Pipe Dreams

Companies in need of quick cash turn to private placements often at less-than-desirable terms

January 15, 2001
By Brendan Barrett

Last March, Owings Mills wireless company Aether Systems was looking for cash to fuel its acquisition binge. Not a problem. Aether raked in $1.4 billion in a secondary offering, a move undertaken by numerous tech companies to raise money on easy terms.

No more. "The secondary offering market is dead," says Brian Overstreet, president of, a San Diego company that follows corporate financing deals. "There is no investor appetite for it."

With the tech downturn, companies desperate to raise cash are finding they will have to pay a steep price if they can get it at all.

The debt markets have dried up, and tech companies that incur net losses generally do not have access to traditional bank financing, says Hovey Kemp, a corporate lawyer at Hogan & Hartson in Washington.

So when the market goes south, where do such companies go to get money? They predominately turn to PIPE financing Private Investment in Public Equities. These "private placements" are securities that are privately sold to investors and cannot be resold until they are registered with the Securities and Exchange Commission.

During a booming market, companies sometimes opt to raise money through a private placement because it is faster than a public offering. But in a bad market, public companies often have nowhere else to turn.

"There are still a lot of PIPE deals getting done," says Overstreet. "But clearly the terms are getting worse." The amount of financing raised in PIPE transactions increased from $7 billion in 1999 to $18 billion in 2000.

There are two basic kinds of private placements, "traditional" and "structured." Traditional private placements generally offer better terms for the companies, says Overstreet. But with the current market, "we're seeing a big resurgence in structured PIPE deals," he says.

Over the past seven months, three area companies each raised more than $100 million in private placement transactions, some getting better terms than others.

In mid-July, United Therapeutics, a Silver Spring pharmaceutical company, raised $143 million in a traditional private placement. At the time, the company's stock was trading at $124 a share. Under the terms of the deal, United Therapeutics sold 1.3 million shares of newly issued common stock to institutional investors at a discounted $110 a share. "It was a plain vanilla traditional pipe deal," says Overstreet. "There were no bells and whistles attached."

But the stock began to plummet right after the deal. As of Jan. 3, it was trading at $13 a share. Because it usually takes 90 days or more to register the securities with the SEC, the investors couldn't unload the stock on the public market as it began to drop. "They may still be holding their entire position," says Overstreet, "or taking a big loss if they sold out."

But terms similar to those United Therapeutics received are hard to find now. Investors are demanding better terms because of greater risk. For example, MicroStrategy's $125 million private placement in June was a "structured" PIPE deal. In a structured deal, the investor gains if the stock price rises and is protected if the stock price decreases.

The protective feature of a structured deal is a "reset mechanism." This allows the investor to obtain more shares of the company's stock if the share price drops. Although all private placements ultimately dilute the holdings of existing shareholders, the reset mechanism causes substantially more dilution if the stock price declines.

Teligent, a Vienna broadband provider, secured up to $250 million in a December private placement that featured elements of both traditional and structured deals. According to the terms, Teligent can have its investor, Rose Glen Capital, purchase up to $250 million of Teligent common stock at a 5 percent discount. But the investors are allowed to resell the stock on the public market as soon as it is registered.

"The investors will be able to flip [the shares] right away," says Charles Kaplan, president of Equity Analytics, a New York firm that analyzes investment deals. He noted that such terms minimize the risk to the investors but cause immediate dilution to existing shareholders.

"It's not a bad deal for the principals involved," says Kaplan, "but it's a bad deal for the shareholders."

The shareholders agreed. Teligent's stock, which had risen to $5.31 on the expectations of financing, declined to $3.46 when the terms of the deal were announced. The stock closed at $2.87 on Jan. 3.

The best part of the deal for the investors, says Kaplan, are the "warrant kickers," which provide a potentially huge bonus to investors if the stock price increases substantially.

"It's going to be more expensive [to raise money] today than six months ago," says Overstreet. And some companies, he says aren't prepared for that.

" had an opportunity to raise money in the PIPE market and chose not to because the terms were expensive," he added. Last November, that company went out of business.

2002 The Washington Post Company