A New Breed of PIPE Deals Emerges
Matthew Sheahan & Ken MacFadyent

Private Investments in Public Entities (PIPEs) might not be skyrocketing, but they're certainly staying on level, if not getting a little more play. Since the beginning of 2003, Warburg Pincus and Apax Partners, have made big investments in the sector.

Warburg Pincus first demonstrated its faith in the public markets, by agreeing to invest in Wellman Inc.'s (NYSE: WLM) $125.4 million PIPE deal. Once Warburg Pincus' transaction into the polyester manufacturer is complete, it will be the third largest PIPE deal so far in 2003.

The Wellman deal is expected to come in just behind the $200 million-plus private investment in XM Satellite Radio Holdings and a $250 million investment in clothing company Phillips-Van Heusen(NYSE: PVH).

In mid-January, BayStar Capital announced the closing of its second investment in XM Satellite Radio, which provides radio broadcasts transmitted by satellite. The transaction consisted of $200 million in new capital from strategic and financial investors, including BayStar Capital, and $250 million in payment deferrals and related credit facilities from General Motors, which will install XM Radios in 44 (75%) of its 2004 models. The new funds component will be increased to $225 million by virtue of the investment round.

PIPEs, which are usually between $10 million and $20 million, are more increasingly becoming much larger, says to Lawrence Goldfarb, a general partner with BayStar Capital and contributor to the upcoming book PIPEs, A Guide to Private Investments in Public Equity. He adds that larger deals are a new part of the PIPE landscape, but not because they are less-risky investments, but because of their strategic value. "Strategic buyers want to have a strategic relationship with the companies and that becomes more important than a gain or loss," Goldfarb says, citing his firm's participation in the XM Satellite Radio deal, which featured strategic investor Hughes Electronics, in addition to General Motors.

In the largest PIPE deal done thus far this year, Apax Partners provided a $250 million equity investment in Phillips-Van Heusen Corp. Lehman Brothers acted as the broker-dealer. Apax Partners has also provided financing of up to $125 million, pursuant to a two-year secured note. Phillips-Van Heusen used the funding to acquire Calvin Klein Inc. for $430 million in cash and stock.

"The PIPE market is on pace to pretty much match the activity levels of last year. Last year, the market slowed quite a bit from levels seen in 2001 and 2000," says Robert Kyle, executive vice president, PlacementTracker, a company that tracks PIPE deals. Additionally, according to PlacementTracker the total value of PIPE deals in 2002 slipped to $11.62 billion, down from $13.9 billion and $21.46 billion in 2001 and 2000, respectively. So far this year, 54 PIPE deals have closed, with an aggregate value of $1.1 billion.

Warburg Pincus has been one of the largest and most active PIPE investors since 1995. Other most active PIPE investors this year to date include BayStar Capital, Cornell Capital Partners, DMG Advisors, Domain Associates, Kingsport Capital Partners and Staro Asset Management.

Michael Littenberg, an attorney with Schulte Rogh & Zabel who works extensively with private equity transactions, sees PIPE deals becoming increasingly popular in 2003. "My view is that this will be a good year for PIPE deals given how difficult it is for companies to make money through traditional offerings."

Venture capital firms flush with large funds are finding themselves drawn to PIPE deals, which are generally more capital intensive than venture capital rounds. "There has been a shift over the last year and a half as investment opportunities for venture firms have started to dry up and they have more capital to deploy," says Littenberg.

The early numbers for 2003 though, may be skewed by the large deals. Most PIPE deals are between $10 million and $20 million. "The PIPE universe as far as what deals look like varies greatly," says Littenberg. "What really tends to be the determining factor is the size of the fund and the stage of the investment."

He adds that hedge funds, general private equity firms and larger, later-stage venture firms are more likely than early-stage VCs to invest in PIPEs. "It's less risky than early-stage investments where they may not be an exit strategy. Also, given the perceived lack of investment opportunity in later stages, PIPE deals help to fill that void," says Littenberg.

PIPEs also present a lower level of risk for firms accustomed to the high-risk stakes in venture capital. Because PIPEs are public companies, there is a well-documented track record of company performance that an investor can hedge its bets on. Also, PIPE investors receive stock that is heavily discounted. Companies receiving PIPE funding benefit because reporting the transaction is not required until after the transaction closes. In a traditional secondary offering, the shares are reported before they are sold, avoiding more expensive SEC filing fees.

"It seems to have become very popular these days," says Goldfarb. "First and foremost, because the capital markets are pretty much shut down even good companies need cash and there's no place to go to get it. A lot of companies have hit the wall. Most companies went this route in the beginning because they had no other choice. Now they understand them and can get them done."