Buying into PE-Backed IPOs

Last night I appeared on CNBC’s Fast Money program to discuss what public investors should look for in buyout-backed IPOs. I can’t yet find the video, but that’s OK because watching me prattle on is almost worse than reading me prattle on…

Anyway, the umbrella answer is that there is no perfect formula for such things, from judging past buyout-backed IPO performance. Moreover, there is some serious discrepancy between aftermarket performance of such offerings over the past two decades and a more recent sampling. Specifically, the historical data since 1980 shows that buyout-backed IPOs have outperformed the non-LBO-backed IPO market. But if you only look at buyout-backed IPOs since the beginning of 2006, they’ve underperformed the non-LBO-backed IPO market by a margin of 23.2% to 27.4 percent (through market close Tuesday). I’ve posted the relevant data here for your downloading pleasure.

If you look a bit deeper at the recent aftermarket performance, a few things jump out. First, companies seem to perform better if they’ve been held longer by their private equity sponsor. This isn’t to say that quick-flips can’t work (think Hertz), but four of the five best-performing offerings received their initial PE funding in 2000 or before. Each of the five worst-performing offerings got funded in 2003 or later.

Other key issues:

  • Debt doesn’t seem to matter very much. Folks like me pay a lot of attention to dividend recaps, etc. — but public shareholders apparently view it more as future upside than risk. Moreover, Josh Lerner is currently working on a paper that reviews reverse LBOs (take-privates taken back public) up until 2002, which shows that highly-leveraged companies actually perform slightly better in the IPO aftermarket.
  • Be careful if the LBO firm is selling lots of stock in the IPO (shows a lack of faith). Conversely, be careful if the firm continues to hold a significant majority position (could be hard to bleed out without shocking the company).
  • Don’t worry too much about the specific LBO firm backing the company. Rock stars are great, but some of the best LBO-backed IPOs come from small firms.