Public or Private?

Newsletter Q4 2004

Introduction
Why do companies want to go public?
Why are many companies looking to revert to private status?
Case study: Chelsfield
Conclusion

Introduction

The decision to stay private or to remain public is one of the most critical in the life of a company. The availability of a variety of financing options from the private equity and banking sectors has provided both large and small businesses with an alternative to a formal listing on one of the main stock exchanges.

Many companies are also considering de-listing from the stock exchanges through public to private transactions. There is often a belief that the market is undervaluing their business prospects or that life outside the public gaze is less onerous.

However, the public markets, at the appropriate time, provide excellent liquidity for investors and facilitate the use of company shares for fund raising, acquisitions and strategic purposes.

In our latest newsletter, we explore the options of staying private or remaining public. The ultimate decision for the company rests with the option that facilitates the growth in shareholder and stakeholder value.

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Why do companies want to go public?

There are many reasons for companies to seek a listing on a major stock exchange and in the appropriate circumstances these far outweigh the associated regulatory and related costs. These are:

Capital for growth. Fast growing companies are often constrained from rapidly raising funding in the private markets. Public companies can raise funds efficiently from equity investors through rights issues and the sale of shares to domestic and international investors. Similarly, once a company is listed and has developed a diverse investor base, it opens possibilities to access the domestic and international bond markets. The hybrid securities markets are also available and provide a variety of options such as convertible securities.

A currency for acquisitions. When a company is public, shares can be used for acquisition purposes as the stock market provides both liquidity and a clear valuation of the business. The shares can be exchanged for those of a target company or funds can be raised from investors to pay for a specific transaction.

One of the principle reasons for France Telecom’s recent financial difficulties was that the French Government, the majority shareholder, did not allow the company to use its shares for acquisitions. Consequently, the company was forced to raise large amounts of debt during the merger mania of the late 1990’s. This led to a painful restructuring during the last 3 years. In September 2004, the French Government reduced its holding below 50% and allowed France Telecom to use its shares for future acquisitions.

An opportunity to exit the business. For the shareholders in a private company and for employees with stock options, a stock market listing provides a market valuation for their equity holdings. It also provides the opportunity to sell all or part of their shares and to exercise their options.

This is of particular importance to short-medium term financial investors looking to exit all or part of their investments. However, it is normal practice when a company obtains its primary listing for existing shareholders and particularly for management to be locked-in and prevented from selling their shares for a short period.

Prestige and peer pressure. Companies on attaining a certain size in an industry and where the leading players are all listed on major stock exchanges often feel that it is necessary to join the “club” of their listed peers. A listed company can also attract talented management and employees in an industry helped by the resulting transparency of the business prospects.

Becoming a public company is an important milestone in the development of many businesses. Being under public scrutiny requires more rigorous regulatory and governance procedures. In addition, a company must be prepared for the enhanced financial reporting requirements and the resulting analyst and investor attention. However, these procedures can be very effective in professionalising and in providing a strong platform for the development of a business.

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Why are many companies looking to revert to private status?

Notwithstanding the many positive benefits of a public listing, there are a number of public companies or large private companies that have eschewed the public markets and have remained private. The main reasons are as follows:

The availability of alternative sources of capital. The phenomenal growth of the private equity market over the past few years provides an almost limitless amount of equity capital for companies with the requisite growth prospects. There are an increasing number of the private equity groups managing funds of several billion dollars combined with an increased capacity of the banking community to provide significant leverage for transactions. This has provided a realistic option for companies with small, medium and large market capitalisations to revert to private status.

The retail sector in the UK provides a classic example due to the strong cash flows and asset bases of the businesses. Public to private deals for companies such as the Debenhams department store chain were completed recently. Even the largest clothing retailer in the UK, Marks and Spencer, recently fought a multi-billion pound hostile bid approach to take the company private. Philip Green, an entrepreneur led the consortium, with financing from his own resources, from private equity and from a banking syndicate.

Undervaluation by the public sector. There are certain sectors which at times become unfavourable for institutional investors. This is often the case for companies which are complex to value, including holding and property companies. The market often values such businesses at a discount to the net assets and provides an investor group with the opportunity to purchase the assets at an attractive price.

One classic example is the Virgin Group in the mid-1980’s. Richard Branson, the flamboyant entrepreneur, wanted to raise funding to develop his airline, music and related businesses and he therefore floated part of his group on the London Stock Exchange. The group’s share price underperformed the market and two years later Richard Branson took the company private, citing that the investor community was short-term focused and misunderstood the growth prospects for his businesses.

He has since grown his group internationally in a variety of sectors, including budget and long haul airlines, train operations and mobile phone networks.

The group has typically raised finance through individual transactions such as the sale of the music business to Thorn-EMI, the formation of a $600m joint venture between Virgin Atlantic and Singapore Airlines or through the flotation in late 2003 of Virgin Blue, the budget Australian airline.

Ability to restructure a business outside the public eye. An undervalued business or a business in need of restructuring can be taken private and reorganised without the quarterly reporting requirements and the associated analyst and media attention.

A number of high profile business leaders such as Luc Vandervelde, formerly of Marks and Spencer, and Mike Grabiner, formerly CEO of Energis the UK and European alternate telecom business, have opted for key roles in the private equity sector in order to restructure and build businesses profitably outside public attention.

Management and investor incentives. Taking a company private, restructuring it and then concluding a sale of the business either in the private or public markets can be very profitable for the management teams and their financial backers.

Institutional investors are however aware of the upside potential in a successful public to private transaction and are consequently demanding a higher premium for the initial sale. They are also often sceptical about the upside potential when a company returns to the public market following a restructuring. Notwithstanding these reservations, there remain significant incentives for a successful public to private transaction.

Whilst strong corporate governance is required for all companies, a private company has a reduced regulatory, media and analyst burden as compared to a public company. However, private equity investors and bankers are rigorous in their monitoring role of their investments and the management team are set strict performance targets. Successful exits are very well rewarded with management teams typically awarded 10-20% of the equity in the business.

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Case study: Chelsfield

Elliot Bernard the founder of Chelsfield, decided in 2003 to take his London listed property company private. The company had grown significantly and in the late 1990s entered the telecom services business through the purchase of Global Switch, a London based data centre. The company’s market capitalisation soared on the back of the telecom boom, but then suffered sharply with the down-turn in the telecom market between 2000 and 2003. This led to company losses of £1.2 million in 2002 and £20.7m in 2003. The uncertainty surrounding potential large property development projects in and around London also negatively impacted the company’s valuation.

With the shares trading at a discount to net assets, Bernard formed a consortium of significant private investors and a bank to take the company private. It took around one year for the company to sell a strategic holding in Global Switch and to restructure the financing for the development projects before the investor group was comfortable with the structure of the transaction. The price offered to the institutional investors also had to increase to £1.8bn, which was raised by the Bernard consortium through a combination of debt and equity. Shareholders were offered a mixture of cash and shares in an unlisted bid vehicle. The price offered provided cash plus upside potential to institutional shareholders with limited liquidity, but at a small discount of around 3% to the net asset value. The transaction was completed in May 2004.

Recently, Bernard has faced disagreements with some of the major investors on the proposed strategy for the company. Other property groups are circling the company which may lead to a rapid sale of the business.

In a private situation, significant investors often require a more active role in deciding the direction of the company. This highlights the complexity of concluding and successfully executing public to private transactions.

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Conclusion

With the availability today of almost limitless amounts of capital, large and small companies with solid growth prospects have a wide range of options in deciding on their public or private status. The regulatory burdens of running a public company today have become onerous and this is prompting a number of companies to consider the attractive option of private status. Whilst the governance and professional requirements are the same whether a business is private or public, the ability to restructure and refocus outside the public eye is a tempting option and provides the management team and the shareholders with strong potential financial incentives.

Selecting and executing the appropriate strategy to support a business throughout its development cycle requires the necessary management expertise, combined with sound financial advice.

The views expressed in this newsletter are those of DC Dwek Corporate Finance Limited and are provided for information purposes only.

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