Analysis of IPO as an exit strategy for Private Equity firms in the present scenario:

Private equity is essentially a way to invest in some asset that isn't publicly traded, or to invest in a publicly traded asset with the intention of taking it private. In India the concept of PE is very young, dating back to 1990s. PE funds raise money from high net worth individuals, financial institutions, etc. for a period of seven-ten years and then invest in opportunities as and when they arise, either in early-stage, maturing or even public companies. These firms exert a tremendous amount of influence on their portfolio companies. They perform a wide range of activities such as strategic guidance, financing expertise or the restructuring of the companies operating business. In doing so, they aim at creating profits for their investors by increasing the value of the portfolio companies. While private equity firms sometimes pay themselves back using the acquired company's profits, this isn't their principal moneymaking area. Since the target is also to exit the investment in a few years and return money to investors this value creation can only be realized at the exit, i.e. when the Private Equity firm sells off its stake in the respective portfolio company. Rather than making money from guaranteed minimum dividends, etc., private equity firms have been generating most of their profit from the exit event or the time when they either sell the company to another private entity or return it to the public markets, presumably for a higher price than they paid originally. Private Equity houses have a number of routes to exit from their investments. They are: Initial Public Offerings Recapitalization Merger Sale to another private group ( Secondary Buyout ) Sale to a Strategic Buyer

One of these exit strategies is to float the portfolio company via an Initial Public Offering through the stock market. The IPO is seen by many PE firms as the ideal exit route for their investment. It is a notion that these firms can achieve a higher ROI in an IPO than in a trade sale where the PE firm sells the company it owns to another player in the same field . This article focuses on how important is the IPO route to exit. The deal teams constantly monitor the capital markets for suitable times to do an Initial Public Offering or find a strategic investor to sell to. Selling the shares of an IPO company into the primary stock market usually earns large profits for the initial shareholders as IPO shares can be sold into the market at a premium over their pre-IPO value. More profitable the IPO company and the more promising the companys financial present and futu re , the higher is the price at which the shares can be sold into the market. For Private Equity investors an IPOs purpose is therefore to raise as much equity capital and thereby generate high returns on their investments. IPO also provide opportunities for liquidity of
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PE firms and enable their portfolio companies to clean up their balance sheets by increasing equity and using the proceeds of an offering to pay off outstanding debt. IPO as an exit strategy is preferred by PE firms when the market conditions are normal or the market is in a boom as this would help them raise more amount of funds because of the fact that investors would reluctantly pay a premium for their shares and thus would increase the earnings of the PE firm. On the other hand many private equity-backed IPOs, like that of Generac Holdings , have also seen reductions in offering size as volatility had returned to the stock market in 2010 amid the European financial crisis and certain macroeconomic factors . An IPO may deliver higher returns than other forms of divestment through the higher valuations that may be achieved in public equity market. It may also provide the company with continued access to further equity finance to secure future growth. However the IPO process can be costly, with an outcome that may be deemed to be uncertain for PE firms looking for quick and sure exit. Furthermore, IPOs typically involve lock-in agreements with the PE firms to retain a stake in the company for some period after the floatation that may not result in complete exit. As an alternative to floating a company on the stock market in an IPO , the PE firms can exit from their investments by selling off their stakes to other companies ( trade sale ) or to another PE firm or financial institution . They can accept a buyback from companys management or they may have to write off the investment if it has not been successful.

Recent Trends
Market conditions after the downturn caused by the global recession in mid-2008, have started to improve, allowing private equity firms to exit some of the investments made during the boom era prior to 2008 . So, 2010 and 2011 YTD has been a successful year as far as PE-based IPO is concerned. The figure 1 below shows that during 2010, 145 IPOs and share sales had occurred. The figure 2 shows that these IPOs raised an aggregate value of $38.7 billion, twice the aggregate value seen in 2009, and a twelve-fold increase in comparison to 2008, the lowest point for IPO activity in recent years. Figure 3 shows that 17% of PE-backed exits in 2010 came from IPOs and share sales, a significant increase from 2008, when only 5% of exits were made via IPO

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No: of deals
100 90 80 70 60 50 40 30 20 10 0 No: of deals

Figure 1

Aggregate exit value

30 25 20 15 10 5 0 Aggregate exit value

Figure 2
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120 100 80 60 40 20 16 0 2006 12 2007 5 2008 15 2009 17 2010 15 2011 YTD 53 56 57 51 53 53 1 30 1 32 31 16

4 18 26

7 25 Restructuring(%) Sale to GP(%) Trade Sale(%) IPO(%)

Figure 3

Some Facts:
145 IPOs and share sales with an aggregate value of $38.7 billion occurred in 2010. This is twice the aggregate value seen in 2009 and a 12-fold increase from 2008. 17% of private equity-backed exits in 2010 came from IPOs; this is a significant increase from 2008 when they accounted for 5%. PE-backed IPOs in 2010 surpassed pre-financial crisis era levels with a 12% and 29% increase in the number of PE-backed flotations in comparison to 2006 and 2007, respectively. In 2011 to date there have been 11 IPO exits worth a collective $10.2 billion. This includes the refloating of Kinder Morgan , the only second exit ever to raise over $2 billion. Shares were priced above the expected range due to strong demand. HCA Holdings, the largest hospital operator in the US, which priced 145 million shares to raise US$4.4b was the third exit ever to raise over $2 billion. Trade sales continue to dominate the exit market, accounting for 53% of exits in 2011 to date. Secondary Buyouts and restructurings account for the remaining 25% and 7% respectively.

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The number of private equity-backed buyout IPO and private placement exits increased significantly during 2010, and it is hoped that the trend is set to continue over the coming months because some of the PE deals which were made in the precrisis period are to mature and some firms who had postponed their exit due to the financial downturn in 2008 are looking forward to divest their holdings in their portfolio companies. The returning appetite of investors has fuelled several notable PE-backed IPOs/private placements since the start of 2010. Despite a global events-driven slowdown across the broader IPO market, PE-backed companies executed some of the largest sponsored IPOs in history in the first quarter of 2011. In aggregate, PE-backed companies raised US$13.5b in 20 separate transactions in the first three months of this year, compared to US$7.2b in 27 deals in the same period in 2010. Despite ongoing uncertainties in the markets, the first months of 2011 saw the record for the largest-ever PE-backed IPO broken twice in rapid succession and proved to be record breakers. In early February, Houston-based pipeline operator Kinder Morgan completed a US$3.3b IPO on the NYSE. For a short period of only a few weeks, this was the largest PE-backed IPO on record. Then came HCA Holdings, the largest hospital operator in the US, which priced 145 million shares to raise US$4.4b in proceeds, making it the largest sponsored offering in history, and the largest IPO on a US exchange since General Motors raised US$18.1b in August 2010. The floatation of TDC A/S, a Danish telecommunications company which was backed by Apax Partners, Blackstone, KKR, Permira and Providence Equity Partners and was purchased back in 2006 for DKK 76 billion, one of the largest buyout deals in Europe at the time. The firms offering was fully subscribed in December 2010, raising DKK 12.3 billion. Market volatility stemming from unrest in the Middle East and the disaster in Japan took its toll on new issuance momentum in the latter half of the first quarter . Globally, 294 companies (both sponsored and non-sponsored) raised US$46.9b over the last three months, down 13% from the same period in 2010, when companies raised US$54.1b in 300 initial public offerings. In aggregate, eight companies backed by PE firms pulled their IPOs in the first quarter due to decrease in attractiveness of the market conditions. One reason for anticipated increase in PE-backed IPO is the large buyouts during the boom years of 2005 to 2007 due to which private equity firms now own many of the biggest companies in any given sector, a big change from the past. Another

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reason is that private equity-backed companies are going to make up a majority share of the IPO market for some time to come, as firms take public the companies that went private during the boom years. By the end of the quarter1 2011, 70% of first quarters PE-backed IPOs were trading above their IPO price, with an average increase over issuance price of 14.0%. Chinese internet company Qihoo 360 Technology, backed by CDH China Holdings, was the best-performing IPO of the quarter. The company, which operates in the mobile and internet security space, opened up 86% in its NYSE debut, and closed out March up 104%, making it the highest-performing US IPO of the quarter. The quarters large IPOs did well also Nielsen Holdings, in particular. The shares gained 18.7% over the companys IPO price. 2011 could be the biggest on record for PE-backed IPOs, given increasing demand for new issuances and ample supply. PE-backed IPOs have performed well as a group with investors seeing good returns on deals both recently and over the last year.

Some of the notable PE-backed IPO in recent times:

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US Leads the world in listing IPO based PE exit:

There were a total of 25 US IPOs recorded in NYSE which raised an amount equal to $14.7 billion. NYSE Euronext lead IPO Markets Globally in First-Quarter 2011 . This strong IPO momentum was backed by various PE-backed IPO deals , where some deals have proved to be the largest of its kind in the world till date , the most important ones being IPOs of HCA Holdings , Kinder Morgan , The Nielsen Company and BankUnited . HCA Holdings IPO - HCA the hospital chain sold 126.2 million shares at $30, the top of the range initially proposed. . HCA was taken private during the boom period of 2006 in a $21 billion deal, excluding debt, that involved Bain, KKR , Bank of America Corp , Citigroup Inc and HCA's founder, healthcare mogul Dr. Thomas F. Frist Jr. It went public on 9th March 2011 with the firm raising $3.79 billion in its IPO making it the largest US PE-backed IPO. After the IPO, the leveraged buyout investors and the Frist family are expected to more than triple their 2006 investment. HCA's success is expected to encourage a slew of similar IPOs of private equity investments made at the height of the credit bubble in 2005 to 2007. Kinder Morgans IPO - Mr Kinder the CEO of Kinder Morgan and the private equity firms, which included funds Goldman Sachs, Carlyle Group, Riverstone Holdings and Highstar Capital, took the company private in 2006 for $22bn, which included $15bn in equity along with $7bn in debt. In February 2011, the firm went public when its IPO raised an amount of $2.9 billions making it the second largest PE-backed IPO. It sold 95.5 mln shares vs 80 mln
expected and it is the biggest U.S. energy IPO since 1998.

IPO as an exit strategy .. A hit or a miss!

According to data reported by Thompson Reuters IPOs lose sheen for private equity firms looking to exit as more than 20 venture-backed IPOs were completed in the first six months of 2010, but only three of those offerings priced above their filing range. The number of IPOs completed in 2010 was higher than 2009 but during this first six month period of 2009 , more IPOs were abandoned (71) than completed (68). Accordingly, an IPO may not be the best exit strategy for every portfolio company, but the public markets do present an exit and as firms are eager to liquidate their portfolios, they continue to compare an IPO to other exit options. There is also underpricing involved in an IPO. IPO underpricing arises by information asymmetries associated with a firm's first public equity offering. Information asymmetries between the firm, the underwriters, the informed investors and the uninformed investors create uncertainty regarding the security pricing which results in the discount of those

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securities at the time of the initial public offering and thus reducing the returns to these firms. Rising inflation and interest rates have raised fears the markets may not improve much in the next five-six months. PE firms that wanted to list their portfolio companies three-four months ago now are wanting to opt for other modes of exit. IPO and Other exit strategies: Fear of private equity firms practicing window dressing when presenting investee companies to public markets is common in the IPO investor market. Private equity firms wish to maximise their exit value and, indeed, have a fiduciary duty to their Limited Partners to do so. Accordingly, they maximise their exit values by showcasing investee companies in the best possible light when presenting them to investors at IPO. While private equity firms are thought to add considerable value to investee companies through their enhanced access to resources and improved corporate governance, not all private equity activities at IPO are considered to have lasting positive effects. Substantial concerns have been voiced over cash stripping, accounting manipulation and short-term cost cutting to maximise reported profits. Due to such reasons other methods of exit would give a better picture and proper information to the investors. One needs to bear in mind that besides the high notional valuation that an IPO may create in some circumstances, the certainty of being able to exit on account of liquidity, price realisation and regulatory constraints may make a trade sale or a strategic sale or an M&A exit a more real and profitable exit. Time value of money is also paramount for PE investors, as most of them invest with a certain time-specific horizon. The end of 2010 witnessed one among the largest exits in the Indian private equity sector, wherein PE majors Actis and Sequoia together made a cool $500-million profit through the sale of portfolio firm Paras Pharma. There is also an anticipation of a big-ticket M&A deal, in which General Atlantic is to exit Patni Computers. In the private equity cycle, the choice of a successful method to exit its investments is one of the most critical choices faced by private equity investors. Of the exit options faced by private equity firms secondary buyout has gained huge importance since 2000. The greater accessibility of the credit market, manifested in the loosening of covenants and the reduction in spreads charged by the banks made the purchasing private equity firms willing to pay more and so the selling private equity firm took advantage of this by selling at a higher price. Although secondary buyouts are not the preferred exit route, private equity funds are not willing to give up on the benefits of a quick exit and a better return .

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Future Prospects:
There are currently 56 PE-backed companies in registration to go public, which could raise an aggregate US$14.7b across global exchanges. In addition to companies that have formally filed, the sometimes volatile nature of the 2009-2010 market has also led to a sizeable shadow pipeline of PE-backed companies that either have yet to make an initial filing, or previously withdrew an IPO due to negative market conditions. Many of these companies are likely to pursue an IPO during 2011. As PE firms seek to exit some of the largest businesses acquired between 2005 and 2008, this year could eclipse the 2007 PEbacked IPO peak, when US$58b was raised from IPOs. Investor appetite for such deals has been tested and reinforced over the last several quarters benefiting from continued momentum in the global equities markets. In the absence of additional economic shocks, the conditions appear to be ripe for one of the most active years on record. The year 2011 is likely to witness maximum number of private equity/venture capital exits in the history of Indian PE industry. The typical cycle of investment-exit is expected to get completed in 2010-11 for many PE investors here.There will be more exits in 2011 as compared to previous years, since the portfolio companies are getting matured. Investments made in 2003, 04 and 05 are matured now and will be able to provide good returns for investors. December 2010 witnessed the largest ever exit in PE, wherein Actis and Sequoia together made a $500-million profit through the sale of portfolio firm Paras Pharma. 2011 will witness the continuation of exit process, which began in 2010. The maximum number of PE/VC investments took place in 2006-2007 when the balance sheets as well as the profitability of the portfolio firms were pretty good. The downturn made the year 2009 tough for exits and 2010 saw change in performance and the euphoria was back. As the reflection, more exits are expected in 2011 and 2012. According to VCCedge, exits worth $5 billion took place in 2010 through 164 deals against 103 exit deals worth mere $2.1 billion in 2009. Buyback was the preferred route in 2010 as deals worth $1.7 billion took place. The next preferred routes were open market ($1.5 billion) and M&A ($1.2 billion). There is an increased interest from foreign companies looking at buyouts in India. As they are aggressively looking to expand growth markets, they are willing to pay a premium for the right assets; Indian promoters see them bringing in vast experience and technology apart from capital. A number of private equity players who have taken up controlling equity positions in the past will continue to use this route to exit their holdings at an attractive multiple.

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PE/VC EXITS 2009 Year 2010 value

Exit Exit Exit Exit value volume volume ($ mn) ($ mn) 6 2 18 69 500 31.64 15 15 1695.32 502.22 1238.13 1448.54

Buyback IPO M&A Open market

157.97 40 1390.1 76

Secondary 8 sales

78.17

18

160.85

As market conditions have started to improve, private equity firms have been able to exit some of the investments made during the boom era. There have already been several notable private equity-backed buyout exits in 2011, and with numerous forthcoming proposed deals in the pipeline, 2011 looks set to be a record breaking year for these exits. However, investors are now more cautious about the level of leverage, at which a company operates, with many now expecting the private equity company to hold stakes in the operating company and use the proceeds from the IPO to pay down debt. This could impact on the success of the IPOs of the more highly leveraged companies from which private equity firms are seeking to exit.

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