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Impact Investing

IPE special report May 2018

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Few financing structures in recent memory have had the impact of private investments in public equity (PIPEs). Privately negotiated equity or equity-linked securities issued by public companies, PIPEs gained notoriety during the tech boom. Their standing soared and then crashed with the Nasdaq. But these structures have reclaimed some of their former popularity. The industry surrounding PIPEs has also developed significantly. Reputable investors are increasingly working with established companies on favourable terms, to the benefit of their shareholders.
For a variety of reasons, the PIPE market has been centred in the US. The legal and regulatory framework is more conducive to issuing PIPE-like structures. The market is also older and more established. US PIPEs first gained favour in the early 1990s, several years before they became common in Europe. In Europe PIPEs have also suffered from a particularly negative reputation, with excessive focus on their infamous past.
Therefore, when considering the industry as an area of alternative investment, the US is an instructive place to begin. The utility of PIPEs has varied enormously in the past decade and it is best seen through US deals. However, the US market is not unique; factors that have determined the evolution of PIPEs there also affect Europe, and there are signs that the European market is trending towards the US so exploring the US market is helpful in understanding the potential and direction of this industry.
The US PIPE market peaked in 2000, when issuance exceeded $24bn (e21.3bn). The volume of these transactions has since subsided slightly (to $22bn and $17bn in 2001 and 2002 respectively), but the quality of both investors and issuers has steadily increased. One reason for this growth in the industry is that PIPEs are increasingly recognised as the answer to a variety of financing concerns, causing them to appeal to a wider range of companies.
PIPEs have transitioned from a hasty form of financing associated with tech boom delusions to a sensible instrument popular with shrewd post-boom management facing the challenges of a lean economy. PIPEs have been established as an efficient means of raising capital, effective despite the adversity of strained financial markets.
The current tightening of bank lending has been particularly tough for many companies. Sectors are struggling to cope with stricter covenants and a chilly reception to credit line appeals.
These transactions often wind up in the PIPE market because the issuer does not consider them appropriate for the public market.
This raises another aspect of the PIPE market’s growing popularity: having had time to mature, the more responsible PIPE investors can now point to a track record. Death spirals were carried out by the subtly named ‘vulture funds’. But with tech-bubble scavengers essentially gone, the remaining players are a considerably more reputable group. Sound PIPE investors now rely on name and referral to win deals with established companies; the effectiveness of this pitch increases as the quality of an issuer grows.
The reputation of an investor is derived from a few areas. A common factor is the investor’s treatment of the security, such as the care with which it insures and exits a position. For a potential issuer that has done its homework, a responsible PIPE investor (with a record to prove it) should be able to offer a deal competitive with, for example, a public convertible offering. While terms of the public deal may be more attractive, the arbitrageurs that inevitably purchase these securities tend to hedge out any nominal advantage (without necessarily stopping there).
Issuers can also expect a boost in the market’s perception following a transaction with a reputable PIPE investor. From an investor with industry expertise or a record of working with successful companies, a PIPE can appear to the market as a notable vote of confidence. As opposed to public convertible offerings, it is not uncommon for a company’s stock to rise in the period immediately following a PIPE. The supportive message potentially brought by a PIPE (and the accompanying increase in institutional ownership) is often cited as a compelling factor.
As with the US, market conditions and tighter lending have prevented many European companies from accessing traditional sources of capital. With a greater number of established European companies seeking alternative means of financing, PIPEs are gaining popularity. Encouraging this growing interest is the maturing European PIPE industry and increased demand in the US.
The greatest impediment to PIPE issuance in Europe has traditionally been the legal and regulatory framework. Specifically, statutory pre-emptive and appeal rights granted to European shareholders can act as barriers. Generally more extensive than those in the US, these rights potentially allow European shareholders either to block or have an initial bid at new securities or issuances. While occasionally making offerings difficult, these obstacles have not prevented PIPEs from being issued in major European jurisdictions.
European PIPEs seem most prevalent in the Netherlands, where companies are relatively free to issue new securities. Some of the largest and most complex European issuers have been Dutch, such as Baan and Buhrmann. In France, PIPEs are gaining popularity despite restrictive regulations. Perhaps recognising the utility of PIPEs in a difficult market, the Commission des Opérations de Bourse has taken a lenient stance on PIPEs, a dozen of which were issued last year. PIPEs are less common in the UK and Germany, due in large part to regulations that continue to act as barriers. However PIPEs are becoming more prevalent here as well; one of the largest ever occurred in Germany, issued by Allianz.
One area where Europe may be setting an example for the US is in the entrance of venture capitalists. With the tech pipeline essentially on hold and low public valuations, venture capitalists are seeing opportunities to put their capital to work in public companies through PIPEs. While they occurr on both sides of the Atlantic, France seems to have actively embraced this concept, with several French venture firms setting aside capital or creating funds specifically for PIPEs. Venture investment may be a temporary phenomenon, but the added interest from these firms is encouraging receptivity for PIPEs in Europe.
In the US and increasingly in Europe, under the right circumstances and with the right investor, a PIPE can be the best way for a company to raise capital. While the number of ‘right’ circumstances has increased in the lean economy, the number of ‘right’ investors has actually decreased as the industry matures. Essentially, there are now a smaller number of reputable PIPE investors considering opportunities in higher-quality companies. Investors that have wisely spent the past few years building solid reputations within the industry are now well positioned to capitalise on growing demand for their product (and generate solid returns for their own investors in the process).
The leading names in the industry come from a variety of investors, including asset managers, venture capital firms, investment banks and institutional investors from Europe and the US.

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