At first glance, private funding and juicy hamburgers would seem to have very little in common. Similarly, the link between private money and toys, groceries, online webcasts and rental cars seems tenuous. There is a common thread, however – all of these products and services are offered by formerly public companies that, either through choice or force, have recently gone private.
Indeed, the current explosion in private equity is resulting in more public companies seeking private capital, which allows them to operate under a more flexible capital structure. In July, the largest leveraged buyout in history, which weighed in at $33 bn, made headlines when Kohlberg Kravis Roberts, Bain Capital and Merrill Lynch agreed to acquire US hospital operator HCA.
‘It’s not easy being public,’ says John Hogan, a partner with Piper Jaffray, a US investment bank. ‘It’s always been a bad idea to be a small public company for a long time. It’s expensive. There’s no real liquidity. Regulation can be complicated.’
‘There are a number of things you can do with a company in private equity ownership when you take it out of the glare of the public eye,’ adds Rod Selkirk, chairman of the British Venture Capital Association.
Some that have taken the plunge are familiar names like US retailer Toys R Us and UK grocer Somerfield. Others, like Florida-based hamburger chain Checkers Drive-in Restaurants, are a little more obscure. Checkers, America’s largest chain of dual-lane drive-through restaurants, completed its journey from public to private company in June, when it finalized its $188 mn sale to Wellspring Capital Management and delisted from Nasdaq. At the time, Checkers’ president stated that the privatization was a way to help fuel expansion, remove the company from a tough regulatory environment, lower its $1 mn annual compliance costs and sharpen customer service.
Checkmate
When a company goes private, IR can find itself in the midst of a giant game of equity chess where the ongoing need for IR communications and management skills is questioned by management and outside advisers. For an IRO who normally delivers corporate strategy and results to fund managers, analysts, individual shareholders and the financial media, having an employer that morphs into a private company can significantly impede – or even end – the function.
‘When you go private, you don’t really have much need to communicate with the wider investment community because your shareholders can now sit around the meeting room table,’ says Nick Donaldson, a former investment banker who is a principal with the London-based Capital Markets Group.
When the new owners are looking to cut costs, they often view the IRO’s responsibilities as not commensurate with his or her compensation. ‘That’s one of the many cost cuts that you’ll often see – the IR capability will go,’ Donaldson says.
Sometimes the IR function is spared, says Aron Izower, a partner at New York law firm Reed Smith. For example, the newly acquired company may have some outstanding securities or debt and the owners might feel it’s advantageous to have a good financial communicator on board.
Many private companies also return to the stock market within two to five years so that private owners can realize their return on investment. In bull markets, that period can be even shorter. ‘Private owners may keep their IR function during this time so that things don’t go cold,’ adds Donaldson.
‘It’s really important to remember that a private equity investor is really a financial investor – it’s all about making the best return,’ Donaldson continues. ‘If there is a window of opportunity to sell quickly and make an amazing internal rate of return, they’ll do it.’
Private equity is a large and growing force of competing capital. These funds come from the same sources as public equity – insurance companies, pension funds, foundations and, in some cases, countries. Investments are spread over several different asset classes, from bonds and equities to private investments and even fine art and property. So far this year, private equity firms have raised more than $260 bn worldwide from big money managers like pension funds and university endowments, according to the New York Times.
New kid in town
Greater percentages of capital are being allocated to alternative assets like private equity because of their recent strong performance. In 2005, for instance, UK private equity funds returned 37 percent on average, compared with 30 percent for the FTSE 250 index and 22 percent for small-cap companies. Private equity also outperformed those indexes over five and ten-year periods, according to a PricewaterhouseCoopers analysis for the British Venture Capital Association.
With greater numbers of investors seeking higher returns, private equity funds have become flush with cash. Firms like the Blackstone Group, Carlyle and Apex regularly do multi-million or multi-billion-dollar deals, with several transactions exceeding $10 bn in 2005.
The sheer size of private equity funds now makes large as well as midcap companies potential targets for buyouts, notes Izower. ‘They’re in a real position to either buy up or buy out these companies,’ he says. Sometimes, private equity firms also seek to force management to take certain actions to improve shareholder value, he adds: ‘Then management has to explain to its current shareholders why it agrees or disagrees with these proposals or transactions being put forward, and what any possible alternative strategy will be.’
Izower continues: ‘IROs in turn must help management defend against these challenges because they’re going to be the ones to make management’s case to shareholders and industry analysts, especially when the company falls short of its competitors with respect to industry benchmarks.’
Funds are becoming increasingly vocal, observes Carlos Deupi, general counsel with Washington-based Hogan & Hartson, a professional firm that advises clients on private equity, venture capital, M&A and international business transactions. ‘As a result you’re seeing more turnover in the senior management of public companies, with as many as 15 percent of CEOs being replaced every year,’ he says.
Point of contact
With activist hedge funds using sophisticated techniques to increase their voting power, it’s up to IROs to monitor the company’s holdings, keep close ties with institutional investors and develop effective communication that mirrors management’s intent – all while minding securities laws preventing selective disclosure.
‘If your public company is approached by a private equity fund that wants it to do some kind of transaction, that’s obviously a challenge for the IR department to get out management’s reaction and communicate shareholder and market views back to senior executives,’ Izower comments.
Brad Cohen, a former analyst who is senior managing partner of Connecticut-based IR firm Integrated Corporate Relations, says flexibility is key. ‘We’ve gone through a couple of takeovers, and the biggest thing is to manage the new relationships in the stock,’ he says. ‘Arbs, with their increased ownership, can be demanding, but don’t succumb.’
With so many different parties involved – including regulators, lawyers, bankers and accountants – unforeseen events can disrupt the best-laid internal plans. ‘Don’t lay out a definitive timetable,’ cautions Cohen. ‘It’s all about managing expectations.’
In early 2006, private equity funds were finding it more difficult to bid successfully for listed companies in the UK, says Mark Pacitti, corporate finance partner at Deloitte. Public companies, he explains, were starting to learn ‘private equity tactics.’ By communicating clear strategic plans for growth and providing special dividends and share buybacks, ‘the corporate UK market is finding it easier to block private equity bids and persuade shareholders to support alternative plans for generating value,’ he observes.
But private equity funds won’t be going away any time soon. They’ll continue to work aggressively to maximize returns for their own investors and maintain their track record for raising large sums. With continued pressure being placed on public companies – especially underperforming or undervalued ones – executives and their IROs must stay ready to fight unwanted incursions or welcome private equity overtures with open arms.
