Why the IPO Offers a Rocky Exit for Financial Buyers: Private equity firms prefer outright sales of portfolio companies to becoming hostage to the whims of public investors

Private equity firms have a love/hate relationship with the IPO market. Selling stock in their portfolio companies to the public can be a rewarding exit mechanism if all conditions are in the right alignment. But the IPO is seldom preferred to selling the company outright, and most financial buyers contend that the perfect balance they need to take a company public doesn’t exist often enough. Sale of the complete company is a total exit that maximizes cash payoffs and allows the financial sponsor in most cases to cut all ties with the former portfolio holding. By contrast, the IPO offers only a partial cash-out that deleverages the company – generates some funds to reduce debt – but usually keeps the owner in control. Aside from that fundamental difference, private equity firms worry about whether they have the right company to appeal to public investors and whether the IPO market itself is right for a high volume of new stock offerings. Yet, if the m&a market is somewhat restrained, as it currently is, the IPO may be an adequate solution, with the first stock offer followed by a subsequent secondary, or perhaps a delayed sale after the business is seasoned as a publicly traded stock. The continuing dilemma suggests, according to some LBO experts, that many IPO registrations with the SEC really are signals that the company is for sale and that the prospectuses are information circulars for possible bidders. “The red herrings in reality are black books,” says one veteran LBO consultant. Others disagree, claiming that there are not enough acquisitions off the IPO rolls to suggest that an IPO registration is actually a for-sale sign. Either thesis is hard to prove by numbers alone. While only a fraction of the registered companies are acquired before going public, the incidence is great enough for some experts to continue to assert that a complete sale is the primary objective. Through mid-September of 2004 seven portfolio companies out of about 70 that had filed with the SEC were purchased before the offering could be executed. One, Borden Chemical Inc., a holding of Kohlberg Kravis Roberts, was acquired by another financial buyer, Apollo Group. The other six were purchased by strategic buyers in fields ranging from cosmetics to software. Two acquisitions were done by European-based firms. Business Objects SA bought software firm Crystal Decisions from Silver Lake Partners while Vorwerk & Co. bought upscale cosmetics marketer Jafra from Clayton Dubilier & Rice. In the manufacturing area, Lubrizol Corp. acquired chemicals producer Noveon International Inc.; Encore Medical Corp. bought medical equipment maker Empi Inc. from Carlyle Group; and L-3 Communications Holdings Inc. picked up Vertex Aerospace LLC from Veritas Capital. Finally, Mimi’s Cafe, a smallish California-based casual restaurant chain controlled by Saunders Karp & Megrue, was acquired by Bob Evans Farms Inc. Four other private equity-sponsored IPOs were withdrawn. They included theater chain Cinemark (Cypress Group), InSight Health Services Holding Corp. (J.W. Childs Associates and Halifax Group), Meridian Automotive Systems Inc. (Windward Capital), and electronics firm Viasystems Group Inc. (Hicks Muse Tate & Furst). Most of the withdrawals were attributed to adverse market conditions. Some analysts and bankers believed there would be a higher volume of LBO-backed initial offerings as a result of the push behind income deposit securities (IDS), which package stock and a debt instrument in one security. These units are designed to maximize cash to investors and were seen as a mechanism that would help drive public market popularity for mature slow-growing businesses. However, since the offering of Volume Services America Holdings Inc. last December there has not been an IDS issue. Nearly two dozen IDS issues were in registration as of mid-September. Restructuring companies that use IPOs to divest unwanted subsidiaries also prefer straight sales, but frequently go the offering route because they have the option of spinning off the asset. Thus far in 2004, one IPO registration, ACCPAC International Inc., was sold by its parent, Computer Associates International Inc. to Sage Group. Carve-out withdrawals included ATX Group Inc. (Vodafone Group AG), Engenio Information Technologies Inc. (LSI Logic Corp.), and Fidelity National Information Services Inc. (Fidelity National Financial Inc.). Copyright 2004 Thomson Media Inc. All Rights Reserved. http://www.thomsonmedia.com http://www.majournal.com