Editor

In times when the clogged economy keeps money from flowing as freely as companies would like, attention often turns to the PIPE - that is, private investment in a public entity, a form of financing that offers advantages aplenty.

The PIPE environment is changing, as Andy Arno, chairman of capital markets for C.E. Unterberg, Towbin noted - for one thing, PIPEs are getting harder to do - but the form has appeal that's likely to last.

Arno spoke on the subject during a keynote address last month at the New York Capital Roundtable conference at the Harvard Club in New York, for which he served as co-chairman.

In a PIPE, a company sells unregistered securities to a specific group of institutional investors in a private placement and files to register the stock later, typically within 30 days after the offering. The deal can be done quickly, without immediate paperwork or big risk. What's more, it can be tailored to fit whatever the investors are willing to provide, in accordance with the company's needs.

In the second half of last year, the stock market was rising, with small-cap and micro-cap firms moving especially well. Most of the PIPEs getting done were accomplished at a small discount, with no warrants (which investors sometimes want as protection, but didn't worry much about because of the hardy stock market).

The good times lasted into the first two months of 2004, with February very active, but by March the party was over, and the past few months have been particularly challenging. Deals that manage to get through carry 25 percent to 100 percent warrant coverage, and the common-stock PIPE has pretty much gone by the wayside, with convertible-bond PIPEs becoming the standard.

Another trend is that smaller, $100 million-market-cap firms (and below) are doing PIPEs. At the start of the year, it was mostly companies with $200 million market caps and higher. Now, bigger companies are waiting for the stock market to improve, but the others need cash now.

Investment banks' approach and strategy toward the PIPE business is shifting, too. Towbin did very few PIPEs in 2000, focusing instead on financing small technology and health care "growth" companies. But during the tight era of 2001 and 2002, the firm saw that when the bear market ended, one of the first vehicles likely to be used by firms to get money was the PIPE. Those needing cash did not want to raise a great deal at first because the terms would be less than ideal, so banks and issuers gravitated naturally toward the PIPE.

Sure enough, at the start of 2003, such were the kinds of PIPEs Towbin was doing: small deals for small companies who wanted to beef up their balance sheets discreetly.

In the second half of 2003, the market took off again and Towbin started doing what managers called "PIPEs on a spike" - fast-moving deals, most of which took less than a week or two weeks, thanks to the lack of pre-registration (which would have drawn out the process at least twice as long). Many of the small-cap companies' stocks were trading at high volume, and investors felt all right about putting money into them.

During that era, it became tough to distinguish between a $30 million to $40 million registered offering and PIPE, except for the rapid turnaround. Nowadays, boards and bankers are urging companies to market themselves each quarter, so the investment community is up to speed on their story when the time comes to go for cash. (Shelf registrations are popular, too, providing the option of selling shares that way.)

What's next? Arno predicted PIPEs would remain an alternative for fund raising but, in keeping with increased scrutiny in other realms, agents and funds would be more regulated by the SEC. Behind much of the push for oversight are directors of mutual funds, who don't want to invest in PIPEs until the enterprise seems safer.

"A major mutual fund may be one of the biggest shareholders in the company, but they're not allowed to buy private securities [according to their charters]," Arno told BioWorld Financial Watch. "They get aggravated because they get diluted," and the company is displeased because it's deprived of good investors, he added. "I'd love to see the mutual fund industry be a bigger participant in the PIPE market."

So far this year, "if you look at the top 25 in the total dollars invested, Wellington's done seven PIPEs, and Fidelity has done one," Arno said. "Those are two of the biggest accounts in the country, and it isn't many deals."

PIPEs might even appeal to mutual funds when other investors shy away.

"A PIPE is usually locked up for a little while, because your shares don't get freely tradable for 90 days, and most mutual funds say they are longer term investors anyway, or at least they say they are," Arno said, making mutual funds a good fit if the regulatory means can be found.

Participants right now are well defined, he said - dedicated PIPE funds plus "a lot of large hedge funds." If mutual funds can become part of the action, Arno said, the shift could benefit the industry and investors, but PIPEs will have to become accepted as "more of a mainstream vehicle."

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