Private Investments in Public Equity (PIPEs)

An Indian Perspective
Rohit Agarwal
(e-mail: rohit@rohit-agarwal.com)

Abstract

This paper explores the Private Investment in Public Equity as a strategy used by Private Equity Investors. The paper evaluates
the future prospects of this instrument in the country, and takes into consideration the rising arguments that question the
sustainability of the investment in listed equities in a private equity context.

The paper is based upon desktop research, and draws heavily upon public data and information available in various journals
and online resources. The paper also quotes a large number of fund managers, General Partners (GPs), Limited Partners (LPs)
and Private Equity investors and takes into account their views on PIPEs in India and the Asia-pacific region. A list of references
has been provided in the end stating the sources in order of appearances in the text.

Introduction to PIPEs statements are not filed or do not become effective

within stipulated time limit (typically 30 days for filing

A typical PIPE transaction involves purchasing

and 90-120 days for effectiveness)

securities of publically listed companies by the means Types of PIPEs

of a private placement. The transaction may occur at
the market price (at par), or at a premium or a
discount. Since the sale of such securities need not be
pre-registered with the market regulators (SEBI in case
of India), the securities have a restricted characteristic
and cannot be sold off instantly by investors in the
secondary markets. Consequently the company will
usually agree to register the restricted securities with
the market regulator to provide liquidity to its
investors. Such an act is usually pre-decided while
entering into the PIPE transaction. Hence a PIPE
transaction offers dual benefits, swift and predictable
placements to the companies and liquid investments
to the investors.
Because of the fact that capital can be raised on a
predetermined time frame (similar to a QIP issue) ,
without any intermediation from the market regulator
PIPEs will continue to be an attractive option for
raising funds for public companies.
Investors in PIPE transactions will demand for some
sort of penalty provisions in case the resale registration
PIPE transactions have many variations – varying in
terms of the deal structure, the terms included in the
deal and the investor base involved in the deal.
Standard PIPE and Pure PIPE:
In a pure PIPE deal the investor gets into an agreement
to buy securities in a private placement with an
imposed condition of the registration statement being
issued immediately after the closing of the placement,
which in turn allows for resale of these securities in the
secondary markets. Thus the closing of the transaction
is delayed till the time the registration statement is
issued i.e. the effective date of registration statement.
This gives investors immediate liquidity by giving them
the option to resell the purchased security right away.
However there are major legal concerns in such a deal
due to which a large section of investment banks and
PE funds will not accept such transactions.
On the other hand, in case of a standard PIPE deal the
placement of the securities is closed not only prior to
resale registration statement coming into effect, but
also prior to the filing of the registration statement
with the market regulator.
There is an agreement in the transaction documents
that ensures that the company files for registration of
such securities within a specified time period after the
closing of the transaction. The agreement also makes
sure that the company obtains the effectiveness of this
registration statement through its best possible
efforts. The illiquidity risk inherent in such deals is a
major reason for such deals usually happening at
below par prices in the markets.
Traditional PIPEs:
Usually under traditional PIPEs the common equity
stock is sold at a fixed price (usually at a 5-10%
discount to the prevailing market price). It may
sometimes also happen that instead of selling the
common stock, the investor is sold convertible
preferred which may later be exchanged for common
stock at a pre-determined conversion price (the price
at which the conversion of preferred to common stock
occurs). Such preferred stocks impart various powers
to the holder including the right to receive dividends,
receive the purchase price before any distribution to
common stockholders in case of liquidation of the
company’s assets. These paybacks give investor a
moderate compensation for the additional risk they
bear by investing in PIPEs as a consequence traditional
preferred stock PIPEs transactions happen at prices
very close to the prevailing market prices.
Structured PIPEs:
Structure PIPE deals involve sale of convertible
securities, which could either be convertible preferred
stock or convertible debentures. In either of the two
cases the investor can convert them to common stock
at the conversion price. The conversion price in such a
case is not fixed and is dependent on several variables
that adjust the conversion price as per the market
price. In case the market price of the company’s
common stock falls below the existing conversion price
the conversion price will be adjusted to a lower price
level. Structured PIPEs are good for its investors since
they provide price protection but at the same time
they induce a risk of substantial dilution to the
company’s common stockholder.
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Under normal circumstances a structured PIPE
transaction will require prior approval from the
shareholders before the securities are issued to the
proposed investors.
The ‘Death Spiral' PIPE phenomena:
If a PIPE transaction is not structured in the right
manner it may lead to significant dilution of
shareholder equity. Such noxious deals are usually
built over convertible debentures or convertible
preferred stocks that have a variable conversion price
which is a function of the market price of the
company’s common stock at a discount. The discount
gives an inbuilt economic gain, which incentivizes the
investors to immediately sell off the stocks rather than
holding them. Excessive selling may make the stock
prices of the company dip, which would then in turn
require the company to issue more stock as per the
terms of the PIPE transaction. This additional issuance
would further dip prices. This would lead to a domino
effect and the common stock is often said to have
entered into a ‘death spiral’.
The ill effects of a toxic PIPE deal are further amplified
by their unpopularity with the institutional investors.
Institutional investors are cautious of the negative
effects of a toxic transaction. Just the declaration of a
PIPE deal that could possibly lead to dilution, can have
a negative consequence on the company’s stock price
due to investors going short on their positions in
anticipation of unfavorable results.
Who are the Investors and what are their objectives
of investing in PIPEs?
A large number of PE funds and Hedge funds have
come into existence in the recent past. These include
funds formed by private money managers, investment
advisory firms and also funds that are surrogates of the
major investment banks such as Goldman Sachs, Citi,
UBS and Credit Suisse etc.
There are no constraints that limit the investment
criteria of any of the hedge funds or PE funds. But in
most case PE funds have a specific focus on a particular
industry sector like healthcare, TMT (Technology
Media and Telecommunications), real estate etc. Such
focus helps fund managers to develop domain
expertise and better understand the future prospects
of the company’s business. It has been observed that
investments backed by a solid understanding of the
industry are more likely to yield better returns as
compared to more scattered investment portfolios.
The focus need not be restricted in terms of industry
but can also be on specific geographies, such as Latin
America, Asia-Pacific, Europe etc. Several investors
may choose to impose restrictions based on various
criteria such as minimum required share price,
companies with strictly positive NPV of future
expected cash flows etc.
Additionally specific PIPE investments are sold and
distributed to a large pool of investors. The target
investors are based upon the kind of the PIPE
Transaction (i.e. pure or standard, traditional or
structured), the market size of the company including
several other factors.
Traditionally, PIPEs were usually sold to sophisticated
investors who considered not only fundamentals of the
firm but also looked at the technical trends of the
market forces such as trade volumes, volatility and
investor sentiments etc. They were not interested in
becoming a part of the board of directors nor do they
seek for special rights apart for their right to resale
registration. Very few of these transactions used to
involve traditional PE investors, however lately a
growing number of VC and PE firms have made
investments in these PIPE deals.
Even though majority of these transactions are
structured in a rather simple and straight-forward
manner, it is quite common for VC investors to try and
alter to the PIPE arena to enjoy full blown rights and
protections that they typically seek with respect to
private company preferred stock investments. It is very
likely that such VC PIPE transaction will raise numerous
concerns under the national securities laws
(Securities Contracts (Regulation) Act), and corporate
governance regulations.
A number of PIPE investors make their investment
decisions based on the company’s liquidity levels, e.g.
they take into consideration the daily trade volumes on
the company’s equity stock. Such investors usually
have a limited time horizon to their investments and
their investment decisions are not long-term oriented.
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The other major class of investors in the PIPE segment
is the conventional private placement investors who
focus on a long term investment perspective. Their
investment decisions will not be based upon technical
aspects such as market liquidity or trade volumes. They
are more likely to carry out extensive and independent
research and due diligence about the prospect deal.
This research is very likely to be based upon the
current and future prospects of the underlying
business.
The Indian PIPE market
The concept of PIPEs has always been a point of
debate in India’s General Partner (GP) and Limited
Partner (LP) community, with the number of
supporters for the strategy varying in accordance to
the performance of the equity markets.
During the time period from January 2008, the time
when the SENSEX stood at an all-time high of more
than 21,000 points, up to October 2008, when the
markets dipped to sub 7,700 levels, critics had an
opportunistic period to portray GPs who relied on
PIPEs as a core investment philosophy as imprudent.
However the scenario is quite different now; the
SENSEX stands at a healthy 17,900 levels, making a
significant increase in excess of 100% from the lows of
October 2008. Fund managers with a focus on PIPEs as
a part of their investment portfolios stand on much
greener grass as the underlying valuations continue to
rise. Seeking advantage of the subsequent drop and
rise in valuations, firms like ChrysCapital have become
more active in this domain.
During March 2007 Norwest Venture Partners (NVP)
made its first ever investment in a publicly listed Indian
company by acquiring a stake of around 5% in the
telecom service provider OnMobile. The deal was
worth around $15Mn (Rs. 77Cr). Later it made another
investment in Shriram City Union Finance (SCUF) in July
for around 8% of the company’s stake.
Sequoia Capital India has also made a couple of
investments in Indian equities after the markets had
bottomed out. One of its recent PIPE deal was the
acquisition of a 6% stake in eClerx, a knowledge
process outsourcing (KPO) firm.
Furthermore, in the first six months of 2009, PIPE
investments stood as high as 20% of the total
investments of PE firms in India in terms of value, up
from 15% in 2008. PIPE investment grew not only in
value but also in volumes. PIPE transactions as a
percentage of all PE deals rose from 15.6% in 2008 to
about 23% in the half of 2009 (Source: Venture
Intelligence).
PIPEs as a percentage of
total number of deals
Limiter Partners (LPs) view
PIPEs seem to have set a new fan following in the
Indian GP community since the economic downturn.
However the views of the LP community are still not
clear. A considerable section of the LPs has strong
arguments about the use of PIPEs by a PE fund. The
rationale behind the fee charged by PE funds is a major
factor. “Why pay 2-and-20 for a listed investment?”
asks Mr. Low Han Seng, Executive Director, United
Overseas Bank (UOB). “Fundamentally, I’m not going
to pay fees because in a PIPE investment, you cannot
be an active investor,” he says. Low is not convinced by
the claims made by certain GPs stating that they can
secure additional rights to those that ordinary
investors would get.
Mr. Wen Tan, MD at Hong Kong’s Squadron Capital,
which has been committing to India focused funds
since 1996, says: “It’s something we are less favorable
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about, to be honest: there’s the increased dependency
on movements in the public market to generate
returns, and the fact that it is difficult for legal and
regulatory reasons to structure the same levels of
downside protection than you can in a private
transaction.”
He states that all conditions being same, “there are
other ways to get more bang for your buck as an
investor than by paying 2-and-20 fees for what is
essentially a long-only public equities fund”.
It has been believed that the exceptional returns in PE
investments are largely due to the operational
efficiencies that a PE fund could bring to a distressed
company, and since PIPE investments usually do not
allow active involvement of the PE funds in the
company’s management thus a high PE fee is not quite
justified. To justify high PE management fees,
managers need to convince LPs that they can apply PE
standards – a level of influence on the company that
includes access to management, voting etc.
However Mr. Low Han Seng says that in the last 1-2
years there has been a mismatch in valuations.
Managers have claimed that while valuations have
become much more attractive in the listed market, the
unlisted space does not seem to exhibit the same
levels of growth.
Mr. Wen Tan agrees that there is money to be made
under current conditions. He says, “In a rising market
the returns can be impressive, particularly in emerging
markets where public valuation multiples can get much
too far ahead of themselves when sentiment is
strong.” However, he does believe that if one was to
look at the market on a risk-adjusted basis, PIPEs are
less attractive than ‘proper’ PE investments.
Indian companies like to list and they list early
As stated by most of the GPs, there aren’t too many
investment opportunities in unlisted India companies,
the primary reason being the fact that Indian
companies usually file for public listing much earlier
than their European ant other foreign counterparts.
This fact further reinforces the GPs decision to
consider investment in PIPEs as a better alternative.
Mr. Wen Tan believes that this is one major reason for
the trend towards PIPE to continue. “There are
proportionately fewer large-cap businesses which are
still private and – given that some GPs have been
raising sizeable funds – it is highly likely that the
relative lack of large-cap private investment
opportunities will result in some of the available
private equity capital spilling over into the public
markets,” he says.
PIPEs as a trend are not limited to India, the
phenomena is quite prominent throughout the entire
Asian region. Mr. Tan states that published figures for
the last quarter indicate that PIPEs are the largest
single sub-segment of the PE market in each of China,
India and Southeast Asia.
Furthermore, there is a firm belief amongst many
players in the PE industry that PIPE investments have
worked in India. Managers such as ChrysCapital, who
have sustained a large inclination towards investments
in listed equities, have produced returns that justify
their strategy.
One leading GP states that the same LPs who voiced
their apprehensions regarding PIPE investments during
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2008-09, when public valuations plummeted seemed
to have no complaints regarding such transactions
when the markets were witnessing a strong bull run.
As valuations in the entire region continue to pick up in
the public markets there is a likelihood of better
returns from investments in listed equities. This is
likely to attract more LPs to the PIPEs space and soften
their stance against the strategy.
Also there have been LPs who never questioned PIPEs
as a favorable strategy in PE investments. A large
section of LPs who were relatively new to Asian
markets and were seeking investment opportunities
during 2007-08 bought into the PIPE game. Mr. Low
says “Some GPs had the numbers to prove their thesis
that PIPEs were the way to the best returns in the
Indian market.”
People in the PE business are not very surprised by the
popularity of PIPEs in the Asian and especially Indian
markets. This is so due a couple of reasons. Firstly,
PIPEs provide LPs and fund managers with greater
liquidity as compared to the traditional PE investments
in unlisted equities. Secondly and more importantly
Asian public equities have consistently outperformed
Asian Private Equities in terms of returns generated for
the LPs after factoring the leverage used in the deal.
Mr. Wen Tan says “This is important since levered PE
deals may generate better numbers, but they come
with more risk.”
Considering the strong growth the Indian equity
markets are witnessing and the fact that Indian
companies continue to get listed much before their
foreign counterparts, the picture looks bright for PIPEs
as a strategy in PE investments. It seems that going
forward the interest in PIPE transactions in the GP
community will continue its rise upward. What remains
to be seen is how well the GP community succeeds to
instill confidence amongst LPs towards PIPE
investments.
References:

1) PIPEs: A Guide to Private Investments in Public Equity by E. Kurt Kim

2) Overview: Private Investment in Public Equity (“PIPES”) - A Friedland Global Capital Markets
publication
3) Weil, Gotshal & Manges Private Equity Group Survey - Private Investment In Public Equity
transactions
4) Venture Intelligence- PE Database
5) PE Asia Online Journal October 2009
6) VCEdge- Deal Roundup ’09
7) Private Equity 2009 –Thomson Reuters.
8) Private Investments in Public Equity (PIPE) – Neha Singhi published 20th Jan 2009.
9) Online refernces:
a. www.india-pe.com
b. www.vccircle.com
c. www.livemint.com

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