Out of the Public Eye

With Internet companies raising investors' expectations to absurdly high levels, more down- to-earth companies are finding it harder than before to raise capital through secondary public stock offerings. Without a dot-com tale or similarly impressive growth story to hype, these companies find much weaker demand for their securities.

"The public markets right now tend to be very binary-- either you can raise capital at a good price, or not at all," says Michael Haynes, assistant treasurer of Sirius Satellite Radio Inc., a broadcasting company based in New York.

Rising interest rates and a tepid high-yield market haven't helped. Rates on B-rated, 10-year debt, for example, now exceed 13 percent, compared with 10 percent a year and a half ago.

So an increasing number of companies are turning to a new type of private market for equity. Unlike a 144a offering, a privately offered form of public security that requires some public disclosure, the newer types of private deals require no disclosure whatsoever. That helps explain why many issuers have come to prefer this route over both the public markets and 144a offerings--at least as a stopgap measure.

The lower profile of strictly private deals can dampen public investors' concern over dilution from the issuance of additional equity. In fact, the strategic nature of many of the deals often boosts the price of the common. Meanwhile, the creative twists possible can help companies manage their balance sheets.

Limited Access
Consider RCN Corp., a telecommunications company based in Princeton, New Jersey. Not long after David McCourt, RCN's chairman and CEO, met Paul Allen, co- founder of Microsoft and now a venture capitalist, at an investment conference, RCN secured a $1.65 billion private equity investment from Allen's Vulcan Ventures Inc.

The company now has enough cash on hand to fund its capital expenditures through early 2003. "We were looking for a deal that would help to insulate us from the vagaries of the capital markets," says Bruce Godfrey, CFO of RCN.

Similar deals are attracting other public companies as well, including those whose access to new equity is limited by a lack of analyst coverage or liquidity.

On the other side of the deals, fund managers that have traditionally stuck to private companies have become more open to taking minority stakes in public ones. Reason: The bull market has pushed up prices of private companies as well as public ones that have generated great expectations, so it's tough to make new investments that will produce the returns these investors have enjoyed in the recent past.

Because they make large investments, it isn't cost-effective for such investors to buy stakes in low-priced public companies through the public markets. The news that they're buying would induce potential sellers to hold out for a higher price before the purchase could be completed. With a private deal, the price is simply negotiated between the company and the investor, often at a sizable premium to the current market price.

As one buyout fund manager puts it: "We can't buy these types of stakes in the public market without pushing share prices much higher, and most of these companies couldn't sell such stakes publicly without pushing their share price lower. In effect, there's an inefficiency in the public markets right now for many companies, particularly smaller ones."

Among private equity investors that have turned their sights on public companies are venture capital firms like Vulcan and corporate VC funds run by such companies as Intel and Microsoft. Also entering the fray are buyout firms like Hicks, Muse, Tate & Furst; Apollo Management LP; and Charterhouse Group International. It's tough to say exactly how much is available to public companies from these investors.

All told, there's an estimated $150 billion to $200 billion available in venture capital funds and buyout firms, but much of that is earmarked for investments in private companies and traditional buyouts.

What Pressure?
Of course, inviting large minority stakes from these types of investors puts added pressure on management. Consider Top Image Systems (TIS) Ltd., a Tel Aviv, Israel-based data processing and imaging software firm that did an IPO in the United States three years ago, raising $7 million, and which has since been listed on Nasdaq. A weak stock price and little analyst coverage made raising another round of equity in the public markets a nonstarter.

Instead, last October TIS secured an investment from Charterhouse Group International, a New York­based venture capital and LBO group. The initial investment will be $15 million placed in newly issued common equity shares of the company, priced at the average closing price of the 15 days prior to the close of the transaction. Charterhouse will invest another $10 million at similar terms.

But while Charterhouse now has a stake of 40 to 45 percent of TIS, management is comfortable with the decision because of the clear benefits of the deal and the dynamics of the relationship with Charterhouse. "This gives us a large institutional holder interested in the long-term growth of the company," says Izhak Nakar, chairman and CEO of TIS. And Nakar says Charterhouse has assured him it will rely on the existing management team to pursue its strategy, though it will provide guidance when appropriate.

• 1
• 2
• next »