Private Equity Peddles a Little MoreBy and
With the stock market rallying 16 percent from the end of June through Nov. 19, private equity firms are finding it easier to take their holdings public—in some cases, that is. Since July 1, buyout firms have sold shares in a dozen of their companies, with 10 of them trading above their initial public offering price as of Nov. 19, including three that went public the week of Nov. 15.
Yet that same week, Harrah's, the world's biggest casino operator—now called Caesars Entertainment—became the first private-equity-backed company in six months to postpone its U.S. IPO after setting a price range, citing market conditions. "A rising tide floats all boats unless there's a hole in the ship," says Paul Schaye, managing partner of Chestnut Hill Partners, a New York-based firm that helps private equity houses identify targets. "When there's been something fundamentally done to [improve] the business, that's when you see the upside."
Private equity firms pool money from investors and obtain debt to finance takeovers with the intention of selling the companies later. The firms, which also earn money from advisory and financing fees, aim to profit by selling their companies to corporations or other investors, or by selling shares to the public. After the financial crisis, the capital markets were essentially closed to new offerings, with the number of IPOs in 2008 hitting a low not seen since at least 1982. That left private equity firms unable to reap profits by selling what they owned, hurting returns. Buyout funds as a class had an average loss of 0.9 percent for the three years ended in the first quarter of 2010, according to researcher Preqin.
Among the latest to go public: consulting firm Booz Allen Hamilton (BAH), backed by Carlyle Group; Boston-based brokerage LPL Investment Holdings (LPLA), backed by TPG Capital and Hellman & Friedman; and semiconductor and testing equipment maker Aeroflex Holding (ARX), owned by Golden Gate Capital, Veritas Capital Management, and a fund run by Goldman Sachs (GS). The 12 U.S. companies that buyout firms have taken public since July have gained 21 percent, on average, through Nov. 19. Only one, Carlyle Group's CoreSite Realty (COR), was trading below its offering price. There have been 27 IPOs of private equity-backed companies this year, up from 22 in 2009 and 5 in 2008, according to data compiled by Bloomberg and Renaissance Capital.
Harrah's was scheduled to sell 31.3 million shares for $15 to $17. The company, which was taken private by Apollo Global Management and TPG in 2008, has cut its overall debt by about $5 billion through debt exchanges and other measures. Even so, it had more debt relative to cash flow than any private equity-backed company that sold shares this year except one, according to data compiled by Bloomberg. Harrah's had $18.39 billion more debt than cash at the end of September and generated $1.13 billion in earnings before interest, taxes, depreciation, and amortization (EBITDA) in the first nine months of 2010, according to its prospectus. That would give Harrah's a net debt-to-EBITDA ratio of 12.2 over a full year, more than triple the average of 3.93 for private equity-backed IPOs this year.
Harrah's has "a massive amount of debt," says Timothy Cunningham, a money manager at Santa Fe (N.M.)-based Thornburg Investment Management. "They really hadn't been private very long, there weren't a lot of material improvements, it just didn't look very attractive." A company spokesman declined to comment.
None of the private equity owners of LPL and Booz Allen sold shares in the recent IPOs. Some private equity firms have taken companies public in the past year and later sold shares in secondary offerings after the stock rose. KKR (KKR) sold some of its Dollar General (DG) stake in a secondary offering in April 2010 after taking the company public in November 2009.
Companies that went public in the recent wave have been showing signs of strength. Booz Allen saw sales rise 8 percent from a year ago, to $2.71 billion in the six months ended Sept. 30. Net income more than doubled, to $43 million, according to a filing. TPG, the private equity firm run by David Bonderman and James Coulter, and Hellman & Friedman bought about 60 percent of LPL in 2005. The owners have overseen an expansion of the business, with the number of advisers growing at an annual rate of 15 percent. Aeroflex went private in August 2007. Its revenue rose 20 percent, to $155.9 million, in the quarter ended Sept. 30, and its net loss narrowed to $5.8 million from $20.5 million, according to filings.
Investors are not sure that the bigger companies owned by private equity firms can deliver robust growth, says Steven Kaplan, a professor at the University of Chicago Booth School of Business. Among the big companies waiting to sell shares are Toys 'R' Us, which filed for an IPO in May and has since sold loans to pay down existing debt, and Nielsen Holdings, owned by KKR, Carlyle, Blackstone Group (BX), and Thomas H. Lee Partners. The television-audience rating company filed for an IPO in June.
HCA, the hospital chain acquired four years ago in a $33 billion leveraged buyout, filed in May for an IPO to raise as much as $4.6 billion. The company said this month it plans to pay a $2 billion dividend to its owners, a sign it will not be proceeding with its IPO in the near future. "What do IPO investors want to see? A growth story," Kaplan says. "If you're one of the big behemoths, it's hard to give them that. You need a strong economy."
The bottom line: Private equity firms are finding they can sells shares of companies with improving operations and without heavy debt loads.