PIPE (Private Investment In Public Equity) deals remind me of the NBA draft. Of course there is no David Stern, but there are plenty of tacky suits and talks of upside.

Optimism reigns and potential dominates substance. This isn’t necessarily bad. Take John Wall for example. He showed enough promise in one year at Kentucky to become the #1 pick of the 2010 NBA draft. Wall’s collegiate numbers were compelling but not off the charts. It’s what Wall will do in three years that causes scouts to drool. Similar to John Wall, many young companies want to cash in when expectations exceed past performance. Why not? Expectations play a huge role in determining the present value of companies.

From an investor standpoint, the big rewards don’t come from drafting the All-American in the lottery; the true spoils come from finding the player overlooked by all the experts who becomes an All-Star. Investment bankers and companies know this. They position companies as “diamonds in the rough.” Proud CEOs tout tantalizing projections and heroic expectations of market share. We investors get caught up too, but we have the balance the hopes of a 500X ROI against the possibility of losing our shirt. Similar to the NBA draft, there are some Hall of Famers who get picked in the second round but the majority don’t last more than a year in the league.

We investors should keep our eyes out for the 6’10” freshman with crazy hops who has yet to average more than 15 points a game, but we can’t lose sight of the role players, those yeomen who do the little things to bring a team over a top. Therefore, PIPE investors should allocate funds to a spectrum of companies with a wide range of return opportunities. Maybe that stable consumer products deal may not get you staggering returns, but it helps form the core of the portfolio that allows the more high flying investments to shine. The Lakers drafted Derrick Fisher the same year they signed Kobe Bryant.

Whether we’re drafting players or companies, we’re all geniuses in hindsight.

This entry was posted on Sunday, June 27th, 2010 at 11:41 am and is filed under General, alternative investing, alternative investing, alternative investment. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.