August 24, 2007 / 1:38 PM / 11 years ago

Dog days of summer for private equity-backed IPOs

NEW YORK (Reuters) - Private equity firms, until recently the high flyers of finance, have had a tough summer.

Not only are they suddenly struggling to finance leveraged buyouts the market once welcomed, the companies they’ve taken public have lately been bombing with investors.

Online travel company Orbitz Worldwide OWW.N and recruitment company Dice Holdings Inc (DHX.N) are two of the summer’s biggest duds, both down about 20 percent since being brought to market by private equity firms.

Of all the companies floating shares this year, three of the five worst performers were backed by private equity firms, according to Dealogic. Of the best performing companies, just one was backed by private equity.

Strong summer offerings like E-House Holdings Ltd EJ.N, a Chinese real estate company previously owned by management, and software maker VMware Inc (VMW.N), spun off by EMC Corp EMC.N, have been a bright spot.

But IPOs backed by private equity -- which have outperformed public offerings overall so far this year, according to Dealogic -- seem to be losing their appeal. High leverage and rich valuations, hallmarks of private equity-backed offerings, are starting to unnerve investors.

“Buyout-backed IPOs have historically done well but that could definitely change in a different credit environment,” said University of Florida finance professor Jay Ritter. “That’s a real concern with so many buyout-backed IPOs having recently gone public and the debt financing environment changing.”

NOT PRICED FOR THE INVESTOR

Private equity firms buy companies by relying on debt, which usually winds up on a target’s balance sheet. The firms often reward themselves with dividends that further load portfolio companies with debt.

“Typically the amount of interest they pay relative to their income is out of whack,” said research firm IPO Desktop president Francis Gaskins on the debt serviced by private equity-backed IPOs. “It’s like over-mortgaging your house.”

The 10 largest private equity-backed IPOs last year had an average debt-to-equity ratio of 1.6, according to PricewaterhouseCoopers -- dwarfing a ratio of 0.1 for offerings that weren’t backed by private equity.

Investors were likely more comfortable with such leverage when companies could service debt cheaply. But with uncertain credit markets and economic outlook, shareholders are wary of high debt loads.

E-House, up about 20 percent since its debut earlier this month, had a debt-to-equity ratio of 0.1, according to IPO Desktop. VMware, which has more than doubled since its August debut, had a ratio of 0.5.

    By contrast, Orbitz and Dice Holdings have dropped about a fifth of their value since their debuts -- with debt-to-equity ratios of 0.8 and 1.5, according to IPO Desktop.

    “Because they’re highly leveraged and the proceeds go to pay off debt, typically these companies take as much money off the table as possible,” said Gaskins. “They are not priced for the investor.”

    “It’s a financial enrichment campaign for shareholders in the private equity fund,” said David Menlow, president of research firm IPOfinancial.com. “If everybody else has a chance to make some money that’s a bonus. But it’s not an objective.”

    PRESSURE TO DEPLOY

    Private equity firms are quick to cite studies showing that companies taken public after their ownership perform better than those not backed by private equity.

    “Private equity investment firms are in the business of creating long-term value in the companies they acquire, value that continues to grow after private equity firms exit the investment,” said Robert Stewart, vice president of industry group Private Equity Council.

    But uncertain credit markets could make richly valued or debt-laden offerings a much tougher sell to public investors going forward -- which could pressure on the firms.

    “There is pressure to deploy,” said Ilan Nissan of law firm O‘Melveny & Myers. “This business is about using resources to buy and sell companies. No one is making money by holding.”

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