For IPOs, Earning a Profit Matters Again

Neiman Marcus Group, the luxury retailer with more than $  4.7 billion in debt, has decided to postpone a possible debut to next year. ENLARGE
Neiman Marcus Group, the luxury retailer with more than $ 4.7 billion in debt, has decided to postpone a possible debut to next year. Photo: Joe Raedle/Getty Images

Investors in initial public offerings are taking a fresh look at companies coming to market and asking a new question: Can they make it through a tough stretch?

Concerns about the economy and jitters in credit markets are prompting skepticism about issuers that aren’t very profitable or are carrying heavy debt loads.

Those concerns were evident this week, when grocery chain Albertsons Cos. Inc. was forced to delay its IPO and payments processor First Data Corp. priced its offering sharply below its expected price range and saw its shares trade slightly lower.

“Investors now are much more focused on the fundamental earnings power of those companies, as opposed to the financial engineering component,” said Matthew Rubin, director of investment strategy at Neuberger Berman.

The moves this week follow a long stretch of difficult debuts for fast-growing but money-losing technology and health-care firms. They also represent a major shift from a year earlier, when investors bought IPOs at a volume and pace not seen since the dot-com boom.

Overall, IPOs this year through Wednesday have raised $ 32 billion across 152 deals, versus $ 82 billion across 240 deals by that point last year, according to Dealogic.

One factor is that corporate access to capital is getting more expensive, as expectations for U.S. economic growth have waned and default rates and ratings downgrades have ticked higher.

Before this year, companies with high leverage had been able to borrow money at low rates, as investors bet on the U.S. economic recovery and sought higher yields. That in turn helped support stock prices for indebted companies.

Shares of private-equity-backed companies with debt more than four times their cash earnings that went public from 2011 to 2014 have gained 67% on average, versus a 61% rise for the S&P 500 index over that period, according to FactSet figures.

“What you saw during the economic recovery was [growing revenue] that helped drive demand in many sectors, and you had the cost of capital…continue to decline,” said James Keenan, global head of fundamental credit at BlackRock.

Now, he said, investors “are discounting future earnings more so in some of these companies because a leveraged company has less flexibility in a downturn,” said Mr. Keenan.

High-yield credit spreads widened at the end of September.

While spreads have improved in the past week, they remain elevated from their levels earlier this year. The volume of refinancing deals, in which new loans are sold to replace existing loans, typically at lower rates, is down 37% through the end of September, according to S&P Capital IQ LCD.

Albertsons had planned to raise about $ 1.6 billion in its IPO to pay down some of its $ 12 billion in total debt. Reducing debt was also a big part of First Data’s pitch to investors, people familiar with the deal said.

To prepare for an IPO, First Data had made a big push to reduce debt—or “de-lever”—over the past two years, the people said.

First Data’s owner, KKR & Co., took the unusual step of investing more cash in the company last year, along with other investors.

Including the IPO, the company will have raised over $ 6 billion in new equity in large part to pay down debt. Total debt post-IPO will be around $ 19 billion, according to filings, down from nearly $ 23 billion at the end of 2013. The company also said that more than $ 10 billion of its debt can be refinanced at more attractive terms through August 2016.

“It’s a pretty dramatic change,” said Chief Executive Frank Bisignano on Thursday. “The most important thing [going public] allows us to be able to do is de-lever.”

First Data shares opened at $ 16.39 in their Thursday debut and ended down 25 cents, or 1.6%, at $ 15.75.

Already, Neiman Marcus Group Inc., the luxury retailer with more than $ 4.7 billion in debt, has decided to postpone a possible 2015 debut to next year, people familiar with the matter have said.

There are still other private-equity-backed companies lined up to potentially go public.

Spanish-language media giant Univision Holdings Inc., owned by a consortium of private-equity firms, filed its paperwork for an IPO in July and has about $ 11 billion in total debt.

Unprofitable but growing companies may also face more skepticism.

Square officially filed to go public. Here are five things we learned about the mobile payments startup and its CEO Jack Dorsey. Photo: Getty Images.

Startup Square Inc. revealed its IPO plans on Wednesday. The small-business payment processor’s net revenue grew 54% last year to $ 850 million, but losses also grew by 47% to $ 154 million from a year earlier.

This year, tech firms are set to make up their smallest share of the IPO market since 2008, according to IPO research and investment firm Renaissance Capital LLC. A number of high-profile startups—including Box Inc. and Etsy Inc. ETSY -0.36 % —are trading below their IPO prices from earlier this year.

“It’s very reasonable for investors in this environment to ask what magic will make a loss-making company more profitable when it’s larger,” said Rett Wallace, chief executive of Triton Research LLC, which analyzes pre-IPO companies.

The shrinking number of large deals, which deliver the biggest underwriting fees, has also taken a bite out of banks’ revenues, third-quarter results show.

Goldman Sachs Group Inc. GS 0.12 % on Thursday reported a 55% drop this quarter in revenue from equity underwriting versus a year ago, which followed reports of a 35% drop in that revenue at J.P. Morgan Chase JPM 0.87 % & Co., a 43% drop at Citigroup Inc., C -0.53 % and a 47% decline for Bank of America Corp. BAC -0.43 %

Write to Telis Demos at [email protected] and Corrie Driebusch at [email protected] Markets

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