IPO.com 1-to-1: Brian Overstreet, DirectPlacement.com
Wednesday, February 14, 2001

As the market for secondary and follow-on offerings has nearly dried up in the past few months, many publicly traded companies have turned to private placements to raise the cash they need. Participation in these so-called PIPE transactions (short for Private Investments in Public Equities) is mostly limited to large institutional investors, but all investors are affected by the resulting effects on the price of the stocks involved. Thus, no one can afford to ignore this market.

Brian M. Overstreet is the president and co-founder of DirectPlacement.com, an online investment bank located in San Diego that specializes in PIPE transactions. Mr. Overstreet's firm also owns and operates PlacementTracker.com PlacementTracker.com, a provider of research and reporting on the PIPE market. IPO.com spoke with Mr. Overstreet in February.

IPO.com: In case there's anyone reading this who doesn't know, what is the PIPE market all about?

Overstreet: The PIPE market is a market for public issuers, normally small-cap and mid-cap issuers, to sell their securities privately to accredited or institutional investors. Basically it uses an alternative to a secondary public underwriting for these companies to raise capital.

I think there's a certain perception out there that these kind of private equity transactions are usually done by companies that are in a sort of a desperate state that can't get money by other means. Is that always the case, or are there real advantages to doing it this way?

The quick answer is "No," it's not always the case. The reason that perception exists is because the media has in the past concentrated on some of the negative aspects of the PIPE market, specifically the so-called "death spiral" convertibles. However, in the year 2000, there was over $19 billion raised in the PIPE market, and about 12% of that was done through floating or "death spiral" convertibles. The rest were done as traditional straight common-stock deals, or fixed-price convertibles. And in a lot of those cases, they were done by companies that wanted to raise the capital quickly and more cheaply than going through a full-blown registered offering.

A prime example: in the first quarter and even going into the second quarter of last year, a lot of small-cap biotech companies ran up dramatically from where they had been previously, and many of those companies went out and raised substantial amounts of money through common stock sales using PIPEs, rather than wade through an entire secondary underwriting process. They recognized that their stock prices might not be as high three months after they started the [regsitration process]. They wanted to lock in a price, get money in the bank, and be able to go on with their business.

You said $19 billion was raised in the PIPE market in 2000. [By comparison, the IPO market raised just over $100 billion in 1999 and 2000.] Has that been growing a lot, or was it just a typical figure?

No, actually it's been a dramatic growth pattern. When we started tracking the data in 1995, there was only $1.5 or $1.6 billion total. In 1999 there was only about $7 billion. Then we had this huge spike up to 2000, which I think had a lot to do with the market in general running up, as well as the fact that a lot of these bigger issuers started to recognize the PIPE market as a realistic alternative to a secondary underwriting. So we're not anticipating as dramatic a year as we had last year, but we think we're going to continue on the same pace as the year prior to last year.

So the downturn that has just about shut down the IPO market recently, has not really had the same kind of effect on the private equities market?

Not really. When we look at this January vs. last January, we've basically been cut in half. But that said, we're still clicking along at a pretty rapid pace. There was $680+ million raised in January alone, outpacing IPOs and secondaries. I think we're on track to do that again in February. So one thing to keep in mind when comparing it to the IPO and secondary market (and the great thing about the PIPE market in general) is that you can always get a PIPE deal done. The only thing is, what kind of terms are going to be negotiated? You're not necessarily dependant on the general market or how an investment banker wants to price you. You either negotiate directly with the investor, or maybe you negotiate through a broker. But at the end of the day if the market is sour, the investment group can come back and say, "Hey, we want more warrants or we want a lower price," whatever it will be. If the company is open to that, you're going to get a deal done.

You mentioned the "death spiral" private placements earlier. What are the red flags investors should look for when their companies do these kinds of private placements?

I think the important thing to keep in mind is that the "death spiral" or floating-rate convertible is not an evil instrument. It is not going to cause the mass destruction that's been advertised by the media. What happens with the death spiral, though, is that if the company is having some fundamental problems, and the stock price comes down even just a little bit, the death spiral is going to amplify that effect. You're going to have a situation where the investor has the ability to convert and sell [stock] at increasingly lower prices, based on where the market is. And what happens eventually is that you're going to have the investor converting a part of the security and getting a bunch of stock which they then have to sell into the market, further depressing the market, and when they go to convert again, they're going to get even more shares at a lower price. And that's why you get that so-called "death spiral" effect, where it's just a circular pattern going lower and lower.

However, in our database, when we look at the number of [death-spiral] deals that get done, a significant percentage of them have not resulted in the stock prices getting killed. It's really the situations where there is some underlying fundamental problem with the company, where their stock price probably would have gone down a little bit anyway, and now you have this overhang where you're going to get hurt even more.

So most of the companies that use this method have no other choice. They might even go out of business without this funding.

Well, the "death spiral" has almost become a self-fulfilling prophecy at this point, because there are people out there that look for companies doing this type of financing, and they go out and aggressively short the stocks. But frankly, I would argue that it's not a financing of last resort necessarily. There are some positives to doing this type of deal, including the fact that most of them involve some initial premium to market conversion price, so if the stock runs up (as it should after they raise money and use it effectively), the investors are giving up a portion of the upside, which they're not going to do in a common-stock deal. The problem only happens when the company doesn't use the money wisely and the stock doesn't go up.

You mentioned earlier that accredited investors can get into this market. Is this something that accredited investors should be looking into?

Well [laughs], my advice is that there are 5000 or more institutional investors that have participated in these deals in the past, and the ones who are successful at the PIPE market are the ones who can build a portfolio of any number of deals at a time. I would not necessarily advise individual investors to be jumping into this marketplace on a one-off basis. I think you're better off seeking out the investment firms that specialize in these types of these deals, and let a professional deal with your money in this market.

Finally, are you noticing any interesting trends out there? What do you expect to happen this year in the private equities market?

I think we'll see a trend that we've been talking about recently, an increase on a percentage basis in the number of structured deals, (in other words) "death spiral" convertibles and structured equity lines, compared to last year, just because of the fact that the market is so tough right now. And it comes back to what I mentioned earlier, that a PIPE deal can always get done. It's just going to be a function of what terms are given up by the company. With the markets rather thin right now and liquidity being tough to come by, the ability to raise capital is going to be restricted to those who are willing to give it up for more aggressive terms. So where 12% of deals were done in a structured format last year, we think that number is going to increase this year to something closer to 20%.

Thank you very much

Dan McCarthy is Market Analyst at IPO.com