When DLJ Merchant Banking Partners last month poised portfolio company Doane Pet Care for an initial public offering, to raise $211 million, the group had every reason to feel confident.
The company, which produces pet food and pet care products, this year will have revenue of more than $1 billion and EBITDA of approximately $109 million, according to Peter Grauer, a managing director at DLJ Merchant Banking. “It is a pretty reasonable-size company with very strong management,” Mr. Grauer says.
However, the IPO, which was set to price at between $11 and $13 per share, ultimately did not generate the interest that DLJ Merchant Banking anticipated-and believed Doane merited-and the group opted to pull the offering.
“If we could have gotten it off at a high enough valuation, we could have gotten some of the leverage off the balance sheet,” Mr. Grauer says. “Rather than get a depressed value, we decided to hell with it.” After this experience, Mr. Grauer says his group now has no plans to take Doane to a public offering in the near future.
DLJ Merchant Banking’s experience with Doane-which several industry observers point to as a solid company that could have thrived in an IPO market prior to the “dot-com” days-should serve as a harbinger to other buyout firms that may be considering a dip into the public offering pool: Be sure to look before you leap.
Although the first quarter racked up a healthy total for initial public offerings sponsored by LBO firms-with approximately $1.112 billion being raised across six issuances, according to BUYOUTS and sister company Thomson Financial Securities Data-sources warn that today’s market has become bifurcated between the tech haves, made up mostly of Internet companies but also entailing some telecom companies, and the tech have-nots.
“Right now, the market is really in love with the Internet. Anything with dot-com’ can go public in a second with no earnings and no infrastructure,” says Warren Smith, a managing director at Boston-based Thomas H. Lee Co. “In another day, with Snapple and Rayovac-companies with strong growth of 20% annually-we used to be able to do very well [with IPOs]. You can’t do these anymore.” To illustrate this point, Mr. Smith notes that his firm at this point last year had completed 4 initial and secondary public offerings, while this year,it has yet to complete one.
To be sure, sources agree that technology and telecommunications companies have been garnering more than their proportionate share of interest from public market investors. In fact, when one excludes LBO-to-IPO companies from the first quarter that have a telecommunications or technology bent to them, the overall proceeds drop markedly to $592.7 million-a decrease of 87.6%.
However, even when taking into account those companies that fall into the more giddily performing sectors of the public market, a healthy number of former LBO portfolio companies still managed to slip through the seemingly closed public offering window. For example, The Blackstone Group in January went through with an IPO of American Axle and Manufacturing, a maker of automotive axles and accessories that is a throwback to the traditional roots of LBO-to-IPO deals, and raised $119 million.
Likewise, Texas Pacific Group in February raised $300 million for Del Monte Foods Co. through an IPO and followed this up in March with an initial public offering for Ducati Motor Holding SpA, a manufacturer of motorcycles. The firm floated shares of the Bologna, Italy-based company on Milan’s Mercato Telematico Azionario exchange and the New York Stock Exchange through American Depositary Shares, representing 10 shares of Ducati stock each, priced at $31.67.
In March, Kohlberg Kravis Roberts & Co. took public The Boyd’s Collection, a McSherrystown, Pa.-based manufacturer and distributor of gift items, for $18 per share, raising $288 million in the process with which to pay back some of the company’s monumental debt load (BUYOUTS March 8, p. 14).
Most recently, The Cypress Group this month brought public WESCO International, a distributor of electrical products, pulling in nearly $175 million from the offering.
Sources offer a variety of reasons for the fickleness of today’s IPO market toward LBO portfolio companies, but most agree the weight of a good story often can be the deciding factor when trying to get an offering priced, especially in the more vanilla sectors. For example, sources say TPG was aided when it took Ducati public by the brand name the company has built up over the last several years among motorcycle enthusiasts. Choosing to take the company to market after a record first quarter, also probably did not hurt TPG’s campaign. “With the investment in Ducati, we got a favorable price, but we also think that it will continue to grow,” says TPG Managing Director William Price. “We wanted to grow the brand name, and the public market has provided for that. Also, Ducati had been performing well, which is a big consideration in the IPO.”
Ducati also proves an interesting case study as a recent example of an IPO by a U.S. buyout firm of a foreign portfolio company-a trend the industry likely will see more of in the next five years as more U.S. buyout firms shop for deals overseas.
The jump to a U.S. exchange from a foreign country often can prove a plus for a company’s valuation. “It is a very sophisticated valuation process here, particularly in broadcasting,” says David Mussafer, a managing director at Boston-based Advent International Corp. “Oftentimes, a more robust multiple can be garnered in the U.S. than overseas.” Last quarter, Mr. Mussafer’s firm took public PrimaCom AG, a Plauen, Germany-based communications company, on both the Nasdaq and Germany’s Neuer Markt exchanges.
However, sources warn that companies which sometimes appear promising when viewed from the size perspectives of foreign markets do not measure up when faced with scrutiny by U.S. investors. Mr. Mussafer-who’s firm last year brought portfolio companies public on the London exchange and the Netherland’s EASDAQ-says U.S. investors, because of the maturity of the U.S. market, tend to look for companies with far larger market capitalizations than investors on foreign exchanges. This can lead to surprises when attempting to bring a company public simultaneously in both the U.S. and a foreign market.
A Market Divided
In spite of the first quarter’s activity, industry observers note that little of the activity in the LBO-firm-sponsored IPO market fit the traditional size parameters for these offerings.
Last quarter saw large IPOs by Chase Capital Partners’ Entercom Communications Corp., which raised $306.6 million, TPG’s Del Monte and KKR’s Boyd’s.
These offerings dwarf those of the traditional LBO-to-IPO, which generally ranged between $25 million and $100 million. “A lot of the offerings that we would do, which would be between $25 million and $50 million, unless it was an Internet company, you could not do it this year,” says Robert Hellman, a managing director at buyout firm McCown De Leeuw & Co. Compounding these difficulties, small- and mid cap industrial companies, the traditional bread and butter of LBO firms, currently are not popular investments in the public market, he adds.
The dearth of LBO firm-sponsored IPOs in the small and mid cap realm was attributed by several sources to a departure by investors from portfolios that revolve around value stocks to portfolios that focus on fast growth. “Because there are no value investors anymore, it has made it very difficult for LBO IPOs,” Thomas H. Lee Co.’s Mr. Smith says. “People want to be perceived as being in the hot areas. If they are still buying value stocks, they’re probably buying in the open market [rather than through IPOs].”
One managing director in the equity capital group of a major investment bank said he has seen, on average, technology related IPOs increasing in value by 60% from their offering prices. This creates a bar in the minds of investors that few LBO-to-IPOs are likely to clear, regardless of the company’s health. “[Market valuation] does not have to do with it being an LBO flip; it is just pretty difficult to get a traditional LBO deal done,” the director says. “Although LBO portfolio companies are not doing as well as the tech or telecom companies, they are still at greater valuations than they would be if they were privately held.”
Who Needs the Public Market, Anyway?
At a time when purchase multiples are as lofty as they have been this decade, several G.P. sources also downplay the importance of the public markets as an exit strategy. “In the final analysis, the IPO market is not the most attractive place to liquidate investments,” DLJ Merchant Banking’s Mr. Grauer says. “You have to sell off incrementally, so it is a very slow means of exiting. You would much rather sell to a strategic buyer.”
The level of investor interest in the stock market, while not having been friendly to LBO-to-IPOs, has bolstered the stock price of many Fortune 500 companies, providing an ample supply of paper for acquisitions and an exit opportunity for buyout firms. “I have seen an increased amount of stock swaps between public companies and LBO portfolio companies,” Mr. Hellman says, adding that he expects this trend to continue, if the market remains difficult for LBO-to-IPOs. McCown De Leeuw currently is in the process of merging portfolio company International Data Response Corp. (IDRC), a teleservices company, with Telespectrum Worldwide Inc. in a stock deal. Under terms of the deal, Telespectrum will issue 9.2 million shares of common stock to IDRC shareholders and refinance approximately $105 million in IDRC debt. IDRC shareholders also will receive 3 million warrants to purchase Telespectrum stock at $9.67 per share. At press time, Telespectrum stock was trading at $6.94 per share.
Opening Pandora’s Box
Other G.P.s note that taking a company public right now can open the door for numerous problems that were not encountered when the company was privately held. In order to push the sale, Mr. Grauer says that when Doane was preparing for its IPO top ranking members of its management had to embark on a roadshow that encompassed more than 60 cities. The preparation for the IPO actually could have approached a level where it became a distraction to running the business, he adds.
Even after a company has been priced and is resting comfortably on its ticker symbol, other pitfalls can occur, sources say. “There is no question that when you bring a company public, you expose it to all sorts of other pressures. For example, small-cap food companies are under pressure now, and that was something Del Monte did not have to deal with when it was private,” TPG’s Mr. Price says. “The public market punishes and rewards a great deal more than the private market.”
Buyout firms also must consider the timing of their offerings, sources say, so as not to develop a reputation with underwriters as a firm that comes to market with lemons. “I do think there is some degree of sponsorship with the underwriter that is important,” Advent’s Mr. Mussafer says. “On the buyout [firm] side it really helps that you have some sort of track record of sponsoring strong companies.” Adds Mr. Price, “I don’t think you get much credit when a company does well after a public offering, but if you take a company public and it underperforms, the firm will definitely take a lot of the blame.”
1999 First Quarter IPOs of Former LBO Investments
(As of March 31, 1999)
Sponsor Company Name IPO Date Proceeds ($mils)
The Blackstone Group American Axle & Manufacturing 1/28/99 119.0
Chase Capital Partners Entercom Communications Corp. 1/28/99 306.6
Welsh, Carson, Anderson & Stowe Mede America 2/01/99 60.0
Texas Pacific Group Del Monte Foods Co. 2/04/99 300.0
Advent International Corp. Primacom AG 2/19/99 152.2
Kohlberg Kravis Roberts & Co. The Boyd’s Collection 3/5/99 288.0
Source: Thomson Financial Securities Data
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