As a means of raising capital,
private investments in public companies are eclipsing IPOs. PIPEs
specialist Brian Overstreet explains why in this Q&A
In need of cash?
Companies can expect tough sledding ahead. The number of companies raising
cash through initial public offerings (IPOs) dropped by 80% in the first
half of 2001, vs. the same period in 2000. These days, it appears only
giants have access to the IPO market -- as in the case of Kraft Foods,
which went public June 12. Smaller companies who went public prior to
January face equally tough conditions in the secondary market. That market
is down more than 40% the past year.
So what's a company to do? One option is a private investment in public
equity or PIPE. A PIPE is when a company sells a chunk of stock to
investors privately, usually below the market price. For years PIPEs have
received a bad rap. Companies offering PIPE deals were considered marginal
players on Wall Street.
In this hardscrabble environment, however, PIPEs seem to be taking on a
new sheen. Some believe PIPEs may be the finance tool of the future. So
far this year, 427 PIPE deals totaling $5.4 billion have been completed,
vs. 46 IPOs and 141 secondaries. Not only have the number of PIPE deals
increased, but top-tier investment banks, which once shunned that market,
are jumping in. For instance, on June 28, Rite Aid announced a $549
million PIPE deal, placed by bankers at Credit Suisse First Boston and
Salomon Smith Barney.
Brian Overstreet is the founder and CEO of DirectPlacement Inc., a San
Diego investment bank that focuses on the PIPE market. DirectPlacement
also runs PlacementTracker.com, a Web site with data and information on
the PIPE market. Overstreet talked to BusinessWeek correspondent Debra
Sparks about what he sees as the latest hot financing trend. Here are
edited excerpts from that conversation:
Q: What is a traditional PIPE?
A: A PIPE is the sale of equity by a public issuer, either in the form
of common stock or a fixed-price convertible. PIPEs in the form of common
stock are typically sold at a discount to the market price. Usually these
shares are registered for reselling after the closing. There have been
3,300 PIPE transactions since 1995. About 30% of those have been death
Q: What has been the average performance of a PIPE?
A: Based on a dollar-weighted average, the 2,300 traditional pipes
sold since 1995 were up 27% one year after being issued. By contrast, the
1,046 death spirals completed since 1995 were down 11% one year later.
Q: What kind of companies are now issuing PIPEs?
A: In the past few years, mostly smaller, cash-intensive, high-growth
companies used PIPEs. Typically, they were high-tech or biotech companies.
We are now starting to see bigger companies looking at the PIPE market.
Recently we've seen such extremely large PIPE deals as Excite@Home, which
on June 8 announced a $100 million PIPE deal. And on April 19, AMC
Entertainment completed a $250 million PIPE.
Q: Why have PIPEs historically had such a bad reputation?
A: Primarily it's been the misperception that all PIPEs are death
Q: What do you mean?
A: Typically, a death spiral is a convertible PIPE that in the
worst-case scenario leads to excessive dilution [of equity]. That's in
contrast with conventional convertibles, in which the conversion price
[from debt to equity] is set in advance. For instance, if an investor buys
a $10 convertible, it can be converted into equity at any time the
publicly traded stock hits $10 a share. In the case of a death spiral,
however, the conversion price can be reset downward if the market price
falls below the conversion price set at the time of issuance. This can
lead to excessive dilution and selling pressure on the stock.
Q: eToys and MicroStrategy both announced they sold death spirals. What
A: In the case of eToys and MicroStrategy, you had two companies which
couldn't raise capital elsewhere. MicroStrategy's stock was overvalued,
and, in both cases, the stocks came down dramatically after the
convertible issuances. However, keep in mind [that] in neither case did
the death-spiral convertible have anything to do with the stock prices
coming down as dramatically as they did. eToys was going out of business.
MicroStrategy had accounting problems before the death spiral.
Q: Who invests in PIPEs?
A: It varies. We see a lot of public mutual-fund companies with name
brands like Franklin Templeton, Fidelity, and AIM Funds. We also see
private-equity funds participating as well.
Q: What is the upside of a PIPE vs. a secondary offering?
A: Usually there is significant time and cost savings in a PIPE. Both
PIPEs and secondaries are typically offered at a 10% to 15% discount to
the stock price. However, when companies sell a PIPE there are usually
smaller underwriter fees. Plus, you don't have all the accounting and
legal fees associated with a secondary because the security is being
Q: What is the average PIPE size?
A: The average deal size is $12 million.
Q: What happens when the capital markets open up again? Will PIPEs go
by the wayside?
A: If companies have an opportunity to do a secondary, they probably
will go that route. But for smaller transactions, say under $100 million,
you can still sell securities at a good price, efficiently and without a
lot of management time or cost, through a PIPE transaction. I think we've
seen this become a legitimate source of investment capital.
Copyright 2001 , by The McGraw-Hill Companies
Inc. All rights reserved.