PIPE-Works and PIPE-Dreams (Part II)

A 23-year analysis of private investments in public stock in Japan and the US shows a history of investing at the extremes.

By: Verdad Research & Rina Okachi

Last week we highlighted the deal flow and deal characteristics from our database of over 29,282 PIPE transactions in the US and Japan since 2000. 

In the dataset there were really two types of PIPE transactions. First, distressed value firms that were struggling to raise capital by any other means. Second, many PIPEs involved small growth companies that had high cash-burn rates, big promises for the future, but no proof of concept in their past. Especially in the US, this involved tech or biotech companies that a bank’s leveraged lending principals would think were on Palo Alto-grown shrooms. Let’s call them PIPE-dreams. 

What both types of companies had in common is an inability to survive without capital injection. Early academic research on US PIPEs around a decade ago found that the majority of the companies doing PIPEs would have been out of cash within a year.

Unsurprisingly, the median PIPE deal lost money, especially in the US, where the median PIPE returned -17% over the next year. But while the median PIPE deal was a loser, PIPEs exhibited extremely skewed returns, which the median does not reflect. Distributionally, they were more like lottery tickets or venture bets than the overall universe of public equities. Most failed, but a small number of big winners made up for the high failure rate. The average returns (even after cutting out the 1% of extremes) were 14.7% for US PIPEs and 26.7% for Japanese PIPEs as shown in Figure 1 below. 

Moreover, if we exclude the PIPE-dreams (the expensive half of the PIPEs that mostly look like venture-backed companies), returns dramatically improved. 

Figure 1: Median and Average Return for All PIPEs vs. PIPEs ex-PIPE-Dreams (2000–2023YTD)

Source: Compustat. All PIPE transactions excluding issuers with a market cap less than 1M USD. US count includes OTC transactions. “PIPE-Dreams” are defined as PIPEs above the median PIPE multiple in the dataset or PIPEs that sold at a premium to the issuer's stock. Above is the CAGRs since 2000.

Our 14.7% average return for US PIPEs is much lower than the 20%+ average return found by researchers in the biggest US PIPE study we came across. In part this may be because we have an additional eight years of data when PIPE discounts were lower or because we include OTC securities (where most of the adverse delistings occur). In either case, we think an average US PIPE return of 14.7% looks a lot like the return an investor got for buying an equally weighted mix of tenth-decile US microcap deep-value and microcap growth stocks at an 8% theoretical discount to public markets (equal to the average PIPE discount over these 23 years.) 

Japanese PIPE returns, however, are particularly interesting, both at the median and the 26.7% average. We think there are two reasons for this difference between US and Japanese PIPE returns. First, Japanese PIPEs were done at substantial discounts to US PIPEs, typically 0.7x revenue vs. 3.9x revenue in the US. Second, bankruptcy was almost nonexistent in Japan during this time. At their peak in 2008–2009, only about 33 out of ~3,300 public firms went through bankruptcy in Japan. Essentially, Japanese PIPEs had the same positive skew but started from a lower starting point and didn’t suffer from the same downsides as US companies did because of the lack of bankruptcy. 

But overall, one of the strongest relationships that jumped out to us in the data set was that of discounts to the underlying issuer and the realized PIPE returns. PIPE common stock transactions generally involve a discount to the public market price of the issuer’s stock. 

Below is a chart of the one-year forward returns of the PIPE investor and the issuing stock returns. The returns are divided into deciles according to how cheaply the PIPE investor got the stock compared to the prevailing stock price one day before the transaction was announced. On the left are the 10% of cases in which PIPE investors got the biggest discounts in history (a -100% to -47% purchase price compared to the actual stock price). By contrast, on the right are the 10% of cases where PIPE investors actually paid 22% or more than the issuer’s stock price to execute the PIPE transaction. Two things are striking to us here: First, the correlation between purchase discounts to what public markets are paying and the private investor’s realized return was near perfect in this dataset. Second, the higher the premium the PIPE investor paid, the better the underlying stock did, but the worse the PIPE investor did based on our research.

Figure 2: PIPE and Underlying Issuer Average Returns by Decile of PIPE Discounts

Source: Compustat. All PIPE common stock transactions excluding issuers with a market cap less than 1M USD. US count includes OTC transactions.

In other words, the best PIPE returns were acually in far worse performing stocks where the discounts the private investor got at the onset were much bigger. The worst PIPE investments were in high performing issuer stocks where the PIPE investor simply overpaid as shown above.

As with many other asset classes, purchase prices seem to go a very long way in explaining realized returns. PIPE investors, to the extent they were able to underpay the prevailing price in public markets seemed to dramatically outperform. To the extent they overpaid, the opposite seems true in this large dataset. The PIPE dataset here may help to demystify some of the real drivers of private investors’ competitive advantages, or lack thereof. 

Based on these results, to the extent private investors can continue to underpay the public markets, we’d expect premiums to follow from there. And to the extent they can do that in Japan while bankruptcy rates stay relatively low there, we’d expect that trend to continue as well. 


Rina Okachi is an MBA Candidate at Wharton. She was born in Japan, is interested in the intersection of public and private markets, and is looking to pursue a career in finance. If you'd like to connect with Rina, please reach out to okachi@wharton.upenn.edu.