The Wall Street Journal




PIPE Dreams: Capitalists
Flood the Public Market


April 3, 2002

AUSTIN, Texas -- In a financial twist on an old maxim, unsettled markets can make for strange bedfellows.

Consider, for example, venture capital and public equity.

So-called PIPE financings, or private investments in public equity, have been booming overall, with this year on pace to be the second largest on record for such deals, trailing only 2000.

Meanwhile, some venture capitalists -- by their nature private equity investors -- are increasingly engaging in PIPE transactions along with more traditional PIPE players as mutual funds and hedge funds.

"Venture capitalists have definitely been getting more involved in PIPEs over the last year or two," said Robert Kyle, executive vice president of DirectPlacement Inc., which operates online financial database

A total of $4.7 billion in PIPE deals have been inked thus far this year, according to PlacementTracker, easily on pace to surpass last year's total of $15 billion. A record $24.4 billion in PIPE financings took place in 2000.

PlacementTracker doesn't break down PIPEs according to the type of investor, but Mr. Kyle said PIPEs by VC firms represent a small but clearly growing percentage of the transactions.

At its core, a PIPE is simply a private placement of a large chunk of public stock, generally at a market discount currently averaging about 15%. So-called "structured" PIPEs include additional terms such as triggers that grant more shares to an investor if a stock subsequently falters.

A Different Motive

The surge in PIPE deals in 2000, much of which took place early in the year before the stock market began to crash, was attributable partly to institutional investors who saw PIPEs as a means of getting stakes in the highflying stocks they coveted without driving up prices inordinately through large open-market purchases.

Opposite forces are fueling PIPE deals now, however. Publicly traded companies with substantial financing needs are increasingly looking to PIPEs in the wake of the crash because the public markets have become hostile to secondary offerings and other more standard funding sources.

Enter the venture capitalists.

Flush with cash, and with their own traditional investment exit strategies -- initial public offerings or mergers -- moribund, some say the opportunities in public equity created by the market downturn simply have been too good to pass up.

"Given the market's varying appetites ... there are times when, in our view, these companies trade at incredible discounts, certainly to what their highs have been," said Daniel Janney of Alta Partners, a San Francisco VC firm that specializes in life sciences and information technology.

Alta Partners took part in its first PIPE in 2000 and now has done 16 such transactions within the biotech sector, most recently taking the lead on a $14.1 million deal for a stake in Orphan Medical Inc. that closed in December. That deal valued Orphan stock at $8.25 a share, about a 16% discount to the market price at the time.

While the vast majority of Alta Partners' investments continue to involve private equity, the firm has created two specialized "biopharma" funds that can put about half their money into public equity.

Mr. Janney doesn't consider the public-equity deals that his firm has engaged in to be significant departures from their private-equity counterparts. Particularly within the biotech sector, he said, the risk profiles for start-ups and for small publicly traded companies are similar, as are the growth and management challenges they face.

In addition, Alta Partners takes an active role in its public companies, which Mr. Janney said justifies the VC management fees that Alta charges its own limited partners. "Really, this is public venture capital in the sense that, a lot of times, these companies need as much help and work as a private company," he said.

Representatives of Technology Crossover Ventures, another VC firm that completed its first PIPE in 2000 and operates a fund targeting public equity, said they also view such deals as mere extensions of their traditional strategy. Technology Crossover Ventures, based in Palo Alto, Calif., specializes in late-round financing for technology start-ups. Like Alta Partners, Technology Crossover's most recent PIPE came in December, when it took the lead on a $23.3 million deal with eLoyalty Corp. That deal valued eLoyalty at $5.10 a share, slightly less than a 15% discount to the market price at the time, and it also involved convertible preferred stock that will accrue 7% annual dividends.

"We are in the business of providing companies with growth financing," said Jake Reynolds, a Technology Crossover general partner. "So [doing PIPEs] isn't very different from our traditional venture investments. Our goal is to invest in great expansion and late-stage companies." He also said he's not concerned about what in some instances has been negative market sentiment toward PIPEs, fueled by a perception that such deals can constitute "toxic" investments for companies with few options.

Mr. Reynolds and other venture capitalists contend they don't stipulate onerous PIPE terms because their goal -- the same as in private equity -- is to get in at good valuations and then nurture successful companies over the long haul. "We're not trading the stock [received in a PIPE deal] on an active basis," Mr. Reynolds said. "We're long-term investors, and we're really looking to help a company grow to become leaders in their space."

A Good Thing

Meanwhile, industry observers say any negative stigma surrounding PIPEs overall is misplaced and has stemmed from a lack of differentiation between standard PIPEs, which are straight cash-for-stock swaps, and the structured PIPEs, which are more complicated and often include unfavorable terms that can accurately be described as "toxic" or "death-spiral" financing.

Statistics from show that the percentage of structured PIPEs has fallen significantly in recent years, registering only about 2% of the total thus far in 2002.

Indeed, far from reacting negatively, Perficient Inc. Chief Executive Jack McDonald said investors have viewed his company's PIPE in early January as "a strong vote of confidence" from a savvy investment group, which included VC firm Watershed Capital based in Austin. The $1.9 million deal valued Perficient's stock at about a 30% discount to its $1.45-a-share close at the time. But the stock climbed to $1.78 a share the next day, and it recently has been trading above $1.60.

"It's a financing vehicle that allows us both to do well," Mr. McDonald said, adding that his company turned to a PIPE because of the poor market for secondary public offerings. "There's clearly no market right now for secondary offerings from small tech firms," he said. "For venture capitalists, [PIPE deals] make sense because you've frankly got incredible values out there in the public markets right now."

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