BYE-BYE BULLS AND BEARS
Fed up with living
in a fish bowl, public companies are going private.
By Steve Thomas
For
faltering public companies, corporate finance is a jungle. Dim trails diverge
in many directions. The undergrowth is thick. Highly capable CEOs who know their
own businesses inside out may have a hard time finding their way through the thicket.
Should they borrow money for expansion or gather equity by taking on new partners
or shareholders? If they issue more stock, how many shares should be offered?
Should they merge with a complementary company or seek to be acquired by a stronger
one? Should they sell off part of what they have? At what price? Who can they
sell it to? With their stock price low and getting lower, like water in a canteen,
and shareholders snarling in the bushes, CEOs of underperforming companies are
hard-pressed to run their businesses and sort through their complex financial
options at the same time. That is where investment bankers like Fred Jager, president
and CEO of Hunter Wise Financial Group LLC, come in. His firm offers a menu of
strategic advisory and corporate financing and restructuring services to small
public companies that are underperforming in the stock market. One increasingly
popular form of corporate restructuring Jager specializes in is taking public
companies private. In this process, an investor or group of investors buys up
a company's publicly-traded stock, consolidating ownership and control in fewer
hands. These buyouts are often led by top managers or key investors who already
own part of the company. Sometimes, the transaction is pushed through by a disgruntled
entrepreneur, someone who founded a company and took it public only to discover
that he or she didn't like Wall Street after all. Funding often comes from several
sources and may include a mix of debt and equity. Some of the goals of going private
include relief from complex regulations, access to new capital and the ability
to focus on long-term strategy instead of quarterly reports.
According to Jager, there were approx-imately 80 such transactions in 1999, compared to approximately 40 in 1998. He expects there will be about 150 public-to-private restructurings this year. A number of prominent Orange County companies, including IrvineApartment Communities, St. John Knits, White Cap Industries and Sunstone Hotel Investors, have gone through the transition from public to private in the last year and a half.
"In our estimation there are close to 11,000 public companies out there that for one reason or another probably shouldn't be public," Jager says. "Those reasons include having lost investor interest because their market segment is out of favor, or because their earnings have declined or been lower than projected. Or they may have lost investor interest because they didn't achieve the kind of technology breakthrough they originally thought they were going to achieve."
"When a company goes public, they have a strategy, a story," says Thomas Turk, professor of management at Chapman University. "If the product or technology the company is counting on doesn't work out, or is slow in developing, investors become disenchanted."
Investor interest is critical to public companies because their value, or market cap, is determined by the aggregate value of their stock. If more investors want to sell the stock than buy it, the price goes down and the company begins to shrivel. As the value of the company shrinks, investors and board members become critical of management. With a lower market cap, managers lose the financial leverage and flexibility they need to make strategic acquisitions or improvements in company facilities and operations.Attempting to please the market, they are forced to focus ever more exclusively on quarterly results instead of on long-term strategy and growth. This may result in worse financial performance and a further drop in stock price. Eventually, lack of capital can strangle a company. Alternately, political infighting and recriminations can lead to business failure via lawsuits and a loss of focus.
This syndrome doesn't just affect companies that have serious flaws in management, production or marketing. It also hurts fundamentally successful public companies, ones that are solidly profitable and growing, but that lack the kind of sizzle and sex appeal the stock market tends to reward.
"A majority of small public companies outside of the high-tech area don't have anyone effectively making a market for them," says Jager. "They aren't followed by any analysts and so they don't have anyone out there beating the drum for them and telling their story to investors. Their stock is available but no one knows who they are or what they are about, so who cares?"
By going private, companies escape investor indifference - which slowly depresses their stock price - and the stock market's volatile shifts, which can send their value up or down dramatically in a single day. They also gain more freedom to plan for long-term growth.
"In private companies, the top management has much more control," says Turk. "They are answerable to fewer people and there is less public disclosure.That is good if the management is making good decisions. It is bad if they are making poor decisions." According to Jager, a successful public-to- private restructuring is good for everyone involved.
"It is a win-win-win transaction," he says. "The first win is for the public shareholders because they typically get a 20 to 50 percent premium for selling their stock to a private investor." Investors pay a premium because it ends up being cheaper and quicker. In short, by making an open offer, or tender, to all public shareholders, they avoid a protracted buying process that might send the stock price up higher than they are willing to pay as momentum buyers join in the process.
"The second win is for the buyers. Even though they pay a premium to the shareholders, investors get an extremely fair deal because they are buying the company at a discount compared to what they would pay for a comparable private company.
"The third and biggest win is usually for the management team. They get new money to grow the company, new incentive packages that are better than what they had before and more freedom to run the company the way they want to."
The new money comes as part of a comprehensive buyout package negotiated by someone like Jager. "By definition, the people who are buying out the shareholders are looking to drive the company forward," he says. "They know they are going to have to put money in to grow the company. Out of the pot of money they allocate for the acquisition, part goes to buy back public shares, part goes to management incentives, part to grow the business."
Companies that go private immediately boost their bottom line by reducing regulatory costs. According to Jager, a small public company has to spend between $500,000 and $1 million a year for the privilege of being public. The money goes to lawyers and accountants who do paperwork required by the SCC, to shareholder relations in the form of quarterly and annual reports, and to stockbrokers and other intermediaries. Once a company is private, that money is available for operating expenses or expansion.
Psychology and Privacy
There are also psychological benefits to going private.
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"Some top managers just aren't comfortable with all the scrutiny they face as the heads of public companies," Turk says. "They want to do what they want to do without all the criticism and analysis. They are uncomfortable, as anyone might be, with Wall Street putting a price on every decision they make, with coming into work and finding out that they have lost 10 percent of their value because of what they did the day before." |
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"When
a company goes private, managers no longer have to live in a fishbowl," says Jager.
"That is certainly a major issue. They don't have to shuffle out and explain exactly
what they are doing every quarter. For a company that is underperforming in the
marketplace - not necessarily underperforming as a company - but lagging in the
marketplace, that is a very frustrating exercise." Psychology seems to have played some role in the recent buy back of St. John Knits led by Chairman and CEO Robert E. Gray. The company, which was founded by Gray and his wife Marie in 1962, makes high-end women's clothing worn by the likes of Hillary Rodham Clinton and Diane Sawyer. Between 1962 and 1989, the Grays built St. John Knits into a multi-million-dollar business with strong brand recognition and customer loyalty. In 1989, they sold 80 percent of the company to German multi-national conglomerate Escada AG of Munich Germany, staying on to run the business. Needing cash in 1993, Escada took the company public at $17 a share, raising over $100 million.
For
the first few years, Wall Street was good to the Grays, who remained in charge
after the IPO. As sales and profits grew at strong rates, the stock increased
in value to more than $30 a share. Then St. John hit a bump in the road. The first
problem arose in April 1996 when CEO Gray appointed his daughter Kelly, then 29,
president of the company. Wall Street didn't like the move and knocked 7.5 percent
off the stock's value the day the appointment was announced. The stock recovered
from that setback, reaching a high of $53.13 a share in 1997, but the Grays clearly
did not enjoy having their family business decisions criticized by a public audience.
Discontent took deeper root in 1998 when lower-than-expected profits and an ill-fated home-furnishing venture undertaken at Kelly Gray's suggestion led to a collapse in the price of the company's stock, which was down to $13 a share by late summer.
In October 1998, the Grays' partner in the failed home furnishing venture sued them for wrongful termination, claiming that he had been made a scapegoat for widespread problems in the corporation. Shortly afterward, a second suit was filed by shareholders accusing the Grays of hiding the company's financial difficulties to protect their own interests. By December, Gray was fed up with running a public company. Early in the month, he tendered an offer to shareholders to buy their stock at $28 a share. Several shareholder groups sued, claiming the price was too low, but St. John Knits' board of directors approved a slightly increased bid - $30 a share, about 10 percent above market price - in February 1999. On June 28, 1999, seven months after Gray's original proposition, six years after the company went public, shareholders approved the $520 million deal to take St. John private. The bulk of the money for the buyout was put up by Vestar Capital Partners, which provided $154 million in equity financing, and by Chase Manhattan Bank, which loaned the investment group $340 million. The Grays own only 15 percent of the recapitalized company, but they have complete control to run it as they see fit.
"It gives me back my own company," Gray said in an interview at the time. "We look forward to running the company in the best interest of the long-range instead of quarter-to- quarter."
Market forces probably played a bigger part than psychology in sparking Donald Bren's decision to take the Irvine Apartment Communities (IAC) private about the same time Gray made his move with St. John Knits. Bren, chairman of The Irvine Co., developer of the masterplanned Irvine Ranch, took IAC public at $17.50 a share in 1993 for the same reason most companies go public: to raise capital on Wall Street. When the company went public, it became a real estate investment trust, or REIT. Bren owned 80 percent with 20 percent trading on the open market. As with St. John Knits, the public structure worked well for Bren for several years. But in 1998, REITs lost favor with investors, losing 16 percent of their collective value. The publicity- shy Bren, who was never completely comfortable with Wall Street looking over his shoulder, decided to buy back the company's outstanding shares. On Dec. 1, 1998, he offered $32.50 a share for 83 percent of the stock he didn't already own. As with St. John, the price was criticized as too low but approved with slight modification by IAC's directors in February 1999. On June 7, 1999, shareholders approved a $569 million offer that paid them $34 a share in cash, 20 percent over market value. Bren gained freedom from the scrutiny and uncertainty of Wall Street.
Michael D. McKee, chief financial officer of The Irvine Co., says, "This agreement allows us to deliver substantial return on investment to IAC's shareholders while enhancing the company's long-term prospects. We believe a private company structure is best suited to take the risks and secure the capital required for commercial apartment development in today's real estate environment." To the extent IAC's shares were undervalued, the company was handicapped in using them to finance land purchases and property development.
Microcaps and Moneymakers
According
to Jager, the March stock market correction, which drastically reduced the paper
value of thousands of public companies, accelerated the trend toward going private.
Hunter Wise has been receiving calls from some of the newly public dot.com companies
that were hardest hit by the pullback. "A lot of these companies are suddenly
out of cash and they have no apparent way to get cash because they are not commercially
successful. As recently as four months ago, a dot.com in any business could generate
investor interest whether they had earnings or not. But there has been a sea change
in the last 90 days and now investors are looking for dot.coms that are making
money. The ones that don't have earnings are floundering and many will, in fact,
probably go out of business unless they can find someone to merge with or sell
to or else change their corporate direction in some way such as going private."
Unfortunately for the floundering dot.coms, Hunter Wise isn't very interested in them. "Dot.coms would probably be our last choice," Jager says. "The companies we are reaching out to most aggressively are the ones that have achieved critical mass, that have earnings and a good, intelligent business, but are not in favor with the investor public. Most are low-tech, no-tech manufacturing companies, distribution companies, medical services companies, mining companies, plastic extruding companies, manufacturing companies of all kinds. They aren't companies that are going to cure cancer or re-invent the wheel. All they do is make money. Most of them should never have gone public in the first place, but they got convinced they should, and did, and now they're spending a million dollars a year for the privilege of being public and get nothing in return for their investment. They don't have investor interest and they don't have the ability to go out and generate more capital because their stock is completely undervalued." Hunter Wise focuses mainly on micro-cap companies, those with market caps of less that $250 million.
"We are looking for public companies that are truly undervalued, and there are thousands of them out there," Jager says. "Whenever we see a company that has a market cap under a couple of hundred million, we have a candidate. Whenever we see a company whose share price is under $5 or whose price-to-earnings ratio is under about 6.5, we have a candidate. That is, providing the company has earnings and growth potential and a commercial reason to exist." Hunter Wise was founded by Jager 15 months ago. The company, which has offices in Newport Beach, Scottsdale, Arizona, and Boca Raton, Fla., employs 14 professionals and five staff people. During the course of their careers, Jager and his partners have collectively performed or participated in more than 1,000 investment banking transactions totaling more than $1 billion in value, guiding companies through divestitures, acquisitions, recapitalization, going public and going private.
"In our first year of operation, we've entered into full engagement agreements with 20 corporate clients," Jager says. "We have engagement agreements out to another 16 and are in discussions with another 40 companies. You have to build rapport with these companies gradually. You take a pass at them and then come back and take another pass and another one after that. It is hard to get corporations to look objectively at where they are and where they need to go.
"It takes right-and left-brain thinking to do our job. You need to do a lot of detailed, specific, precise kinds of financial and legal and technical things but, at the same time, you have to be able to generate big-picture ideas, to offer options that will satisfy all the different stakeholders in a company - the employees and lenders and vendors as well as the shareholders and management. You have to have a team that can walk the various stakeholders through all the different legal and financial and securities concerns. We end up playing part lawyer, part accountant, part rabbi and part psychologist. We also have an extensive team of affiliates to assist with technical issues - people who are international experts in the aerospace business or mining business or whatever.
"When you walk into a transaction, you have to keep your ears open and your mouth shut and try to figure out what is going on, what will work for a majority of the stakeholders. We end up taking on as clients only a very small percentage of the companies we meet with - maybe 1 in 15. We only get paid on transactions that close, so if we find that there is an environmental problem or a legal problem or an emotional problem, we walk away. You spend a lot of time kissing frogs in this business." Of the 20 companies Hunter Wise has acquired as clients, six are planning to go private. The others are employing the company's expertise for guiding recapitalization, acquisition, divestiture or merger.
The largest public-to-private deal Jager has in the works involves a company with a market cap of $140 million. "We expect to have five serious offers for the shareholders and management to consider," Jager says. "They will be very different. Some will offer more for the shareholders, less for the management. Others will offer more for the management, more for business development, less for the shareholders. In the end it isn't necessarily who is paying the highest price for the stock but who brings the best value to the company overall. These deals put a tremendous responsibility on the members of the boards of directors who are ultimately responsible for sorting out all the various interests and deciding what is best for the company and all the stakeholders." OCM.
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Hunter Wise Financial Group, LLC
Arizona
Office Florida
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