We all know that initial public offerings are called "exit strategies" for the company's owners, so somebody has to be making money before you can even buy the shares.
Some owners of private companies, however, benefit more than others when IPO investors pump their cash into a new issue. And that's an important lesson, as the market for new offerings is experiencing its hottest run in nearly three years.
Let's look at two examples from last week's flood of U.S. deals, one where the company's cash-out plans failed due to weak demand, and another where it took a reading of the fine print to realize just how much investor money was being pumped into previous shareholders' coffers.
First, the bad-luck story. Global Geophysical a Texas company that sells data to the energy industry, planned a robust IPO of 11.5 million shares, to be priced between $15 (U.S.) and $17 a share.
Part of the trouble with the offering, however, was that insiders hoped to sell off 4.5 million of those shares. One of the major stockholders planned to get out of its stake of 2.35 million shares completely, and the officers and directors hoped to sell more than 700,000 shares, including 485,000 by chief executive officer Richard Degner.
To be fair, it was not a total selloff. Mr. Degner, for instance, planned to rid himself of less than 20 per cent of his stake. But somewhere along the line, Global Geophysical got the message that there were a lot of problems with its plans. It had to price the offering at just $12 per share, and it scaled back the insiders' sale to just 500,000 shares, mostly by its smallest original investors. (Mr. Degner sold 119,648 shares.)
For Global Geophysical, it seems weak investor demand meant the insiders' shares were first off the table. The shareholders of DynaVox another of last week's IPOs, were more fortunate.
DynaVox, a Pittsburgh, Pa., seller of speech recognition devices for the disabled, sold its entire offering, albeit at $15, below the $17 it hoped for.
A quick glance at DynaVox's prospectus makes it seem as if there were no insider sales: All 9.375 million shares were offered by the company.
A deeper look at DynaVox and its odd structure reveals, however, that its new public shareholders have just handed over nearly all their cash to the previous owners of the company.
DynaVox is a holding company whose sole asset is now DynaVox Systems Holdings LLC, the actual operating company. It acquired it by virtue of last Thursday's IPO, paying $15 apiece for units of the LLC. The plan was to buy 4.2 million newly issued units, which cost $63-million, and buy almost 5.2 million units from the LLC's existing owners - for almost $80-million. (If there's enough demand for an overallotment option, the existing shareholders will offer up another 1.4 million LLC units for $21-million.)
So, somewhere between about $80-million and $100-million of the offering will go to selling shareholders. What will DynaVox Systems Holdings LLC do with its $63-million in proceeds?
Well, it will retire debt: $32.6-million in senior subordinated notes held by BlackRock Kelso Capital Corp., which also happens to be a shareholder in the LLC. (That debt was taken out to redeem LLC units held by Vestar Capital Partners, its controlling shareholder.) And it will pay back $10-million on its line of credit, which was taken out to give directly to the stockholders, so, according to the prospectus, they could take the money and invest it in a different company owned by Vestar.
DynaVox estimated the offering expenses at $17.9-million, which included a $3.1-million consulting fee to its two major LLC shareholders. That leaves less than $3-million for the company to use going forward.
Why couldn't DynaVox have done a more straightforward IPO, converting the LLC into a stock company and selling both new shares and the stakes of existing shareholders?
Well, Vestar and the other owners will still have plenty of LLC units after the offering. And American LLCs pay no corporate taxes, passing their profits directly on to the owners. New shareholders in DynaVox Inc. don't have that luxury, as the holding company will get taxed before any profits can be distributed.
(To make matters worse, a special tax-sharing agreement will further cut the original owners' tax obligations by roughly $50-million, with DynaVox Inc. and its public shareholders footing the bill.)
DynaVox Inc. tells its prospective shareholders: "We do not expect to pay any dividends in the foreseeable future." True enough - as it sent nearly all of the money it raised back out to the previous shareholders.
New investors may or may not get a payoff from their DynaVox investment one day; they're the ones, however, who've made sure the original owners have been taken care of.