Private equity has a reputation for buying underperforming businesses on the cheap, fixing them up, gearing them up, dressing them up for show and flogging them off to the highest bidder, usually some retail sap buying through an initial public offering (IPO). Don't blame a lion for being hungry – that’s private equity’s job and they’re pretty good at it.
Wise investors refuse to play along. Shy about all floats, you’ll often hear our colleagues at Share Advisor singling out an offering for further bad-mouthing because it is being sold by a private equity seller. Intelligent Investor Funds Management shares their suspicion.
But perhaps this is just based on anecdotal evidence? Perhaps poor private equity is getting a bad rap, one not fully deserved. I mean, I’ve never really ‘done the numbers’ to see if IPOs brought to the market by private equity vendors underperform.
Luckily, the Australian Private Equity & Venture Capital Association (AVCAL) have. The report was released to much fanfare last week and reported in numerous articles, such as Private equity study backs sector’s floats in The Australian.
The industry body has offered us some ‘research’, put together by Rothschild, showing that over the period 1 January 2003 to the end of February 2014, IPOs from private equity (PE) vendors significantly outperformed so-called ‘non PE-backed’ floats, often sales from operating companies.
In fact, as The Australian reported front and centre, PE backed floats provided an ‘average return of 95 per cent since listing, compared with a 2.2 per cent decline for floats that were not backed by private equity’. Wow! This, according to AVCAL CEO Yasser El-Ansary, ‘puts to bed the view held by some in the marketplace that companies backed by private equity tend to underperform once listed on the capital markets—the data makes it very clear that’s simply not the case.’
So should we just all go to bed on this issue? Or is this report about as enlightening as Kerry Armstrong’s mythbusting for Coca-Cola, or the dietary advice offered by Monica Trapaga?
Through mind-numbing waves of exposure, I’ve become pretty good at smelling marketing disguised as statistics. It usually starts with a carefully crafted piece of research, an abbreviated press release with some big headline numbers, and then a call to the various press mediums around the country.
Sometimes the news coverage that follows even feels like the self-interested parties are the ones writing it. Which, of course, is at least half true. And the big headline numbers are reproduced dutifully without question, lest someone in the pressroom actually has to do some work.
My tip? Always go to the full report rather than rely on media summaries. In this case, you can download it here – IPO Performance Analysis. Then read sceptically.
Here are a few pertinent question for AVCAL, ones the press should have been asking:
1. Why use averages? All attempts to turn a series of numbers into a single, useful, representative number have pluses and minuses. But median might have been a more useful measure than average in this case. The PE-backed average results are completely skewed by 3 big winners; JB Hi-Fi, Seek and Invocare. PE-backed floats still win on median measures (+6.0 vs -8.9% for non PE-backed) but not as convincingly. By the way, that’s total return, not average annual return. The media release itself doesn’t include the word median, the supporting data attached to the media release includes the word median once, but not in the same pretty chart form as the averages data. The Australian doesn’t use the word ‘median’ a single time in its article.
2. Why not adjust for oversubscribed floats? If one did try to put $10,000 into JB Hi-Fi, Seek and Invocare, as your averages data assumes, they would have received a large return cheque and, if they were lucky, a small amount of stock. These floats were massively oversubscribed. Do you know what PE-backed stocks they probably would have got their full $10,000 allocation in? Boart Longyear (down 98.0%) and Emeco (down 86.5%), among others. Now it’s hardly AVCAL’s fault that the good floats were popular, and the same effect will have distorted non PE-backed floats. But it’s further evidence that ‘average’ isn’t a particularly useful number.
3. Is the sample size sufficiently large? When it comes to making claims about a statistical data set, it’s important to have a sufficient sample size. Else any ‘findings’ from the data are useless. Schoolkids learn in algebra that unless you have a sample size of 30, you can’t be sure if your sample is a representative ‘normal’ distribution of results. The number 30 is actually arbitrary, there’s nothing magical about it. But can we look at the 21 floats larger than $100m from private equity sellers since 2003 and read anything useful into the data? Maybe it's just noise.
4. Why not compare with trade sales only? You’ve compared private equity sales with anything that’s not a private equity sale. That means the comparative group includes all the investment bank packaged rubbish that flooded the market in massive numbers in the 2004-07 boom. Might not a comparison with actual trade sales be more appropriate, if less flattering?
5. What makes something a private equity sale anyway? This question isn’t as stupid as it sounds. I’ve looked through the prospectus of SEEK, one of the companies that most skews the AVCAL data in favour of PE floats. Yes it had some private equity and venture capital investors and some of them sold down in the float. But more of the stock for sale seems to have come from management and board members. Of the SEEK shareholder base prior to the float, less than 30% of it was in the hands of PE or VC investors, by my definitions at least. Most of it was owned by company management and operating companies like PBL and Yahoo. Why do you get to claim it as a PE success? Put another way, why was the +714.8% return from SEEK (less than 30% private equity owned) considered a private equity sale, while the far less impressive +12% return from Nine Entertainment (more than 50% owned by Apollo and Oaktree) lumped in with the non PE-backed results?
6. Why the 11 year study period? The report measures results from 1/1/2003 until 28/2/14. Eleven years and 2 months. Why that length? I mean, it’s not a nice round number like 10 or 20 years. Was it selected so that the report could include two of the three big winners in your report – JB Hi-Fi and Invocare both floated in 2003 – while excluding the rash of massive winners from non PE-backed floats in the 1990s, including Commonwealth Bank, Cochlear, CSL, Computershare, Macquarie Group, Woolworths, Toll Holdings, Perpetual, ResMed, Sonic Healthcare, Ramsay Healthcare, Tabcorp, NSW TAB, TAB Queensland and some of the big-winning demutualisations like ASX and SFE?
7. Why invest in an IPO at all? You appear to have cherry-picked the duration of the study, the very definition of PE-backed and non PE-backed, and focused on the average return because it shines PE-backed floats in the best possible light. But even then a 95% total return for an average holding period of perhaps 8 years is not that impressive (around 9% per annum, versus 10% per annum for the All Ords Accum Index over the same period). Use the weighted average return of 45% (which might itself been cherry picked – I don’t understand why you’ve reweighted the portfolio on 1 Jan 2009 and 1 Jan 2013), and annual returns are anemic. Make some adjustments for the fact that investors were unlikely to get a full allocation of the big winners, and there’s a good argument to suggest that IPOs just aren’t worth the bother.
Thanks for taking the time to put this report together, it's a fun read. But may I suggest a more appropriate title? ‘Don’t buy floats’ is an idea. Or perhaps ‘Don’t buy floats unless you can tell a JB Hi-Fi from a Boart Longyear AND have an amazing broker who’ll get you a full allocation to the heavily oversubscribed floats’. Or ‘Numbers can prove anything, see’.
Nothing has been put to bed here. But I can’t blame you for trying. Best put a few extra staff on the hotline for the next private equity float, in case this report's intended message gets through to the typical float investor. But you'll know that if the phone doesn’t ring, it’s me.