December 6, 2007 / 10:14 PM / 12 years ago

DEALTALK-In credit crunch, private equity turns to PIPEs

(For more DealTalk columns, click [DEALTALK])

By Megan Davies

NEW YORK, Dec 6 (Reuters) - Private equity firms typically seek majority buyouts, but the credit market turmoil has forced them to think small.

With roughly $400 billion raised in the last year, private equity funds are searching for places to put their cash other than big buyouts which rely on large loans.

That’s fueling an interest in PIPEs, or private investments in public equity. PIPEs can either be straight equity investments or where investors purchase debt convertible to stock.

The average deal size for PIPES this year has surged to about $45 million this year compared with $21 million last year, according to research firm PlacementTracker, but it noted that was because of a relatively small number of large transactions.

PlacementTracker’s data also shows that private equity took a bigger share of the PIPE market this year, making up about a tenth of PIPE investments as opposed to about 3 percent in 2006.

“Private equity is going to look for ways to invest their money and if it’s a good investment — even for less than a majority of the company — I think they will make those investments,” said Morton Pierce, chairman of the mergers and acquisition group at law firm Dewey Ballantine in New York.

“In this market, the financing of purchasing an entire company may be more challenging than it was before July and they may be looking for other ways to invest their money.”

With the credit crunch pinching lending at investment banks, some private equity firms have expressed they are pursuing smaller deals.

Goldman Sachs (GS.N) said in September it plans to pursue capital injections and PIPES, while Blackstone Group LP (BX.N) has said it too sees opportunities in PIPEs and minority stake rescue financing.

When buyout firm Kohlberg Kravis Roberts & Co [KKR.UL] and Goldman Sachs’ $8 billion deal for Harman International Industries Inc HAR.N fell through, the pair instead struck a deal to buy $400 million of 1.25 percent senior notes, that can be converted under some circumstances into Harman stock. That was a compromise to not have to go through with an $8 billion deal to buy all of the high-end audio equipment maker.

Last month, a consortium including private equity firm Providence Equity Partners made a proposal to mobile phone company Sprint Nextel Corp (S.N) to invest $5 billion in Sprint in the form of a convertible preferred securities that could be changed into equity. Sprint, touted by some earlier in the year as a takeover target, rebuffed the approach.

PIPE deals, which are typically smaller than buyouts, are often easier for private equity firms to fund, because they are less reliant on borrowing in order to raise the capital for the deal.

“Those deals are typically not done on a leveraged basis, they’re not vulnerable to the financing markets the way a typical private equity transaction is,” said Joel Greenberg, partner and co-chair of law firm Kaye Scholer LLP’s Corporate and Finance Department.

But it is questionable whether minority stake deals will bring in the returns private equity typically aim for.

“It’s a tool some will use — it doesn’t really meet the needs though of a typical private equity fund because it won’t provide the returns and in fact some funds aren’t even allowed to make non-control investments,” said Greenberg. (Additional reporting by Michael Flaherty; editing by Tim Dobbyn)

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