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Don't Get Burned By PIPEs
Private investments in public equities are a way for cash-starved public companies to raise money. But shareholders should beware.

Monday, February 4, 2002
By Adam Lashinsky

Just when you thought you were finished with the alphabet soup of investment fads (remember B2B, P2P, B2C, and the like?), it's time to master one more acronym: PIPE. It stands for private investments in public equities, and any shareholder of a company that has sold a PIPE needs to understand the ramifications of these instruments.

As the IPO market has slowed, PIPEs have become a favorite way to raise capital--especially for cash-starved public companies. According to PlacementTracker.com, there were more than 1,000 PIPE deals worth a total of $13.7 billion in 2001, compared with just 122 deals worth $1.4 billion in 1995. PIPEs come in all shapes and sizes, however. And knowing what to look for can help shareholders understand whether the PIPE is about to deliver a welcome cash infusion--or just a load of trouble.

At first blush, a PIPE looks like a good thing. Say a company needs more money but doesn't want to turn to public markets for fear of signaling imminent shareholder dilution. Instead, it raises a chunk of cash by quickly and quietly selling shares to some investment pros. No fuss, no muss. Indeed, the shot of cash often gives stocks a short-term boost.

But as the hush-hush nature of these deals suggests, shareholders aren't getting the full story. For starters, a typical PIPE deal rewards the large buyer by offering an often sizable discount to the public stock price. And that's just where the goodies begin. Other incentives can include warrants that can be exercised in the future, preferential treatment on who gets paid if the company ceases operations, and "reset" provisions that enable the professional investors to buy shares at a lower price down the road.

That's why investors need to consider closely the downside protection these pros have negotiated for themselves--and the commensurate downside that this may imply for the stock price. For example, shareholders of tech consulting firm Gartner were heartened when Silicon Valley's Silver Lake Partners agreed in March 2000 to pump $300 million into the struggling company. But the fine print revealed that the convertible notes Silver Lake bought contained a so-called one-way floorless re-set provision entitling them to adjust the conversion price downward if Gartner's shares--trading for $15.50 at the time--fell by a certain amount a year after the deal closed. Sure enough, Silver Lake reset the exercise price on its notes from nearly $16 to around $7.50 a year later. That, of course, will not only increase Silver Lake's stake when it converts its $300 million in notes, but will also dilute the holdings of ordinary investors. Gartner's shares traded recently for about $12.

For common shareholders, the fewer sweetheart provisions that PIPE investors get, the better. "The cleanest deal for an investor is one where there are no warrants involved and where the discount to common isn't too steep," says Steven Tuch, co-head of private placements for Thomas Weisel Partners in San Francisco. Any discount greater than 15% is too much.

Individual shareholders should also assess the level of commitment the PIPE investors are making. Are they locked in for a certain time--or can they cash out at will? Witness Trimble Navigation, a Sunnyvale, Calif., maker of global-positioning-system products. The company raised $26.8 million in late December by selling a combination of common stock and warrants to "certain qualified investors," according to its news release. The common stock was priced at only a slight discount to Trimble's market price ($15 compared with $15.16), and the warrants carry an exercise price of $19.48. But once Trimble registers the shares with the SEC, it will be easy for those "certain" investors--subsequently identified in a securities filing as a group of seven investment firms--to sell their common shares.

Contrast that with the latest Martha Stewart deal. When the Dinner Set Diva decided to lighten her personal stake in Martha Stewart Living Omnimedia, she sold shares to Value Act Capital Partners, a San Francisco investment fund. Value Act invested $45 million at $15 a share, a 3% discount to the market price. Value Act's Jeffrey Ubben, who will join Martha Stewart Living's board as a result of the transaction, says his company won't be allowed to sell its shares for a year. "We're really good for those folks because we're not a hedge fund, so we're not going to be trading around the position--and we're not a private-equity fund with all sorts of control demands," he says. It's a good thing.

Yes, all things being equal, existing shareholders can benefit when a well-known investor commits to a private placement. Just make sure you're not smoked out if a PIPE deal goes down the tubes.

PIPEs Are Smoking

Year Amount raised
(in billions)
1995 $1.40
1996 $4.10
1997 $5.40
1998 $2.90
1999 $10.40
2000 $24.50
2001 $13.70
Source: placementtracker.com

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