Q1 2016 Middle Market Equity Capital Report

Middle Market Equity Capital Report ― Q1 20161

Is the IPO Window Closed?

A CohnReznick LLP Report

Q1 2016 Middle MarketEquity Capital Report

A CohnReznick Report 1

Since the inception of our Quarterly Middle Market Equity Capital Reports, the basis of our analysis, observations, and insights has been grounded in middle market equity capital transaction activity. This quarter is different. This quarter, we break the mold. With so few IPOs making their way to market in Q1, a statistical analysis of middle market transaction activity seems futile—there are just too few numbers. And that’s the story. With economic fundamentals in the United States strengthening, IPO transaction activity through Q1 2016 was at its lowest point since 2009. After a record number of IPOs in 2014, it didn’t take long for the IPO market to collapse under the pressure of market volatility and a continued lack of investor confi dence. Even a growing U.S. economy can’t seem to create enough confi dence to jump start IPO transaction activity. As a point of reference, when Q1 2014 ended, 81 companies had gone public. At the end of Q1 2015, only 40 companies had gone public. In Q1 2016, there were no IPOs at all in January and just a trickle through February and March. In fact, at the close of Q1 2016 the IPO window has practically closed with only 9 companies having gone public.

Uncertainty throughout the capital markets ecosystem has placed a road block in the middle of the IPO on-ramp. Most companies with plans to become public have either postponed or withdrawn them. These companies are now rethinking their

ecosystem has placed a road block in the middle of the IPO on-ramp. Most companies with plans to become public have either postponed or withdrawn them. These companies are now rethinking their

IPO activity may not fully recover until 2021

IPO transaction activity typically peaks about 2 years before a low

Once every 6 or 7 years, IPO transaction activity experiences

a severe dropdrop

IPO transaction activity is off to its slowest start since 2009slowest start

“This quarter is different. This quarter, we break the mold.”

Alex Castelli

CPA, Partner, CohnReznick’s

National Liquidity and Capital Formation AdvisoryGroup

timelines and considering alternative sources for raising capital. We expect that strategic plans that had included a near-term IPO will be revisited and revised.

Growth-oriented private companies still need access to capital to fund research and development, retire existing debt, fi nance acquisitions, and expand operations. But it seems they may have to do these activities without accessing public equity capital. Options like debt or accessing private capital certainly deserve consideration. And, for those companies in a fi nancial position to hold off until the IPO window opens again, a smart strategy may be to look inward with a goal of improving operational effi ciencies, decreasing burn rates, and accelerating growth.

For middle market companies and their management teams, today’s capital markets ecosystem offers its share of opportunities and risks. I hope our Q1 2016 report offers observations, insights, and analysis for your thought and consideration.


Current Environmentfor IPO ActivityAlthough not formally closed, when will the IPO window open again? No one knows for sure. However, in analyzing Q1 IPOs since 2000, and assuming typical patterns of recovery, IPO activity is likely to make progress over the next few years and recover completely by 2021. It is interesting to note how quickly IPO activity defl ates (1-2 years) and how long it takes to recover (4-5 years). Confi dence seems to be quickly lost and slow to return. The “confi dential fi ling” provision of the JOBS Act has made the IPO pipeline less transparent. Therefore, no one really knows how many companies may be preparing for an IPO in the event that market stability and investor confi dence returns to the markets. Most companies that have publicly announced their intentions to go public have either postponed or canceled those plans.

Private companies are showing that they are less motivated to accept the risks of going public today. Pricing pressure and additional scrutiny from public investors make the decision to go public a diffi cult one. Private capital remains plentiful as both fi nancial and strategic investors are searching for opportunities to put their money to work. Even though valuations in the private market have been moderating, companies will likely not experience the current levels of pricing pressure and scrutiny concerning valuations that exist in the public markets if they strike a deal for private capital.

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2021

190

39 34

11

62 57 59

78

26

4

36

60 55 54

81

40

90

50

100

150

200

Q1 IPO ACTIVITY(2000-2016)

“IPOs aren’t the end all strategy for companies. Public and private clients continue to seek out other means of capital successfully amid today’s market volatility. We expect strategic plans that included a near-term IPO will be revisited and revised, not only in the near term, but quite possibly for the next several years.”

Alex CastelliCohnReznick Partner, National Liquidity and Capital Formation Advisory Group


A Dip in IPO Activity May Translate to More Opportunities for Strategic and Financial Investors

Today’s reduced level of IPO transaction activity may present some interesting opportunities for fi nancial and strategic investors. Moderating valuations in the public market are helping to rein in sky-high valuations in the private market. Those companies once destined for life as a public company have now become acquisition targets for private investors. Cash hungry companies have become more reasonably priced acquisition targets for strategic and fi nancial investors. Together, lower valuations and a challenged IPO environment may signal opportunities for fi nancial investors who have been struggling to win deals.

The good news for companies interested in accessing private capital is that there is plenty of it available. With an increased supply of companies seeking

capital at lower valuations, we may see private equity and venture capital fi rms shift their emphasis from selling assets to buying them. However, even private investors are proceeding more cautiously as a result of current market conditions. For the last 18 months, the public market has been characterized as a buyers’ market with investors putting pressure on pricing and scrutinizing valuations. Conversely, the private market has been characterized as a sellers’ market featuring investors with plenty of cash and few investment opportunities. As a result of the decreased level of transaction activity and decreasing valuations, the private market is transitioning to more of a buyers’ market—an important change for those negotiating the sale or partial sale of their business.


The current IPO environment may be motivating more companies to stay private longer. Without an immediate need for growth capital, more middle market companies may choose to sit tight and focus on increasing operational effi ciencies and exercising growth strategies. Companies that don’t need immediate access to capital, but will need it in the near term, may tend to focus their attention on cash management. Strategies to reduce burn rate and make cash last longer may grow in importance.

One of the advantages of becoming a public company is the ability to access additional capital after the IPO in the form of follow-on transactions. Current market conditions have put a damper on follow-on transaction activity. Some public companies have turned to ATM—or at-the-market—offerings, which are follow-on offerings used to raise capital over time. ATM offerings provide greater control of the timing and the proceeds raised. In a volatile market, the issuer can always refrain from selling stock when prices are lower

Shifting Mindset from “Position for an IPO” to “Strategies for Sustainable Growth”

Follow-On Transactions: ATM Offerings and PIPEs May Substitute for Traditional Follow-Ons

Reducing cash burn rates may involve cost cutting measures such as delaying or canceling new product development, or reducing research and development budgets. If companies stay private longer, they may place greater emphasis on growing through operational effi ciencies and mergers and acquisitions. In the long term, this may strengthen the foundation of the company and make them a better public company candidate when the IPO window opens.

and begin selling stock when pricing is improved. As proceeds from an ATM offering typically fl ow back to the issuer sporadically, it may not be a suitable way to raise capital for a company with immediate needs. Private investments in public equity (PIPEs) offer another option for companies unable to generate demand for a follow-on offering. Even though the pricing of the PIPE includes a discount to buyers, sellers in need of capital may attract more interest from private investors than their public counterparts.

“Growth-oriented companies continue to need access to capital to fund research and development, retire existing debt, fi nance acquisitions, and expand operations, but must do so without accessing public equity capital. Companies can overcome this challenge by seeking non-public options to access capital.”

Stephen Wyss, CohnReznick Partner, Retail and Consumer Products Industry Practice


2016 2015

9 402016 2015

1.2 7

% CHANGE % CHANGE

2016 2015

130 2902016 2015

35 73

% CHANGE % CHANGE

2016 2015

78 642016 2015

7.4 5.2

% CHANGE % CHANGE

2016 2015

1566 2361

% CHANGE

2016 2015

720 9962016 2015

53.3 72.7

% CHANGE % CHANGE

2016 2015

2220 35512016 2015

18 19.6

% CHANGE % CHANGE

-78% -83%

-55% -52%

+22% +42%

-34%

-28% -27%

-37% -8%

IPOActivityMarket volatilityis taking a tollon IPO activity.

Follow-OnTransactionsPricing concerns and a lack of investor confi dence are pressuring follow-on transaction activity.

PIPEsPIPEs, an alternative to traditional follow-ons, are a bright spot in the capital raising landscape.

Mergers and AcquisitionsM&A activity has decreased year over year, but has been buoyed by continuedemphasis on growth.

Private EquityTransactionsPrivate equity investors continue to be challenged originating and closing deals, but the transcation activity is impressive when compared to public options.

Venture CapitalTransactionsVCs, active technology sector investors, may be proceeding with more caution as a result of shifting valuations.

IPOs

Follow Ons

Deals

Deals

PIPEs

Transactions

Proceeds ($ billions)


Capital Invested ($ billions)

Capital Invested ($ billions)


Thinking of Raising Capital?

Our capital raising indicators refl ect Q1’s choppy waters. When market stability and investor confi dence increase, conditions should improve.


Growth-oriented biotechnology and pharmaceutical companies will be signifi cantly impacted by the slow-down in IPO activity. Healthcare and life sciences companies, including biotech and pharma, had been the major benefi ciaries of the vibrant IPO market of 2014 and early 2015. In fact, they accounted for nearly 40% of middle market IPO activity. Life sciences companies, faced with long development and approval processes, viewed the IPO as the form of capital that best met their near-term needs and offered a platform for additional access to capital in the form of follow-on transactions. Of the nine IPOs making it to market in Q1 2016, six were issued by life sciences companies. The general decrease in access to equity capital may force many early-stage life science companies to delay research and preserve cash due to the lack of opportunities for raising capital. Without the option of an IPO, we may see even more life sciences companies place greater emphasis on fi nding the right strategic or fi nancial partner. The acquisition arms of large pharma companies may be in a position to acquire smaller life sciences companies that can’t support their operations or access additional capital. The reduction in access to capital may spur an increase in collaboration and licensing deals in an effort to

maximize resources. Debt capital is less of an option for these companies as many are “asset light” and may be without revenue. Biotechnology and pharmaceutical companies with promising drugs—those in the later stages of approval and monetization—will be in the best position to attract public equity capital in the form of IPOs or follow-on transactions. By timing the achievement of important milestones with capital raising activities, these companies may be able to lift pricing and attract investors.

For technology companies, IPO transaction activity has been in decline for some time. Strategic and private investors have rewarded technology companies with chunky valuations. Technology companies and their venture capital investors may now have to adjust to an environment of moderating valuations coupled with a severely limited opportunity to go public. Some technology companies can’t make the jump to public company status without adjustments to their stock prices and their high valuations. Those that are developing interesting intellectual property will continue to receive investment interest from corporate VCs and larger partners. IPO and follow-on activity, however, are likely to remain slow.

“Given decreased IPO transaction activity, life sciences companies in need of capital will focus on alternative methods such as collaboration agreements and private capital raising opportunities, often with existing investors in order to sustain and grow. If possible, coordinating the achievement of important milestones with capital raising activities may yield positive results. In today’s environment, management teams are likely to redouble their cash management efforts to decrease burn rates.”

Craig GoldingCohnReznick Partner, Technology and Life Sciences Industry Practice

Life Sciences and Technology Sector Companies Are Most Affected


It’s clear that investors have developed a stronger aversion to risk amid volatile market conditions. Even a strengthening U.S. economy, and what appears to be a resilient stock market, seem unable to create enough confi dence to stimulate an increased level of IPO activity. Typically, as goes the stock market, so goes IPO activity. But there seems to be a disconnect. The stock market is making progress, but IPO transaction activity is stifl ed. IPOs, a riskier investment proposition to begin with, require a greater sense of calm to create any traction. IPOs would certainly benefi t from longer periods of market stability. Right now, the risks associated with IPOs are perceived to outweigh the

rewards. Instead, IPO activity has been replaced with mergers and acquisitions (also decreased in Q1 2016 when compared to 2015). Private capital has fi lled part of the void left by fewer IPOs and is likely to continue its important role in the near term. Looking forward, we believe that IPO activity will improve, but the time horizon is questionable. Private companies with good stories to tell investors, a solid track record, experienced management team, strong fi nancials, and within specifi c industry sectors will be in the best position to go public. We anxiously await the return of a robust IPO market.

Conclusion


Source: Thomson Reuters

About CohnReznick’s Public Companies Group

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Q1 2016 Middle Market Equity Capital Report

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