Tapping the Cash in PIPEs


In need of cash? Companies can expect tough sledding ahead. The number of companies raising cash through initial public offerings (IPOs) dropped by 80% in the first half of 2001, vs. the same period in 2000. These days, it appears only giants have access to the IPO market -- as in the case of Kraft Foods, which went public June 12. Smaller companies who went public prior to January face equally tough conditions in the secondary market. That market is down more than 40% the past year.

So what's a company to do? One option is a private investment in public equity or PIPE. A PIPE is when a company sells a chunk of stock to investors privately, usually below the market price. For years PIPEs have received a bad rap. Companies offering PIPE deals were considered marginal players on Wall Street.

In this hardscrabble environment, however, PIPEs seem to be taking on a new sheen. Some believe PIPEs may be the finance tool of the future. So far this year, 427 PIPE deals totaling $5.4 billion have been completed, vs. 46 IPOs and 141 secondaries. Not only have the number of PIPE deals increased, but top-tier investment banks, which once shunned that market, are jumping in. For instance, on June 28, Rite Aid announced a $549 million PIPE deal, placed by bankers at Credit Suisse First Boston and Salomon Smith Barney.

Brian Overstreet is the founder and CEO of DirectPlacement Inc., a San Diego investment bank that focuses on the PIPE market. DirectPlacement also runs PlacementTracker.com, a Web site with data and information on the PIPE market. Overstreet talked to BusinessWeek correspondent Debra Sparks about what he sees as the latest hot financing trend. Here are edited excerpts from that conversation:

Q: What is a traditional PIPE?

A: A PIPE is the sale of equity by a public issuer, either in the form of common stock or a fixed-price convertible. PIPEs in the form of common stock are typically sold at a discount to the market price. Usually these shares are registered for reselling after the closing. There have been 3,300 PIPE transactions since 1995. About 30% of those have been death spirals.

Q: What has been the average performance of a PIPE?

A: Based on a dollar-weighted average, the 2,300 traditional pipes sold since 1995 were up 27% one year after being issued. By contrast, the 1,046 death spirals completed since 1995 were down 11% one year later.

Q: What kind of companies are now issuing PIPEs?

A: In the past few years, mostly smaller, cash-intensive, high-growth companies used PIPEs. Typically, they were high-tech or biotech companies. We are now starting to see bigger companies looking at the PIPE market. Recently we've seen such extremely large PIPE deals as Excite@Home, which on June 8 announced a $100 million PIPE deal. And on April 19, AMC Entertainment completed a $250 million PIPE.

Q: Why have PIPEs historically had such a bad reputation?

A: Primarily it's been the misperception that all PIPEs are death spirals.

Q: What do you mean?

A: Typically, a death spiral is a convertible PIPE that in the worst-case scenario leads to excessive dilution [of equity]. That's in contrast with conventional convertibles, in which the conversion price [from debt to equity] is set in advance. For instance, if an investor buys a $10 convertible, it can be converted into equity at any time the publicly traded stock hits $10 a share. In the case of a death spiral, however, the conversion price can be reset downward if the market price falls below the conversion price set at the time of issuance. This can lead to excessive dilution and selling pressure on the stock.

Q: eToys and MicroStrategy both announced they sold death spirals. What happened?

A: In the case of eToys and MicroStrategy, you had two companies which couldn't raise capital elsewhere. MicroStrategy's stock was overvalued, and, in both cases, the stocks came down dramatically after the convertible issuances. However, keep in mind [that] in neither case did the death-spiral convertible have anything to do with the stock prices coming down as dramatically as they did. eToys was going out of business. MicroStrategy had accounting problems before the death spiral.

Q: Who invests in PIPEs?

A: It varies. We see a lot of public mutual-fund companies with name brands like Franklin Templeton, Fidelity, and AIM Funds. We also see private-equity funds participating as well.

Q: What is the upside of a PIPE vs. a secondary offering?

A: Usually there is significant time and cost savings in a PIPE. Both PIPEs and secondaries are typically offered at a 10% to 15% discount to the stock price. However, when companies sell a PIPE there are usually smaller underwriter fees. Plus, you don't have all the accounting and legal fees associated with a secondary because the security is being offered privately.

Q: What is the average PIPE size?

A: The average deal size is $12 million.

Q: What happens when the capital markets open up again? Will PIPEs go by the wayside?

A: If companies have an opportunity to do a secondary, they probably will go that route. But for smaller transactions, say under $100 million, you can still sell securities at a good price, efficiently and without a lot of management time or cost, through a PIPE transaction. I think we've seen this become a legitimate source of investment capital. Sparks covers finance for BusinessWeek in New York


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