Private equity firms, until recently the high flyers of finance,
have had a tough summer.
Not only are they suddenly struggling to finance leveraged buyouts
the market once welcomed but also the companies they've taken public have
lately been bombing with investors.
Online travel company Orbitz Worldwide and recruitment company
Dice Holdings are two of the summer's biggest duds, both down about 20 percent
since being brought to market by private equity firms.
Of all the companies floating shares this year, three of the five
worst performers were backed by private equity firms, according to Dealogic. Of
the best performing companies, just one was backed by private equity.
Strong summer offerings like E-House Holdings, a Chinese real
estate company previously owned by management, and software maker VMware, spun
off by EMC, have been a bright spot.
But IPOs backed by private equity—which have outperformed public
offerings overall so far this year, according to Dealogic—seem to be losing
their appeal. High leverage and rich valuations, hallmarks of private
equity-backed offerings, are starting to unnerve investors.
"Buyout-backed IPOs have historically done well, but that
could definitely change in a different credit environment," said University of Florida finance professor Jay Ritter.
"That's a real concern with so many buyout-backed IPOs having recently
gone public and the debt financing environment changing."
Private equity firms buy companies by relying on debt, which
usually winds up on a target's balance sheet. The firms often reward themselves
with dividends that further load portfolio companies with debt.
"Typically the amount of interest they pay relative to their
income is out of whack," Francis Gaskins, president of research firm IPO
Desktop, said regarding the debt serviced by private equity-backed IPOs.
"It's like overmortgaging your house."
The 10 largest private equity-backed IPOs last year had an average
debt-to-equity ratio of 1.6, according to PricewaterhouseCoopers—dwarfing a
ratio of 0.1 for offerings that weren't backed by private equity.
Investors were likely more comfortable with such leverage when
companies could service debt cheaply. But with uncertain credit markets and
economic outlook, shareholders are wary of high debt loads.
E-House, up about 20 percent since its debut earlier this month,
had a debt-to-equity ratio of 0.1, according to IPO Desktop. VMware, which has
more than doubled since its August debut, had a ratio of 0.5.
By contrast, Orbitz and Dice Holdings have dropped about a fifth
of their value since their debuts—with debt-to-equity ratios of 0.8 and 1.5,
according to IPO Desktop.
"Because they're highly leveraged and the proceeds go to pay
off debt, typically these companies take as much money off the table as
possible," said Gaskins. "They are not priced for the investor."
"It's a financial enrichment campaign for shareholders in the
private equity fund," said David Menlow, president of research firm
IPOfinancial.com. "If everybody else has a chance to make some money,
that's a bonus. But it's not an objective."
Private equity firms are quick to cite studies showing that
companies taken public after their ownership perform better than those not
backed by private equity.
"Private equity investment firms are in the business of
creating long-term value in the companies they acquire, value that continues to
grow after private equity firms exit the investment," said Robert Stewart,
vice president of industry group Private Equity Council.
But uncertain credit markets could make richly valued or
debt-laden offerings a much tougher sell to public investors going forward—which
could put pressure on the firms.
"There is pressure to deploy," said Ilan Nissan of law
firm O'Melveny & Myers. "This business is about using resources to buy
and sell companies. No one is making money by holding."
By Reuters
Copyright 2007 Reuters.