To SBO or IPO, that is the question

Emanuel Eftimiu
17 February 2010

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Recent evidence has shown that for good companies the barren exit market of last year has been replaced by a tug-of-war between viable divestment routes, writes Emanuel Eftimiu

Private equity-backed IPOs have certainly made the headlines in recent weeks, although mostly because of pulled flotations than actual successful listings. Last week alone New Look, Travelport and Merlin all added their names to the list of hopeful aspirants that have shelved plans to go public.

While this is mainly due to deflated market valuations, private equity owners have also often found secondary transactions offering far better value. Indeed with slightly improving leverage markets secondary buyout activity, which had been virtually dormant for more than a year, has seen a well publicised and dramatic revival.

In fact, anecdotal evidence suggests that most portfolio companies readying themselves for an exit are currently running a dual track process. In January, for example, pet supplies retailer Pets at Home, a reported IPO candidate, eventually changed hands between Bridgepoint and KKR for £955m.

Pets at Home is indicative of a general trend: with debt market liquidity growing the majority of secondary transactions taking place today occur at the top end of the market. "Leverage is coming back to the market, with particularly larger transactions finding growing support as certain banks' appetite to underwrite is increasing," comments Jacques Callaghan of Hawkpoint Partners.

However, counter-intuitive though it may appear, Callaghan does not see this loosening of the debt markets replicated in the mid-market. "Deals valued at less than £250m are facing a challenge, as debt financing for such transactions still relies on a club of banks," he adds.

The logical conclusion of this would be that private equity houses would be more readily inclined to exit mid-market portfolio companies via an IPO. What is more, such listings have historically performed rather well. "The best performing companies listed during the last IPO window from 2003-2007 were those with a market cap of £100-500m," notes Callaghan. "12 months post-IPO such private equity-backed listings recorded on average a 25% share price outperformance."

Obviously, though, institutional investor appetite is key to any flotation. "Investors are looking for growth companies and want the weight of proceeds to be put towards growing the company and less towards deleveraging the balance sheet or paying for vendor equity," notes Piers Coombs of Collins Stewart.

"Having spent much of 2009 funding rescue rights issues, having a well capitalised balance sheet is also a real focus for investors and it is certainly difficult to bring a company to the market that has a higher net debt to EBITDA ratio than 2.5-3x," he elaborates.

The elephant in the room, however, is the growing disenchantment among institutional investors with the current dual track processes, which often result in them losing out to secondary buyouts. That said, competition for strong assets should always be expected – particularly in a downturn - and such competition certainly stimulates the market.

Callaghan remains bullish for more successful flotations, expecting more than 10% of private equity exits to come through IPOs in the current cycle. Given the state of the exit market 12 months ago, the luxury of choice with regards to exit route is certainly a nice place to be for private equity houses.