PE-backed IPOs: A Spectacular and Complex Exit Route

by Francesco Bargellini and Giovanni Ferrari

Introduction

Private Equity (PE) fund managers are one of the highest-paid in the financial industry. One of the reasons behind this fact is their ability to provide investors with market-outperforming returns, a characteristic which requires a well-thought-out strategy as well as considerable attention to execution. A key element in the decision-making process is the choice of the type of exit, which strongly reflects on the financial outcome of each deal. As the data presented will show, there is a specific exit option which is often discarded but that, in the right condition, is able to deliver incredible results: the Initial Public Offering (IPO). In the following paragraphs, the potential strengths and weaknesses of this choice will be analysed, comparing its main features to other alternatives, and putting it in the context of the current market outlook. Furthermore, the case study of the SECO IPO in Italy will be presented, which will highlight the practical application of the theoretical notions and data-based hypothesis previously outlined.

PE Exits: Classification and Recent Market Trends

The Exit phase is the final step of a PE deal: it represents the conclusion of a long process (ranging typically from 3 to 5 years) which includes investment sourcing, acquisition, and portfolio company management. It is the last opportunity for the General Partners (GPs) to maximise the return for investors and, as such, it requires a careful evaluation of the available alternatives. When facing this decision, PE investment managers can choose between different options: the most common include secondary buyouts (sponsor to sponsor sales), trade sales (sponsor to strategic/corporate buyer), and IPOs. Additional variations may involve auction processes or GP-led secondary deals. A PE-backed IPO is the public sale of the shares of a previously private company controlled by PE investors. For example, a common strategy adopted by PE funds involves taking listed companies private, undertaking a value-creation strategy, and finally, offering the shares again to the public.

Looking at the data for PE-backed Exits for the years 2018-2022, it is possible to observe that trade sales are the preferred option, ranging from 45% to 50% of the aggregate exit value. A notable exception is 2022, with an extraordinary 77%. Secondary buyouts follow with a range between 22% and 29%, while IPOs remain in a lower 10-17% interval. As for sales to strategic investors, 2022 is an outlier also for PE buyouts (13%) and public market exits (6%). The motivations behind the trend observed in the type of PE-backed Exits are deeply connected with the strengths and weaknesses of the chosen method. In particular, while secondary and corporate buyouts tend to be less influenced by external macroeconomic factors (less cyclical), IPOs are more dependent on the financial markets outlook, as exemplified by the 2022 data. However, this is not entirely true. In 2022, while lower stock prices induced PE funds to avoid IPOs, higher interest rates also restricted the ability to sell to other financial sponsors, due to higher financing costs and uncertainty. This combination of factors has led to the dominance of trade sales among the different exit options. As noted by Moonfare, in recent years, PE funds have leveraged an additional alternative, GP-led secondary buyouts, which could be an efficient option to delay the exit from the investment in order to wait for more favourable macroeconomic conditions.

Cost-Benefit Analysis of IPO Exits: An efficient or risky strategy?

IPO Exits present various differentiating factors that distinguish them from secondary buyouts and trade sales. Despite providing relevant benefits, they also involve material risks and costs for GPsand investors.

There are three fundamental advantages of PE-backed IPO compared to other alternatives. The most relevant one is the opportunity to achieve the highest valuation possible, thanks to an “IPO premium” on multiples. When the macroeconomic outlook and the stock market activity are favourable, PE funds can benefit from the increased valuation assigned by public investors. For example, as reported by Pitchbook, in 2021 median EV/EBITDA multiples for public listing have reached the striking value of 34x, compared to a much lower 14x for secondary buyouts and 11x for trade sales. Further benefits include higher visibility for the Fund and increases in reputation following successful IPO Exits. Finally, PE investors can retain an option to further price upsides by not selling their entire initial stake. However, the cost of this additional option can be reflected in a negative price pressure connected with the looming sale of the PE held equity stake.

On the other hand, choosing to exit through an IPO means following a more complex path. Regulatory and disclosure requirements are more stringent, implying that more time and monetary resources must be allocated to fulfilling legal obligations. Furthermore, the IPO process itself is lengthy, requiring an in-depth preparation as well as a seamless execution.

Expanded timelines involve higher timing risks, with the possibility of missing the identified “high IRR” window and being locked in costly advisory contracts without an exit date in sight. Additionally, before going public, investors may ask for aggressive deleveraging, putting supplementary pressure on cash flows. Last but not least, listing a portfolio company exposes PE investors to unwanted market risk: General Partners must be sure to obtain an adequate valuation to compensate. As reported by Daniel Meschaninov, director at Jamieson, IPO Exits have also relevant consequences connected with management teams’ compensation schemes.

IPOs in Europe: Recent Years in Review

As previously mentioned, PE-Backed IPOs are strongly influenced by current market trends; high market valuations and multiples can induce PE firms to take advantage of positive market windows to a portfolio company public. Equally, a volatile and bearish market often induces PE investors to postpone planned IPOs and look for other exit opportunities.

In the last few years, we have seen extremely favourable markets, as it was in 2021, with a record year for IPOs in Europe, followed by a bearish year in 2022 when the Russian invasion of Ukraine, inflation, and interest rates hikes put institutional portfolios to the test.

According to “PwC IPO Watch Europe 2021” report, European markets have delivered 422 IPOs for a total amount of €75bn raised, supported by the reopening after the Covid 19 pandemic and overall optimism about corporate earnings. The biggest 10 IPOs were all transactions of €1bn+ and accounted for c. 27% of the year’s total issuance. Among these, we can see a strong presence of PE-Backed IPOs with investors leveraging the strong market momentum to realise liquidity events and monetize their investments; InPost, a Polish logistic company that listed on Euronext-Amsterdam with the biggest European IPO of 2021, with a total raised amount of over €3bn, was in fact backed by Advent International, that invested in the company back in 2017. Other main PE-Backed IPOs in 2021 include the listings of Allfunds Group, a Spanish WealthTech platform backed by Hellman & Friedman, Azelis Group, a Belgian specialty chemical company backed by EQT, and Dr. Martens, the footwear and clothing brand backed by Permira.

As opposed to 2021, 2022 was a difficult year for public equity markets; as investors retreated due to macroeconomic uncertainty and volatility, the global IPOs market plunged. According to “PwC IPO Watch Europe 2022” report, European markets raised just €15.6bn compared to the €75bn of the previous year. According to the report, the traditional IPO market was largely cut-off with planned transactions being postponed to at least the second half of 2023. The market was in part sustained by less traditional transactions including reorganisations such as spin-offs and demergers. The biggest transaction of the year was in fact Porsche’s landmark IPO, which happened to be a reorganisation of Volkswagen AG group. The IPO raised over €9bn and represented one of the largest all-time European IPOs. In this market environment, PE investors often delay exits and search for alternative routes.

2023 could offer some opportunities for PE-Backed companies to go public, with some IPOs being already announced or in the pipeline. An important transaction in the European market will be marked by the IPO of Lottomatica Group, the Italian betting company backed by Apollo Global Management, which has recently announced to be ready to list on Euronext Milan in H1 2023.

SECO and Fondo Italiano d’Investimento: A Tech IPO in the Italian Panorama

During 2021, many IPOs involved companies belonging to the tech sector in which PE funds are greatly involved in, controlling or minority stakes in companies with high growth potential. An exemplary case of a PE-Backed IPO executed in Italy is the case of SECO S.p.A., an Italian electronics company active in the production of miniaturised computers, integrated hardware-software systems, and solutions for IoT (“Internet of Things”) applications.

Fondo Italiano d’Investimento SGR joins SECO S.p.A. in April 2018 with a minority stake acquired as part of a growth capital transaction carried out by FITEC (Fondo Italiano Tecnologia e Crescita). The investment is made through a capital increase of about €10m and marks an important step for the company. In fact, the fund’s contribution is not limited only to financial support but is accompanied by important strategic support. SECO, which until then had been led by the founding partners, embarked on a process of “managerialization,” with the inclusion, first and foremost, of a new CEO. The PE fund also provided crucial advisory support to the implementation of several acquisitions that enabled the company’s growth.

Fondo Italiano d’Investimento SGR supported the process that led to Seco’s IPO on the Italian Stock Exchange, which concluded in May 2021. The listing was a key step in SECO’s development process; the proceeds from the listing, as the company itself stated in the IPO disclosure document, are intended to “support the implementation of its three-year strategic plan through consolidation and growth in international markets”. SECO’s IPO enabled the company to raise about €100m; as part of the listing, several shareholders offered a part of their holdings to the market, including founders Daniele Conti and Luciano Secciani and FII SGR. As previously highlighted, PE-backed IPOs allow the financial investor to divest his stake only partially, with the advantage of retaining the possibility of enjoying the additional capital gains related to the eventual appreciation on the stock market. In the case of SECO’s IPO, in fact, FII SGR divested its stake only partially, going from owning about 20 percent of the company’s share capital prior to the listing to owning about 5 percent post-IPO (due to both the sale of shares and the dilution resulting from the capital increase carried out at the IPO). Trading of the Shares on the MTA (Mercato Telematico Azionario) began on May 5, 2021, with an initial offering price of €3.70 per share. As of April 13, 2023, the closing trading price was €4.88, with a positive price change of 32%.

Conclusion

Performing an IPO as an exit route for a PE sponsor can produce impressive returns thanks to the generous valuations that public markets can give during bull periods, especially for companies with strong brands that operate in growing sectors such as Technology, Healthcare, and Luxury Goods. This upside is mitigated by the complexity of IPOs as an exit route, due to the lengthy process needed to perform a successful IPO and the risk of adverse market conditions that undermine ongoing processes. The importance of the market’s contingency is in fact reflected in the strong decline in the number of IPOs between close years such as 2021 and 2022. It is indeed a difficult task to foresee the near future for PE-Backed IPOs but with some degree of confidence, we can expect to see some spectacular market exits during the following few quarters. After breaking the ice in February with Eurogroup Laminations (backed by Tikehau Capital), other Italian firms might continue to take the stage in the European IPO market. Lottomatica is set to join the Italian stock exchange around the end of April, but recent news seems to indicate that “Piazza Affari” could see another PE-backed IPO in the beginning of May: Italian Design Brands, controlled by the Milan-based Private Equity Partners. After a year of hibernation, the IPO market is warming up its engines, and PE funds are leading the way.