Big PIPE. (Wall Street West).

Private investment in public equity deals, known as PIPEs, were once something of a backwater capital-raising tool. Now, they have nearly become mainstream investment banking tools.

"In the last several years, the quality and size of PIPEs has increased, though it really was never low' says Alex Cappello, chairman and chief executive of Cappello Group Inc. in Santa Monica.

He says his firm was just retained by a Fortune 500 company to raise between $200 million and $300 million in a PIPE. He declined to name the client.

PIPEs accounted for $12 billion in investment last year, according to the Strategic Research Institute, compared with $3 billion in 1998.

PIPEs involve a pre-negotiated sale of large blocks of stock in a publicly held company at a fixed price, usually at some discount to the market. The buyers are generally one or more large institutions. Convertible bonds are privately placed in a PIPE as well.

In one deal, Cappello raised $23 million in March for Calabasas-based children's wear outfit Right Start Inc., to buy toy house FAO Schwarz (the combined company's headquarters have since moved to Pennsylvania).

He contends public companies can actually raise money more cheaply through a PIPE than other mechanisms, given skittish markets. If a company publicly announces its intention to raise capital, such as issuing new bonds or stock, that can depress the stock's price, especially in the current, choppy market. "In a PIPE, the price is established, and then the deal is announced," says Cappello.

In some circles, PIPEs retain a sinister reputation. So-called "toxic convertible" bonds, in which a convertible bond converts into more shares if the issuer's stock price decreases, are a form of PIPE.

If call options are written into the convertible bonds, bondholders can end up converting into a controlling stake in a company when the share price tumbles enough. Some convertible bondholders actually short a stock, spreading rumors to sink its price, then converting shares to gain control of a hapless company.

Cappello says that as the market for IPOs and secondary offerings remains flat and banks are loath to lend, PIPEs become more appealing routes to capital.

"So many of the public companies out there are orphans. They don't know how to talk to the Street, how to talk to institutional investors, the brokerages," he says. "Yet, at the same time, there has never been more liquidity in private equity funds than today."

By convincing just a few institutional investors to plunk their money down, a public company can get the capital it needs. "It just makes sense to fund certain public companies with private equity, and PIPEs is a growing way to do it' says Cappello.

Contributing columnist Benjamin Mark Cole writes about the local investment community for the Los Angeles Business Journal. He can be reached at [e-mail].