Credit Market Turmoil Could Sour Outlook for U.S. PE-Backed IPOs

  • Rising interest rates, market volatility take their toll
  • Investors lose interest in highly leveraged companies' IPOs

You can add one more factor to the reasons why U.S. private equity-backed initial public offerings have had a shabby few months: the convulsing junk bond market.

Languishing commodities prices and turmoil in emerging markets had already prompted a selloff in high-yield credit, even before the markets could fully react to the impact of the Federal Reserve raising interest rates in mid-December.

In 2015, U.S. junk debt registered its first annual loss since 2008, down 4.64 percent, according to Bank of America Merrill Lynch Indexes. That could be a harbinger for new equity offerings, and not an auspicious one.

Investors have retreated from stocks of companies with the lowest credit quality. That’s a bad sign for IPO-bound PE-backed companies with a lot of debt, and ratings lower than investment grade that want to try for an initial public offering. Investors may be drawn to less risky investment grade companies, or highly leveraged companies may have to offer a discount to get the deal done.

“Is there a spillover from the high yield market to the equity market? Yes,” said Michael Goldberg, head of U.S. equity capital markets at Royal Bank of Canada. “Investors are going to be more selective, as they have been recently, about what companies they are going to invest in.”

Volatile Markets

That attitude has been further reinforced by almost half a year of volatile U.S. stock markets. In August, worries about China’s economy and the flailing energy industry sparked a rout. On Jan. 4, the first trading day of the new year, Shanghai equities plunged almost 7 percent and the rest of the world followed.

Investors have already balked at offerings from PE-backed companies that were poised to be among the biggest of 2015. Supermarket chain Albertsons Cos., owned by Cerberus Capital Management, postponed its plans indefinitely, while KKR & Co.-backed First Data Corp., the payments company, priced its shares below the planned range.

Albertsons, with about $10.5 billion in debt outstanding as of mid-September, and First Data, with $21 billion in total debt at its October IPO, are both rated below investment grade by Moody’s Investors Service and Standard & Poor’s Ratings Services. While the lure of junk debt is higher yields, investors have turned toward companies with better ratings, and less risk.

KKR-backed Laureate Education Inc., the largest for-profit college network in the world, is planning to raise $750 million to $1 billion in an initial public offering as soon the first quarter of next year, people with knowledge of the matter said in September.

Also on file since 2015 are Neiman Marcus Group Inc., the retailer owned by Ares Management and the Canada Pension Plan Investment Board, that had $4.7 billion in debt as of May, and Univision Holdings Inc., the Spanish-language broadcaster taken private by a group including Saban Capital Group Inc. and Madison Dearborn Partners. Univision listed $9.4 billion in debt as of the end of September in its latest IPO filing.

“A lot of the financial sponsors IPOs went on the shelf in the fourth quarter,” said Frank Maturo, vice chairman of the Americas in UBS Group AG’s equity capital markets group.

For those companies looking for a 2016 IPO window, investors are going to be paying attention to the Fed’s increase in interest rates and how that’s going to affect the more leveraged companies, Maturo said. Higher interest rates could make it costlier for businesses laden with debt to refinance, which could change how potential public investors view the stock.

M&A Rules

Some private equity-owned companies that had filed to go public instead avoided weathering volatile market conditions by selling the company, locking in a sure price for its backers.

IPO-bound SunGard Data Systems Inc. was bought by Fidelity National Information Services Inc. in a deal valued at $9.1 billion, helping its seven private equity owners, including Silver Lake Management, Blackstone Group and KKR, reap about a $2.2 billion profit on their $3.6 billion investment, a person familiar with the matter said in August. Silver Lake- and Warburg Pincus-backed Interactive Data Corp. agreed to be purchased by Intercontinental Exchange Inc. for $5.2 billion in October.

Petco Holdings Inc., backed by TPG, Leonard Green & Partners and Abu Dhabi Investment Authority, is being taken over by CVC Capital Partners and the Canadian Pension Plan Investment Board in a deal worth about $4.6 billion. The deal announcement came three months after the retailer filed to go public in August.

“You are seeing a lot more M&A activity out there,” said RBC’s Goldberg. “If it’s compelling with respect to valuation, and it gives you 100 percent certainty, in this environment, it seems to give you a winning hand.”

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