I recently did an article on Debenhams, where a private equity consortium bought the firm in 2003. It re-floated three years later. 13 years later, shareholders are nursing a 70% capital loss!
So, I start investigating some UK IPOs because of the nature of private equity. Because they businesses to turn it around (general consensus) and offload it to others. These buyers are private investors or offload to the market at premium valuation (in most cases).
The intention is not to demonise Private Equity role in offloading businesses to the IPOs market. But, whether retail investors are able to profit from them private equity-backed IPOs.
Next, we explore the red flags signalling to retail investors to sell, or not take part in the IPO.
P.S. It is not an in-depth research, but gets people discussing the topic.
Are all private equity firms bad?
Well, they perform a necessary function of turning the businesses around. It can be closing down unprofitable stores, cutting staff numbers or reorganising debts to keep the business alive.
The issue people have is the use of leverage.
For example, Debenhams had £100m in debt before their private equity takeover. And within three years, Debenhams owe £1.9bn. Even worse, is the business didn’t expand, so no reason for it to borrow huge amounts of money.
Other UK Businesses with Private Equity connections
Bonmarche on Sales?
Bonmarche was part of The Peacock Group before the group went into administration. Bought by an affiliate of Sun European Partners LLP called BM Holdings Management S.A.R.L & Partners S.C.A in 2012.
The price tag: £10m.
Sun Partners affiliate bought a part of Bonmarche. (The brand closed 160 stores with a loss of 1,400 jobs.) The closure of loss-making stores helped turned the business around. 18 months later, it raised £40m in the stock market, valuing its IPOs at £100m.
900% in 18 months, crazy right!
For Sun European Partners, it offers 20m shares to investors at 200p each or £40m, an instant 300% profit!!! It still controls 52% of the shares.
What happened to Bonmarche since the IPO?
Shareholders weren’t pleased when shares tumbled by 65% to 77 pence, valuing it at £39m. According to the company, this is down to the warm weather causing like-for-like sales to drop by 8%!
On Sun Partners’ financial stake on Bonmarche. Even if they sold the remaining holdings it will bank another £20m. Taking total profits to £50m in five years’ worth of work.
Why has the share price collapsed?
Bonmarche doesn’t have a debt problem because net cash stood at £10m. The problem lies in the competitiveness of the retail sector. And being a niche (the older ladies’ generation) can get you so far.
Also, Bonmarche is prone to downturns.
Even established businesses like NEXT PLC, Debenhams and Primark are struggling to grow sales. So, a small player like Bonmarche is likely to suffer far worse.
Pets at Home still a good business?
The business operates pets store for the animals’ lovers in the UK. It has been through two private equity transaction. First bought by Bridgepoint for £230m in 2004. Under Bridgepoint stewardship, sales double to £404m, while EBITDA tripled to £70m.
In 2010, KKR bought Pets at Home for £955m. (BTW, Bridgepoint earned “8-times” returns on its initial equity investment.)
The IPO occurs in 2014, valuing it at £1.2bn at £2.45/share.
Results from private equity
Pets paid out hundreds of millions of pounds in dividends and interest to KKR, including a £135m dividend in 2013. The reason is because it owed KKR and its management of £600m in payment-in-kind notes. Payment-in-kind securities are a type of mezzanine financing.
Example of Payment-in-kind
Let’s say you offer £500,000 in PIK notes with a maturity of five years. The notes pay a 15% interest every year, or £75,000.
The difference is INTEREST gets added to the original loan. After year 1, that loan grew to £575,000.
By year 2: Interest is £86,250, and the loan grew to £661,250 and so forth.
So, leaving Pets with bigger loans and interest every year.
How much did KKR make from Pets at Home?
Nobody knows. Because the details are COMPLICATED and unavailable. Also, we don’t know if Pets were paying huge dividends to KKR during the period of private ownership.
Why has the share price collapsed?
The level of collapse isn’t like a Bonmarche. Currently, the share price of Pets at Home is £1.84/share or a drop of 25%.
Pets at Home is making money with operating margin at 12%. The problems lie with having too much debt. And investors are spooked if Pets has an off year. Now, Pets deleveraged by cutting total debt by 60% to £200m.
Is it a Buy?
I can give you that information, only if I have done a full analysis.
And, Moving On
This is a Central and Eastern European spirit producer. And created by private equity firm Oaktree Capital Management.
The IPO raised £207m at £2.35/share, with additional share sale of £52m. By 2014, Oaktree exit the firm in bizarre fashion. Oaktree sold its remaining 36.8% stake (72.67m shares) at an 11% discount at (£2.75/share). Also, despite a lock-up period lasting till 22 April. (they sold early April)
Why has the share price collapsed?
Five to six months after Oaktree sold its entire stake, Stock Spirit shares lost 25% in a day. The culprit?
A profit warning.
Management expects annual profits to be £7.8m lower than expectation. The cause is a levied tax of 15% at the end of 2013 by the Polish government. It explains why Oaktree was quick to sell before investors discovered the change in regulation.
Stock Spirit fell further to £1/share, before recovering to £2/share. (still 17% below IPO price)
Now, for some new positive for the little guys and gals.
SSP, your brand operators during long-distance travel
One of the few bright spots is SSP or known as Select Service Partner.
The company bought by EQT Partners in 2006 for £1.822bn. It does brand catering and retail units at over 125 airports and 270 train stations. These brands include Starbucks, Burger King, WH SMITH, Upper Crust and M&S Simply Food.
It floated in 2014 at an IPO value of £1bn (a bargain already) at £2.10/share. The offer raised £482m with the intention of paying down debt. It helps to reduce SSP’s net debt to £450m.
Did EQT do well with their investment?
Again, we will never know!
We do know they sold its remaining 20% stake to raise £275m in 2015.
Why did SSP shares rise in value?
First, SSP business model is successful because long-term distance and air travel is growing. There are more and more people using these services.
Second, it operates well-known recognised brands. People knows what they are getting. Plus, it is a convenience for them.
Despite the success of its business model, valuation has to make sense. And for SSP, it did.
Remember EQT paid £822m more for this business than the floatation valuation, eight years ago. The proceeds raise helped reduce financial leverage. Meaning if SSP continues to churn out profits, the equity component will rise in value.
Today, shareholders are sitting on 95% capital gains, valuing it close to £2bn.
WHEN TO BACK OR NOT TO BACK PRIVATE EQUITY IPOs
The last section will look at factors that make businesses a great buy or a big no-no for your portfolio. In most cases, Private Equity firms acquire profitable businesses.
They won’t acquire a business with inconsistent profits or making losses consistently because banks won’t borrow the money. If they do, then the responsibility lies with private equity or retail investors.
Below are some factors why you shouldn’t back IPO from Private Equity: –
–Always check the total borrowing size.
When I did my Debenhams piece. The consortium bought the business for £1.7bn, but Debenhams had debts of £100m.
Three years later, the same valuation was offered in the IPO, but total debt ballooned to £1.9bn.
So, when it comes to valuation, always add net debt to market capitalisation.
Lesson: Always check total debt before the private equity firm took over the business. And again, if they list on the market.
–Checking the competitiveness of the company. So, with Bonmarche, there was no debt (net cash of £10m). But it was vulnerable to a slowdown in consumer spending. The last financial crisis saw it closed 160 stores from a total of 400.
Lesson: Avoid weak competitive businesses with weak brands.
-Sometimes you can’t spot the red flags during the IPO. But trouble starts to brew months later. In Stock Spirit case, Oaktree sold its remaining stake at a discount to current share price. That should raise alarm bells!
The reason was a regulatory change of alcohol taxes leading to a profits warning.
Lesson: Watch out for company’s stake sold at a discount. Also, check with changes to regulatory issues affecting the bottom line.
Okay, but when do you invest in a private equity backed IPO?
–When the private equity firm sold or (value it less) than they acquire for it. But it must be a recognised brand and earns consistent profits.
One reason why a private equity would sell it for less than they acquired is because at the top end of the business cycle.
The other reason is they desperately need to raise money to pay off loan and would sell for any price.
Lesson: Invest when the private equity is putting the firm up for sale.
–When the company paid off most of their loans. Years after the IPO, these profitable businesses go on a deleveraging crusade, but their stock price never recovery.
Because they lost their reputation in the investment community. With market value below IPO and still profitable, it can be your time to invest in the company.
These are just some factors to avoid investing in IPOs. Any companies with these symptoms would be a bad investment, regardless whether it is backed by private equity.
Some IPOs (those AIM stocks) would make a worse investment for the retail investors. Like everything else in life, there is a pro and a con for everything.
CALL TO ACTION
What are your thoughts on Private Equity? Do they do a good job or screw the business long-term sustainability? Leaving them vulnerable to rivals and financial institutions.
Finally, are there private-equity backed IPO that you made a profit from or lost some of your initial investment. Love to hear your thoughts.