Public or Private? IPOs May Be Set to Take Off

After the announcement of Panera’s deal to be taken private by JAB Holdings in April 2017, the company was quick to tout the benefits of exiting the public markets. "Being private is a point of competitive advantage," CEO Ron Shaich explained to CNBC.

Fortunately for Panera and other companies looking to exit the public markets, private equity firms are eager for new additions to their portfolios. Financial data provider PitchBook reported that private equity dry powder hit a record $552.6 billion in the third quarter of 2016, leading to increased competition and valuations among firms. Meanwhile, 2016 marked the slowest year for US IPOs since 2009, according to Dealogic.

Despite a multitude of factors working against the IPO market, there is reason to believe that 2017 could be the start of a resurgence of IPOs. Data from Dealogic shows that 29 IPOs priced in the first quarter of 2017 on a US exchange to raise over $13.4 billion (including Snap Inc.’s $3.4 billion offering), compared to a disappointing 9 IPOs raising $1.2 billion over the same period last year.

Much of the IPO attraction can be attributed to financial sponsors gravitating toward the public market’s returns. The major equity indices’ healthy gains over the past year have extended to companies that recently completed IPOs, with the Bloomberg IPO Index posting a 25% return over the last 12 months.

Retaining Upside

While private equity firms typically lack the ability to sell the entirety of their positions through an IPO alone, they have the advantage of retaining upside once their portfolio companies become publicly traded. Last April, Clayton Dubilier & Rice (“CD&R”)-backed SiteOne Landscape Supply Inc. priced a $242 million initial public offering, representing one of the first financial sponsor IPOs to price in 2016. Within a month of the lock-up expiration, CD&R sold an additional 10 million shares at $33 a share, a 57% increase over the IPO price. Sponsors with the patience and willingness to take on share price risk may find it worthwhile to pursue an IPO instead of a quick exit via a sale.

Regardless of the returns, the IPO market’s momentum can only continue with companies whose best interest is served by being a standalone public company. Equity investors in Bats Global Markets Inc. sold $444 million of their holdings through an IPO and two subsequent follow-ons in 2016, only to ultimately be acquired by CBOE Holdings less than a year after going public in March 2017.

Acquisition Struggles

In many instances, IPO candidates may find that there is no ideal acquirer. As shifts in technology have led to increased convergence of digital companies in traditional industries, many firms are finding it difficult to find a strategic buyer that’s willing to pay for lofty tech valuations. Identity management software provider Okta was rumored to be seeking a buyer before ultimately completing an IPO in early April 2017. The $215 million offering priced at $17 per share, above the initial $13 to $15 announced range.

Even if IPO candidates are able to successfully find an acquirer, difficulties can arise when a company with a longstanding track record of profitability takes on a high-growth startup and must reconcile traditional valuation benchmarks like P/E with revenue-focused metrics for the newly acquired business. An IPO avoids those issues and provides a path that allows investors to easily and objectively value the company.

Balancing Objectives

Still, Panera’s concerns over the hurdles faced as a public company are echoed by many other firms. Management teams that find it difficult to balance the short-term demands of investors with the company’s long-term objectives may ultimately find that staying private is an easier solution.

Snap Inc. recently attempted to resolve some of these issues by only issuing no-vote stock in the IPO. By retaining voting control for the founders, the chair of Snap’s board, Michael Lynton, claims that the structure “will provide substantial future benefits” to both the company and its stockholders. Despite vocal pushback from investors, the stock priced at a valuation of more than $20 billion despite never having turned a profit.

It’s remains to be seen whether a smaller IPO candidate without the same level of interest could show similar success with a dual class structure. But if investors expect to see IPO growth continue, they should be prepared for companies to find new ways to sidestep public investors’ demands, especially when there are alternative capital-raising options readily available without the pressures a public company faces.

About the Author

Rebecca Monico is a vice president in equity capital markets at KeyBanc Capital Markets. She specializes in the origination and execution of initial public offerings and secondary equity and equity-linked offerings. Rebecca holds the Chartered Financial Analyst designation and is a member of the CFA Society of Cleveland.