Private companies have long had access to public investors through publicly traded permanent financing vehicles, but a number of competing listing platforms recently expanded that access by allowing companies to sell of stock, while avoiding regulatory scrutiny. Their development has dramatic implications on how capital is raised, despite the fact that the venues themselves may be short lived. Stephen Lacey reports.
The lines between public and private equity have blurred in recent years. The advent of alternative listing venues targeted at institutional investors have further obscured those lines by enabling private-equity firms and alternative asset managers to sell stakes in themselves without the headache of a traditional public listing. The importance of trading platforms developed by Goldman Sachs, Nasdaq and others, have arguably been enhanced by regulatory scrutiny of the industry and recent market volatility.
While private companies have been able to raise capital in the private equity markets for decades, the process has been unappealing to both issuers and investors because of a lack of transparency and antiquated technologies used to trade stock. Under Portal, a platform launched by Nasdaq in 1990 to facilitate trading of 144a securities, both debt and equity, investors were required to contact broker-dealers directly to buy and sell securities.
“It was a great place to raise money but a terrible place to trade securities,” says John Jacobs, executive VP at Nasdaq, which operates Portal. Nasdaq enhanced the liquidity of the system, where both equity and debt are sold, with the launch of a centralised trading platform on August 15 this year.
With registration rights
In the late 1990s, Friedman Billings Ramsey Group (FBR), a regional investment bank, helped change the way that institutional investors thought about private equity. One concept that would gain popularity was simply to offer registration rights on private stock sales. This enabled companies to raise capital in the private markets by selling stock and, within 180–270 days, allow initial investors to realise a return through a public listing, either a marketed IPO or simply registering the shares with the SEC.
This became a favoured strategy for investment firms looking for start-up capital that, once deployed, would enable them to achieve the higher valuation in the public markets. KKR Financial, a mortgage REIT formed by its namesake, marked the height of the private-to-public equity format in June 2005 through a US$800m IPO that featured six bookrunners led by Citi and that included FBR. The listing satisfied registration requirements as part of a US$775m private placement the previous August.
A shortcoming of the private-to-public model is that fees eat into the amount of capital that can be deployed. The large number of copycat financings also made it difficult to attract new investors in a marketed public sale, which at times resulted in a disorderly distribution of shares upon registration. More importantly, such private stock sales failed to address the fundamental problem, the lack of a centralised, electronic exchange.
FBR provided one answer when it unveiled FBR PLUS (Private Link to Unregistered Securities), an electronic trading platform that provides qualified institutional buyers (QIBs) access to trading information, in June 2007. At launch the system displayed transaction volumes, latest pricing, indications of interest, and trading history on 14 144a securities where the firm acted as placement agent. It currently supports 17 securities.
“We’ve had this system in place since 2002,” notes Lauren Burk, a spokesperson for FBR Capital Markets, a majority-owned subsidiary of Friedman Billings Ramsey Group. “FBR PLUS represents the latest upgrade to the platform by providing additional information about each trading security and using Bloomberg as the distribution platform.”
Tracking shareholders
Goldman Sachs provided a competing solution when it launched its GSTrUE (Goldman Sachs Tradable Unregistered Equity) trading platform in May. A subtle, but critical feature of Goldman Sachs’ solution is the ability to track the specific number of shareholders, something that at the time was not possible through existing systems. The bank worked with American Stock Transfer & Trust Company, a shareholder services firm, to develop a proprietary mechanism to settle trades.
The tracking feature is important because private companies that exceed 499 shareholders are obligated to register with the SEC. Oaktree Capital Management, which raised over US$1bn, including the over-allotment option, through the sale of a 10% stake in May, was particularly attracted to this feature of GSTrUE. The hedge-fund operator would continue to run its business with a long-term vision and communicate that message to a small, sophisticated group of investors.
“GSTrUE really started because issuing clients saw that there were a growing number of business model and regulatory hurdles to the traditional public listing,” says Rob Pace, managing director in the financing group at Goldman Sachs. “We were definitely operating in what we viewed as uncharted space. It was really providing a solution to a customer need.”
Although issuers that use GSTrUE remain outside of regulatory scrutiny, Goldman designed its system to be informed by public-like disclosure – audited quarterly and annual financial results as well as alerting investors of material events. “You have a very adult discussion with investors,” said Stuart Bernstein, an MD in ECM at the bank, of bookbuilding private-equity placements. “You eliminate a lot of the game playing. It’s just a different dynamic,” he added in reference to the inability to short or flip allocations.
Frustrated by the lack of progress on an enhanced electronic version of Portal, which would eventually go live on August 15, rival investment banks worked to develop their own proprietary trading platforms. Citi, JPMorgan, Merrill Lynch and Morgan Stanley formed a consortium to solve the problem. JPMorgan hedged its bets by working on its own system, 144a-plus, as well. The central criticism of rivals was liquidity, given that Goldman Sachs and FBR generally were the only market makers.
The commitment of a Goldman Sachs as sole market maker in Oaktree was tested in mid-June, when Congress held hearings to consider adopting higher tax rates on partnerships. “It is very important to distinguish between volume and liquidity. We are absolutely committed to providing a liquid market even in low volume environments,” said Stuart Bernstein, an MD in ECM at the bank. Evident of that commitment, says Stuart, is the fact that Oaktree’s valuation is in-line with public comparables Blackstone Group and Fortress Investment Group.
Apollo Management highlighted speed as another advantage when it raised US$828m over GSTrUE at the beginning of August. The private sale, which was led by Goldman, Credit Suisse and JPMorgan, enabled the buyout firm to avoid the lengthy review process that would come with a traditional public listing. Similar to the FBR model, the offering carried registration rights that require Apollo to register the securities within 240 days. The firm intends to do so as early as the first quarter of 2008 through an NYSE listing.
“There is a higher degree of certainty that you can access the market with similar conditions as when you made the initial decision,” suggested Gregg Weinstein, an MD in the ECM group at Goldman. The entire process, from documentation through marketing and pricing, takes about six weeks, noted Weinstein. Goldman Sachs and FBR have clearly enjoyed a first-mover advantage, though it remains to be seen how long that will last.
Open to competition
Nasdaq launched its centralised trading platform for Portal on August 15. Initially the system will support equity, with debt securities to be added later this year. The exchange has traded 144a securities, both debt and equity, over Portal for 17 years, giving it name recognition. For example, there were 2,699 sales of private equity on Portal in 2006 that raised US$162bn, compared to US$138.4bn over US stock exchanges, according to Nasdaq’s Jacobs.
The number of broker-dealers that support Nasdaq Portal would seem to give it a significant advantage over rival systems. The exchange pilot tested the platform at a dozen banks before launching, and hopes to enlist another dozen over the near term. All of the broker-dealers will be able to post bid and offer prices. “There are multiple market participants competing for orders, not just the underwriter. Competition lends to transparency,” suggests Jacobs.
The primary detraction to Nasdaq Portal is that it does not currently have the ability to track the number of shareholders. The exchange is working with the Bank of New York to add that functionality. The tracking feature, which is expected to be up and running by September, will support settlement through the Depositary Trust Company (DTC), the clearing agent for the vast majority of listed stocks. “We’re not interested in a solution that does not utilise DTC,” said Jacobs. “That would be going back in time in our opinion.”
Frustrated by the lack of progress on an electronic version of Portal, and with a view that Goldman Sachs and FBR held a competitive advantage, investment banks worked over the summer on competing listing venues. Citi, Lehman Brothers, Merrill Lynch and Morgan Stanley banded together to offer a solution that would be open to all market participants, not just a particular underwriter.
The consortium unveiled OPUS-5 (Open Platform for Unregistered Securities) on August 14, a day before Nasdaq Portal electronic was to go live, with a launch targeted for September. Like GSTrUE, OPUS-5 is able to track the number of shareholders. The difference is that the system is open to other broker-dealers.
“What we have designed is an open system, and as long as there are fewer than 500 shareholders, any member broker/dealer can access the system,” said David Ballard, an MD in ECM at Merrill Lynch. Additional securities firms are expected to join the consortium over time.
Aside from their catchy monikers, the listing platforms all appear to offer similar functionality. JPMorgan, which was understood to have been an original member of the OPUS-5 consortium, is marketing its own private-listing venue, 144a-Plus, to clients. Bear Stearns was able to offer its own solution, Best Markets, to JG Wentworth on a US$140m private stock sale. “I think the thought process is that once Nasdaq gets up and running, the choice of listing venues will be effectively decided,” confided one investment banker.