Private equity: Worldpay IPO highlights sponsors’ weak hand
IPO values firm at 33 times forecast profit; sponsors struggle to compete on deals.
There is a certain irony in the fact that private-equity owned payments processing firms Worldpay and First Data both decided to launch IPOs in October.
Current market conditions are very favourable for private equity sellers. Timing one’s exit well is key, and it is all about where you are in the cycle
Bain Capital and Advent International bought Worldpay from RBS in 2010 for £1.7 billion in a forced disposal arising from the bank’s taxpayer-funded bailout after the financial crisis. First Data was sold to KKR in 2007 for $25.6 billion in the second largest LBO of all time, part of an LBO boom that is widely seen as having precipitated that financial crisis.
However, the PE owners of both firms have now opted for IPO exits from their investments in deals that valued Worldpay at £4.8 billion and First Data at $14 billion – a stark contrast in fortune from their original LBO worth.
The IPOs of these firms are a clear illustration of the continuing strength of the equity markets as an exit route for private equity – and also of the contrasting environments in Europe and the US. The top 10 private equity exits in 2014 involved five IPOs, four trade sales and just one secondary buyout.
In Europe, PE firms raised $11.2 billion equivalent across 21 IPOs in the first half of this year, according to EY, up nearly 50% year on year.
The Worldpay IPO saw the firm valued at an astonishing 33 times net forecast 2016 profits, while First Data was priced at $16 a share, or less than 12 times enterprise value ebitda. Indeed, in the first half of this year the Americas saw the lowest number of PE-backed IPOs since 2009, with just eight deals pricing.
“Current market conditions are very favourable for private equity sellers,” says William Mansfield, head of EMEA financial sponsors M&A at Credit Suisse in London. “Risk appetite is up, leverage is back, corporate margins are strong and there is enough macro-economic stability for people to be able to make informed decisions. Timing one’s exit well is key, and it is all about where you are in the cycle.”
The timing of the Worldpay exit seems particularly fortuitous given the recent volatility in the equity markets. The firm ran a dual-track process and received strong interest from sponsor, strategic and IPO investors. “The Worldpay story is a good example of how sponsors have been more disciplined. This is a high growth industry with high barriers to entry. IPO investors like that,” says Ed Eyerman, head of European leveraged finance at Fitch Ratings in London. Indeed, the fate of the various bids sums up the relative competitive strengths of the various exit routes for sponsors in these markets.
It is hard to see the mainstream buyout market
A consortium including US private equity firms Blackstone and Hellman & Friedman, together with the Government Investment Corporation of Singapore, bid for Worldpay in August but could not compete with the lure of an IPO. Neither could it compete with the strongest strategic bid from French payments processing group Ingenico, which tabled a bid of more than £6 billion for the firm at the end of August.
“There has been a shift in competitiveness between sponsors and trade buyers,” says David Slade, global co-head of leverage finance and leverage capital markets at UBS. “Sponsors are very focused on market valuation while trade buyers take a longer term view. Before, even a trade buyer with synergies could not compete with a sponsor’s valuation.” Now the positions are often reversed. Nevertheless, despite an IPO valuation below the Ingenico offer, Worldpay went ahead with the float and shares began trading on October 16.
It is more typical for firms to opt for an IPO only when the valuation on offer is more attractive, due to the fact that they are locked in to the shares after the firm has floated. For example, when TPG and the private equity arm of Credit Suisse were looking to sell bathroom equipment supplier Grohe in September 2013 they opted for a trade sale to Japanese bathroom supplier Lixil for €3 billion when the IPO valuation would have been around €3.5 billion.
“If private equity can sell they will if it is at or below the IPO price,” says one private equity specialist. “They will typically settle for a 10% discount. You are taking cash off the table but you get a whole sale.”
The desire for a clean exit is strong. “PE sponsors prefer to exit completely if they can,” says Nick Tomlinson, partner at law firm Gibson Dunn in London. “It is all about trying to get a clean exit in order to return funds to shareholders. With an IPO, money is locked up over time and it is unlikely that the shares the sponsor holds on day one of trading will provide the 20% return on equity they are looking for.”
The Debenhams IPO in 2007 showed the risks that IPO buyers run from buying into PE exits at very high valuations. CVC Capital Partners, TPG Capital and Merrill Lynch Private equity sold the firm at 195p a share, valuing it at £1.68 billion. The share price collapsed almost immediately and by December 2008 it had hit 23p. On October 20 this year it had recovered to 83p, still less than half of its IPO price.
The risks remain very real in today’s febrile market conditions: CVC Capital Partners floated Swiss telecoms operator Sunrise Communications in a $2.2 billion deal in February this year at a price of SFr68 a share. On October 20 the Swiss firm was trading at SFr50 a share.
Despite the extraordinary valuations on offer for some firms, an IPO exit will remain the preserve of very high quality firms as market unease continues. This could open up opportunity for sponsors to get back in the race. For example, French medical diagnostics firm Labco abandoned plans for an IPO in May this year and instead sold to private equity sponsor Cinven for €1.2 billion in a deal that valued it at just over eight times ebitda. The €440 million IPO was abandoned on the day it was due to trade, over concerns about market volatility.
“The IPO markets suit a mature business that may have been public before. Just because the IPO market is hot does not mean it is the answer for everyone,” says Tomlinson.
This will be very good news for funds that are sitting on substantial dry powder. “We are now coming up to the third anniversary of high valuations,” observes Slade. “If you look at fund sizes and what they have invested quite a few funds are well below their rational investment rate.”
Even so, with competition for new deals so intense, sponsors need to exhibit an iron discipline to avoid overpaying for assets. “There is a relative lack of opportunity for private equity buyers given competition from the IPO markets, which is creating real frustration for people who raised a fund a few years ago and are currently underinvested,” says Mansfield. “Sponsors are therefore willing to step down for certain assets for which a few years ago they wouldn’t have.”
This has prompted many larger firms to start to play in the mid-market, where the pressure from alternatives is less acute. “For sponsors the inflexion points are the large deals where their return requirements limit their ability to pay premia over competing IPOs and strategic buyers,” says Eyerman. “Some moved into peripheral markets, the mid-market and later stage technology, while more recently they are taking a page from the strategics and combining assets in order to grow into larger businesses.” One of the attractions of Labco for Cinven was the potential to merge it with other portfolio holdings.
Sponsors are also far more willing to explore alternatives to a straight exit to realize value. For example, in February this year, rather than an outright exit Lion Capital raised €602 million via a dividend recap of French frozen food retailer Picard Surgelés. It also sold 49% of the firm to Aryzta, which has the option to acquire the remainder within three to five years.
“People feel pressure to reinvest but not at any cost,” says Tomlinson. “There are other options: they can do bolt on acquisitions to their existing portfolio, partner with a strategic or take minority stakes in businesses through tactical opportunities funds. But if sponsors are going to be able to compete they have to be more creative.”
Certainly, in a buyout market that has shrunk as much as Europe’s, all options have to be on the table. “It is hard to see the mainstream buyout market continuing to grow,” says Michael Abraham, managing director of the European financial sponsors group at UBS. “As a GP, if you want to grow your business you have to go into different asset classes.”