VideoBetween the weak economy, the financial-reporting crisis, and a terrorist threat of uncertain dimensions, public investors are holding on to their purse strings with both hands these days. With good reason. In the first quarter, 94 companies defaulted on their bond payments, an all-time high and 60 percent more than the previous record of 59 in the fourth quarter of 2001, according to Standard & Poor's. Moribund stock prices have killed the initial public offering market and made secondary offerings prohibitively expensive for most public companies.
Banks aren't picking up the slack either. With scores of problem loans to manage, they are focused more on watching their balance sheets than on lining up new business. As a result, capital is hard to come by for public and private companies alike.
In theory, it is in times like these that private investors step up to the plate. Institutional investors have lots of experience. Since public market values have fallen so far, they also have more opportunities than they have had in years.
In reality, however, they are only beginning to go bargain hunting. For the past 18 months, private equity and debt investors largely sat on the sidelines along with public investors. With no exit strategy through the still-disabled IPO market, most equity groups are holding devalued investments and are wary of making new commitments. "At best, they're proceeding cautiously," says Moody's Investors Service economist John Lonski. "And they'll probably continue to do so until they see their future returns more clearly."
There are some encouraging signs, however. The private placement market for corporate debt remained firm last year, with commitments of $23.6 billion in 2001 versus $20.8 billion the previous year. And at this point, private equity groups are sitting on an estimated $150 billion in funds raised during the past few years--enough to burn a hole in the most cautious pocket.
"There's a lot of pent-up demand out there," says Anthony DeLuise, head of private placements at Credit Suisse First Boston in New York. "Since September 11, institutional investors have been waiting to come back into the market, and they have to put their money to work." When they do, it's increasingly likely to go into the private placement market before publicly traded securities.
Attention Deficit
For the most part, private placements are made by companies that are unable to access cheaper public debt. "If you can't issue more than $200 million, it's tough to get attention in the public markets," says Allen Weaver, Chicago-based senior managing director at Prudential Capital Group, which invests in investment-grade as well as mezzanine debt. "We have plenty of money to invest." One of the largest players in the private placement market, Prudential Capital had originations of $3.6 billion in 2001 and managed a portfolio of $31 billion at the end of last year.
What private placements give up on price to public offerings, they make up in other ways. The first is speed. A private placement doesn't require registration with the Securities and Exchange Commission, and can usually be arranged in a fraction of the time needed for a public offering.
What's more, private companies don't have to make financial disclosures to the market, and can usually tailor the securities to their specific needs in terms of maturities and principal payment schedules. Private placements also provide a much-needed alternative to short-term bank debt, says Weaver. "In the 1990s, bank financing was cheap," he says. "Now the banks are raising their prices and cutting their exposures."
And the private placement market has become all the more important for midmarket companies. Jerry Whiteford, CFO of Elkhart, Indiana-based Nibco Inc., a privately held company in the flow-control industry, says that privately placed debt is a vital source of financing diversification for his company. "With all the bank consolidation, our syndicate financing options are fewer," he says. Despite the fact that cheaper short-term bank credit is readily available, Whiteford has historically arranged 40 percent to 60 percent of his debt financing through private placements. "I look at private placements as a piece of our long-term capital," he says.
The biggest investors in private placements -- insurance companies and pension funds -- typically hold the securities until maturity. But that isn't always the case.
Choosing the right investors is key, says Hal Logan, CFO of TransMontaigne Inc., a refined-products distribution company based in Denver. "You want a long-term partner that will hold the securities for at least three to five years," he says. Patient, long-term investors are also apt to commit to more funding if the company requires it down the road.
When it comes to private equity financing, finding good investors is all the more important. As Seth Lemler, managing director with Morgan Lewins & Co., a New York-based investment bank serving midmarket companies, puts it, "You're going to be living with these people for a long time."
For private companies, vetting potential investors amounts to determining what the company needs and whether or not the investor is a suitable fit. For public companies, the decision can be of much greater consequence.
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