A BIRD IN YOUR HAND

Multiple exit routes are important in private equity. Funds seeking realisations will always try and heed the old corporate finance rule that one should never sell an asset unless there are at least two potential buyers at the table – the idea being that even a little competitive tension in the sales process tends to do wonders to exit realisations and hence internal rates of return.

This is why a reopened IPO market is such a critical element of the value creation process in private equity – even if the trade sale remains the staple exit route. Increased appetite for new issues in the public equity markets makes a significant difference to return prospects. If you have a company with strong, steady cashflows capable of servicing dividend payments over the long term, you have a good flotation prospect.

After four consecutive years of declining IPO registrations, this change in sentiment represents a major opportunity for private equity firms to accelerate the flow of capital back to investors. By the end of the first quarter for instance, Goldman Sachs counted over thirty new offerings in the US alone, more than in the whole of 2003.

A number of private equity firms are succeeding in listing portfolio companies on Europe's stock exchanges too. In April for example, Montagu Private Equity successfully floated Dignity Funeral Services on the LSE valued at £184 million. In March, Nordic investor Industri Kapital scored with a keenly subscribed offering of Oriflame, the cosmetics distributor. Prior to that, Soros Private Equity and Providence Equity Partners successfully floated Eircom, the Irish telecommunications groups – even though the shares subsequently slumped in secondary trading.

Several other European sponsors are also mulling IPOs at present. UK Motoring accessories retailer Halfords, owned by CVC Capital Partners, is among the most eagerly anticipated transactions expected to come to market soon, as are Doughty Hanson's ATU Automotive, a German car parts business that is thought to be worth around €1.5 billion, and C&C, the BC Partners owned drinks business scheduled to float this summer.

But how robust is institutional – let alone retail – appetite for IPO paper at this point? On this, the jury is still out. Many market participants agree that despite the significant up-tick in activity over the past year, equity market fundamentals remain vulnerable. Underlying economic trends, interest rate movements and geopolitical uncertainty are all seen as particular concerns. Others take a more optimistic stance, maintaining that short- and mediumterm equity valuations are to rise further.

To private equity sponsors, the current uncertainty poses an interesting dilemma. A successful IPO can do a great deal to boost a fund's performance figures and its manager's standing with limited partners. This must be particularly tempting to houses that are currently raising new funds. Firms such as IK and Doughty for instance will hardly find a better way of injecting fresh momentum into their ongoing fundraising campaigns.

Stock market bulls in the general partner community might of course be wondering whether it is in fact not too early to sell a well performing asset to the public at this point. Their internal valuation forecasts might project that a good deal today could be a great one tomorrow.

wever, general partners under pressure to return cash as soon as possible after the exit drought of recent years may not be in a position to gamble on holding out for a better market. If the IPO window were to suddenly close again and the GP were left holding a perfectly floatable portfolio company, investors could well ask: what went wrong?

Getting a listing done sooner rather than later is clearly the safer option. Also, if structured as a partial exit, an early IPO might still be more appealing than a trade sale, as retained shares mean potential extra upside later in the cycle – if the market holds up.

If underwriters active in the European new issues market are to be believed, this is the view that the majority of financial sponsors currently subscribe to. These practitioners report that there is already such a significant backlog of pending private equity-backed offerings that market indigestion is a genuine possibility at this point – another reason why ‘the sooner the better’ might be the best advice IPOminded general partners should follow at this point.