The ability to obtain financing is the lifeline that growing and established companies cling to. When traditional financing options like stock or bond offerings become too costly and time consuming, companies including U.S. financial firms have been taking advantage of private investments in public equity (PIPE).

A PIPE allows a company to obtain financing or a capital infusion faster than traditional forms of financing. Investors should be aware of how a PIPE deal can affect a current or potential future stock holding.

Financial PIPE Deals
Sovereign Wealth Funds began purchasing large equity stakes in U.S. financial companies late last year as the credit crisis and bad debt write downs dominated media headlines. China Investment Corporation entered into a PIPE transaction with Morgan Stanley (NYSE:MS), and similar investments were taken by the Abu Dhabi Investment Authority into Citigroup (NYSE:C) and the Government of Singapore Investment Corporation into UBS AG (NYSE:UBS).

Benefits to PIPE Investors
PIPE investors can either purchase their equity stake at a discount or have the security they invest in convert into shares at a future date. PIPE deals also close relatively quickly.

Concerns for Investors
Use of the PIPE could signal that a company is struggling to find financing through a traditional channel. Resale of the equity purchase by the private firm into the public market could have a dilutive effect on the current outstanding shares of existing shareholders. (For further reading, check out The Basics Of Outstanding Shares And The Float.)

Recent Returns
Since January, Morgan Stanley has fallen nearly 40% while UBS and Citigroup are both down nearly 60%. Given the tightening of credit markets and the amount of bad debt these banks are working to shed, it's difficult to determine if the PIPE deals truly had a negative or positive impact on the stocks mentioned.

Profiting from PIPEs
According to Sagient Research, the $64 billion raised in the PIPE market during the first six months of 2008 is the largest amount raised in any six-month period. Investment Banking League tables reveal that the top PIPE placement agents for the first six months of the year were Goldman Sachs (NYSE:GS), Lehman Brothers (NYSE:LEH) and UBS. An alternate strategy for investors could be to align themselves with firms that stand to benefit from the PIPE transactions.

Final Thoughts
PIPEs have carried a negative stigma for years. The criticisms are worthy given the dilutive effects that PIPE holders' equity stakes can have on outstanding shares and the financial binds that companies attempt to avoid by using the equity deals. When a company that an investor owns decides to use a PIPE, the investor should determine the reason for this before staying put or looking for the exit.

For more on private investments, read our related article Private Equity A Trendsetter For Stocks.

Related Articles
  1. Options & Futures

    Use Options to Hedge Against Iron Ore Downslide

    Using iron ore options is a way to take advantage of a current downslide in iron ore prices, whether for producers or traders.
  2. Home & Auto

    Understanding Rent-to-Own Contracts

    They can work for you or against you. Here's how to negotiate a fair one.
  3. Stock Analysis

    Net Neutrality: Pros and Cons

    The fight over net neutrality has become an amazing spectacle. But at its core, it's yet another skirmish in cable television's war to remain relevant.
  4. Home & Auto

    Avoiding the 5 Most Common Rent-to-Own Mistakes

    Pitfalls that a prospective tenant-buyer could encounter on the road to purchase – and how not to stumble into them.
  5. Home & Auto

    Renting vs. Owning: Which is Better for You?

    Despite the conventional wisdom, renting might make more financial sense than you think.
  6. Investing Basics

    Explaining Options Contracts

    Options contracts grant the owner the right to buy or sell shares of a security in the future at a given price.
  7. Home & Auto

    When Are Rent-to-Own Homes a Good Idea?

    Lease now and pay later can work – for a select few.
  8. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  9. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  10. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
RELATED TERMS
  1. Implied Volatility - IV

    The estimated volatility of a security's price.
  2. Plain Vanilla

    The most basic or standard version of a financial instrument, ...
  3. Normal Profit

    An economic condition occurring when the difference between a ...
  4. Theta

    A measure of the rate of decline in the value of an option due ...
  5. Equity

    The value of an asset less the value of all liabilities on that ...
  6. Derivative

    A security with a price that is dependent upon or derived from ...
RELATED FAQS
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. How does a forward contract differ from a call option?

    Forward contracts and call options are different financial instruments that allow two parties to purchase or sell assets ... Read Full Answer >>
  6. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!