Actionable Ideas for Companies and Sponsors
Heightened Investor Scrutiny on “Use of Proceeds” from PIPE Transactions
History suggests that sponsor-backed PIPE transactions tend to surge in times of turbulent market conditions, which is a trend that proved to be true again over the past year as more companies raised money via PIPEs than ever before in the wake of the COVID-19 pandemic and ensuing recession. There were over 100 PIPE transactions announced in 2020 alone, including Silver Lake’s $1 billion investment in Twitter, Apollo and Silver Lake’s $1.2 billion investment in Expedia, and KKR’s $500 million investment in US Foods. Although PIPE deals often provide issuers in need of cash with strategic benefits that do not always come with more traditional capital market financing options, such deals are often subject to criticism from common shareholders because of the perceived notion that these deals can create a misalignment between the PIPE investor and the common shareholders.
Earlier this year, tech company Box, which already was considered to be “flush with cash,” agreed to a $500 million convertible preferred equity deal with KKR in exchange for one Board seat. The investment gave KKR an 11% stake, making it one of the largest shareholders in Box. Later, activist investor and Box shareholder Starboard criticized the deal, opining it served no business purpose and was done in the face of a potential Board election contest to “buy the vote.” Influential proxy advisory firms Glass Lewis and ISS each raised concerns over the KKR transaction. In its report, Glass Lewis stated, “Starboard fairly argues Box had little clear impetus to undertake a further capital raise in such a short time frame” while ISS noted the timing of the deal was a “head scratcher.” Box shareholders ultimately rejected the Starboard slate at the annual meeting, an election result that Starboard in an open letter to shareholders blamed was “heavily skewed by the voting rights tied to the preferred equity financing”.
Board and management teams should consider the public perception of raising capital, particularly through PIPE transactions. Without a demonstrated use of proceeds for the cash, shareholders are likely to view these deals as entrenchment maneuvers designed to create an almost veto-proof block of votes to ward off an activist or interloper. At the end of Q2 2021, corporate balance sheets held an all-time high of $6.8 trillion in cash and short-term investments, representing a 45% increase over the five-year average preceding the pandemic. With this high level of cash and potential inefficiency on corporate balance sheets, PIPE investments will continue to be subject to heightened scrutiny from investors.