08/26/2003 – [Investor's Business Daily] More Companies Exit Public Markets; New Accounting Rules Get The Blame Burden For Small Companies
Publication: Investor's Business Daily
LOS ANGELES (January 17, 2005) – Like many small businesses, Tumbleweed is feeling the impact of a slow economy.
Sales at the Kentucky-based restaurant chain are expected to fall 5% to $55 million this year. But just a few years ago, Tumbleweed thought it was rolling into heady times. The economy was booming and initial public offerings were fetching plenty of new capital.
So after 24 years, in April 1999, Tumbleweed took the plunge and jumped into the public market.
Now it's jumping back out.
"We've seen very little benefit from that move," said Buddy Mattingly, Tumbleweed's chief financial officer. "Coverage by Wall Street has been thin and our stock is lightly traded."
By mid-September, the 57-outlet chain plans to be delisted from the Nasdaq stock exchange. "We didn't see much value in being public," said Mattingly. "It was costing us a lot of extra money. Then Sarbanes-Oxley came along and that was the last straw."
As of July 31, 67 public firms applied to the Securities and Exchange Commission to go private. In all of last year, 97 such requests were filed, says researcher FactSet Mergerstat. Fifty of them were filed by the end of July.
Businesses blame the Sarbanes-Oxley Act of 2002 for the current wave. Following accounting scandals at firms such as Enron and WorldCom, the law sought to make companies more accountable to shareholders.
It's had other effects, say those trying to adhere to new regulations. Critics say it's added unnecessary layers of red tape. And many executives complain that extra costs are driving perfectly healthy companies, especially smaller ones, out of the public markets.
But sometimes firms go private for other reasons, such as an inability to attract the attention of investors and analysts.
"Whether Sarbanes-Oxley is the driving force or not," said Mergerstat's Kurt Kunert, "the pace of public companies going private is definitely greater than it was last year."
In the past, some firms unable to raise capital in the public markets made themselves acquisition targets. With an economic rebound still gaining steam, it can be hard for companies with lagging sales to drum up any interest.
"A lot of companies are still struggling," said Kunert. "In that environment, many firms can't find partners to merge. So they're turning private to find other ways at raising capital."
Government regulations may be well-intended, says Robert Lindal, CEO of Lindal Cedar Homes, which went private in 2001. "But if the cost is so great to comply with all of the public filing requirements, it means companies will have fewer resources to raise capital to create jobs."
The Seattle-based home builder generates around $50 million a year in revenue. It went public in 1971. But even after nearly six decades in business, Lindal Cedar Homes couldn't overcome being out of the dot-com spotlight in the late 1990s.
"We were a small, family company that had expanded into building homes all over the world," said Lindal. "But we had to compete with all of the dot-coms for Wall Street's attention."
Lindal acknowledges that more traditional businesses are getting the nod again from investors. But he says competition for investment dollars in public markets remains tight.
The Return Of Low Tech
"Low tech's come back," Lindal said. "But we're very pleased with being private. The costs of being public for a small business now are just getting enormous."
Mergerstat's Kunert says he's hearing more of that sentiment these days. "Given the increased scrutiny from regulators, private equity funds are telling companies it's a good time to go private," said Kunert. "It's becoming much more difficult for public companies to put their money and resources to work in the most effective ways."
Sarbanes-Oxley's requirement that CEOs sign off on financial statements poses several potential problems for small businesses, says Christopher Baclawski, an investment banker with CB Capital Partners.
For starters, he said: "Premiums for insurance to protect corporate directors and officers are going up 30% to 40% now. It's something a public company, particularly if it's small and lacks in-house oversight expertise, can't afford anymore."
Sarbanes-Oxley also raises the possibility of costly litigation. Errors in financial statements could lead to millions of dollars in fines. And the Justice Department can now seek prison sentences for offenders.
Following the new law is often time-consuming and distracting for small firms with limited resources.
"Another new rule is that a company's board has to be comprised of a majority of independent directors," said Baclawski, who works with public firms planning to go private.
With stricter compliance standards and rising demand for qualified independent board members, analysts say a growing number of candidates will either turn down offers or raise compensation demands.
"Small companies are really having a difficult time finding qualified outside board members as a result of Sarbanes-Oxley," said University of Southern California finance professor Tom Taulli. "They're also finding the talent pool for top executives shrinking."
Some firms that go private cite the nature of their business as a reason for sparse investor interest. For example, Quintiles Transnational. The firm, which plans to go private by the end of next month, had revenue last year of $1.8 billion. It's a leading independent researcher for drug makers, health care providers and biotech firms. The company also develops marketing campaigns for major players in all three fields.
"Quintiles has a broad mix of products and services," said David Windley, an analyst at Jefferies & Co. "So it hasn't been an easy business for investors to evaluate."
Taulli has seen that happen before. "The more complex and diverse a business, the more difficult it's going to be to raise interest in public markets," he said. "That's going to be true for small as well as large companies."
An author of several books focusing on management issues involved in mergers and acquisitions, Taulli says many corporate executives have asked him recently about going private. He says it's hard for any company with less than $50 million in yearly sales to justify staying public.
"In the past decade, there have been relatively few public firms going private," said Taulli. "It's a very complicated and time-consuming process. But with the added costs and restrictions of Sarbanes-Oxley, the trade-offs are looking much better to go private."
It certainly does to Chris Randles. The CEO of Mathsoft Engineering & Education Inc. was at center stage in early 2001 when the firm went private. "Not too many people had seen a public software company go private at that time. But we haven't regretted it for a minute."
Sarbanes-Oxley just reinforces that decision, says Randles. He's confident that small businesses looking for money to expand can still find financing through private placements. "The main reason most companies go public in the first place is to gain more access to capital," said Randles. "But going public to get rich isn't always the best decision."
In fact, he says, Sarbanes-Oxley is making it easier for private firms to raise capital. "Is access easier today on the public side than on the private side? Absolutely not," said Randles. "On the private side, capital is available and cheap these days."
Many lenders, he says, look favorably at private firms.
Mathsoft, which makes software that runs calculations for engineering design and other technical work, says it generates about $20 million a year in revenue.
"If a company our size flicked a switch today and became public, it would probably cost $750,000 to $1 million a year just to meet all of the existing regulatory requirements," said Randles. "With Sarbanes-Oxley and tougher enforcement by the SEC, those costs aren't going to do anything but go up even more."