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Spurt of Initial Public Offerings Fails to Lift VC-Backed Companies

The reports of the IPO market’s return have been greatly exaggerated. In truth, it’s much more of a debt-swap market for private equity firms.

  • Udayan Gupta

The market for initial public offerings surged early this year, with 31 deals raising $7.6 billion in the first quarter, but few young growth companies are cheering. The IPO market resembles a giant debt-swap in which private equity firms like Blackstone Group and Madison Dearborn Partners and corporate titans such as Pfizer are cashing in on a buoyant equity market to unload bulky assets. By contrast, few venture capital-backed companies are managing to go public.

On April 18, SeaWorld Entertainment priced a $702 million IPO after attempts to sell the company in the private market failed. In 2009, the $210 billion-in-assets Blackstone Group paid $2.3 billion to buy SeaWorld from multinational brewer Anheuser-Busch InBev. SeaWorld paid Blackstone a $100 million dividend in 2011, then took on additional debt in March 2012 to pay the firm an additional $500 million dividend. As part of the IPO, SeaWorld offered 10 million shares at $27 apiece, raising $245.4 million net of expenses. The company said it used the proceeds to pay down $177 million of debt and to pay Blackstone a $47 million fee for terminating a management advisory agreement. Blackstone and shareholders affiliated with it offered 16 million shares in the IPO.

More such deals could be in the offing as private equity funds come under pressure from their investors for increased capital distributions, market watchers say.

Meanwhile, the year got off to a dismal start for venture-backed IPOs, with activity falling to the lowest level in three years, according to the National Venture Capital Association (NVCA) and Thomson Reuters. Venture-backed IPOs raised only $672 million from eight offerings in the first quarter, a decline of 52 percent from the amount raised in the fourth quarter of 2012, and a decline in both deals and dollars raised in the first quarter of 2012. (In the first quarter of 2012, venture-backed IPOs raised $1.68 billion from 19 offerings.)
 “Political, taxation and sequestration concerns weighed even more heavily on the exit market for emerging growth companies,” noted John Taylor, head of research for the NVCA, in a press release from the Washington, DC-based venture capital trade group.

The performance of the quarter’s IPOs was lackluster. The average aftermarket return dropped to 4.9 percent from 11.2 percent in the first quarter of 2012, according figures compiled by Greenwich, Connecticut-based Renaissance Capital, an advisory firm that tracks IPOs and IPO markets. The average first day return declined to 12.6 percent from 18.4 percent a year earlier. And the average total return dropped to 18.3 percent from 32.2 percent in the first quarter of 2012.

The current surge in IPO activity is being driven by the stock market’s momentum and by specific sectors, says Jackie Kelley, head of Americas IPOs at Ernst & Young’s Strategic Growth Markets practice. But unlike past quarters, issuers have been selling smaller portions of their holdings to test the waters. If the market holds up, she adds, they come back for additional financings.

Indeed, three of the quarter’s four top performing deals were leveraged buyouts being recapitalized in the market, notes Renaissance. The average return for all private equity-backed deals was 26 percent, exceeding the overall average of 18 percent for all new issues in the quarter. Issuers seem to have learned from past overpricings, notes Kelley, and are selling less of smaller stakes and pricing them conservatively.

On January 25, Bain Capital took Bright Horizons Family Solutions public in an offering in which the company raised $222 million. Bright Horizons first went public in 1997, then slumped in the weak economy of the mid 2000s. Bain took it private in 2008 in a highly leveraged $1.3 billion deal, paying a premium of 47 percent to the market price at the time. Now it is offering up the company at a value of nearly $1.8 billion.

On January 31, Pfizer spun off Zoetis, its agricultural and veterinary products division, in a stock offering that raised $2.3 billion, more than half the division’s 2011 revenue. Never mind that Zoetis is the ten-ton gorilla in a global market that has slowed to a 6 percent annual growth. Pfizer, in its S-1 registration, admits that the offering is simply a “debt exchange,” saying, “In connection with this offering, Pfizer will exchange shares of our Class A common stock for indebtedness of Pfizer held by affiliates of certain of the underwriters, which we refer to as the debt exchange parties.”

On February 6, Madison Dearborn, the private equity firm that in 2004 acquired paper maker Boise Cascade for $3.7 billion, sold 30 percent of the company for $263 million. For Madison Dearborn, this is the second time it tried to unload a stake in Boise. The company abandoned its first effort in 2005, a year after the purchase, because it couldn’t get the price it wanted. “Market conditions in general aren’t receptive to an IPO at the moment,” a Boise Cascade spokesman said at the time. “The company is operating well, the businesses are performing well, and we didn’t think we were getting fair value for our shareholders.”

And on March 29, Blackstone raised $580 million to pare down Pinnacle Foods’s debt, which had ballooned to $2.7 billion since 2007, when Blackstone bought the maker of Vlasic pickles, Duncan Hines cake mixes and Birds Eye frozen foods. (Pinnacle is not out of a pickle. Its existing debt is rated B2 by Moody’s, a junk-bond rating that the agency attaches to obligations that “are speculative and are subject to high credit risk.”

Buyout-backed companies continue to dominate the IPO pipeline. “And as long as the equity markets stay strong, private equity funds will continue to go to the equity markets for cheap capital to replace debt,” says Joseph Cohen, a veteran investment banker and chairman of JM Cohen & Co. Without full-scale research and market coverage, the markets will continue to favor mature companies they know rather than small companies that don’t have adequate visibility, Cohen and others say.

The pipeline for coming quarters is smaller than expected with just 112 companies planning to raise a total of about $32 billion, down from 196 companies planning to raise $50 billion at the same time last year. The confidential filing process of the JOBS Act has caused deals to move quickly once they enter the pipeline, notes Renaissance Capital, adding “The JOBS Act also has tipped the pipeline towards the larger companies.”

Waiting in the queue, according to Renaissance, are a number of major LBOs planning an exit, including Bausch & Lomb (estimated deal size: $1.5 billion) and Taylor Morrison Homes (estimated deal size: $500 million). The lion’s share of the pipeline consists of buyout-backed companies, but there are a number of technology and healthcare companies on the list, including Intelsat, CDW and Quintiles, according to Renaissance. Venture-backed companies that are on the Renaissance IPO watchlist include Benefitfocus, a cloud based platform for benefit enrollment and management; Cvent, a large on-demand event management software provider; and Tableau, a provider of interactive data visualization software.

The strength of the overall market has created a spate of new stock offerings. But until there is greater economic stability and certainty, IPOs of true growth companies may still be overshadowed.