Lessons for participating in private equity floats
The ‘will-they, won’t they’ vacillation of the private capital firm Archer Capital as to whether it will float fast-food restaurant chain Craveable Brands – known until last month as Quick Service Restaurants Holdings – shows yet again the uncertainty that periodically sweeps through the initial public offerings (IPOs) market.
A weakening market outlook is not good news for the vendors of companies looking to take them to the stock market – particularly if the vendor is a private equity owner.
Private-equity vendors are very hard-nosed. They make money by buying companies – whether privately or off the stock market – and running them more efficiently, building up their value, and then selling them. They do this either in a ‘trade sale’ to another company, or back to investors through a stock market IPO. In many cases, they sell them back to the same investors.
The critical thing to keep in mind about private equity is that when it sells a float onto the stock market, it is exiting the investment. The float crystallises all of the private equity owner’s work on the company, and its internal rate of return (IRR) on the investment: therefore, the private equity owner wants to maximise the price that it can get for the IPO.
In retail investor land, private equity exits have earned a bad reputation, through a succession of floats that tanked after their private equity owners floated them.
Myer (MYR) is the most often-cited example of this: it was floated in November 2009 by its owners, US private equity groups TPG and Blum Capital Partners and the Myer family. Sold through the prospectus at $4.10, Myer shares opened on the market at $3.88 and have never traded above the issue price – the best that shareholders have done is a peak of $3.96 in September 2010. With the retail industry spooked by the imminent entry to Australia of Amazon, Myer is struggling at 88.5 cents, down 36% this year alone.
There are plenty of similar tales of woe.
Private equity group Anchorage Capital bought electronics retailer Dick Smith Holdings from Woolworths (WOW) in September 2012 for $115 million, and after a quick repair job floated it on the stock market in December 2013. Dick Smith spent just over a year trading above its $2.20 issue price, and was still in the black when Anchorage Capital sold out in September 2014, making $400 million. The stock subsequently blew up, going into administration in January 2016, at a last price of 35.5 cents.
Financial services comparison website operator iSelect (ISU) was floated in June 2013 by its founders and US private equity firm Spectrum Equity, at $1.85 a share. The stock opened below that, and two months later, iSelect announced that it had missed its revenue forecasts. By January 2016 the stock was trading at 80 cents: iSelect has rebounded to $2.05, but it took until November 2016 for float subscribers to see the stock trade above the issue price.
Industrial services company Spotless (SPO) was bought off the stock market by private equity firm Pacific Equity Partners in May 2012 for $720 million: after a rapid turnaround, PEP refloated the business in May 2014 in a $1 billion float, at $1.60 a share. After reaching $2.22 in May 2015, a disastrous profit warning in December that year tipped Spotless into a 42% plunge, and the shares slid to just 72.5 cents in March. Spotless has recovered some ground, trading at $1.145, on the back of a $1.15-a-share takeover offer from engineering and contracting firm Downer EDI (the Spotless board has urged shareholders to reject the offer.)
Aged care operator Estia Health was floated in December 2014 after a sell-down by private equity firm, Quadrant. Quadrant acquired Estia for about $175 million in 2013, later combining it two other aged care operators, before floating the company in a $725 million deal, at $5.75 a share. Estia Health fell 17.6% on debut, but the stock rose to $7.30 by November 2015. However, an earnings downgrade in late 2016 disappointed the market, and to put it mildly, investors subsequently lost faith in the numbers Estia was producing. The stock now trades at $3.15.
PE business Next Capital floated specialist business financier Scottish Pacific Group in July 2016, retaining a 29% stake: Next Capital raised $293 million at $3.20 a share, and while the stock reached $3.41 on debut, and traded as high as $3.93 by September, a very unwelcome profit downgrade in November derailed the stock, and Scottish Pacific has sunk back to $2.37.
More recently, in November 2016, the nation’s largest chicken producer, Inghams Group (ING), and financial services software provider Bravura Solutions were floated by private equity firms: in Bravura’s case, returning to the stock market.
The Ironbridge Capital-backed Bravura Solutions dropped like a stone on debut – down almost 14% from the $1.45 issue price – but has recovered most of that fall, to be at $1.40. Inghams’ private equity owner TPG cut its initial asking price for the shares from a range of $3.57–$4.14 to the final issue price of $3.15: the stock closed its first day on the ASX at $3.22, and now trades at $3.29.
It’s important to note that not every private equity-backed float struggles on the market: PE firm Archer Growth Fund sold motorbike dealership chain Motorcycle Holdings (MTO) on the stock market in April 2016, at $2 a share: the stock surged to $2.71 on day one, and has moved to $3.52, albeit down from the March 2017 peak of $4.43. Motorcycle Holdings managed to beat its prospectus net profit forecasts.
Quadrant-backed car parts Burson Auto Parts (now called Bapcor (BAP) was listed on the ASX in April 2014, at $1.85 a share. Having spent $283 million in mid-2015 buying Metcash’s automotive operation, which gave it ownership of Autobarn, Autopro and Midas Mufflers, Bapcor has moved to $5.31.
Outdoor advertising operator APN Outdoor (APO) – also a sell-down by Quadrant – came to the ASX at $2.55 a share in November 2014, and by June 2016 was trading at $8.24. Even after a brutal reaction to a profit downgrade in August 2016, which took 40% off the share price, and the decision of the Australian Competition and Consumer Commission (ACCC) to block the company’s proposed merger with rival oOh Media!, APN Outdoor has proven a good investment, trading at $4.58.
PEP-backed credit reference agency Veda Group came to the market in December 2013, with the shares opening more than 40% above the issue price of $1.25: Veda was taken over by Equifax in February at $2.85 a share.
A new report from the Australian Private Equity and Venture Capital Association Limited (AVCAL) and Rothschild found that in the three calendar years 2013 to 2016, PE-backed floats had delivered an average return of 24% to investors, versus 17% for non-PE floats. The report said there has been 81 floats in the period with an offer size above $100 million, and nearly half of those were private equity spin-offs.
Private equity firms are always balancing the benefits of a trade sale versus an IPO – this is called a “dual-track” sale process. If there is a trade buyer, that can be a lot cleaner and quicker way to sell the asset. Navis Capital was considering floating Retail Apparel Group (RAG), which owns menswear brands Connor, yd., Tarocash, Johnny Bigg and women’s “athleisure” brand Rockwear, in a $400 million issue, but recently signed a deal with South African group Foschini to sell RAG for $302 million.
The same could still happen to Craveable Brands, which operates the Red Rooster, Oporto and Chicken Treat chains, although Archer Capital still says the float is on.
It could also happen to Western Australian gas producer Quadrant Energy, whose owners, Brookfield Asset Management and Macquarie Capital, are considering a float (it is unrelated to Quadrant Private Equity. It could also happen to Lattice Energy, the name given to Origin Energy’s upstream oil and gas assets, which could also come to the ASX.
For investors, the lesson should be that participating in a private equity float does not necessarily mean being a patsy for a vendor that is smarter than you; nor does it necessarily mean a ticket to riches. Private equity vendors are gun-shy from the high-profile duds their industry has flogged off in recent years, and are toning down their pricing – let’s face it, they had to. More are retaining significant stakes in their sell-offs, which the market very much likes to see.
Just remember, when you are confronted with a private equity IPO proposition, don’t be seduced by the brand, don’t be seduced by the glossy prospectus – Myer’s contained multiple photographs of supermodel Jennifer Hawkins, including the cover – and do your homework. Look at sites like Switzer Super Report, look at all the independent assessments of the stock you can find, and never forget that if IPOs are buyer-beware propositions, the large private equity IPO doghouse means that private equity IPOs are doubly so.