me the money|
As cash reserves dwindle and secondary markets fizzle,
public companies turn to Pipe financing. Jane Welch reports
America's stock exchanges are back in business. But the rhythm of
capitalism is slow to rebound. As continued worries of a recession ripple
through the economy and financial markets, we see glimmers of hope,
excitement and opportunity shadowed by sadness and fear.
In business, we have been experiencing a focused return to fundamentals.
Many deals that would have been funded by the public markets are no longer
interesting to investment bankers. Companies are reevaluating their
relationships, business strategies and methodologies for growth and
profitability. In the public company arena a strong trend towards private
investing under the banner of Pipe (private investment in public entities)
According to PlacementTracker.com, a web site with information on the Pipe
market, more than 654 transactions raised $8.6 bn during the first three
quarters of this year. There were several notable Pipe transactions in
August 2001, including Tower Automotive which raised $39 mn in common
stock; Triangle Pharmaceuticals ($75 mn in common stock); and TiVo ($51.7
mn in convertible notes). One of the largest Pipe deals was in September,
when Seattle-based InterNAP Network Services raised $101 mn through
preferred stock, warrants and common stock.
Traditionally, public companies that needed to raise money would make a
secondary offering, handled much like an IPO. But dramatic changes in
market sentiment have sharply decreased secondary offerings.
'After September 11, the capacity and interest of most investment banks to
conduct secondary public offerings is virtually non-existent, especially
for small and mid-cap public companies,' says Brian Overstreet, founder
and CEO of San Diego investment bank DirectPlacement, which compiles the
online database for PlacementTracker.com. 'Since public offerings are
largely dependent on market whim and investor confidence, the market is
very bleak for those now. Pipes are placed with sophisticated
institutional investors who - as spooked as they might be by the general
market today - are expressing that they are open for business and looking
for quality Pipe product.'
PlacementTracker.com is a good place to go for information on the Pipe
It reveals who the investors are; who the placement agents are; and it
provides details of how the stocks of past deals have performed after
closing. Many executives going the Pipe route use sites like this as a
resource to identify the most appropriate partners.
Many public companies are discovering that private placement financing for
cash has certain advantages over a secondary public offering. Among the
most important of these advantages is that the time and expense needed to
complete a private placement is much less. But there is significant risk
as well. Some inexperienced companies agree to such arduous terms that the
financing can harm the company more than it can help. These are called
'toxic' or 'death-spiral' financings that could result in severe dilution
of the value of existing shares and wound other shareholders.
'Making the decision to go the Pipe route takes serious planning. The key
is to identify investors who show an appetite for a particular company,'
says Tim Curtiss, COO of Wall Street Investor Relations, an IR
consultancy. 'Many of these groups manage their own proprietary funds that
invest, and also can conduct investment banking work to introduce the
prospective issuer to their lists of investors. It's important for the
issuer to work with a respected investment banker who has the right
contacts in the private equity investment world.'
Structuring the deal
According to Instream Partners, a San Francisco-based investment banking
firm, Pipe deals tend to come in two forms: traditional and structured.
Traditional Pipes are fixed-price issues of common stock, convertible
preferred stock and convertible debt. Structured deals include convertible
floating (where the conversion price continually changes based on the
future market price of the common stock); convertible/common stock reset
(deals with repricing rights which change the terms at a later date to
give investors more shares or reduce the conversion price); and structured
equity lines (which require investors to purchase a predetermined amount
of stock or debt over a specified period). Under Regulation D, the SEC
allows public companies to issue securities without registration and
without a prospectus.
'Pipe pricing can be less finite than a public secondary offering,'
cautions Instream Partners' co-founder, Samantha Lincoln. 'In both a Pipe
and a secondary, if no one likes the offering price, the company has to
take a lower price or withdraw the offering. In a public deal, the market
will clear at a certain fixed price. However, the most toxic Pipes are
structured so that future stock prices continue to reset the price of the
issue. In this case, the price is not fixed, and the company can have
almost unlimited cost. That means - in the worst scenarios - the investors
can end up owning virtually all of the company.'
Free trading dilemma
In a Pipe deal, the issuer typically prefers to hold off trading for
somewhere between 90 and 180 days to keep from immediate, downward stock
'If the stock becomes free trading when the market is doing well and when
the company is achieving success, it's probably not too much of a
problem,' says Michael Manahan, the co-founder and chief executive of Los
Angeles-based communications firm Magnum Financial. 'But, if the stock
becomes free trading when the market is depressed or if the company is not
performing well, then the added overhang of that stock now coming into the
market - and those people potentially going into the market and selling it
- can push the price of the stock down. That's particularly true if the
price at which the private placement sold was less than the current market
price of the stock.'
'If you've completed a Pipe with appropriate pricing and terms, and
investors and have made good use of the proceeds raised, you have
absolutely nothing to fear,' counters Overstreet. 'The vast majority of
Pipe investors in today's market are longer-term players who, while they
require a registration to be filed post-closing, are not looking to exit
the position unless the company has had exceptional problems
Investor relations professionals and investment bankers agree that any
decision to go the Pipe route is highly dependent on the company, its
industry sector, growth opportunities, trading volume, research coverage,
level of business maturity and market value. A few words of caution: Read
the fine print. A large number of new Pipe players are actively soliciting
public companies. Some of these firms are trading the stock and realizing
profits from short positions. 'Companies must be very diligent in
exploring who their placement agent is and who their investors are,'
Jane Welch is the co-founder & CEO of Welch Consulting, based in
Pacific Palisades, California. Her e-mail address is Jane.Welch@Verizon.net
In January 1999 e-MedSoft.com approached Magnum Financial Group to handle
its IR. The Amex-listed company had gone public through a reverse merger
and wanted to do a secondary offering. To that end, one of the founders
was flying back and forth to New York on his private jet every two weeks
visiting all the major investment banking firms, trying to cut a deal for
the secondary offering - with no luck.
'Many in the investment banking world feel that a company that goes public
through a reverse merger is less likely to be as ready for the public
market as one that goes through an investment banking firm,' says Magnum's
Michael Manahan. 'We took a serious look at the company and the market and
said, We don't think any of the major investment banks will be interested
because they have already backed their e-health players - Healtheon,
Trizetto, Care Insight, Web MD, etc. We had to go to a second or
third-tier firm that had yet to back a player in this space.'
The approach worked. Magnum helped the company negotiate with investment
banking firm Sutro & Company to raise some $67 mn. That included $7.1
mn in restricted shares of common stock and warrants for additional
restricted shares with an exercise price of $4. On top of its fees, the
private placement agent got warrants for 350,000 restricted shares of e-MedSoft
at $5 per share and warrants for 1.3 mn restricted shares at one cent per
share. Another $60 mn came when e-MedSoft sold 4 mn shares to some 50
accredited investors at $15 per share.
Unfortunately, even with this capital infusion, e-Medsoft.com had a tough
time in the market. 'The medical community has been slow to adopt e-health
solutions,' Manahan points out. 'All of these companies, including e-MedSoft.com,
have been pressed to generate revenues and, as a consequence, they have
seen their stock prices tumble. And they have had to go out and raise
additional funds.' Notwithstanding these pressures, however, e-MedSoft's
Pipe deals proved highly successful.