A disconnect exists in my opinion between the interests of private equity investors and those of the IPOs they use to realize their gains. IPOs often end up trading at or below their offering price one or two years after going public. The private equity firms and their investors are long gone by that point with money in pocket while the IPO investors who bought shares with the intention of holding them beyond the first day of trading are stuck in neutral. It's definitely not a win/win situation and to explain my point of view, I'll look at three companies that Bear Stearns Merchant Banking, now known as Irving Place Capital, has taken public. I hope to find plenty of reasons why investors should avoid this type of IPO in the future.
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Bear Stearns Merchant Banking bought Aeropostale in 1998 for $15 million, took it public in 2002 and by the time it sold the last share of the teen retailer in November 2003, had made over $470 million from a $6 million commitment. That's an unbelievable return. Julian Geiger, the Chairman and former CEO of the retailer suggested in a 2002 interview that the company was in "total disarray" when Bear Stearns provided the capital for a management buyout from Macy's (NYSE:M). However, one look at the 2002 IPO prospectus and you'll see numbers that don't exactly jive with Geiger's assessment.
In Aeropostale's final year as a Macy's subsidiary, its revenues were $141 million with an operating profit of $1.5 million from 119 stores. A year later, revenues jumped to $153 million with an operating profit of $9.5 from 129 stores. The improving financial picture likely would have occurred with or without Bear Stearn's money. It was a great deal for Geiger and Bear Stearns and a lousy one for Macy's. Flash forward to May 16, 2002. Its shares closed the first day of trading up 54% to $27.75. Less than five months later, its stock hit a low of $5.35 ($1.59 on an adjusted basis), 70% below the $18 IPO. It's clear who won and who lost.
Reddy Ice Holdings (NYSE:FRZ)
The largest manufacturer of packaged ice went public August 10, 2005, at $18.50 a share. This was a little more than two years after Bear Stearns and Trimaran Capital Partners bought Packaged Ice Inc. for $450 million with Bear Stearns and Trimaran each contributing $41 million in capital to the deal with the remainder financed with debt. What exactly did Bear Stearns bring to the table besides access to capital? Not much. Reddy Ice barely opened above its $18.50 offering price and today trades 84% below its IPO thanks in part to a $150 million goodwill impairment charge in fiscal 2009. Bear Stearns, on the other hand, sold 6.7 million shares between the IPO in 2005 and November 30, 2006, generating (by my calculations) approximately $94.6 million in profits. Once again, it seems Bear Stearns added little value to the company itself while leaving IPO investors holding the bag.
New York & Company (NYSE:NWY)
This retail investment didn't turn out nearly as nicely as Aeropostale, but Bear Stearns still made out like bandits. It bought Lerner New York from Limited Brands (NYSE:LTD) in November 2002 for $78.5 million in cash, a $75 million subordinated note and warrants for Limited Brands to purchase 15% of the stock in the new company. Since then, the company's realized profits of approximately $111.6 million since the IPO. CEO Richard Crystal has been at the helm since the buyout in 2002 as both gross margins and operating margins deteriorated. Retail Geeks, a blog, had a scathing commentary about Crystal in May 2010, suggesting he should have been sent packing a long time ago. It's hard to disagree when IPO investors have seen their shares drop in value all the way to $3.50 in just six years. Bear Stearns made money in spite of themselves. If only the IPO investors could say the same.
These companies have two things in common: They were taken public by Bear Stearns and in all three cases the IPO investors didn't do nearly as well as the private equity investors that sold them their shares. This isn't a knock against Bear Stearns (they're in the business of making money after all), but rather a not-so-subtle hint that when a private equity firm takes a business public, there's usually a good reason for doing so. In my experience, it has less to do with the potential of the business and more to do with maximizing profits. Unfortunately, this profit often comes at the expense of IPO investors. (For more, check out Recent IPO Winners.)
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