By Cristina Alesci, Jason Kelly and Eric Martin
Nov. 2 (Bloomberg) -- Investors suffering the worst returns on initial public offerings in at least 14 years are shunning companies laden with debt, forcing bankers to pull one sale and cut the price of others.
The postponement of an $800 million offering by AEI, a former Enron Corp. unit with $2.9 billion of net debt, followed reduced sales by RailAmerica Inc. and Select Medical Holdings Corp., both owned by private-equity firms. AEI’s IPO unraveled last week after Ashmore Group Plc, the London-based fund manager that controls the company, withdrew when institutional buyers refused to pay the $16-a-share it sought for the deal.
“Investors are more focused than ever before on buying healthy balance sheets,” said Timothy Monfort, head of U.S. equity capital markets at Jefferies & Co. in New York. “They don’t want to see a stop-gap measure and they want to know that the equity investment offers a complete solution for the company.”
IPOs deteriorated as the Standard & Poor’s 500 Index suffered its first monthly decline since February and the benchmark gauge for U.S. stock-market volatility surged the most in a year. With $4.2 billion of private-equity sales in the pipeline, companies burdened by debt from leveraged buyouts are being forced to lower offering prices, limiting gains that can be passed on to their investors after $3.7 billion was raised through U.S. share sales in the past six months.
‘Bloodletting’
A “bloodletting” for LBOs that will damp the economic recovery may be coming, according to billionaire investor George Soros.
“In commercial real estate and leveraged buyouts, the bloodletting is yet to come,” Soros said on Oct. 30 during a lecture organized by the Central European University in Budapest, where he was born. “These factors will continue to weigh on the American economy, and the American consumer will no longer be able to serve as the motor for the world economy.”
Stocks are slumping as buyout firms count on IPOs to exit some of the $2.1 trillion in LBOs they made since the start of 2004 and return cash to investors. Distributions to their clients fell by two-thirds to $63 billion in 2008 from the previous year, according to London-based researcher Preqin Ltd.
AEI, an operator of power plants and natural-gas pipelines in emerging markets acquired by Ashmore in 2006, would have been valued at $3.9 billion, or 1.3 times net debt, had its shares sold at the midpoint of its original range, according to data compiled by Bloomberg. Underwriters led by New York-based Goldman Sachs Group Inc., Citigroup Inc.,JPMorgan Chase & Co. and Credit Suisse Group AG in Zurich dropped the sale Oct. 29.
‘Happy to Wait’
The postponement came about seven hours after the deal was cut to less than $300 million from $800 million following the withdrawal of Ashmore, which oversees $31 billion focused on emerging-market stocks, credit, currencies and private equity. Ashmore’s decision was based on investor demand, according to Jerome Booth, the firm’s London-based head of research.
“We’re not in the business of selling at any price or at a bad price,” Booth said in a phone interview on Oct. 30. “If that’s being price-sensitive, then yes, we were sensitive to price in this case. We don’t have to sell, and we like the company. We’re happy to wait for market conditions to improve.”
Underwriters couldn’t find buyers for AEI even after lowering the forecast range of the offering from $14 to $16 to as little as $12, according to government filings. After Ashmore pulled out, George Town, Cayman Islands-based AEI increased the shares it planned to sell to 20 million from 16.7 million, the filings show. Stockholders including Goldman Sachs were going to sell 1 million shares, down from the prior plan of 33.3 million.
‘Any Price’
An investor who declined to be identified said bankers managing the offering called him at least nine times in the week and a half before the pricing, attempting to sell AEI when the low end of the range was still $14 a share.
“The underwriters asked, ‘Is there any price you would be willing to pay, even at $11 or 12?’” said the manager, who asked not to be identified because the negotiations were private. He analyzed the IPO and decided against participating.
JPMorgan spokeswoman Tasha Pelio, Jeanette Volpi, a spokeswoman for Citigroup, Credit Suisse spokesman Duncan King and Goldman Sachs spokeswoman Andrea Rachman declined to comment. AEI spokesman Chuck Dohrenwend cited the company’s Oct. 29 statement, which said the offering was postponed “due to market conditions.”
The IPOs of 18 U.S. companies that went public since September have outperformed the S&P 500 by 0.1 percentage point on average in the first month of trading, the worst performance in Bloomberg data going back 14 years. Offerings by American companies have beaten the S&P 500 by an average 21.3 percentage points since 1995, the data show.
VIX Surges
The S&P 500 slumped 4 percent last week, the steepest retreat since May 15, as declines in consumer confidence, personal spending and home sales, along with the threat of a bankruptcy at New York-based CIT Group Inc., spurred concern over the durability of the economic recovery. CIT filed for Chapter 11 yesterday.
The VIX, the benchmark for U.S. stock options that is known as Wall Street’s “fear gauge,” jumped 24 percent on Oct. 30, the biggest surge since Oct. 22, 2008, as the S&P 500 ended a seven-month streak of gains.
Private-equity firms earn the richest fees from their 20 percent cut of profits on investments, known as carried interest. Pressure is building on some managers to move past their bets of two years ago to what they project will be more profitable transactions, industry executives said.
‘Get Out’
“For certain sponsors, the reality is they’re unlikely to get any carry from these funds, so they want to get out and get on to the next one quickly,” Guy Hands, founder of London-based Terra Firma Capital Partners Ltd., said Oct. 14 at an industry conference in Dubai.
Blackstone Group LP, the world’s largest private-equity company, may take as many as eight of its holdings public, Chief Executive Officer Stephen Schwarzman told investors at the same conference. Knoxville, Tennessee-based Team Health Holdings LLC, a health-care staffing company owned by New York-based Blackstone, filed last month to raise as much as $100 million.
Schwarzman said it’s hard to predict how demand for new stock will hold up.
“No one knows how long a window will be open for IPOs,” he told reporters in Dubai. “It’s been a streaky type of market.”
Investors are rewarding some companies with healthier balance sheets.
Vitamin Shoppe, RailAmerica
Vitamin Shoppe Inc., the North Bergen, New Jersey-based retailer of nutritional supplements that has a debt-to capitalization ratio of 0.35 and is backed by New York-based Irving Place Capital, sold its shares for $17 last week. That was above the planned range of $14 to $16. The stock gained 9.8 percent in the first two days of trading.
Vitamin Shoppe outperformed RailAmerica, the railroad operator owned by Fortress Investment Group LLC that has debt exceeding more than half of its capitalization. The Jacksonville, Florida-based company reduced the amount of its IPO and has lost 22 percent since going public.
RailAmerica cut its offering price to $15 a share from a range of $16 to $18 before it began trading Oct. 13. The company sold 10.5 million shares, while New York-based Fortress increased its sale to 11.5 million shares from 10.5 million.
Moody’s Investor Services said in a statement Sept. 30 that the transaction wouldn’t boost the company’s credit rating.
‘Primary Driver’
“Going forward, long-term ratings are more likely to be affected by developments in volume and pricing in the rail- freight sector, which is the primary driver to RailAmerica’s growth and profitability,” Moody’s said.
Select Medical, owned by buyout firms Welsh Carson Anderson & Stowe in New York and Chicago-based Thoma Cressey Bravo LLC, cut its IPO price to $10 from a range of $11 to $13 on Sept. 24. The Mechanicsburg, Pennsylvania-based hospital operator extended the maturity of $384.5 million of term loans by two and a half years to August 2014 on Aug. 5.
Moody’s still left Select Medical’s main credit rating at B2, five levels below investment grade, even as the company said it would use most of the IPO proceeds to pay down debt.
The ability of private-equity managers to cash out of their investments has also been limited by the two-year slowdown in mergers and acquisitions since the onset of the credit crisis.
M&A Slowdown
Announced M&A deals worldwide have dropped 42 percent to $1.3 trillion through last week from the same period in 2008, and 63 percent from two years ago, according to data compiled by Bloomberg.
Private-equity firms have struggled to find buyers to sell their holdings to since the collapse of subprime mortgages locked up credit markets, spurring losses and writedowns at the world’s biggest financial firms that reached $1.6 trillion.
“All options for exiting investments are impaired right now,” said Bill Atwood, Chicago-based executive director of the Illinois State Board of Investment. “The equities market right now is stronger than the strategic sale option.”
Buyout firms are putting their best companies into the markets first, according to Steven Kaplan, a finance professor at the University of Chicago’s Booth School of Business. A weak economic recovery would mean that some less-attractive companies will go bankrupt, he said.
‘Struggling With Them’
“There are a variety of deals which are at or near default,” said Victor Khosla, founder of Strategic Value Partners, a Greenwich, Connecticut-based private-equity and hedge-fund firm that invests in distressed assets. “The industry is going to be struggling with them for years.”
Private equity-owned companies have $455 billion in outstanding leveraged loans with maturities through 2014, even after reducing debt by $72 billion this year through Aug. 7, according to data compiled by S&P in New York.
“Even if things are getting better, we might need another bubble to digest the debt,” said Antoine Drean, chief executive officer of Triago, a Paris-based firm that raises money for private-equity funds and sells existing interests in buyout pools. “The debt will still be a big issue and it’s difficult to take care of today.”
To contact the reporters on this story: Cristina Alesci in New York at Calesci2@bloomberg.net; Jason Kelly in New York at jkelly14@bloomberg.net; Eric Martin in New York at emartin21@bloomberg.net.
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