Was This Retailer Ready for Prime (Public) Time? Quite Possibly Not

Some companies shouldn’t have public shareholders. Sport Chalet Inc. is probably one of them.

Almost from the day the company made its initial public stock offering on Nov. 19, 1992 at $9.25 each, the price of the shares has been falling. At $3.125 today, the stock has lost two-thirds of its value.

Worse, the investors who bought the 1.6 million shares that Sport Chalet offered generally weren’t big institutions for whom a two-thirds loss on a single stock is a minor annoyance. Instead, Sport Chalet’s investors were mostly individuals, perhaps mostly buy-and-hold types enticed by the company’s heady growth plans.

Sport Chalet is by no means the worst disaster among new Southland stock issues of recent years, and it’s conceivable that the shares may yet prove to be a decent long-term investment.

But the sporting goods retailer’s current management crisis and earnings shortfall raise an issue that Wall Street is often reluctant to address: Whether the public should have been lured into buying a piece of the company in the first place.

Everybody knows why companies sell stock: to raise capital. Brokerages underwrite stock offerings because the deals generate lucrative fees. And investors clamor to buy new stocks in the hope of getting a piece of a business that’s poised to soar.

But in cases such as Sport Chalet--a relatively small, family-owned business in a highly competitive market--it’s not enough for potential investors to focus on the company’s bottom-line prospects.

A bigger question is whether the firm is ready to make the transition to being a public company, which demands that the founding family be responsive to new shareholders’ concerns in addition to its own interests and those of other key constituencies, including customers and employees.

Were Sport Chalet and its 69-year-old founder, Norbert Olberz, ready to make that transition?

In retrospect, it doesn’t look that way. Olberz didn’t return phone calls for comment, but insiders say he has come to regret turning Sport Chalet into a public company, with the many hassles that entails: the disclosure issues, the emphasis on quarter-to-quarter financial performance and the irritating stock price fluctuations.

“I don’t think he realized what being public is all about,” said one person intimately familiar with the company’s operations.

Edward W. Wedbush, head of Los Angeles-based Wedbush Morgan Securities, which underwrote Sport Chalet’s stock offering, said that if Olberz were asked today whether he fully understood the implications of going public, “I think he would say no.”

Yet Wedbush insists that “we raised this question very aggressively” in the process of arranging the deal in 1992, and that he was satisfied with Olberz’s understanding of his obligations.

Anyone reading the Sport Chalet stock prospectus in 1992, however, should have grasped that the issue of corporate control could be problematic. The terms of the deal were such that Olberz was giving up relatively little to new shareholders for their investment. They would just be along for the ride.

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For example, while it is common for a family-owned business to remain largely in the family’s control after an initial stock offering, Olberz retained fully 70% of the stock--currently 4.6 million of the 6.5 million total shares outstanding.

What’s more, Olberz retained ownership of the company’s headquarters in La Canada Flintridge, its warehouse and distribution facility in Montclair and its stores in La Canada Flintridge and Huntington Beach. Sport Chalet paid him $1.7 million in rent for those facilities in fiscal 1994 alone.

There’s nothing illegal about that setup, but it further concentrates control of the company’s destiny in Olberz’s hands.

Finally, if investors perusing the Sport Chalet stock prospectus in 1992 had studied how the $13.7 million raised in the share offering was to be used, they would have noticed that the money wasn’t going directly for the company’s grand (and ill-fated) store-expansion program.

Instead, the cash paid off Sport Chalet’s primary bank credit line, which had been secured by Olberz’s personal guaranty. The company then opened a new bank credit line.

All of this suggested strongly that, despite the investment by new shareholders, nothing would change the fact that Sport Chalet was Norbert Olberz’s baby.

So when he decided to fire his longtime chief executive in February--and then let the replacement CEO walk out two months later--minority shareholders’ opinions about the management shake-up weren’t likely to carry much weight. In the parlance of Wall Street, Olberz is an “entrenched” chairman.

Not surprisingly, some shareholders have voiced disapproval by simply selling out, driving the stock as low as $2.625 on April 4.

Of course, the stock’s plunge has made Olberz poorer, too. His shares, worth $43 million when Sport Chalet went public, are valued at $14.5 million today.

Yet Olberz still gets a $250,000 annual salary and collects rent from the company; minority shareholders receive no cash dividends.

It’s easy to argue that Sport Chalet has been a victim of unfortunate circumstances, considering the Southland’s recession and last year’s Northridge earthquake.

But the company’s minority shareholders now may well wonder if Sport Chalet was ready to go public even under the best of circumstances, given its relatively small size, its exclusive focus on Southern California (i.e., no geographic diversification) and the seasonal nature of the ski business.

“Some companies are not really ready for prime time,” said William Smith, who analyzes new stock offerings for Renaissance Capital in Greenwich, Conn. Yet public stock offerings from businesses that ought to remain private are, unfortunately, commonplace, Smith said. “We see a lot of that.”

Which raises the question of Wall Street’s responsibility when new stock issues go bad.

Sport Chalet’s underwriter, Wedbush Morgan, included all of the obligatory risk-disclosure items in the stock prospectus. But should the brokerage have found private financing for Sport Chalet--from savvy investors who undoubtedly would have demanded a bigger say in operations--instead of making this a public deal?

Edward Wedbush insists that “at the time we took it public, the company had all of the characteristics of a company that should do well. . . . But their expansion plans ran into a brick wall.”

One frequent criticism of regional brokerage firms is that they will underwrite stock deals that major Wall Street firms wouldn’t touch. But Wedbush defends his firm’s underwriting record, noting that the brokerage’s last two initial stock offerings--for clothing firm Sirena Apparel and for inkjet-printer maker ENCAD Inc.--have been successes.

Sirena, which went public last August at $4.75 a share, now trades at $7.75; ENCAD sold shares at $5 each in December, 1993, and now trades at $19.50.

Still, Wedbush said, he hopes that any of his clients who decide to buy into new stocks offered by the firm realize that such issues are by definition “risky propositions.”

Amen.

The Long Slide

Sport Chalet’s stock began falling shortly after its initial public offering in November, 1992, at $9.25 a share, and has since lost two-thirds of its value. Monthly closes on Nasdaq, except latest: Fri.: $3.125

Source: Knight-Ridder TradeCenter