There has been a trend recently that when private equity firms take one of their portfolio companies public, they pay themselves a huge dividend before the IPO. Burger King is one example: a $367 million dividend was paid out to Bain Capital, Goldman Sachs and Texas Pacific Group. The dividend is usually funded by debt financing which goes on the company balance sheet. If this is leaving these companies vulnerable to bankruptcy, then maybe they are good short candidates.
In theory investors should note the added debt and lower the price they are willing to pay for the IPO. Do they do this? Its hard to tell since we don’t know what the offering prices would have been without the debt. If investors are only looking at multiples such as P/E ratio, then the reduction in share value will be a function of how much the added interest expense affects earnings.
Should private equity ownership before an IPO be a reason per se for selling short a company? No. The company should be viewed on its fundamentals: valuation, riskiness of its indebtedness, sales prospects, likelihood of insider sales, etc. All things equal, private equity investors may be a good thing for a company if they provide management expertise or are especially vigilant about their investments. Some private equity investors are adamant that they look after their portfolio companies in ways mutual funds and other institutional investors can’t. On the other hand, private equity firms are getting larger and larger and their attention span may becoming stretched. They also generally retain large stakes even after the IPO, and these get unloaded in future secondary offerings. This supply overhang could in theory keep the stock price down.
Acting on this theory, I have recently shorted both Burger King (BKC) and J Crew Group (JCG). They have high valuations (P/Es of 45 and 77 though falling), high debt, recent secondary offerings and large stakes still held by private equity firms. I’m near break-even so far. We shall see what happens.
For more info on private equity see:
Special Report of Private Equity (The Economist)
Private Equity Public Offerings (MarketWatch)
This Dog Was Fixed (SD Reader story on Petco)
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Trading Idea: Shorting Private Equity IPOs
There has been a trend recently that when private equity firms take one of their portfolio companies public, they pay themselves a huge dividend before the IPO. Burger King is one example: a $367 million dividend was paid out to Bain Capital, Goldman Sachs and Texas Pacific Group. The dividend is usually funded by debt financing which goes on the company balance sheet. If this is leaving these companies vulnerable to bankruptcy, then maybe they are good short candidates.
In theory investors should note the added debt and lower the price they are willing to pay for the IPO. Do they do this? Its hard to tell since we don’t know what the offering prices would have been without the debt. If investors are only looking at multiples such as P/E ratio, then the reduction in share value will be a function of how much the added interest expense affects earnings.
Should private equity ownership before an IPO be a reason per se for selling short a company? No. The company should be viewed on its fundamentals: valuation, riskiness of its indebtedness, sales prospects, likelihood of insider sales, etc. All things equal, private equity investors may be a good thing for a company if they provide management expertise or are especially vigilant about their investments. Some private equity investors are adamant that they look after their portfolio companies in ways mutual funds and other institutional investors can’t. On the other hand, private equity firms are getting larger and larger and their attention span may becoming stretched. They also generally retain large stakes even after the IPO, and these get unloaded in future secondary offerings. This supply overhang could in theory keep the stock price down.
Acting on this theory, I have recently shorted both Burger King (BKC) and J Crew Group (JCG). They have high valuations (P/Es of 45 and 77 though falling), high debt, recent secondary offerings and large stakes still held by private equity firms. I’m near break-even so far. We shall see what happens.
For more info on private equity see:
Special Report of Private Equity (The Economist)
Private Equity Public Offerings (MarketWatch)
This Dog Was Fixed (SD Reader story on Petco)
Like this: