Thursday, October 02, 2008

Market Theatrics

Remember the last dip in the public markets, which due to plunge protection was not allowed to become an honest to god correction and which was abruptly halted and reversed by 9/11, was called a "stealth bear" market. A slow slide, the focus NASDAQ. Now the NYSE's suffering and torture is displayed on television, its image a trader or two on the floor staring aghast at something horrible - falling digits - whose position we the viewer of this photo are assigned. We are collapsing, these kindly bystanders are watching us collapse! Help us!Help!

But the public markets can be yanked about like a marionette on strings. (It must be the herd!You all saw the Dark Knight didn't you? You know what the selfish capricious ignorant herd is like!)

On Sept 19, NASDAQ filed for a little practically automatic rule change with the SEC, shuffling around the Portal Alliance (some of the members vanished recently but still appear in the filing) which anticipates its long promised offerings of Portal debt securities alongside its already flourishing Portal equity securities to the superrich private equity buyers of 144as. It's just kind of funny to read it today, with the headline names, it's a bit like picking up a tabloid:

The Nasdaq member firms expected to enter into agreements with Nasdaq either directly or through affiliated or successor entities are: Banc of America Securities LLC; Citigroup Global Markets Inc.; Credit Suisse Securities (USA) LLC; Deutsche Bank Securities Inc.; Goldman, Sachs & Co.; J.P. Morgan Securities Inc.;
Lehman Brothers Inc.; Merrill Lynch, Pierce, Fenner & Smith Incorporated; Morgan Stanley & Co. Incorporated; UBS Securities LLC; and Wachovia Capital Markets, LLC.

From Forbes back in January:

Not ready to take your company public? Take it semipublic. Do a Rule 144a offering. The Securities & Exchange Commission rule allows companies to raise capital while dispensing with such formalities as registering with the SEC, filing financials or following accounting standards. The securities can be sold only to sophisticated investors, to wit, hedge funds and investment advisers with at least $100 million under management. Issuers are also exempt from the nitpicking requirements of Sarbanes-Oxley.

Although most of the $2 trillion in Rule 144a securities outstanding represents debt, the equity portion is nonetheless big enough to eclipse the public market in recent issuance. Through the first nine months of 2007 companies raised $300 billion in 144a equity, compared with $215 billion for public markets, reports Dealogic. Often these deals were for private offerings in companies that are already public. But within the 144a category is a subset that goes by PIPO (for "pre-initial public offering"): These are privately offered shares in companies that are not yet public. In the two years before Sarbox went live in 2002, there were only two PIPO deals. Since then there have been 83, raising an average $282 million.

Not being public doesn't prevent a company from having its shares traded. In the coming months the semipublic sector will be getting an assist from Nasdaq, whose Portal Alliance database provides price information to buyers and sellers of 144a shares.

Individuals should keep a sharp eye on this market--not to buy in but to avoid being whacked by the tail end. Dealogic says that 20 of the 85 PIPOs have led to public offerings, which then tend to perform poorly. During the first 12 months after going public the average PIPO did 21.5% worse than a simultaneous investment in the s&p 500, while new issues as a whole beat the markets by 7.2%.

Example: the $1.6 billion (sales) Aventine Renewable Energy. Formerly the biofuel operations of Williams Cos. (nyse: WMB - news - people ), Aventine was picked off by a private equity arm of Morgan Stanley (nyse: MS - news - people ) for $75 million in 2003. It then issued $160 million of debt to pay its investors a $107 million dividend. In late 2005 Morgan sold the company to 144a equity buyers through a PIPO for $275 million, quintupling its investment in two and a half years. Pushed by investors hoping to flip at a profit, Aventine filed to go public soon after Morgan's exit, and raised $390 million in its mid-2006 offering. Great for PIPO investors, who recouped a 42% return (before banking fees) in six months. Not so great for individual investors: Aventine's shares recently dropped to $10, 74% below their close on its first day of trading. Analysts see earnings falling 63% in 2007 and another 71% in 2008.

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