PIPES strategy makes public firms an attractive investment target
7/24/00
By Steve Robblee
Area investors say an investment strategy known as “PIPES” will be used more frequently soon to keep cash flowing to public companies.
PIPES is an acronym that stands for “private investments in public equities.” The concept isn’t new, but it may become a more popular investment vehicle, investors say. The Nasdaq’s dips haven’t just closed the IPO window somewhat, they have also made secondary stock offerings more difficult for companies that need to raise large amounts of cash.
Cahill Warnock & Co., a Baltimore investment fund, soon will announce that it will begin investing a $250 million fund focusing on publicly traded companies, said Chip Stelljes, a general partner.
“We think that’s a way to go in that it’s a little less risky than the traditional early-stage tech companies” investments, Stelljes said. “You end up with a company with a little more meat on the bones.”
The fund is the second such creation for Cahill Warnock. Its first fund focused on public equities closed at $125 million. The second fund will invest about 70 percent in public companies and 30 percent in late-stage private deals, Stelljes said.
But an increase in PIPES won’t spell doom for companies looking for early-stage funding, local experts say. Most venture funds that are willing to consider investments in public companies would make that strategy a small part of their overall portfolio. Many VC funds wouldn’t participate in PIPES at all, either because the funds’ bylaws don’t allow it or because the size of investments exceeds their criteria.
“It’s not going to replace anything that’s happening” in funding for private companies, said Jonathan Silver, managing director of Core Capital Partners. “It’s another investment path.”
His Washington, D.C., fund hasn’t invested in a public company, but the fund is open to those investments, Silver said.
“I think you will see more private equity firms looking at opportunities in public markets than we have in the past,” Silver said. “Our job as investment managers is to make the best possible investments.”
XM Satellite Radio Holdings Inc. is one local company that recently arranged private equity funding. The Washington, D.C., company raised $235 million from a consortium that includes Columbia Capital of Alexandria, Va.
Terms of the deal called for investors to be able to convert their shares into cash at $26.50 a share and an annual interest rate on the capital of 8.25 percent. However, shares of XM Radio, which is developing a satellite-based radio service, are trading around $40.
“The return potential is well worth the investment,” said Columbia principal Karl Khoury.
XM Radio was the fund’s second public company investment, and both deals were follow-on rounds for companies already in Columbia’s portfolio, Khoury added. But the firm would consider other PIPES outside its portfolio companies, he said.
“I don’t know that PIPES have a return that’s better than previously,” Khoury said. “But people are discovering the days of the easy 100, 200, 300 percent returns in dot-com B2B sites have ended.”
He said XM Radio’s fundraising was to raise capital to finish building its technology platform — news that should play well on Wall Street.
Investors say they use the same scrutiny on public company investments as they would when considering whether to invest in a private company.
They also like that management is often more realistic about potential wealth, since their companies’ stock price has often sunk or leveled out. However, some VCs believe that more stringent reporting requirements can be a downside to a public company investment.
Silver noted that PIPES candidates often have intriguing technology but lack analyst coverage, are thinly traded or have missed their targeted earnings figures for a quarter.
PIPES investors often get some special benefits that regular investors don’t — such as preferred stock that provides some protection against bankruptcy liquidation or a seat on the board.
Stelljes said the Cahill Warnock fund will likely focus on companies with a market capitalization of $300 million or lower. That category gets less attention from investors and should provide plenty of good opportunities, he said.
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