KKR-owned companies a test for IPO market

NEW YORK (Reuters) - Private equity firms are ramping up plans to take portfolio companies public as a long freeze in being able to exit investments seems to be thawing.

Portfolio companies backed by powerful buyout firm Kohlberg Kravis Roberts & Co's KKR.UL could be the first major test for the market, with KKR-backed chipmaker Avago Technologies to start trading on Thursday. Discount retailer Dollar General is possible before the year-end, according to a source.

IPOs are also on the horizon for rival private equity firms as they look to take advantage of rising equity markets.

"What gives me optimism is both the steady flow of deals that have been done -- that's slowly picking up -- but more significantly is the number of deals we're working on that have yet to file," said Richard Truesdell, co-head of the global Capital Markets Group at law firm Davis Polk & Wardwell.

Truesdell said there has been a dramatic increase in the past couple of months in the number of potential IPOs that people are working on, that haven't yet filed.

Private-equity firms buy companies with the view of exiting investments several years later, either by selling to a trade buyer or a rival or by taking the company public.

Exiting allows them to make distributions to the investors that put money in their funds, but that route has been effectively closed since the credit crunch began.

A sustained rally in the equity markets so far this year, however, has reopened the possibility of exits by IPOs.

"It is something everyone is considering, especially the mega-funds," said William Shields, partner at law firm Ropes & Gray in Boston, although he expects IPOs to be more prevalent in 2010 than this year.

"I think we'd expect to be seeing some evidence of their interest in hitting the public markets pretty quickly if they're expecting to do anything this year -- which suggests lots of firms either haven't made up their mind yet or are deciding they'll wait for 2010," said Shields.

For KKR, Dolar General is likely to follow on the heels of Singapore-based Avago Technologies. Advanced preparations are in place to take the discount retailer public, which could happen in the late third quarter or fourth quarter, a source familiar with the situation said. Underwriting of the offering is likely to be led by Goldman Sachs, Citigroup and KKR itself, two sources said.

Another of KKR's portfolio companies, hospital firm HCA, bought with a consortium which included Boston-based Bain Capital, is also being considered for an IPO, the first source said. But plans are unlikely to get off the ground until there is more clarity around the Obama administration's reform of healthcare.

HCA recently reported a jump in second-quarter revenue and profits.

The private equity firms declined comment.

PORTFOLIO SURGERY

While optimism is returning, private equity firms continue to struggle to keep portfolio companies above water, and that means only select firms will be successful IPO candidates.

"There's a lot of triage going on; and it will continue to go on," said Harris Smith, managing partner of Grant Thornton's private equity practice.

Smith, in a recent report, cited a survey by the Association for Corporate Growth and Thomson Reuters showing that 47 percent of firms said more than half their portfolio companies were generating lower earnings than a year ago.

However, Josh Lerner, a Harvard Business School professor specializing in private equity, said private equity portfolio IPOs typically do substantially better than IPOs as a whole, which could be due to having the private equity owner remaining an influential shareholder for some time after going public.

Investors waiting for distributions from IPOs are unlikely to see immediate riches as payouts will likely not be from the initial IPO but from follow-on offerings.

Upcoming IPOs are likely to use the initial money raised to reduce leverage on the company, said Truesdell.

That is seen in the IPO of Avago, whose backers will still own 85 percent of the company after flotation while a large proportion of the proceeds will be used to pay down debt.

Experts warn that with the market so volatile, the outcome of an offering is largely outside the private equity firm's control.

"A lot is out of the control of the private equity firms themselves," Lerner said. "In a lot of ways they are hostage to the markets."

(Additional reporting by Phil Wahba; Editing by Steve Orlofsky)