The PIPEs Are Flowing

Small public companies can find it less costly to raise new money privately, but only if they can find the right investors.

When Evergreen Solar needed a fresh infusion of capital in 2003, the public markets were not the place to go. True, Evergreen had encountered little difficulty going public in November 2000. But that was before the stock-market bubble popped, and before Enron’s demise fouled conditions for any company that even vaguely posed an investment risk. “The public markets were shut down for almost every type of energy company,” says CFO and co-founder Richard Chleboski.

Investing in the Marlboro, Massachusetts-based solar energy equipment manufacturer isn’t much safer today. Its business, like biotechnology and other research-and-development-oriented manufacturing, requires considerable capital to produce expensive products, and lots of time to produce significant returns. And the public markets these days are notoriously impatient.

So in May of last year, the company turned to the private markets via a hybrid security called a PIPE (for private investment in public entities) — an instrument developed by Wall Street in the late 1990s, and once associated with the kind of “last resort” capital that companies with poor fundamentals were forced to seek.

For Evergreen, which is considered to have healthy prospects despite the market’s skepticism last year, the deal provided $29.5 million in additional financing, in the form of preferred stock convertible into common equity. Enticing institutional investors was a discount of 25 percent from Evergreen’s public-market price — compared with an average 9 percent discount for other PIPEs at the time — and warrants giving an investor the right to sell the stock at a hefty 125 percent premium over the PIPE’s offering price after the deal was registered with the Securities and Exchange Commission.

Evergreen is far from alone in getting capital to flow through PIPEs instead of the public markets. According to Sagient Research Systems, a San Diego firm that tracks PIPE deals, the number of transactions completed so far this year has already exceeded last year’s 926, and should approach 2000′s record of 1,253 (see “Wrenching Up Again, below”). The Evergreen PIPE was unusual in key respects, though, and generous pricing wasn’t the most critical difference. The conversion rate was fixed, for one thing, and Chleboski and his team did the deal without hiring an investment bank to help arrange it. Those differences helped Evergreen avoid the problems that other small, yet-to-be-profitable companies have experienced trying to raise money through PIPE deals — problems often associated with their attraction for short-selling speculators interested in driving down the price to make a killing. Indeed, last June Evergreen raised another $20 million through a second PIPE, this one for common stock placed through a bank. And it has seen its stock price climb 124 percent since its first PIPE issue.

Broken Pipes

Other corners of the PIPEs market continue to attract trouble. Among the most worrisome of the potential woes is the possibility of stock-price manipulation. Last summer, the SEC launched an inquiry into apparent PIPE-related price manipulation, suspecting that short-selling in advance of transaction announcements was causing huge declines in the share prices of several PIPE issuers and increasing the cost of the deals. In one suspected case last November, involving small software maker Faro Technologies, short-selling was believed responsible for driving the price down 11 percent in advance of a $40 million deal. And some companies have fared even worse. Pharmaceutical maker Durect, for instance, saw its stock lose nearly half its value between the announcement and closing of a deal done earlier this year.

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