Is investing in PE-backed IPOs a good idea?
Is investing in PE-backed IPOs a good idea?
Part one of our series on investing in Private Equity through the public markets.
Private equity (PE) has gained quite a bit of attention in the media recently. PE firms are usually depicted as aggressive, predatory entities that ruthlessly acquire businesses – while taking away our ability to own anything independently.
Is PE truly good or bad? That's a question for another time.
For now, let's see how we, as regular investors, can be on the winning side. This post is the first in a series about investing in PE-related companies. Its goal is to demystify private equity and explain how we, as regular investors, can get a piece of the action.
Why should investors in public companies care about Private Equity?
The answer to this question is simple: PE is now too big to ignore. To put things in perspective, here is how big PE has become:
In 2000, private equity firms managed about 4 percent of total U.S. corporate equity. By 2021, that number was closer to 20 percent.1
In the late 1990s, there were fewer than 1,000 PE funds. As of 2024, this number had grown to over 14,500.
Global private equity assets – if we exclude venture capital – reached a new high of $11 trillion.2
The industry has grown at a 14% compound annual growth rate (CAGR) since 2005.3
In fact, PE-owned companies have officially outnumbered publicly held companies since 2012, and this trend doesn’t seem to be slowing down.4 Your universe of choices now has to include PE-related companies in some way, shape, or form.
And, of course, returns have been pretty good, too.
What is PE, and how can we invest in those juicy deals?
Private equity (PE) investing involves buying shares in companies not listed on a stock exchange. This usually involves a ton of leverage, which makes these deals very profitable for everyone involved.5
Unfortunately for us, these deals are accessible only to institutional and accredited investors.
However, there are a few ways to still get a piece of the action:
investing in PE-backed IPOs;
investing in PE firms' shares directly (buying KKR or Apollo, for example), or even an ETF tracking an index of these firms;
or investing in companies that might be the target of a PE buyout.
I'll go through all of these in a separate article for each. Today, let's look at PE-backed IPOs.
What about Venture Capital? Isn’t it also PE?
Venture capital (VC) and private equity (PE) are often lumped together under the private equity umbrella but differ quite a bit in focus and strategy.
VC firms invest in early-stage startups with high growth potential, taking minority stakes to spread risk. In contrast, PE firms target established companies, often acquiring controlling stakes in mature businesses or those needing restructuring.
However, the distinction between the two can sometimes be blurred. For instance, a buyout may incorporate elements of both VC and PE – we’ll look at an example below in this post.
The critical question for investors is: should we invest in PE-backed IPOs or VC-backed ones? Let’s look at what research says first.
An excellent report to read to see the difference in nature, culture, and returns of VC, as opposed to PE, is "The YC Report" by
.The article looked at the performance of Y Combinator (YC), a startup accelerator that operates in many ways similarly to a venture capital firm. Y Combinator has had tremendous success in the private market: its $1 billion invested across 5,000 companies has grown to a portfolio with a combined valuation of $600 billion.
But these returns were only available to YC and its partners: despite Y Combinator's success in private markets, many of its portfolio companies struggle after going public. If you had invested equally in all YC companies on their IPO day, you would now be down -49%, compared to the +58% return of the S&P500.
Or take a look at this chart, which shows the performance of VC-backed IPOs vs PE-backed ones during the latest market crash:6
Why are PE-backed IPOs interesting?
Private equity (PE) firms acquire companies through leveraged buyouts, using a combination of investor capital and debt to take control and drive operational changes. Their goal is to enhance company value for a profitable future sale.
This usually involves drastic cost-cutting, layoffs, and divestment of company assets. Many PE firms have been criticized for prioritizing cost-cutting over sustainable growth, which can harm the company's long-term health.
However, not all private equity firms degrade a company's quality and performance for profit. In many cases, companies targeted by private equity firms perform better after acquisition and often outperform market indexes in the long run.
Eventually, just like VC firms, PE firms “divest” from their portfolio companies too, and the incentive is similar: to make a significant return from taking a company public.
Luckily for us, there are studies looking at the performance of PE-backed IPOs.
One of these, very descriptively called “The Performance of Private Equity Backed IPOs”, looked at the performance of private equity-backed IPOs compared to venture capital-backed and non-backed IPOs from 1992 to 2005.7
It found that PE-backed IPOs perform better than others over three years. They also differ in market size, industry, and how they operate when they first go public.
Most importantly, it also found that :
PE-backed IPOs are more effective in terms of asset turnover, with a ratio of 1.48 in comparison to 1.05 for their VC counterparts. This ratio measures the efficiency with which a company uses its assets to produce sales.
PE-backed IPOs’ average operating margin of 15% is almost twice (7.7%) that of non-backed and about 3 times (5.4%) of VC-backed ones.
In other words, all of the management and operational improvements that private equity implement, as painful as they may be, tend to work.
Other studies found similar things. A professor from UNSW, for example, found that PE-backed IPOs listed on the ASX have significantly outperformed non-backed ones. This study even excluded any return over 100%, to limit extreme values, even though “this adjustment actually biases in favour of the non-private equity-backed IPOs”.8
In short, while investing in VC-backed IPOs can be disappointing, investing in PE-backed IPOs seems promising. Let’s look at some examples and see what the real world looks like.
Examples of PE-backed IPOs and their performance
Studies and research are fun to look at but it’s hard to get a sense of how stocks actually perform after an IPO. So let’s look at some well-known companies that went private and how they became “better” or “worse” after going through the “PE treatment”.
Dell Technologies
This is a story of how Michael Dell pulled off the riskiest deal of the century, borrowing and flipping his way to a $50 billion fortune.9
In the late 1990s, Dell thrived during the dot-com boom, reaching a valuation of around $100 billion. However, from 2000 to 2013, its stock lost about 75% of its value due to the rise of smartphones and tablets.
In response, founder Michael Dell led a $24.9 billion leveraged buyout in 2013, taking the company private with Silver Lake Partners' backing. During this period, Dell restructured and shifted from its core PC business to high-margin areas like software services, data storage, cloud computing, and software-defined networking, highlighted by its $67 billion acquisition of EMC Corporation in 2015 – one of the largest tech acquisitions ever.
By 2017, Dell had regained its footing and returned to the public market in 2018 in a much stronger position. During its time as a private company, Dell paid $14 billion in debt and invested $21 billion in research and development (R&D). The company's return to the public markets was met with skepticism, as reflected by its low valuation of just 0.2 times its trailing sales.
But eventually, investor confidence gradually improved due to two factors:
Dell massively grew its profits by doubling its high-margin services revenue to $24 billion from 2017 to 2024, cutting operating expenses. This resulted in a significant improvement in operating income, which reached $5.2 billion in 2024.
Dell also focuses on AI-optimized products, particularly servers. By Q4 2024, Dell had a $2.9 billion backlog of orders for AI-optimized servers, nearly double the backlog from Q3.
All of this meant serious returns for IPO investors. If you had invested $5,000 in 2018, your stake would be worth $29,000 today, including dividends.
Burger King
Burger King’s acquisition is bit different from what we saw with Dell. Its PE romance has quite a few twists and turns. Here’s how it happened.
In 2010, 3G acquired Burger King for $3.3 billion ($4 billion including debt).10 Known for its cost-cutting approach, 3G implemented strategies such as pivoting to a franchise-based model, which reduced operational costs and earnings variability. Cutting costs also allowed Burger King to introduce new menu offerings and update store technology.
They then installed a new management team, including Bernardo Hees as CEO and Daniel Schwartz as CFO, who were known for their expertise in turnarounds and financial management.
By 2012, Burger King’s earnings had increased 49%, and 3G sold a stake in the company to Justice Holdings at an $8 billion valuation. The primary goal of this deal with Justice Holdings was structured to allow Burger King to return to the public market.
Two years later (2014), Burger King merged with Tim Hortons under Justice Holdings to form Restaurant Brands International. The merger was valued at approximately $11.4 billion, creating one of the largest fast-food operations in the world.
By 2017, it was reported that 3G Capital and Burger King’s other shareholders had made over $14 billion from the turnaround that began in 2010.11
Hilton Worldwide
Blackstone took Hilton private in 2007 for $26 billion, one of history's largest private equity transactions. Before the buyout, the company was struggling: it had abandoned international expansion, grappled with low employee engagement and satisfaction, and had a relatively small “HHonors” loyalty program with only 39 million members.
To make things worse, the 2007 buyout was heavily leveraged, with $20.5 billion (78.4%) financed through debt and the remaining $5.6 billion in equity. But when the 2008 financial crisis hit, Blackstone moved quickly to restructure Hilton's debt:
They negotiated with banks to extend loan maturities to 2015.
Blackstone bought back $2 billion worth of debt for $800 million, forcing banks to take a $1.2 billion loss.
And the bank consortium converted $2 billion of debt into Hilton's preferred stock.
Blackstone didn’t stop at financial engineering, though. Under Blackstone's ownership and Chris Nassetta's leadership as CEO, Hilton underwent operational changes:
It invested heavily in property renovations, technology upgrades, and service enhancements.
It moved its headquarters from Beverly Hills to Virginia, reducing renting costs and attracting customers.
It created an employee performance evaluation, making the workers more performance-driven.
It launched new brands such as Curio, Tru, and Canopy, which are more upscale (meaning with higher profit margins) versions of Hilton Hotels.
With this slow and steady approach, Blackstone created real, sustainable cash flows that allowed it to refinance its remaining $14 billion in debt.
More importantly, they also managed to grow Hilton even more:
The company nearly doubled its global property and room count and expanded its brand portfolio.
The loyalty program was digitized and rebranded as Hilton Honors. As of September 30, 2023, it had over 173 million members.
Internationally, Hilton expanded into over 30 new countries and territories..
Hilton is now named the No. 1 World's Best Workplace by Fortune and was also awarded the “Great Place to Work” badge.
More importantly for us, since its IPO in 2013, Hilton has delivered a return of over 370%, outperforming the S&P 500’s return of only 250%.
It's even more impressive that Hilton's refinancing and restructuring happened during the 2008 financial crisis. Hilton is now one of the leading hotel franchises in the world, just behind Marriott and IHG. This success wouldn't have been possible without Blackstone.
Should we invest in the next PE-backed IPO we see, then?
Perhaps not. In some cases, it’s difficult to say when an investment is “VC” or “PE”, even if it comes from a PE firm. For example, Blackstone acquired a majority stake in Bumble in 2019, which then went public in 2021. Both the deal and the -87% post-IPO drop, though, resembled more a “hyped” VC investment than a true PE one.
Sometimes, the debt payments can cripple a company. This happened with Toys R Us, taken private in 2005 and never taken public again – it filed for bankruptcy in 2017.
I looked at which PE-backed IPOs are happening soon, and found Panera Bread.
The fast-casual restaurant chain is quite popular in the United States, and in its last 20 years as a traded company (1997 to 2017), it was the best-performing restaurant stock. It has over 2,000 locations and was once the biggest provider of free Wi-Fi hotspots in the United States. In 2017, the company was acquired by JAB Holding, a private equity firm that owns other major brands such as Krispy Kreme and Pret A Manger. The deal was worth around $7 billion.
However, Panera has gone downhill since this deal.
As this article in the Nation puts it, “it used to make on-site sourdough. Now, the private-equity-owned chain is better known for its (allegedly) killer lemonade.”12
What was once a charming place now resembles a “hospital cafeteria, where middle-aged people gather for unpleasant conversations.” On top of this, Panera is still grappling with several lawsuits surrounding customers who reportedly died after consuming highly caffeinated lemonade energy drinks.
Yet apparently, despite these issues, Panera's IPO is still happening this year. But while for Burger King and Hilton cost-cutting exercises and debt made them more disciplined, in Panera’s case it led to declining product and service quality. Panera Bread has seen little growth under JAB, adding fewer than 100 net new locations since its acquisition at around 2,050 locations.
In short, we can't recommend investing in Panera. This is the kind of PE-backed IPO that private equity critics warned us of. But we'll keep an eye out for any upcoming PE-backed IPOs that have potential.
In the next post, I’ll look at whether investing in private equity firms is an even better deal – and if so, which firms look interesting.
Until then, any specific PE-backed IPO on your radar? Let us know and we’ll look into it!
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