the number of IPOs for buyouts rose 67% worldwide last year, from 112 in 2012 to 187 in 2013. Some 84% of those buyouts came to market at or above their target range. This proved a windfall for GPs that invested in the mega-buyout boom of 2006 and 2007 as exits from some of these deals have finally become a possibility. One of the best examples of this trend is last December’s $2.34 billion Hilton Worldwide offering, the largest-ever hotel IPO. Blackstone Group took the hotel group private in 2007 in a $26.7 billion deal. Hilton used the proceeds of the IPO to repay $1.25 billion of its debt.
Many private equity firms are now looking to follow this example. At the beginning of 2013 GPs were sitting on assets with an unrealized value of nearly $2.3 trillion. “There are a lot of assets still sitting on PE books from the 2006 to 2008 period. They are mostly public to privates and there is only one place to exit these investments, which is the public markets,” says Elton. According to Bain & Co, companies best suited to an IPO tend to be larger: IPOs accounted for more than half of the 100 largest PE exits in 2013.
According to EY, 89 PE-backed firms filed for new IPOs during the first quarter of this year, nearly doubling the pipeline to $27 billion from more than 100 deals.
That is a lot of business relying on appetite for PE-backed IPOs remaining buoyant. But the recent performance of UK roadside assistance provider AA’s £1.4 billion IPO demonstrates that this should not be taken for granted.
The deal, which facilitated the complete exit of private equity owners Charterhouse Capital, CVC Capital and Permira from the business, traded down 7.2% on the first day of trading. The same PE firms sold their Saga business, which provides insurance and holidays to people aged over 50, in an IPO in May, with that deal having traded down 8% by the end of June. It will take more than a few underperforming deals to derail the IPO exit frenzy but investors might start to become more selective.
The strength of the IPO exit route so far in 2014 has seen secondary buyouts slump by 25% year on year.
According to Bain & Co, of the 230 companies that IPOed in the US in 2013, more than 80% were businesses that might have been attractive PE targets. This is making life very hard for PE sponsors who have to compete with buoyant equity markets to put money to work.
“In this market you have got to have an investment thesis that is semi-proprietary. This is very hard,” reckons Elton. “You now have to roll your sleeves up and price risk properly. You can either adopt a turnaround strategy which involves turning poor/average businesses into average businesses or you can opt for high growth firms and pay nosebleed multiples.”
Neither looks a very enticing prospect. What this means is that private equity sponsors will have even more difficulty putting the huge volumes of funds that they have amassed to work.
“Contrary to pre- the financial crisis there is now significantly more dry powder in PE hands than any reasonable expectation of dealflow will consume,” Elton says.