Next year could be another banner year for IPOs, thanks to all the private-equity-backed corporate buyouts. But ordinary investors may want to stay clear when these deals hit the tape.
With buyout firms snapping up public companies at a record clip this year, expect many of those same savvy buyers to begin looking for a way to take a quick profit and throw their debt-laden acquisitions back into the marketplace. That's especially so if the private-equity crowd begins sensing the mergers-and-acquisition party is coming to an end.
One of the easiest ways for buyout artists to cash in their chips and generate returns is through an initial public offering. Yet IPOs backed by cash-rich private-equity firms tend to be clunkers, faring far worse than traditional new stock offerings. This year, the average gain for an IPO of company owned by buyout firms is just 1%, compared to a healthy 30% return for all other U.S. company IPOs, says Thomson Financial. (Admittedly, the outsize gains posted by
( NMX) have juiced those returns.)
Some of the IPO dogs churned out by the buyout crowd include drug manufacturer
, down 9% from its offering price,
( MGG), also off 9%, and mattress company
, down 7%. Rental-car giant
, one of the year's biggest IPOs, is up 4%, but that's only after the private-equity firms that own the company had to price shares below the anticipated range.
Market observers attribute the poor performance of private-equity-backed IPOs to the debt that's been added to company balance sheets. In the case of Hertz, institutional investors balked because much of the proceeds from the $1.32 billion IPO went to paying a special dividend to the car-rental company's private-equity owners.
So with private-equity firms making liberal use of junk bonds to finance all their gargantuan takeovers this year, there's every reason to expect the next round of IPOs will get an equally as rude reception from Wall Street. Still, that won't stop the deals from coming.
In fact, on Wall Street, private-equity-sponsored IPOs are sometimes referred to LIPOs -- short for leveraged initial public offerings.
"We expect the number of private-equity-backed deals will continue at the same level or higher," says Scott Gehsmann, the leader of PricewaterhouseCooper's global capital markets group in North America.
Gehsmann notes that earlier this year a number of private-equity-backed IPOs were postponed because the buyout firms were concerned about how they would be received by the market.
Some of the private-equity-backed deals that got postponed, or withdrawn, this year include ones from nutritional-supplement chain GNC, ethanol producer Hawkeye Holdings and heath care company Light Science Oncology. Geshmann says many of those deals could come back into play next year.
Overall, it's been a big year for IPOs, with the 206 deals that have come to market raising $40 billion, according to Dealogic. The dollar value of those IPOs already has eclipsed last year's tally and is threatening the $52 billion raised by U.S. companies in 2004.
But the bigger story is the surge in the number of private-equity-backed IPOs the past two years. This year buyout-sponsored IPOs account for 42% of the total dollars raised in the market for new stock offerings. That's a down bit from last year, when such deals accounted for 49% of the IPO market. Yet both years are up sharply from 2004, when stock offerings backed by private-equity firms represented 31% of the market's take.
There's no denying that private-equity-backed buyouts are on a tear. To date, the dollar value of leveraged buyouts now accounts for a whopping 26% of all U.S. mergers this year, according to Dealogic. In all, buyout firms have paid $340 billion to take out U.S. companies. Last year at this time, private-equity firms had spent $149 billion on LBOs.
In the past, private-equity firms typically held onto an investment for several years trying to make the business more efficient before looking to cash out. But now private-equity firms are paying themselves hefty dividends and looking to cash out just months after taking over a company.
Of the 10 biggest private-equity-backed IPOs this year, four -- Hertz, Warner Chilcott,
( GGL) and
-- came to market within two years of an LBO.
Clearly, patience is no longer a virtue for the wealthy managers of private-equity funds.