After Aritzia, Bay Street has to decide which IPO is next

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Like wine makers, private equity funds describe their investments in terms of vintage years.

For an example of what's in the private equity cellar, look no further than Berkshire Partners LLC, a Boston-based fund manager that pulled the cork on a 2005 vintage this week by selling a portion of its stake in Aritzia Inc. for $230-million as part of the Vancouver-based fashion retailer's $400-million initial public offering. Aritzia shares begin trading Monday on the Toronto Stock Exchange.

Aritzia's debut marks the first IPO of the year on the TSX. Strong investor demand translated into a larger-than-expected stock sale, priced at the high end of the projected range at $16 a share. Berkshire Partners' success has rival private equity funds dusting off their own vintage holdings, many of which have been aging for a decade, and weighing the prospect of cashing in by taking these businesses public.

In coming months, if markets remain buoyant, expect to hear investment banks roll out the Aritzia game plan in IPO marketing campaigns for a string of companies. Potential IPO candidates include companies with strong U.S. growth potential – Aritzia's pitch to investors focused on expansion of its 75-store network – or businesses that can satisfy income-seeking investors by kicking off a steady cash dividend. Dean Braunsteiner, head of the National IPO Service at PricewaterhouseCoopers (PwC), said: "The strength of the U.S. economy and the advantage of the lower Canadian dollar for manufacturers make this a good time to go public."

While the IPO party may have begun, not every private company is invited. Two traditional Canadian sources of new issues – the energy and mining sectors – are seen as unlikely candidates for IPOs in the foreseeable future, due to the ongoing uncertainty around the outlook for commodity prices. That clears the field for private equity funds, as their portfolios are typically focused on industrial, consumer product and service businesses.

Private equity demand for IPOs is driven in large part by the predictable life cycle of these asset managers. PE companies raise money, then invest with an eye to cashing in within 10 to 12 years. They then return any profits to backers and launch a new fund. Scores of PE funds pulled in significant capital ahead of the 2008 global financial crisis and put that cash to work within three or four years – there are plenty of 08, 09 and 10 vintage businesses PE funds are anxious to serve up.

That dynamic means Canada's largest PE companies – a list that includes Onex Corp., Brookfield Business Partners LP, Birch Hill Equity Partners Management Inc. and Torquest Partners – have owned businesses for the better part of a decade and are motivated sellers. In the absence of IPOs, PE companies typically exit by selling businesses to competitors, or to other PE funds. Strong demand for IPOs adds a welcome source of liquidity to the market. When asked if investment banks plan to start pitching the PE crowd on IPOs in the wake of the Aritzia deal, one experienced deal maker said: "Don't assume we ever stopped pitching. The tone of the conversation just got a little more intense."

Like air traffic controllers, Bay Street bankers now have to determine which IPO they want to land behind Aritzia. Any decision on who goes first will be largely driven by the merits of the business being sold, but relationships also matter: Larger PE companies that have consistently paid fees to the Street for past deals are going to get priority now that the door is open for new issues.

When Aritzia begins trading, it will mark the end to a Canadian IPO drought that began in January with a stock market swoon. But PwC's Mr. Braunsteiner points out that investors never stopped putting their money to work, as this year featured a vibrant market for secondary equity offerings and a buoyant debt market. He said: "Investors have looked to mature companies and well-known names for investments and have found a surprising menu of options."

This year's total lack of IPOs, prior to the Aritzia offering, compares to 22 Canadian new issues in 2015 that raised $3.9-billion, a total that includes the $1.6-billion debut of Hydro One Ltd. In 2014, there were 14 Canadian IPOs that raised $3.4-billion. Based on the pace of new issues in recent years, investment bankers say they are confident investors would step up for $1-billion or more of IPOs in the final quarter of this year and into 2017, assuming equity markets continue to bump along near historic highs.

After drinking deeply of the 05 vintage from Berkshire Partners, investors can expect to be served up a string of slightly more recent vintage offerings.

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Vintage investments

A selection of well-aged companies are stored in the cellars of Canadian private equity companies

Onex Corp.

• Res-Care Inc.: Acquired in 2004, this is a specialized services business
• Carestream Health Inc.: A 2005 investment in medical imaging

Brookfield Business Partners

• Maxx Inc.: This 2008 investment makes bathroom fixtures

Torquest Partners

• SCM Insurance Services: Acquired in 2010, SCM provides outsourcing for property and casualty insurers
• Global Traffic Technologies: This 2007 investment makes traffic lights

Birch Hill Equity Partners

• Biox: Purchased in 2006, it makes fuel from agricultural feedstocks
• Creation Technologies: A 2007 vintage, this is an electronics manufacturer