More Companies Find It’s Better to Go Private
Larry Tanning knows what it’s like to enjoy Wall Street’s favor. After taking his computer-systems design firm public in 1999 at $15 a share, he saw the price top $70 within seven months, giving the company a market value of more than $1.4 billion.
But over the last three years, Wall Street has virtually turned its back on Denver-based Tanning Technology Corp. Like many other tech firms, its shares are worth mere pennies.
For Larry Tanning, the public market no longer holds much allure. So he’s turning his back on it -- by going private.
“There’s no question we’re now in a business cycle where being private makes more sense than being public,” said Tanning, whose 10-year-old company agreed in April to be acquired by Los Angeles investment firm Platinum Equity for $24 million.
“The cost of all the needed public disclosure, reporting and auditing has become way too expensive for us.”
Many entrepreneurs at small and medium-size companies apparently feel the same way: Since Congress passed the Sarbanes-Oxley corporate reform act last summer in the wake of ruinous financial scandals at Enron Corp., WorldCom Inc. and other firms, 63 going-private transactions have been announced in the U.S., a 34% jump from 47 in the comparable nine-month span a year earlier, according to data tracker FactSet Mergerstat.
Companies that have recently announced or completed deals to go private include 152-year-old Dole Food in Westlake Village; Sports Club Co., which runs the upscale Sports Club/LA chain of gyms in Southern California; and software maker Resonate Inc. in Silicon Valley
Many Fed Up With
Costs of Being Public
The trend is accelerating, entrepreneurs and investment bankers say, because many companies are fed up with the growing expense and regulatory burden of being public -- especially if their stock price has been crushed by the bear market.
“Some companies have gotten exasperated,” said Ric Kayne, chief executive of L.A.-based Kayne Anderson Capital Advisors, which, along with Sports Club’s founders and another equity firm, has offered to buy out the other shareholders and take it private for $3 a share, or about $55 million.
“The costs of being public are going up,” Kayne said, “and the benefits are going down.”
As Jon Goodman, a private investor in Los Angeles and author of an upcoming book about the effect of the Sarbanes-Oxley Act, put it: “They are asking themselves, ‘Why go through the headache?’ ”
Many of the companies thinking about going private have been shunned by Wall Street brokerage analysts and large investors leery of their thinly traded shares, and are unable to tap the capital markets with new debt or stock offerings.
“The bear market has created a significant number of orphaned public companies,” said Johnny Lopez, head of mergers and acquisitions at Platinum Equity, referring to firms with no analyst coverage.
“Their valuations are depressed, and the capital markets are closed to them, “ Lopez said.
Rex Licklider, co-chief executive of Sports Club, agrees.
His company had revenue of $122 million last year. “Any company doing less than $1 billion in revenue is off the Wall Street radar screen,” he said. “And if you don’t have analyst coverage and brokerage trading, it’s difficult to extract the true value of your company.”
The costs of being public are spiraling not only because of Sarbanes-Oxley reforms but also because of new listing requirements at U.S. stock exchanges.
Overall, according to an estimate by corporate law firm Foley & Lardner in Los Angeles, for the typical “middle market” company (with $1 billion or less in annual revenue), the cost of being public has risen to $2.5 million a year from $1.3 million before Sarbanes-Oxley.
“The cost falls disproportionately on the smaller companies,” said Lance Jon Kimmel, an attorney at Foley & Lardner.
In today’s heightened regulatory climate, public firms must spend more on everything from forensic accountants and additional legal staff to director salaries and segregated Web sites for potential whistle-blowers.
Meanwhile, directors and officers face escalating insurance premiums -- if they can get coverage at all -- amid higher scrutiny and liability fears.
Given the rising burdens involved in being public, investment banker Brooks Dexter of L.A.-based USBX Advisory Services said, he has discussed the going-private option with six corporate clients in the last three months, and he said each is seriously considering it.
One, which he declined to name, is a technology company that generates about $2 million in annual operating profit but figures it will spend $1 million a year staying public, Dexter said.
“They could increase their cash flow by 50% just by going private. That’s one of the few synergies a buyer will pay for, since it’s so clean.”
Aside from cost savings, there may be strategic advantages to being private.
“If we go private, we can keep information close to the vest,” Licklider said. “If we sign a lease on a new property in a new town, we don’t have to disclose that to every competitor. We can announce it when we want to.”
Similarly, Goodman said, a private company need not disclose if it wants to branch into a different business line, for example, or it can quietly dump a lousy executive without worrying about the shareholder reaction to his severance package.
Being private also allows managers to focus on the long haul rather than worrying about whether quarterly earnings may miss Wall Street’s estimate by, say, a penny a share.
Some observers say companies may be overreacting to the changes imposed by Sarbanes-Oxley and other regulation.
“There is some grousing, but I don’t see the issues of cost and increased liability as motivating factors to make a choice as dramatic as going private,” said Scott Wendelin, chief executive of Prospect Financial Advisors, a Los Angeles investment bank.
The griping reminds some of the initial reaction to equal-employment laws in the 1960s or the advent of “Reg FD,” the federal regulation barring selective disclosure of important information, a few years ago: Companies whined, but they learned to live with the changes.
There can be major hurdles -- and drawbacks -- to going private.
The process carries costs associated with SEC filings and obtaining a “valuation and fairness opinion.” If the buyout involves borrowed money, the firm and its owners must be confident they can service the debt in the long run.
Also, getting shareholders to agree to a deal may not be as simple, or as economical, as hoped.
Kimmel said the average buyout premium -- the excess price offered above a stock’s current market value -- has steadily risen, from an estimated 30%-35% in the mid-1990s to about 45% in 2002.
There also is the longer-term issue of losing access to capital markets. A company may find it harder to raise expansion capital as a private enterprise than as a public one.
For top managers, there can be emotional issues as well. Being public is a hard-won prize that is difficult for many entrepreneurs to give up.
“There may be a feeling of remorse, that the move is a reflection of a failed strategy: The team wasn’t able to deliver its value proposition,” Wendelin said.
Some Firms Weren’t Ready to Be Public
Still, many private equity investors say the benefits of exiting the public market often outweigh the costs. Some companies, investors say, now are realizing they weren’t cut out to be public, and were simply swept up in the bull market mania of the late 1990s.
“We’re seeing opportunities in the marketplace to acquire companies like Tanning that never should have been public in the first place,” Lopez said.
When the initial public offering market was robust, many companies went public too early, said David McGovern, head of mergers and acquisitions at L.A.-based investment firm Gores Technology.
In 2000, Sunnyvale-based software firm Resonate went public at $21 a share. Yet the company was far from being profitable.
In March, Gores was able to buy Resonate for about $1.90 a share, or $54 million. The price was below the firm’s per-share cash value but a premium to the $1.20-a-share range in which the stock traded for much of late 2002.
Gores assumed the liabilities of the company, including funding the costs of restructuring the money-losing business.
Of course, there are plenty of struggling public companies that might wish they could go private -- except that they couldn’t find new investors to put up the money.
“To get the kind of returns new equity shareholders will want, managements are going to have to show a model of profitability that works whether or not there are savings from avoiding the cost of being public,” Goodman said.
In that sense, the going-private movement could be considered a reality check for shareholders, McGovern said.
“Stockholders have finally come to terms with the real value of these companies. If a company was valued at $300 million two years ago and now is worth $20 million, they realize they are never going back to $300 million,” he said. “Now, if somebody offers $30 million, they will consider it.”
With many stocks languishing despite the recent market upswing, “There are going to be more of these opportunities,” McGovern said.
“You’ve had willing buyers, now you have willing sellers.”
