Three more multibillion-dollar private-equity firms have recently turned to the public markets, a move that allows ordinary investors to dabble in the world of high-end leveraged buyouts. Securities and Exchange Commission documents filed late last week by Evercore Partners, Porticoes Investment Management and the Blackstone Group show that the firms hope to raise a total of about $2 billion from stock sales, using the capital to make mezzanine investments in the debt of private companies. Employing a previously little-used structure known as a business development corporation, private-equity firms figure to be a major presence in the IPO market in the next few months, as a combination of worries about government regulation and investors' hunger for yield creates a new market niche. Investors get a chance to play with the buyout boys, and private-equity firms shave many months -- and millions of dollars -- from costly private fund-raising routines. The three offerings come
hard on the heels of similar fare from Kohlberg Kravis Roberts (KKR) and Apollo Management, which are in the vanguard of a movement toward public financing by the usually secretive private-equity industry. Industry observers say more will surely follow, and soon. "It's kind of a cross between a closed-end fund and a public company," says Marjery Neale, a partner in Shearman and Sterling's asset management group, which worked on the deal that created Apollo Investment Corp. ( AINV) earlier this month. That deal originally sought to raise $500 million through the sale of ordinary shares of stock, but investor demand put $930 million in Apollo's closed-end investment company's coffers within two weeks. Observers say the money was raised from a combination of typical private-equity investors, such as pension funds and retail investors that want to run with the buyout bulls, and institutional investors, which bought the lion's share.
Federal regulations require a business development corporation to invest at least 70% of its capital into developing companies, which then allows these private-equity parent firms to branch out using public capital. KKR, for example, said in a SEC filing that it would use up 30% of its $750 million fund for distressed debt investments. The very real possibility of increased government regulation of private investment firms, made more likely by a few hedge funds' roles in the ongoing mutual fund scandal, coupled with rule changes that will allow private-equity fund directors to keep their jobs while also overseeing investments from publicly raised money, helped create conditions for the current IPO mini-parade. Some observers suggest that may turn to a stampede as more private equity firms seize on the public market as a new source of cheaper capital. As private-equity firms look to their hedge fund brethren and take note that increased regulation of private investment is more a question of "when" than "if," the hybrid structure of a BDC looks more attractive. By creating a registered investment pool using the business development structure, buyout firms get to keep doing business almost as usual. (Business development companies must pay out a high percentage of their income in dividends, much like a real estate investment trust.) But investors shouldn't expect quick gains from their new stocks, as they are essentially paying into blind pools of capital whose managers can make any investment decisions they want, taking a 2% annual management fee and 20% of any profits from the sales or public listings of companies that their firms finance. Still, public eagerness to tap into these high-end investments comes at a time when traditional private investors are becoming wary of making long capital commitments in the face of diminishing returns.
Private-equity funds in North America raised $108 billion in 2003, up sharply from 2002's $64.6 billion but well behind the peak figure of $152 billion in 2000, according to PricewaterhouseCoopers and Venture Economics. "They're all playing on this incredible search for yield on the part of the public markets," says Dale Meyer, a partner at Probitas Partners and longtime observer of the buyout industry. "There's no high yield out there, and you can't get squat for an interest rate in the money market anymore." Roy Ballentine, a Wolfeboro, N.H., investment adviser to wealthy clients, says he won't be recommending the BDC option as an alternative to direct investments in typical private-equity and venture capital private partnerships. He says the stock offering looks like a high-risk, low-reward option in comparison. "We'll have to see what the results look like over time," he says. "I am not wild about this." Whether these new hybrids make money for investors remains to be seen, although they are already proving profitable for the investment banks doing the underwriting. An underwriter collects a 6% to 7% commission, which will certainly boost the revenue streams of UBS Investment Bank, a unit of UBS Group ( UBS); J.P. Morgan Securities, a unit of J.P. Morgan Chase ( JPM); and Citigroup ( C) ( C). Credit Suisse First Boston, a unit of Credit Suisse ( CSR); Banc of America Securities, a unit of Bank of America ( BAC); Merrill Lynch ( ML); Bear Stearns ( BSC); and Lehman Brothers ( LEH) have also participated in the recent IPO quintet. Other deals are said to be under way or in the planning stages. Likely candidates include private-equity firms Thomas Lee Partners, Black Rock Partners and the Triarc Cos., according to industry sources. While there are a handful of existing companies that have already used public markets for investment capital, including debt specialists Allied Capital and American Capital Strategies, Canadian buyout shop Onex and venture capital providers Safeguard Scientifics and CMGI, the venture capital arm of CMGI Inc. ( CMGI), the arrival of large private-equity firms may herald an IPO trend. "There are literally dozens of smaller shops trying to do this," one observer said.