Private investment in public equity (PIPE) has continued to gain stature as a potential solution to financing challenges from both sides of the Atlantic. Several factors have caused increased demand for such a product, and there is reason to believe that the market for PIPEs is ripe. However issuance continues to be hindered by substantial obstacles, and the popularity of this security remains to be seen. Regardless of whether PIPEs ever become a common form of financing, they play an increasingly critical role in mature and competitive economies and will continue to create significant opportunities for issuers and investors.
Privately negotiated equity-linked securities issued by public companies to a single or group of investors, PIPEs gained notoriety during the tech boom: their reputation soared and subsequently crashed with the Nasdaq. PIPEs have since enjoyed a resurgence, largely due to growth in market maturation and demand. Recognised for providing efficient capital, reputable investors and reliable funding have gained the PIPE market considerable attention from challenging economic
Populating such a demanding environment, with the expanse of both the EU and the global economy, are western European corporations – who now face heavy competition from eastern Europe, Asia and beyond. Confronting growth in both global and continental challenges, these companies have found little reprieve from the public markets. Although buoyed by a weakened dollar and growing corporate profits, recovery in the equity markets has generally lagged and secondary issuances remained flat.
With increased competition and sluggish markets, western Europe seems in significant need of alternative financing. Reflecting this, private equity activity has increased substantially over the year. According to the European Private Equity and Venture Capital Association (EVCA), private funds invested last year increased over 5% - making 2003 the second highest year ever for investments of private equity. This activity was dominated by buyouts, which represented 63% of the total amount invested, the EVCA reports.
However, despite strong demand for private equity and no shortage of investor capital, there is little evidence of a breakthrough in European PIPE issuance. There certainly has been no activity on a scale comparable to the US – which peaked in 2000 with nearly $25bn (e20.4bn) and currently is on course for one of the largest years ever.
PIPEs in Europe appear to be few and far between, which is remarkable when put in context of the larger private equity market. PIPEs present distinct advantages over traditional and more popular structures, such as the buyout. Through a PIPE, investors can gain large positions in public companies. However, these are often purchased at a discount (as opposed to a premium) and readily exited through the secondary market (and not a liquidity event) – making the investment less risky. Advantages exist for the issuer as well, an obvious one being that they remain publicly traded. With competition fierce among the private equity houses themselves – an arena where privilege and dominance are eroded by equalising factors such as auction sales and commoditisation of financial engineering skills – one would expect innovation to have leapt at the PIPE.
The major impediments to European PIPE issuance are found in legal and regulatory frameworks, and have caused a schism between the ideal of quick and efficient financing and a more onerous reality. Statutory pre-emptive and appeal rights granted to European shareholders, more extensive than those in the US, potentially allow shareholders to block or have an initial bid on any new securities or issuances. Additional obstacles are found in various European national laws – such as listing rules in the UK that can prevent companies from issuing discounted shares.
While creating difficulties, these barriers have not prevented the issuance of European PIPEs. Providing critical financing – often for debt reduction, acquisitions or other growth opportunities – PIPEs are compelling enough to enjoy limited, though potentially growing, regulatory backing. Current support for the PIPE market is varied: the Dutch are relatively encouraging with several major issuances, such as those by Baan and Buhrmann, while the Germans have seen relatively few PIPEs (despite one of the largest issued by Allianz).
In transition are France and the UK, where regulatory bodies have on occasion taken lenient stances to allow for PIPE issuance. However, there is indication that national stances may be less relevant in the future. Recent judgments, such as those in Uberseering and Inspire Art, indicate that the European Court of Justice (ECJ) is moving in the direction of permitting EU corporations to re-establish themselves within other member states –potentially taking advantage of more beneficial regulatory systems. Exactly how the ECJ’s recent or future decisions will effect the PIPE market is not clear, but it is probable that as the EU integrates further, states with efficient financing will influence those with more constraining regulations.
Regardless of national and integration concerns, PIPE issuance continues to proceed in Europe. For recent examples, one can turn to the most active investors – such as General Atlantic Partners (GAP), the international technology investor. GAP has long been involved in PIPEs, and structured some of the largest and earliest in Europe. GAP recently announced the conditional purchase of shares from Intec, an LSE-listed telecom, to fund a $75m US acquisition. GAP invested in another LSE-listed company last year through a £34m (e49.7) PIPE in iSoft, a supplier of healthcare software.
On the other side of the Atlantic, the PIPE market has developed significantly. Seeing similar strong demand but without regulatory constraints, American PIPEs are on track for a phenomenal year. Having raised over $8bn in nearly 800 transactions, 2004 may overtake last year’s total of $13bn from over 900 PIPEs. If this pace were to continue, 2004 would be an enormous year for US PIPE activity – second perhaps only to 2000, when nearly $25bn was raised in over 1,000 transactions.
The composition of this market reveals why the PIPE is so compelling structurally. The usual suspects – biotech, pharmaceutical and telecom companies – dominate PIPE issuance again this year. However, a new sector has also begun to embrace PIPE financing: the oil and gas industry. Representing 5% of current deals, oil and gas is the seventh most active sector for PIPEs – figures never before seen in the industry and comparable to those usually found in tech and healthcare businesses.
This sudden and substantial popularity is indicative of the PIPE market’s unique functionality: as the capital intensive oil and gas industry faces an increasingly tight market and geo-political concerns, interest increases in the efficient and available capital quickly provided through a PIPE. Distressed sectors such as oil and gas present companies with both challenges and opportunities; those that have PIPE financing available are better able to effectively cope with both.
However, the PIPE market in the US also faces significant obstacles. While pre-emptive and regulatory hurdles may be uniquely European, issues in the US are more political – and perhaps distinctly American. PIPEs have recently received press attention, with The Wall Street Journal and The New York Times among others focusing on an ongoing Security and Exchange Commission (SEC) investigation into the PIPE industry. They note that the SEC has begun an inquiry into potential abuses of securities law between brokers that act as agents and funds that invest in PIPEs. Violations would centre around hedge funds acting illegally on material, non-public information by shorting the stock of a company known, but not declared, to be considering a PIPE. The SEC has apparently questioned over a dozen agents and brokers about such activity.
Despite the fanfare, the current focus on PIPEs may not amount to much in terms of general demand and issuance. Within the industry, there is speculation that the SEC is ultimately using inquiries into the PIPE industry as an entrée to a much larger and politically charged issue: hedge funds regulation in the Patriot Act/Sarbanes-Oxley era of US business administration. It is true that no charges, or even formal investigations, have yet to come from the inquiry – which so far is being handled by the Office of Compliance and Inspections (OCI), the non-enforcement division of the agency. The PIPE industry, like many other areas of alternative finance, probably does have an element that warrants attention from the SEC’s enforcement division. However, at the moment these cases seem few and far from prosecution, and given past SEC behaviour the potential for settlement or abandonment may be likely.
What the SEC does have from these inquiries of PIPE brokers and agents is new insight into the unregulated world of hedge funds – and in its quest to shed light on the murky world of hedge funds, the SEC has probably has gained significant leverage. By focusing on a regulated aspect of the PIPE market, the SEC may leave the industry alone as it moves closer to managing the much larger and unregulated issue of hedge funds.
While these articles are right to bring attention to such developments, they may have missed the larger point concerning PIPEs: that these structures perform a substantial and increasing critical role in sophisticated trans-Atlantic economies. By providing capital efficiently and quickly, the PIPE market has allowed companies facing enormous pressure, whether regional or from a sector, to effectively cope with new challenges. As the industry matures and both issuers and investors gain stature the PIPE market should continue to provide a significant alternative to the public markets on both sides of the Atlantic.