Investors aren’t the only ones fleeing the stock market these days. Companies are heading for the exits, too.
So far in 2003, 15 publicly traded companies have kissed their listings goodbye, going private in transactions worth a total of $798 million, according to New York research firm Dealogic. The 2003 pace is well ahead of last year’s total of 21 deals worth $1.35 billion. Indeed, 7 percent of acquisitions under $500 million this year have been going-private deals, the highest level in more than a decade (see graph).
With only 14 companies having completed initial public offerings in 2003, more corporations are going private than are going public -- a highly unusual circumstance.
Why? The three-year-old bear market has made orphans of scores of loss-making start-ups that were welcomed by investors during the late 1990s IPO mania. During saner times these companies would never have gone public in the first place; now the market is abandoning them. Amid historic droughts in IPO and merger activity -- not to mention the fallout from allegations that some of them issued fraudulent research during the boom -- Wall Street firms are scaling back research coverage, focusing on the large-cap names that institutional investors favor. Less coverage means less visibility with investors and less support for small caps’ share prices. Usually, the result is that their cost of capital rises.
This trend has been eating away at small caps for some time. But things got far worse last fall, when Congress passed the Sarbanes-Oxley Act, the most comprehensive capital-markets reform legislation enacted since the Great Depression. Among other requirements, the law forces public companies to document internal controls and requires executives to certify that financial results are accurate. This means hiring staff, lawyers and consultants and buying expensive software. In a recent Parson Consulting survey of 100 public corporations, 70 said that compliance with the act was costing them more money.
“Most firms are saying it’s increasing their finance budget by about 20 percent,” says Therese Webb, a managing director at Parson in Chicago. “Their resources are being stretched further than they already are. Particularly in the finance function, you risk people making mistakes, overlooking things, which is exactly what the law is designed to get at.”
The Sarbanes-Oxley compliance costs, compounded by higher premiums for directors’ and officers’ liability insurance, hit smaller companies harder than those with billions in annual revenues.
Says Frederick Joseph, formerly CEO of Drexel Burnham Lambert and now a senior rainmaker at a new boutique called Morgan Joseph & Co: “I was talking with a CEO who said it’s costing his company $2 million a year for D&O insurance, certification costs, compensation for his audit committee, independent counsels, hiring investment banks. And this company has an equity value of $20 million. It just doesn’t make sense for him to be public.”
The motivation for going private may be straightforward, but the mechanics are often anything but. Management usually lacks the cash to buy the company. In most cases, a private equity backer is needed and must be convinced that the company can make it as a private concern. A bigger problem occurs when financing is in place but management doesn’t own a controlling stake. Faced with a management offer, some boards will decide to hold a formal auction, possibly raising the price of going private and drawing hostile bids from rivals.
“A lot of these companies are scared to death of starting the process, for fear that they’ll be swallowed up by one of their competitors,” says Greg Feldman, managing partner of Wellspring Capital Management, a private equity firm that specializes in middle-market companies.
Still, the advantages of going private are generating “tremendous interest,” notes Joseph. “It’s a simple cost-benefit analysis: The costs of being public outweigh the benefits.”
