2007 Coller Capital Prize Research - Myth or Reality: Do Private Equity-Backed IPOs Really Underperform?
Two empirical studies analyse new issue performance in the UK and Germany
Private equity funds have been criticized for their focus on maximizing short-term
returns. Much has been said about how much value they capture and how little is left
when they exit a business in an initial public offering (IPO). These concerns have
resulted in a lot of debate and many public equity investors are wary.
However, an academic study analysing the stock returns of leveraged buyout fundbacked IPOs in the UK shows that these concerns are invalid. The analysis was
commissioned by Terra Firma and backed by Citi. A companion paper was produced
for LBO- and VC-backed IPOs Germany and backed by Deutsche Bank.
The UK report finds that a strategy of investing an equal share in every IPO backed
by an LBO fund over the last 17 years, would have beaten the market markedly and
produced 3.3 times the return of the market. An equivalent strategy for non-LBO
backed new issues would have outperformed the market by only 9% over the period.
This is evidence that buyout firms create long-term shareholder value.
If private equity fund managers really took advantage of an informational asymmetry
and hyped their IPOs to achieve inflated offering prices, one would expect to see
negative long-term returns after the floatation. However, the studies demonstrate
there are significant positive returns - evidence that PE-backed IPO investors get
attractive returns compared to the market and relative to other new issues.
Some market observers have complained that LBO funds often put too much debt on
their companies, extract too much cash and push them too rapidly into an IPO
without adding much long-term value to the business. The UK analysis finds no
evidence that the level of debt has any significant impact on the long-term stock price
performance. But the study shows that "Stake Matters", "Size Matters", and "Time
Matters". The greater the equity stake of the LBO fund in the company after the IPO,
the better the returns. The higher the fund's assets under management, the bigger
IPO returns. And the longer the fund's involvement with the firm before the IPO, the
better the new issue performs.
The authors of the studies, Christian von Drathen and Flaviano Faleiro (both Sloan
Fellows at London Business School), commented:
"The research demonstrates that the criticism of private equity-backed IPOs is largely
unwarranted. In fact, private equity-backed new issues outperform both the stock
market and all other IPOs over the long-term. Portfolio strategies involving private
equity-backed floatations beat index investments by a wide margin and give IPO
investors an excellent return. Moreover, the longer term outperformance of these
IPOs demonstrates that private equity-firms also generate long-term value for public
shareholders."
