Peter Fogel September 10, 2013
Private equity firms are renowned for their long-term planning and impeccable attention to detail, but many investors have found that when it comes time to exit, it’s best to keep your options open. On September 9, Ares Management and Canada Pension Plan Investment Board (CPPIB) announced they had reached an agreement to acquireNeiman Marcus from Warburg Pincus and TPG through a secondary buyout valued around $6 billion. Earlier this summer, Neiman Marcus filed for an opaque $100 million IPO, but it was by no means clear that Warburg Pincus and TPG ever intended to follow that path to fruition. Shortly after Neiman Marcus filed its S-1, rumors abounded about a club deal with KKR and CVC to acquire Neiman and possibly roll it up with KKR’s other luxury retailer target, Saks. That potential faltered when Saks was acquired by Hudson’s Bay in July, and since then talks between Warburg Pincus and TPG and Ares and CPPIB have been moving closer to a deal. It seems as though the IPO filing was, for the most part, simply a backup plan employed by the private equity firms in what is known as a dual-track strategy, which is intended to drive up the price that an acquirer would need to offer to close the deal.
The strategy of pursuing multiple exit options simultaneously is not new, but has been coming into vogue in recent years. With soaring equity markets, IPOs have returned as a very viable exit option for both private equity- and VC-backed companies (as PitchBook’s forthcoming Exits Reports detail). Following the financial crisis, public markets are soaring and private equity sponsors that are desperate for exit options are seeking to take advantage of this. There are multiple ways that a private equity or venture capital firm can take advantage of inflated public markets. Firms can take their portfolio companies public while maintaining large stakes and benefiting from the expected upside of continued strength in the stock markets. At the same time, there are significant benefits for investors to seek the dual-track in a strong market environment. Firms are able to create a price tension between the markets and potential acquirers, thus allowing price premiums to be harvested by investors regardless of the final exit route.
A study published in the Journal of Business Venturing has quantified the premium paid for PE investments realized via dual-track exits versus single-track exits. The study examined 679 exits from 1995-2004 and shows that private companies following the dual-track strategy earn a 22-26% higher premium than single-track strategies. Following the dual-track and filing for an IPO, the company is able to signal its financial strengths to potential interested buyers. It also allows firms to indicate to potential buyers that it is open to the idea of a takeover having already established a price floor through its filings, thus creating an auction environment, which auction theory would show to drive prices higher.
The benefits of the dual-track exit strategy seem to have benefited Warburg Pincus and TPG in the Neiman Marcus deal, which carries a 10.3 valuation/EBITDA multiple (with an EBITDA of $583.8 million for the 12 months ending July 28, 2012). This represents a 24% premium compared to the median multiple for private equity-backed exits in the first half of 2013, as shown in PitchBook’s Exits Report detailing exit trends and multiples.
As one would expect, the dual-track strategy is more prominent when public markets are healthy and capital markets are functional. These conditions allow both strategies to be viably profitable options. PitchBook’s data shows that over the last 14 years, the number of companies following the dual track exit strategy has peaked in 2000, 2007, and is at its highest level ever so far in 2013.
Recently executed dual-track exits:
We expect this trend to continue for multiple reasons. First, the public markets are at an all-time high, making IPOs especially attractive for investors. Secondly, private equity firms need to be looking for an exit as the inventory of platform companies is at an all-time high. And the most recent development is the enactment of the JOBS Act, which enables companies to file a confidential S-1. This allows companies and their investors to register with the SEC without having to divulge important financial information. Private filings would not remove the leverage of the dual-track strategy, as companies will still be able to leverage public company valuations to command a higher price. Expect to see a surge in registrations that do not necessarily come to fruition.
– Photo by Marc Ryckaert from Wikimedia Commons