Hype Springs Eternal: PE-Backed IPOs Are Not Always Happy Events

The excitement surrounding buyout-backed IPOs is heartening at best and over-hyped at worst. Even though companies have steadily filed for IPOs for the past ten weeks (the longest streak in over a year), some industry professionals believe the market recovery won’t heal most private equity wounds.

“The idea that going public is a panacea for private equity guys is not really true,” said Dan O’ Donnell, the private equity chair at law firm Dechert LLP. Even with a successful portfolio company IPO, a buyout firm faces the same issues it did before, including frustrated limited partners, he said. That’s because an IPO does not translate directly to cash in the LP’s pocket, like a sale to a strategic buyer would.

“Absent a dividend recap, it’s unlikely that the sponsor will be able to do a direct cashout,” O’Donnell said. The private equity firm is typically left with a large, somewhat illiquid position that it will gradually exit over time.

Furthermore, many debt-laden portfolio companies are raising money in the public markets to lighten their debt loads.

The IPO of health care revenue cycle management company Emdeon, backed by General Atlantic and Hellman & Friedman, did just that. The company raised a $367 million in its public market debut, which exceeded its initial pricing by 10 percent. Around $200 million of the offering will go to service the company’s $800 million debt load.

The IPO of semiconductor company Avago Technologies, Kohlberg Kravis & Roberts and Silver Lake was similar. In its public offering, Avago Technologies raised $648 million. Around 45 percent of that, or $290 million, will be put toward the company’s $704 million debt load, according to a regulatory filing.

But even if buyout firm doesn’t mint a return in the initial offering, the process of delveraging can set the firm up for liquidity in the future. “Companies that use the IPO market primarily to delever typically have more challenging IPOs but they are in a better position to do secondary offerings going forward,” said Bill Kirsch, a partner at law firm Paul Hastings.

Elsewhere, KKR found a way to have its exit and eat it too. In late August, the firm filed to raise $750 million in the IPO of discount retailer Dollar General. That amount includes a special $200 million dividend to “existing shareholders,” meaning KKR, Goldman Sachs, Citigroup Capital Partners, CPP Investment Board and Wellington Management Company. Meanwhile the firm will take an additional $50 million to terminate its management agreement.

The Dollar General IPO, and its special dividend for KKR, is an exception and not the rule for the current market environment, Dechert’s O’Donnell said. The recovery of the IPO market is sector-specific. “(IPOs) are not the next new wave,” he said. “It’s really small window for companies that are sector-appropriate.”

Those sectors include the discount retail sector Dollar General plays in, as well as health care, energy, and infrastructure. According to a survey of IPO lawyers conducted by communications consultant Kreab Gavin Anderson Worldwide, health care and energy are likely to dominate the new issuers. It is widely anticipated that hospital operator HCA Inc. will file its intentions to go public in the coming months. The company was taken private by Bain Capital, KKR and Merrill Lynch & Co. for $21.3 billion in 2006.

Despite the influx of new filings (see chart for those from the past month), a majority of industry professionals don’t expect IPOs to return to a “normal” issue rate of between five and ten offerings per month until mid 2010 or later, the Kreab Gavin Anderson Worldwide survey noted.

Previously: IPO Fever

Data Dump: IPOs Blazing In The Aftermarket

Two More IPO Candidates

What Follows Dollar General? 15 More PE-Backed IPO Candidates