Why Private Equity is going Public
In short:
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There are several reasons that help us understand why private equity is going public.
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The first and foremost driver of such is the hot issue market.
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Additional reasons which have helped in this IPO frenzy include the rise in both the SPAC and growth equity industries.
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However, many PE firms still prefer the traditional route of raising debt, due to its advantages.
‘Hot Issue’ Market
Historically, market conditions have played a massive role in the timing and clustering of Initial Public Offerings or IPOs. The ‘Hot Issue’ market can be observed in Figure 1. In the figure, we see a notable correlation between the avg initial daily returns (an indicator for market performance) and the IPO count (number of IPOs in the US in that given year).
Figure 1
©️ From a paper by J. Ritter, 2016. The clustering number of IPOs in the US on a given year coincides with an elevated avg first-day returns. This goes to show that executives tend to time their IPOs in a manner that fully accounts for broader market conditions.
Similar to Figure 1, in a report published by EY on December 2021, Figure 2 illustrates a similar trend in the markets.
Figure 2
©️ EY, Dec 2021. The figure shows the absolute number of Initial Public Offering (IPO) deals. A notable increase can be seen from 2020 onwards - as a result of monetary policy and fiscal stimulus to combat the covid-19 pandemic. 2021 was a record-breaking year. With quantitative tightening and inflationary-combating policies coming up, will 2022 be an inflexion point for the IPO trend?
Figure 3
©️ EY, Dec 2021. Figure 3 breaks down the number of IPOs by the exchange. A notable y/y increase of 70% and 151% to the number of IPOs on the Nasdaq and the NYSE, respectively. This is adding fuel to the fire of a ‘hot issue’ market.
As it relates to financial companies and private equity. The same report by EY provides clarity in the IPO deals by sector. This goes to show that equity markets surely rallied and executives managed to time their IPOs well.
Figure 4
©️ EY, Dec 2021. Figure 4 shows the notable increase in the number of IPOs by sector. A notable increase can be seen in the tech sector with a 76% increase y/y from 2020 to 2021. The financial sector also saw a y/y increase of 116% from 2020 to 2021.
The pandemic brought along much of the desired fertilizer to financial markets – expansionary monetary policy along with fountains of stimulus. Eleven listed private equity firms collectively gained nearly $240bn in market value in 2021. London-based Bridgepoint, New York-based Blue Owl and Paris-based Antin Infrastructure Partners all listed last year. The latest of the private equity giants to go public is one of the largest US buyout firms, 30-year-old, TPG. European firms CVC Capital Partners and Ardian and US-based L Catterton have all had conversations with advisers about potential initial public offerings. Listing on the public market has enabled the listed players a much larger pool of funds, resulting in diversifying their funds and activities.
Previously, some of the largest private equity players had timed their IPOs around times of crisis. KKR, Carlyle, Apollo, and Ares have all gone public between 2010 and 2014; with Blackstone having listed in 2007. Hence, it came as no surprise when Bridgepoint, Blue Owl, Antin Infrastructure Partners, and now TPG, went public around the time of the pandemic crisis. This is in line with expected managerial behaviour and empirical market observations.
Figure 5
©️ Financial Times, Jan 2022. Figure 5 shows the surge in listed private equity firms’ valuations, by market cap. All firms have seen an increase in absolute terms of market value increase ($bn). By far, the largest such increase belongs to Blackstone, with over 880bn AUM. This left a disparity between the listed and unlisted PE firms.
Adding fuel to the fire
With the market conditions ripe for an IPO and valuations skyrocketing, an additional boost given to the private equity markets come in the form of SPACs. Special Purpose acquisition companies are formed for the purpose of acquiring one or more operating companies pursuant to a business combination. Prior to having a specific target for the business combination, the SPAC raises the funds through a public offering of the SPAC’s equity securities, with the private equity sponsor retaining 20% of the post-IPO SPAC. The SPAC IPO market has seen significant demand in recent years, which has further encouraged private equity sponsors to take advantage of SPACs. As we can see from figure 6, SPACs typically have a liquidation timeline (expiry date) of around 24 months. In fast-paced and greedy market conditions, PE SPAC sponsors saw the opportunity in jumping in. Due to the nature of SPACs’ acquisitions, when a SPAC raises relatively large funds, their target firm can also be much larger. The desire to tap into the SPAC market expansion helped sway the decision of some executives in going public and gaining access to much larger pools of capital. Hence, this added fuel to the fire of private equity’s listing frenzy.
Figure 6
©️ PwC, Feb 2017. The figure above shows the SPAC lifespan from initiation to the time of returning funds to shareholders.
Figure 7
©️ S&P Global Market Intelligence, Sep 2021. The number of private equity-backed SPACs increasing by 82% y/y from 2020 to 2021. The overall number of SPACs saw a CAGR of 41% between 2019 and 2021.
Growth Equity
Another reason also helping expand the market is the rise of the so-called ‘growth equity’. Growth equity is driven by the fact that the private equity and venture capital heavyweights have immense amounts of ‘dry powder’ to invest, which is then spilling into investing in the industry. By nature, growth equity is more mature than traditional venture capital investing, but with less cash flow generation than what private equity traditionally invests in. They have a proven business model with sure abnormal returns in the future.
Figure 8
©️ Crystal Capital Partners. The figure shows that growth equity is lodged in between the stage of venture capital and buyout (private equity). Their cash flow generation is ideally at an inflexion point, right in between early and accelerated growth.
Figure 9
©️ Financial Times, Jan 2022. Growth equity has seen the highest CAGR out of all the types of AUM, 21%.
Alternative Way of Raising Capital
Not all private equity firms prefer the path of the public market. The advantages of issuing debt to raise capital include avoiding dilution of ownership, tax advantages by deferring some capital gains, and not requiring registration with the US SEC.
Figure 10
©️ Financial Times, Jan 2022. Figure 10 shows Warburg Pincus and Bain Capital to be the only 2 firms with higher than $1.4 billion in debt sold during 2021. With 4 firms selling debt worth $1 billion or above.
Concluding Remarks
In conclusion, developing consensus is valuations are high. “If there is one thing most people agree that private equity firms are good at, it is knowing when to sell,” said Peter Morris, an associate scholar at the University of Oxford’s Saïd Business School. “Why not themselves?”
However, as much as things have been going well for equity capital markets (ECM) over the last 2 years, there are many who believe that, with the pandemic ending in sight and inflation on the rise, we are at an inflexion point. Central Banks have been quantitative tightening (QT) and implementing contractionary monetary policy to try and tame this heating engine that is the economy. This will no doubt have implications on equities and deal flow. Many financial institutions have already said that 2022 probably will not be as good as 2021, in terms of funds raised or deals stuck. Hence, it is worth noting that this IPO frenzy may be declining in the near future.
