Posted by: Aaron Pressman on June 21, 2007
It is a truth universally acknowledged that a single pension fund in possession of a good fortune (of hot IPO shares) must be in want of a sucker, err, buyer. And none of the reforms induced by Elliot Spitzer, the Securities and Exchange Commission, Sarbanes Oxley, tougher market discipline or even the demise of Merchant Ivory Productions have altered that fundamental truth. When your broker comes calling the day after the big initial public offering, hang up, just hang up.
I fear that’s likely good advice in our latest case study, the public debut on Friday morning of leveraged buyout titan Blackstone Group, which priced its initial public offering tonight at $31 a share and hits the NYSE tomorrow under the symbol “BX.” There are reports that the IPO was ten times oversubscribed, meaning that investors asked to buy ten times more shares than the 133 million Blackstone was selling. In that kind of climate, underwriters rarely raise the price to an efficient bid clearing level. Instead, they go high but not insane, leaving it to the first round of buyers to reap half again the proceeds that the IPO just collected — or more.
Blackstone Rival buyout and hedge fund manager Fotress Investment Group (Symbol: FIG) priced its shares at $18.50 on the evening of February 8. They hit $37 before closing at $30.30, a 68% gain in one day for the lucky few who got in on the 34 million share IPO. They’ve rarely traded above $30 since then and closed today at $25.88.
In fact, this year, like many years, the higher the IPO shares go on day one, the less likely anyone is to make money buying them that day. Fortress has the top one-day return among 2007 IPOs. Among the top five best, only one is above its close after day one. Infinera (INFN) gained 52% a few weeks ago and has since gained another 30% or so — give it a few more weeks. The rest of the top 5, Accuray (ARAY), China Sunergy (CSUN) and Limelight Networks (LLNW), are all well below their day one closes. Of the top 10 best one day gains this year, only four are higher today. Tip o’ the cap to Renaissance Capital’s IPOHome.com for the data.
And the structural issue only add to concerns that while the buyout business has been great for a good long run here but it’s starting to attract attention for all the wrong reasons. Congress wants to tax the firms’ profits more, shareholders want more in their offer premiums, strategic buyers want some targets more, and the bond market wants more on the bonds needed to finance these deals. Don’t get left holding the bag.
A final problem with the Blackstone deal is the built in disappointment factor that’s perversely the exact opposite of the built in delight factor featured in the reverse LBO deals when Blackstone takes its portfolio companies public to cash out. Typically, in those reverse LBO IPOs, a company’s most recent results are hampered by high interest costs. Proceeds from the IPO often pay down a company’s debt and, surprise, surprise, you get several quarters of fabulous earnings growth that really shouldn’t be a surprise. In the case of Blackstone, there’s no debt to be paid off and in fact the firm has kept compensation levels at unrealistically low levels prior to the IPO inflating earnings for several quarters. As the company concedes in its SEC filings, compensation costs will have to eat up a much larger share of profits in coming quarters. Shouldn’t be a surprise to anyone but I suspect we’ll see a sell-off none the less. That’s exactly what happened with Fortress when it reported seemingly dismal first quarter results. And that may be a much better buying opportunity!