Speak Softly and Carry a Big PIPE

Raising capital in a recession is tough, but some established companies are turning to private-investment-in-public-entity transactions known as registered direct offerings. Here's why.

Amid today’s capital-markets cacophony, the ability to raise money quietly is especially attractive. And for many, private investment in public equity transactions (PIPEs) seem to be a silent, safe haven for issuers unsure whether an offering will attract investors. “The last thing a company wants to do is go to the market publicly and fail,” notes Stuart Bressman, an attorney at Proskauer Rose, who works on PIPEs.

It was not always thus. During the Internet bust the private placements were often a capital-raising approach of last resort for smaller public companies closed out of the wider markets. But now, Bressman says, PIPEs have matured to become relatively mainstream, What’s more, a subset of the PIPE, known as a “registered direct” transaction, has also come into its own, and is being used by big and small companies.

Registered direct deals are PIPEs that involve shares already registered with the Securities and Exchange Commission. Completing the regulatory paperwork early through a shelf registration gives companies two to three years to issue the shares, thereby allowing them to move quickly when the market conditions are right, says Bressman. The company’s board of directors must approve the issue, in the same way they would approve any secondary offering. But a registered direct offering is presented only to a tiny group of hand-picked investors and brokered bilaterally by an investment bank acting as a placement agent, rather than an underwriter.

OrientExpress OGrady2Orient-Express CFO Martin O’Grady saw a need for speed when opportunity knocked, so he worked with bankers to place nearly 8.5 million shares with select investors.

Nearly eight years after the air oozed out of the Internet bubble, investors and large, well-known issuers have become more comfortable with the idea of buying and selling stock behind closed doors. As a result, some big names are taking their cue from smaller companies and completing registered direct deals.

For example, in October, tax service retailer H&R Block Inc. sold 8.3 million shares of common stock at a price of $17.50 per share through a registered direct offering. The company plans to use the proceeds to “enhance capital and maintain financial flexibility,” according to its regulatory filing.

Then in November, luxury travel and leisure company Orient-Express Hotels Ltd. announced a registered direct offering of almost 8.5 million common shares priced at $6.50 per share. The travel company expects to use the net proceeds for general corporate purposes, which could include reducing debt, capital investment in existing properties, and funding working capital needs.

So far this year, there have been 78 registered direct deals totaling $2.9 billion in gross proceeds, which represents about 8 percent of the 969 PIPE transactions completed in 2008 for an aggregate $108 billion, reports Sagient Research, which runs the PlacementTracker database. However, despite the interest from large companies, this year’s deal tally trails the totals for the previous two years, which reached 107 ($3.7 billion) and 104 ($3 billion) for 2007 and 2006, respectively.

“Our preference would have been to make a rights issue,” says Orient-Express CFO Martin O’Grady, which is more common in the UK market. But the finance chief tells CFO.com that such a deal would have taken longer. “We saw a window of opportunity to raise cash in an accelerated timeframe in a discrete manner. In essence we did a ‘targeted rights issue’ and reached out to our key investors, including our more active, more vocal hedge fund investors,” notes O’Grady. Based on PlacementTracker data, the Orient-Express offering, which raised more than $55 million, was the tenth largest deal in terms of gross proceeds completed this year (see chart.)

O’Grady’s need for speed pointed him in the direction of a registered direct deal, as the transactions are closed lightening fast. Investors commit to the deal upon pricing, and within three days the transaction is closed and the stocks are tradable the next day, explains Richard Gormley, a managing director with investment bank Lazard, the placement agent on the H&R Block and Orient-Express deals. Because the shares are registered when they are sold, and therefore “fully liquid,” the stock tends to command a better price for the issuer than a PIPE deal done with unregistered shares.

Coming Direct to You
Ranked by gross proceeds, here are the largest registered direct transactions of 2008 — so far.
Company name Closing date Gross proceeds* Purchase price per share Shares issued* Discount at closing
St. Joe Company 3/3 $600m $35.00 17.1m 8.97%
Solutia Inc. 11/8 $290m $13.00 22.3m 15.80%
Regent Energy Partners 7/25 $200m $22.18 9m 7.58%
Solutia Inc. 8/21 $150m $14.00 11m 8.68%
H&R Block 10/22 $145m $17.50 8.3m 2.62%
Crosstex Energy 4/9 $100m $30.00 3.3m 8.28%
Omega Healthcare Investors 5/1 $100m $16.93 6m 3.26%
Vivus Inc. 8/6 $ 65m $ 7.77 8.4m 16.00%
Kinder Morgan Energy Partners 2/12 $ 60m $55.65 1m 3.37%
Orient-Express Hotels 11/14 $ 55m $ 6.50 8.5m 21.97%
*Rounded up.
Source: Sagient Research, PlacementTracker, December 2008.

Better pricing also means that the issuer generally can offer the select investors an attractive discount. For instance, according to PlacementTracker, Orient-Express stock was offered at a 22 percent discount, while specialty materials and chemical maker Solutia Inc. offered a 16-percent and 9-percent discount to investors on the two deals it completed in 2008.

There are other advantages too. With a registered direct deal, a company can shop the issue to key investors. “You can cherry pick who is going to give you the best deal, and do that within a week,” insists Bressman. Also, registered direct deals give more control to the companies selling stock, adds Gormley.

He explains that the issuer — rather than the investment bank — allocates the shares and has more flexibility to cancel the transaction if it doesn’t like the pricing, “because nothing is announced until the transaction is complete.” To be sure, a holder of unregistered shares cannot sell the stock for 90 to 120 days, and as a result, investors demand to be compensated for that illiquidity with a better pricing discount.

Pricing pressure plays another part in the registered direct story, contends Bressman, who explains that downward pricing pressure caused by short-sellers is what led many small and mid-size public companies to take the private placement route in the first place. Consider that one trade-off issuers must make regarding registered direct deals is that they give up the exposure of a traditional secondary offering in exchange for the secrecy of a private placement.

That means, lesser-known companies agree to forego the public road shows that provide them important exposure to analysts and investors to fend off short-sellers. By not drawing attention to the secondary offering, companies lessen the chance that short-sellers will depress the price of the stock in advance of the offering so it can be bought up at a discount when the new stock is issued.

Short-sellers have a much harder time depressing the stock of large, well-established companies. Still, when the stock market is highly erratic, as it is currently, short-selling on public information can disrupt even the stock prices of the bluest blue chips, warns Bressman. He speculates that that may be one reason why larger companies are now using registered direct offerings.

The attorney also points out that a registered direct transaction is less expensive than a secondary offering because all the regulatory paperwork is already done. One measure of cost comes from Orient-Express, which said it paid $250,000 in fees to complete its Nov. 14 deal.

For long-term investors like Berkshire Hathaway’s Warren Buffett — who completed a PIPE deal in November, investing $300 million in USG Corp. — it does not make a difference whether the issuers use a traditional PIPE or registered direct structure. It’s likely that Buffett just wants an opportunity to negotiate a deal quietly, reckons Bressman.

“But to me, a registered direct is an effective vehicle, because when you have a panicky market, you want to have more control over the process of selling securities, you want to have the benefit of having enough time to negotiate a deal that makes sense, and you want the ability … to tell the investor that ‘we’re going to walk if we don’t get a good deal.’”

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