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.)
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.
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.