PIPEs: Traditional or Structured

By Antonio Melo

When it comes to PIPEs, issuers can be overwhelmed with all the different structures and terms. For simplicity, they are classified as one of two categories, Traditional or Structured. The Traditional PIPE has a fixed issue or conversion price, while the Structured PIPE might have any combination of a variable conversion price, reset provision without floors and/or a structured equity line-of-credit. Traditional PIPEs typically attract long term-investors who are betting on the performance of the company and its stock price. Structured investors are ambivalent towards the performance of the company as they can realize profits through trading strategies based on the structure of the financial instrument.

According to Placement Tracker, since 1995 there have been 6,137 PIPEs completed of which 1,692, or 28%, were classified as Structured. More recently, out of the 838 PIPEs completed this year only 42, or 5%, were structured, still a significant drop from last year where Structured PIPEs represented 14%. Even more dramatic, based on dollar amounts as of year-to-date only 1% were Structured. Much of the trend away from Structured PIPE has been due to the notoriety of short selling abuses associated with floorless, floating convertible issues, which have earned names such as “death spiral” and “toxic” convertibles. Issuers have been trying to avoid this type of financing at all costs and have forced some investors to offer terms where the issuer has a certain control over dilution. Equity lines of credit are the most common type. However we have seen new structures, the pitfalls of which the issuers may not fully understand.

Recent SEC filings show one investor, who had previously been active in floating conversion PIPEs, has been providing convertible financing to companies structured as a amortizing loan or redeemable preferred stock, where the issuer could pay the interest/dividend and principal in either cash or stock, at the issuers’s option. The conversion price of the stock is stated to be at a fixed price at a premium to the market at the time of closing. However, there are contingencies that must be met for this fixed conversion price to be applicable. If the issuer elects to make a portion or all of a payment in stock, then the issuer must give notice to the investor in advance. From the time of notice until the payment date, the stock must close at a stated premium to the fixed conversion price or the conversion price changes to a floating discount to the current market price. Therefore, if the company needs to issue stock due to lack of cash, a likelihood given the company’s notice to pay in stock, and yet cannot meet the premium to the fixed conversion price, it could be faced with a floorless floating conversion. It is this type of floorless floating conversion feature that gave the Structured PIPE its bad name. Thus the issuer, who is already facing an overhang on its stock during the amortization/redemption period, could be facing unaccounted, increased dilution. Fortunately for the issuers, this structure is not as dilutive as the true floorless floating issues due to its amortization schedule and because companies have the option of paying with cash if a floating conversion rate applies. Even so, this deal appears to be a wolf in sheep’s clothing.

But what is the difference in the performance of the issuer’s stock price after closing? According to Placement Tracker, there is a significant difference between the performances of the stock of companies who issued Structured vs Traditional PIPEs. Ranking¹ investors with portfolios of Structured PIPEs by measuring the post deal stock performance of the companies who issued Structured PIPEs since 1995 shows that only 1 investor had a portfolio of companies, where the dollar weighted average of the stocks of these companies exhibited positive gains 6 months after closing. Comparatively, investors with portfolios of Traditional PIPEs, using the same metrics, showed vastly different results whereby the top 10 investors’ portfolios all have positive gains.

With these types of results, it is incomprehensible why any issuers would still consider a Structured PIPE. Unfortunately, microcap companies, by themselves might not have the flexibility or leverage to demand traditional structures from investors in these markets. But there is a place to turn to. Taglich Brothers has been helping microcap companies execute traditional PIPEs with long-term investors in all types of markets. By specializing in placing traditional PIPEs of microcap companies with long-term investors, we are able to help our clients avoid deals, which might have a negative impact on their share price. For more information, please contact Taglich Brothers at 800-456-1220 x306.

¹This Ranking shows the Investors with the top post deal stock performance in Structured and Traditional PIPEs since 1995 at 6 months after closing. The percentages reflect a dollar-weighted average performance for all of the stocks that Investor has invested in using the respective PIPE. The list only includes investors that have participated in at least 5 PIPEs in the past 24 months. Only the top 8 were available for Structured PIPEs.

Data as of 10/7/03

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