Considering an IPO? Consider the Risks
September 6, 2004
Although fund advisors are beginning to return to initial public offerings, particularly to expand offerings and competencies, (see MME 8/30/04), there are risks associated with tapping the capital markets.
Just last month, real estate fund firm Cohen and Steers launched an IPO and Calamos Asset Management registered for one. Both niche firms' registration forms clearly state that their key executives are instrumental to their future success. Neither firm returned a call seeking comments.
While a laundry list of the potential risks a company issuing stock can face is part and parcel of every IPO registration, Calamos' filing also details the increasing pressure on lower fees amid fierce competition and the increased independence of fund board trustees. In addition, it notes that an SEC proposal to register hedge funds, in addition to proposed legislation that would ban a manager from managing both a mutual fund and a hedge fund, could negatively impact the firm's business and future revenues. Lastly, Calamos points to the possibility that regulators will ban or curtail soft-dollar arrangements, an initiative that would have cost Calamos $900,000 for broker/dealer research in 2003, its filing noted.
Both Cohen and Steers and Calamos manage a selection of closed-end funds, in addition to open-end funds and institutional assets. Managing closed-end funds may provide a bit of a security blanket to these firms, analysts said. Once the initial assets are raised, outflows aren't possible because they don't offer the same daily redemption features that open-end funds do. Consequently, closed-end funds provide a constant annuity of management fee revenue to the fund company, explained Jeff Margolin, vice president and senior closed-end fund analyst with Ryan Beck in New York.
But there are drawbacks. Closed-end fund assets can shrink in size due to depreciation, Margolin conceded. Moreover, closed-end fund managers tend to depend on the mood of the market when it comes to IPOs of all sorts, including closed-end funds. The real risk to favorable IPO market sentiment would be continued interest rate spikes, as they can "hurt the performance of funds and investors' appetite for new funds," Margolin said. When the Federal Reserve Bank raised interest rates in April and May for the first time in years, some fund advisors shelved plans for closed-end IPOs, he said.
There could also be challenges for these niche players if a serious market correction were to takes place, said Robert Hansen, an equity analyst at Standard & Poor's in New York. If the bottom should fall out of their niche markets, depreciation of the closed-end funds could cause a widening discount between their exchange-traded net asset value and regular NAV, Hansen said. Simply put, that would cause mass redemptions, he said.
Extended periods of double-digit discounts have historically caused some shareholder activists to push to open-end a closed-end fund so that they, and other investors, could redeem shares at the higher NAV price. But data has shown that when funds are open-ended, assets quickly flow out, causing the newly opened fund to limp along and often fold.
Although Calamos and its co-underwriters have not yet publicly suggested an IPO price range in SEC filings, Cohen and Steers hoped to obtain a starting share price of between $13 and $15. In the end, the stock began trading at $13. "It is significant that it priced at the low end of the expected price range," said David Menlow, president and founder of IPOFinancial.com, a Milburn, N.J.-based research firm. "The market has clearly stated that they don't want this deal," he added.
Ray Hanley, senior vice president, corporate finance at Federated Investors in Pittsburgh, said it's not as compelling for asset management firms to generate capital through IPOs since the business itself generates cash flow. Federated executed its IPO in 1998 in order to raise its global profile and consequently acquire other managers. But it has also used its new public offering to design an employee compensation program tied to the company's publicly traded stock, Hanley said.
Asset management firms going public should consider how that requires more substantial infrastructure, additional compliance and added risks that mean more insurance, he said. And then there's a whole new constituency to cater to, he added.
Neil J. Hennessy, chairman and CEO of Hennessy Advisors of Novato, Calif. which staged its IPO in May 2002, agreed that going public brings a whole new set of requirements to a firm. Due to the scandal, current popular opinion is that investment management is a bad industry, he said. IPOs in general are eye opening, he added. "Every day you have to make money for two sets of shareholders," he said. Moreover, there is a lot more paperwork and scrutiny once you are a public company, he added.
Further, public sentiment currently is largely anti-investment management, thanks to the fund scandal, he noted. He believes that "the hardest part to undertaking an IPO today lies in investors' perceptions." Nonetheless, he advises asset management firms that want to stage an IPO to forge ahead. "Keep your head down, do your job honestly and ethically and whatever happens, happens," he said.