Special Situation Investing

Sunday, September 17, 2006

PIPEs (Private Investments in Public Equity)

The New York Times published a good and fairly thorough review of modern day PIPE transactions, with special emphasis on their abuse by insiders. For those of you new to PIPE's a quick overview:

PIPE's involve the sale of equity to a firm (generally a hedge fund these days) at a price below the current market value. This is performed when companies are in need of capital (often desparately in need) and their financials or the size of the firm makes traditional equity offerings unappealing. The problem of course is that the sale is not handled through traditional markets and average investors do not have access to the deal. This in itself can lead to mispricing and abuse (in my opinion) of common shareholders rights. In addition, during the process of negotiating PIPE's numerous individuals (potential buyers) are made aware of the transaction and are in a position to make short trades as PIPE's generally cause decline in share prices.

From the article:

Over the last 18 months, the Securities and Exchange Commission has filed four lawsuits against individuals and hedge funds that the commission said had profited on nonpublic information about stock offerings.


The hot tips at issue in these cases involve an increasingly popular type of security called a “private investment in public equity.”

To be objective we should put these numbers into perspecitve:

According to Sagient Research Systems in San Diego, 2006 is on the way to becoming the biggest year for PIPE’s. As of this month, almost 800 deals worth $18 billion have come to market; in 2005, a total of 1,301 deals worth $20 billion were done.

I am not particularly concerned about the insider transactions as insider trading is in no way isolated to PIPE's. What bothers me, as I said previously, is that certain companies are gaining access to funds at prices negotiated not by the market but by management and the purchaser. Furthermore it seems that at least some of the purchasers have the shortest of time frames in mind:

After the deals close, a company issuing the securities typically files a registration statement with the S.E.C. that will, when approved, let buyers resell their shares in the open market — a process that usually takes about 60 days.

I would be extremely wary anytime a company you are following raises capital through this type of transaction. If the purchase price is at a steep discount, if the company does not desparately need the funds or if there has been any evidence that the deal was leaked (via trading spikes prior to the annoucement), you would be better off investing elsewhere.

As a side note and more rant that practical information, the article also made reference to a web site www.measuredmarkets.com that performs analysis of stock trading patterns. Their goal is to give individual investors information which can be used to predict these types of insider trading activities. So far so good. I looked at the web site and the analysis they have performed, they have indeed shown that they are able to spot the insider trading in some cases. They have not, however, shown that they are able to differentiate betweeen trading pattern changes caused by valid insider trading and those caused by any other type of regular transactions (large institutional buyers). This bothers me and is fairly typical of wall street. Tools are provided, success stories are listed but in the end there is no hard evidence that you can reliably predict what is going to happen. I would love to be proven wrong but I see no alpha here.


I received a reply from an individual involved with measuredmarkets.com after publishing this blog. While I am not going to post his reply, in the interest of accuracy I will just concede 1 point. His site may be able to predict block trades as separate entities from insider trading. Block trades can be a major component of institutional buying but certainly not all institutional buying is done through this type of trade.


  • Los Angeles private equity and hedge fund borrowing are the main things propping up the stock market these days. That won't last forever, but for now it's hiding the real economic damage that is being done.The tax issue is valid, and something most people can understand, but the real tragedy of the current situation is much more complex.

    By Anonymous Anonymous, at 4:53 AM  

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