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PE-backed IPOs hit a speed wobble

IPO exits have fallen dramatically in recent years and the causes are deeper-rooted than stock market price cycles. Private Equity Wire’s Paul Bryant investigates…

Headline numbers signal that Private Equity is falling out of love with IPOs as an exit route. Globally, the value of PE-backed IPOs surged in the 2013-2015 period, but have been on the decline since. The value of IPO exits in 2018 (USD24 billion) was just one-fifth of the 2014 peak (USD118 billion). 

Across Europe, the value fell from EUR26 billion in 2015 to EUR8 billion in 2018, with deal numbers down from 49 to 13. Over the same period, deal value in London fell from GBP11 billion to GBP3 billion, and deal numbers from 19 to just five. Although activity has ticked up in the first half of 2019 – financial sponsor backed IPOs have raised USD3.5 billion in London, up 78 per cent year-on-year – it’s still some way off the heady days of 2014 and 2015, and far too early to indicate a reversal of the downward trend. 

Christophe De Vusser, head of EMEA Private Equity practice at Bain & Company, doesn’t see much prospect of a turnaround: “You would have to believe that public market valuations are going to move higher than private market valuations. And at the moment, we don’t see structural trends of that happening. It’s probably the reverse.”

De Vusser says this relative difference in valuations is the most important factor driving the decline of IPOs. PE funds are simply achieving higher exit prices when they sell to private markets.

He says there will always be a cyclical element to the relative attractiveness of IPO exits – they become more attractive in times of buoyant public markets, and vice versa. And recent public market uncertainty – caused by factors such as a slowdown in China, geopolitical tensions and escalating trade wars – has played into the hands of private exits becoming more attractive. 

However, according to De Vusser, the most important driver today is not a cyclical move in public markets, but a secular rise in private valuations: “Selling to strategic buyers has always been the most common exit route for PE funds, primarily because these buyers typically pay for part of the synergies they can capture. This route also provides a full exit faster than an IPO, where the PE fund usually needs to stay partially invested for a period after the listing. 

“But today, private sales are making up an even bigger share of exits. This is mostly because of the large amount of capital that has been put to work in PE. More PE funds and PE-backed strategic buyers are pursuing M&A strategies aimed at extracting synergies, and consequently, valuation multiples of private deals have continued to increase.” 

The Bain & Company Global Private Equity Report 2019 expands on this point: “Investors have never been more drawn to the private markets than they are today, and it’s plausible this abiding enthusiasm is leading to long-term change in how markets value assets … Over the past 20 years, private-market capital has grown at more than double the rate of public capital globally, and, at the moment, there’s no slowdown in sight.”

According to Peter Whelan, partner and UK IPO Lead at PwC, it has also become the norm for PE firms to test the differences between private and public valuations when exiting, and to ‘maximise the tension between these groups of investors’. He says they typically use a ‘dual-track process’ to do this, which involves going through the various stages of an IPO, dependent upon degree of interest, at the same time as testing private buyers in order to determine the optimal exit.

De Vusser highlights a second secular trend working against IPOs as an exit route for PE – management teams increasingly prefer to be privately owned. He says: “The regulation and scrutiny over listed companies has become more intense over the years. So management teams tend to prefer an exit to a strategic buyer or to another PE fund in a ‘sponsor-to-sponsor’ transaction. Under PE ownership, they can work on longer-term strategies without having the reporting demands of public markets, or being in the public eye.”

He adds that the ‘scaling-up’ of PE and the emergence of ‘long-hold’ funds is fuelling this trend. Because of increasing investor appetite in these funds with lifespans of up to 20 years, PE investors are able to deploy more capital than they used to on deals that take an even more long-term view than classic buyout funds. 

Free from the pressures of needing to secure a quick exit, management teams can work on increasingly larger deals and bolder strategies with longer time horizons such as ‘buy and build’; where a larger entity is created through multiple acquisitions by a private equity firm in a similar segment. 

A partner in a mid-market London PE firm – operating in the GBP30 million-GBP50 million market capitalisation range – says that public ownership is also falling out of favour with management teams in smaller companies, resulting in fewer IPO exits. 

He says: “They can get frustrated with the difficulty in getting their value recognised on public markets. They will probably only have one research analyst covering them, whereas a larger business might have half a dozen or so. So there is typically less information readily available to public market investors and it can take longer for the good work of management to be reflected in the public valuation.” 

One of the implications of this trend away from IPO exits and towards more and larger companies remaining private, is that it will deprive certain investors of the ability to gain exposure to some of the world’s most exciting companies. Although some LPs have shown an appetite to go along with the trend and increase allocations to PE, others will remain reluctant to move capital away from more liquid markets and from publicly listed companies with greater transparency. 

Many retail investors will also be excluded. However, this issue is being tackled head-on by the PE sector. 

According to the Bain & Company Global Private Equity Report 2019: “A number of firms are experimenting with ways to make PE investments available to retail investors. If these innovative new vehicles take off, it could open the floodgates to a massive new investor channel … It makes more sense than ever to push the door open for retail PE investors. Around 15 per cent to 20 per cent of Blackstone’s annual fund-raising already comes from retail investors, and this is likely just the start.”

But it is not entirely a one-way street against IPOs. Charlie Walker, Head of Equity Primary Markets at London Stock Exchange, says the profile of PE-backed exits has changed noticeably: “We have recently seen a tendency for the number of sponsored deals to be lower, but the size of these deals to be larger. In the whole of 2016, USD4.8 billion was raised by PE firms in 14 transactions. 

“So far in 2019, we have seen over 70 per cent of that raised (USD3.5 billion) from just five financial sponsor backed transactions. What is also noticeable this year, is that we have seen a concentration towards mid and larger cap transactions more broadly across IPOs.” 

Walker is confident London is well positioned to thrive in this changing landscape. He says: “London is especially attractive as an IPO venue for larger, internationally diverse businesses. They tend to be looking for a capital market where they won’t be unusual in being a non-domestic company looking to raise capital in that market. And that’s compatible with the changing profile of PE-backed IPOs.”

And according to Whelan of PwC, particularly given some of the recent high profile listings (such as Trainline plc), it would be wrong to call the death-knell of PE-backed IPO exits. Further he notes that in certain instances there can be a ceiling to the value of private exits. He says: “When you see the growing number of very large PE deals, you have to ask how they will exit down the road. And the answer is most likely to be through an IPO.” 

But that ceiling seems to be getting higher. 

As the Bain & Company Global Private Equity Report 2019 summarises: “Uber, which has ridden almost USD21 billion in venture capital to a private valuation of around USD72 billion, is the poster child for this new reality.” It grew to such a size that public markets became the only realistic exit option for shareholders. 

For now, it certainly looks like PE is not going to feed the IPO pipeline with the number of deals it once did. But among those PE exits which do go down the IPO route, look out for a healthy number of mega-deals.


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