Pondering PIPEs

Notwithstanding the lower market valuations of listed companies, GPs in Asia are still shying away from PIPE deals, writes Siddharth Poddar.

Asia's plunging stock markets are posing a problem for many private equity managers active in the region. Pre-IPO and PIPE deals, or private investments in public equity, were very popular until the markets began dipping, and a number of private equity firms generated healthy returns by taking advantage of the rapidly rising stock markets and the valuations of listed companies.

A classic example is Baring Private Equity Asia’s $50 million investment in Chinese coking coal producer Hidili in 2006. Hidili was listed on the Hong Kong stock exchange in 2007 and in October of that year, Baring divested its stake for more than $400 million or about eight times cash on its original investment.

But by January 2008, the region’s stock markets began sliding in value and investments that looked attractive only a few months back, started looking dire (at least in terms of valuations).  This is particularly the case “where investments have been made in listed companies or where GPs use publicly listed company comparables for valuation”, said one Hong Kong-based fund of funds manager.

However, this very phenomenon is the reason some market participants expect a re-emergence of PIPE investments.

At the end of September, at the Private Equity International India Forum in Mumbai, Indian fund managers said it was “a good time to invest” because of lower valuations resulting from a stock market that had crashed by about a third from its January 2008 peak. The Bombay Stock Exchange index is now down by about 50 percent since its peak, yet a flurry of PIPE investments remains elusive.

The number of Indian PIPE deals had been rising steadily every year since 2004, when a total of 28 PIPE deals worth $592 million were completed, according to Venture Intelligence, an Indian private equity-focused research service. The volume and value of PIPE deals reached its peak in 2007, when a total of 87 investments were made in the listed markets for a total sum of $4.4 billion. Last year, the numbers dipped sharply by 63 percent in terms of value to just $1.63 billion and by 28 percent in terms of deal volume.

Discussions with Indian managers reveal that most of them are still cautiously sitting on dry powder. One GP said that while there are opportunities in the market, managers may be wary of the conduct of some promoters, particularly after disclosures pertaining to the Satyam fraud where its founder admitted to inflating company revenues by about $1.4 billion. There has also been the other odd instance of alleged accounting irregularities. For example, Educomp Solutions, an Indian education software company, saw its share price crash by 25 percent in January following allegations of accounting irregularities which haven’t been proven yet.

While anomalies, these cases have dented the confidence managers have in PIPEs. This is because  managers, while keen to invest at the lower valuations, are concerned about their inability to conduct effective due diligence on these companies as they are only privy to information in the public domain, which is often not sufficient. There is “so much of the unknown” when things get tough, the manager says.

These factors make it very hard to actually act on a PIPE strategy in this environment and that is why it is “back to the basic private equity model”, the manager says. This is something many LPs will appreciate — some regional fund of fund managers say that they are reluctant to commit to private equity funds relying on public markets as their sole exit avenue. They are keener to invest with managers who can demonstrate that they can add value to their companies by working with them on the operations side.

All of these factors indicate that, for now, despite the potential PIPE bargains to be had in Asia, GPs will continue to cautiously sit on dry powder and stick to tried and true strategies.