IPOs are a hot topic in private equity at the moment – and not only in China, where the window is finally re-opening after being closed for more than a year.
In Europe, barely a day seems to go by without another new rumour emerging of a sponsor eyeing the public markets as a potential exit route. In the UK, for instance, discount retailer B&M (owned by Clayton Dubilier & Rice) and furniture chain DFS (owned by Advent) are two of the latest to be talked about as likely IPO candidates this year.
Not all of these rumours will come to fruition. But what it does demonstrate is that relative to twelve months ago, the public markets hold a lot less fear for private equity owners – and vice versa.
Looking at the numbers, the change in sentiment last year is very apparent. In 2012, a mere five of the 103 private equity-backed IPOs globally were in Europe, according to EY. In 2013, according to London Stock Exchange data, there were 26. In London alone, 14 sponsor-backed offerings collectively generated more than $7 billion in proceeds for the GPs concerned.
Clearly this was partly just down to a general improvement in market sentiment, as the eurozone panic started to recede. But there were also a few confidence issues specific to private equity. Some public market investors got their fingers badly burned in the pre-crisis days by private equity-backed businesses that sold at a high price and subsequently tanked (retailer Debenhams being the most notorious example) – which then made all sponsor-backed IPOs a tough sell.
Equally, GPs were sceptical about the degree of uncertainty and execution risk involved in an IPO process, given the possibility of the window suddenly slamming shut, or the wrong information leaking out (usually via indiscreet bankers) at the wrong time. Alastair Walmsley, the head of primary markets at LSE, admits that at the start of last year most of his time was spent trying to persuade sponsors that public markets were a viable exit option.
But as investors' risk appetite started to come back in the early part of the year – helped by big inflows into equities funds – a few brave souls started to test the water again. This time around, though, the process typically looks a bit different: GPs are spending much more time getting investors up to speed on a business before the start of the formal marketing process, as opposed to just turning up at a roadshow and asking people to sign on the dotted line.
Importantly, these businesses have generally traded well in the after-market: just four of the 14 were below their issue price as of the end of last month, and some of them (notably Bargain Booze, HellermannTyton, Countrywide and Foxtons) were well above it. That suggests GPs didn't take too much off the table with the original pricing, and that investors remain confident in these companies' growth prospects. Positive stories like these offset some of the damage done by Debenhams et al, and ought to make it easier for those GPs looking to tap the public markets in the coming months.
So just how much potential for further deals is there? Walmsley argues that the proportion of public market exits was relatively modest even before the crisis – and that “structurally, there's no good reason for that”. Activity levels are certainly well below those in the US, where nearly 100 private equity-backed companies floated last year on the NYSE and the Nasdaq, generating total proceeds of nearly $35 billion (i.e. about five times as much as Europe). So there's plenty of room for improvement.
But it's not going to be right for everyone. Investors are still picky about what they’ll support: businesses with a lot of gearing are likely to be treated with suspicion, while those with a big emerging markets focus might be a difficult sell this year. Execution risk may have diminished, but it hasn’t gone away entirely. And there’s a possible reputational risk if the company under-performs – or is seen to.
Take Partnership Assurance, an insurance business still majority-owned by Cinven, which in share price terms is the laggard of last year’s LSE cohort. As of the end of January, it was trading 28 percent below its issue price – apparently because the market has decided it isn't growing as fast as expected (although it was still improving profits and outperforming its peers). Presumably the shares will come back – and given that Cinven is thought to be sitting on a 6x return even now, it can afford to be patient. But the point is that being public forces a GP to speak to and care more about the sort of short-term noise that they’re normally able to screen out.
In short, expect to see more private equity-backed IPOs this year (barring an economic cataclysm). But most GPs would still prefer a nice discreet strategic buyer any day of the week.