Al Waxman: IPOs Are Looking Dicey, But PE Can Pick up the Slack

Last month, one Psilos Group-backed portfolio company was all set to file an S-1 to go public. We did have one IPO in France in July before the world markets got strange. But then there was the debt ceiling crisis in Washington, more bad news on the economic front, and a steep sell-off in the stock market. Our second IPO candidate delayed its filing on the advice of its investment bankers and it probably won’t take another stab at going public until sometime next year.

That company’s move makes perfect sense.

The high U.S. jobless rate has not really budged, housing remains in the tank, and the sovereign debt crisis in Europe now threatens the United States. In addition, the U.S. government’s debt load grows greater every day. And, of course, we have stalemate over fiscal policy in Washington which grows greater as the next Presidential election grows closer.

Predictably, all this makes the stock market very volatile, and that isn’t a good backdrop for IPOs. When the market goes up 300 points one day and down 300 points the next, very few investors are interested in seeing whether Silicon Valley’s latest flavor can handle the rollercoaster. You need market stability and better economic predictability. Because uncertainty breeds paralysis, most companies will be on the sidelines until well into 2012.

Many of these companies are good, solid middle market companies that are growing briskly and making money but are just now reaching a size to interest Wall Street investment bankers. In this climate, however, it’s hard to get anyone excited about an IPO. Some fear this is the new normal. I don’t think it will come to that.

The picture isn’t completely bleak, because there are alternatives in the private market, both short-term and long-term. One is the advent and growth of markets for trading illiquid assets online, which have created an exchange for trading shares of private companies in the near-term. This allows company founders and key managers to liquidate some of their stock and tie themselves over financially until their real payday comes along. Longer-term, more private equity buyers will enter the fold and employ more creative ways to help middle-market companies monetize themselves. The incentive is there; unlike the IPO market, a record amount of cash was generated from exits in the private equity sector in the second quarter, inspiring confidence in the asset class. (According to Preqin, an alternative asset research firm, private equity general partners generated $120 billion from 300 exits in the second quarter of 2011)

Seasoned technology private equity firms such as TA Associates and Summit Partners already are a part of this picture. If we are really an efficient capital system, more novel ways will evolve among other private equity firms to address the middle-market company challenge. This is a particularly ripe opportunity in the healthcare marketplace. For example, some of the more traditional companies can be acquired, operated and re-tooled to become even more effective in the newly emerging healthcare economy – it’s standard work for a private equity firm in select industries and the impetus for healthcare reform makes this field a perfect target. And it is certainly a worthwhile endeavor — middle-market companies generate $6.1 trillion in annual revenue, or 40 percent of the national GDP, and employ 25 million people.

Younger, more innovative companies that have risen to address the tide of healthcare costs and demand are growing despite the economic chaos. These companies will be in excellent shape to deliver positive returns to IPO investors when the market stabilizes, albeit their growth may be slower than originally hoped since the large infusion of cash available from an IPO will not be readily available. Clearly it would be easier and better if strong healthcare technology companies could go public to maximize near term opportunity. But given the market dynamics and rules and restrictions, today is not their day. Private equity is providing an option besides bread-and-butter acquisitions that will allow these companies to prosper as the opportunity to capitalize on the great changes taking place in the healthcare marketplace.

Al Waxman, Ph.D., is CEO and Co-Founder of the Psilos Group. Opinions expressed here are entirely his own.