Wednesday, November 25, 2009

PIPE's Face Flaw

The affects of recent economic shock waves have reverberated throughout the entire World and can be felt everywhere- from Beijing to Bahrain; Wall Street to Main Street, no investor or manager has been safe from the troubling aftershocks of this credit crisis. The PIPE’s (Public Investment In Private Equity) industry has been no exception, in fact most of the industries leaders facing insurmountable liquidity requests, have utilized provisions in their Private Placements allowing for restructure of the original investment vehicle which should serve to protect the investor from a run on the fund and lead to a more orderly sale of positions and redemption process. In the case of PIPE’s, the shockwaves may have a much more costly long term unintended affect.

The capital markets in the United States provide many exchanges for public and even private trade. As a company grows they have the ability to utilize these markets. In order for a company to grow, they must be funded. As we are discussing companies that are small by nature whether a company is self- funded or funded by an investor it relies on this capital heavily- as typically small companies lack the cash flow necessary to operate week to week or month to month- investment is critical to survival.

It is a fact that roughly half the capital invested in the PIPE’s market was requested for redemption during the crisis. Billions upon billions of dollars had flowed into the PIPE’s space from 2001-2006, literally half of it was being requested back at the same exact time. This is the same capital that was being utilized to fund nano and micro cap companies that relied upon the investment funding to survive. At the time, with the credit markets frozen and absolutely no inflows of new capital, yet massive net redemptions the issue becomes obvious- how will all these companies operate on half as much investment? The answer is as obvious, they cannot. The numbers simply don’t work.

The choices are extremely difficult for a fund manager amidst financial crisis. For most of us financial crisis is realizing we bounced a check, can’t afford the cable bill or we wonder- ‘how will we pay for our children’s college?’ During this crisis managers all over the world were put in the position of asking themselves “hard questions.” Many of these questions had no answers. Many of these questions were answered in theory and conjecture as are typically the only way to answer questions regarding uncharted territory.

In the case of the PIPE’s market there were gates, SPV’s (Special Purpose Vehicles), restructures, liquidating classes, non-liquidating classes and even a secondary market developed. The managers are obviously doing everything in their power to theorize their way through this uncharted territory in order to take the appropriate steps to move forward on behalf of their investors, but as they do so their valuations are being taken into question by regulatory authorities, their investments are being scrutinized by government agencies and their reputations are being destroyed by unsubstantiated innuendo- all in the name of truth and justice- this type of scrutiny tends to instill a massive lack of confidence in ones investors and only leads to reputation issues and further redemption.

We are all for truth and justice, but we also believe in a reality check from time to time. As we saw in the case of Bear Stearns employees Cioffi and Tannin, sometimes things happen and there is no one to blame. The reality is that their was nothing these two men could have possibly done to their investors or for their investors because they couldn’t have ever conceived of such a melt down. In fact, the greatest economic minds of our times, the worlds largest investment banks and several multi-billion dollar ratings agencies didn’t foresee the implosion at our heels.

The state of financial quagmire we are living through will not just end, it needs to be managed in order to assure an appropriate economic climate change that will lead to future prosperity. From Ben Bernanke to Larry Sommers, we have the greatest economic minds of our time doing their best to lead us forward through the implementation of economic policy which include: TARP’s, TALF’s, restructures, new management, programs like ‘Cash for Clunkers’, all with a common goal of strengthening the economy and all utilizing a theorized plan. A PIPE’s manager has to restructure without a TARP or a TALF and has to do it in the face of mass redemptions, lawsuits, investor ire and government scrutiny. Most are doing everything in their power to realize appropriate solutions. Ironically, the unfortunate fact may be that the strategy was simply flawed- in the face of a credit crisis, tightening liquidity and massive redemption- the PIPE’s market froze and contracted. In other words, its not a valuation issue, its not a shorting issue and its not a question of investment, what we have here are the affects of economic shock waves which have lead to tremendous aftershocks which constituted the ‘perfect storm’ that obliterated the PIPE’s market even while the managers did everything in their power to try to right a sinking ship, while desperately gasping for their last breath.

No comments:

Post a Comment