TWEAKING IT

The potential return of the IPO as a viable exit remains at the front of many Europeans' minds at present. As you'll find in this issue's Privately Speaking, BVCA chairman Anne Glover is intent on seeing the London Stock Exchange deliver the goods. But it's not clear which way the public markets will be turning at this juncture. Amid a raft of candidates, many of them private equity backed, which are currently grading their prospects for an LSE float, there seems to be more to achieving success in the current climate than taking a quality company, pricing it properly and getting the timing right.

The structural features of a deal are also seen as potentially making a big difference, which is why a number of innovative variations to the vanilla offering process have appeared in Europe recently.

The most obvious example is the Accelerated Initial Public Offerings, a mechanism devised by Terry Smith and colleagues at London-based stockbroker Collins Stewart. Their technique of underwriting the purchase of an asset in order to immediately sell it on to institutions via a stock market listing was first applied successfully last year in a transaction for Northumbria Water, the UK utility. Similar deals followed, and UK practitioners expect there may be more.

Whether the mechanism will find followers across Europe and beyond remains to be seen, but it is an interesting new tool to have in the exit toolbox, adding a welcome alternative to vendors – including private equity firms.

Also making headlines in Europe at present is the so-called income depository security. This instrument, invented in 1997 in Canada where it has become the structure of choice for companies going public, is a publicly traded debt and equity hybrid designed to maximise dividend payments to investors in a tax-efficient manner. Because tax can be avoided, the issuer can pay buyers significantly in excess of what equity issued in a conventional public offering would yield. And again, the private equity firms have taken note: here is another option in the toolbox.

Findexa, the Norwegian yellow pages company owned by Texas Pacific (TPG), is currently trying to introduce the technique to European investors by way of a listing on the Oslo Børs, with a proposed dividend of up to 12 percent – a figure that caught the eye of many curious investors (as was intended).

Advocates say the technique could be an important innovation to the conventional IPO process in that it can help persuade investors to buy into companies that offer relatively low growth and limited upside. As such, it should appeal to private equity firms who hold assets that can churn out cash flow but which are not expected to grow rapidly post exit.

Sceptics warn that committing to high dividend payments could bring with it the risk of excessive pressure on a company's cash flows, draining its finances to such an extent that the sustainability of the yield that attracted investors in the first place could be compromised. On top of that, would they not deprive the company of the flexibility it requires to finance its operations going forward, post exit by the sponsor?

These are aspects worth pondering, although the question of how much leverage a business can cope with will arise no matter what type of capital structure it adopts. From the point of view of a vendor looking to realise value, the closest alternative to placing high income securities would be to pursue an ordinary high yield bond offering – which, from the point of view of the underlying company, wouldn't come cheap either.

Vendors, especially private equity firms, will always look to maximise their return. But the balancing principle is that for an exit to work for everyone, not just the sponsor, there has to be enough ongoing vigour in an asset for buyers to play ball. Findexa will be no exception, but given that the seller is attempting to break new ground, current developments in Norway certainly make for an interesting test case.

That is, if the deal gets away as planned. At the time of this issue going to press, Findexa's IPO had just been postponed, suggesting that investors were taking longer than anticipated to get their heads around the offer's structural complexities.

Should Norwegian investors ultimately decide to stay clear of Findexa's income depository securities, TPG will need to find another way to exit from the business. Undoubtedly an alternative strategy has already been drawn up, but just in case Plan B needs some tweaking, a call to Terry Smith might be a good idea.