Debt strain unclogs PIPEs

Bank of America’s $2 billion investment in Countrywide marks the return of private investments in public equity

The PIPEs are smoking again. With the cost of credit rising, companies struggling to raise cash in either the debt or equity markets have been increasingly looking for alternative financing through private investments in public equity, also known as PIPEs, turbocharging an already booming market.

While the pricing terms for PIPEs may have tightened for some companies over the summer, most of those seeking funding are still able to rely on abundant cash from investors, typically private equity firms and hedge funds.

“When debt is cut off as a financing option, it certainly opens the door for PIPEs,” said Robert Kyle, executive vice president of Sagient Research Systems, a provider of research and data on the PIPE market. “It’s hard to price debt right now.”

For mortgage-related companies, which have been hit hard by losses in subprime loans, and for some small-cap companies, access to bank loans has become more difficult too, and repercussions from the credit turmoil have spilled over into the equity market. “The amount of companies looking for PIPE financing or PIPE-like financing has increased somewhat as other secondary and follow-on offerings have been stalled on Wall Street,” said Corey Ribotsky of NIR Group, an investor in PIPEs.

The most visible, if unacknowledged, PIPE transaction this year took place less than three weeks ago: Bank of America’s $2 billion investment in convertible preferreds of mortgage lender Countrywide Financial on Aug. 22. The deal, in which Bank of America bought preferred stock that can be converted into common shares at $18 and in the meantime yields 7.25% annually, was struck as Countrywide’s access to capital was being squeezed and rumors began to fly that it might have to file for bankruptcy.

To be sure, Bank of America’s investment isn’t a typical PIPE transaction. Companies commonly raised an average of $20 million in PIPE financing in 2006, and the typical PIPE candidate has a market capitalization under $1 billion, far from Countrywide’s $12 billion or so. But the transaction clearly shows that the PIPE market is soaring.

U.S. corporations have raised more than $35 billion using PIPEs so far this year, already surpassing last year’s $28.3 billion, according to Sagient Research. Mr. Kyle said he anticipates the total for the year could reach just under $50 billion. The average size of transactions has mushroomed too, doubling to about $40 billion so far this year over 2006.

Mr. Ribotsky of NIR Group said his firm looks at 1,200 to 1,500 companies seeking PIPE financing each year. NIR did about 50 transactions in 2006 and 68 already this year.

Still, financial executives should be aware that PIPEs aren’t without risk. Existing shareholders could sell a company’s securities if they know a PIPE is pending, since the deals put them at something of a disadvantage to a PIPE’s owners. CFOs should also remember that PIPE investors could be looking to sell their stock short. At the very least, they’ll want to avoid deals that require them to issue more stock as the price falls. But most new deals are considered less risky than the ones that gave PIPEs a bad name in the late 1990s, thanks in part to the Securities and Exchange Commission’s efforts to curtail short-selling abuses.

“People are getting more comfortable with the PIPE structure,” Mr. Kyle said. “The secondary offering process is more cumbersome.”

But pricing terms have also tightened. “The pricing on some deals has definitely changed, and underwriting standards of certain investors have sharpened,” Mr. Ribotsky said, adding that his firm’s investments have been fine but that “some deals have been impacted” at competitors, although he declined to comment further.

Although the PIPE market has become more competitive, financial executives looking to raise PIPE financing will still find firms willing to invest.

Hedge funds and private equity shops, typical PIPE investors, have been raising large sums of money in the past couple of years, and as opportunities to invest in leveraged buyouts and high-yield bonds and loans have dried up, they will have to find other places to invest. PIPEs are an obvious target.

“There’s a lot of money out there,” said Steven Siesser, chairman of the specialty finance group at law firm Lowenstein Sandler. “The money still out there needs to be put to work. That’s their only choice,” he added, referring to PIPEs.