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by Rebecca Fannin

Chief Executive Magazine, May 2004

The public markets look better, but there are still plenty of reasons for CEOs to take their companies private.

By 2002, more than half a century after it was founded, Lillian Vernon Corp. was definitely showing its age. The gifts and housewares cataloger had $260 million in revenues, but was losing money. Seeing this, last April Strauss Zelnick, the media mogul turned private equity investor, seized an opportunity. He offered founder Lillian Vernon and other shareholders $7.25 per share in cash, a high premium over the $4.22 closing market price of the stock, bought the company for $60 million, took it private and named himself chairman.

Out of the public limelight, Zelnick began making tough decisions about how to revitalize the company, which in 2002 lost $9.1 million and saw revenues decline by 9.5 percent. He cut the work force by 20 percent, recruited former McKinsey executive Joseph Shapiro as president, and introduced pinpointed merchandising and marketing strategies. Today, Zelnick says, the company is breaking even, though "not out of the woods" yet.

In December, Zelnick followed up by buying Time Life, a unit of Time Warner's magazine division that uses online and TV ads to directly market videos, music and books. He folded it into Direct Holdings Worldwide, the New York-based investment partnership he formed with private equity firm Ripplewood Holdings to operate Lillian Vernon. Then, he began strategizing recovery plans for the business, which lost more than $50 million in the first nine months of 2003.

The chances for recovery, Zelnick says, are far better now that the company is private. "A turnaround in a private scenario is better than in the public, because there are always tough decisions to make in any turnaround-reducing costs and reducing people-which can be heart-wrenching," says Zelnick, who ran 20th Century Fox and BMG Entertainment before forming Ripplewood-backed ZelnickMedia in 2001. "Even though stock prices are up now, it's still a good time for a going-private transaction. What we look for is an opportunity to manage a company better."

To be sure, the market swoon a few years back gave many CEOs of public companies pause-particularly those that had gone public a bit prematurely in order to ride the IPO wave-and many subsequently took their companies private. But the stock market rebound in recent months doesn't necessarily mean that all public companies should stay public. The number of companies opting out of public listings declined only slightly in 2003, to 142 from 162 in 2002, according to investment researcher Thomson Financial. Altogether, 664 companies have made the move since 2000. Ed Nusbaum, CEO of Chicago-based management consultancy Grant Thornton, says his firm is advising an estimated 10 companies on going private as the cost of being public has nearly doubled under new government regulations, such as the Sarbanes-Oxley Act, and shareholder litigation has increased.

The Many Perks of Privacy

Why go private even in improved economic times? Plenty of reasons. Despite the higher stock prices, many smaller companies are still struggling with low stock market valuations and low trading volumes. For most companies with market capitalization below $300 million, there's little or no analyst coverage, regardless of company performance or prospects, and therefore little or no interest from institutional investors, says Robert Max Crane, a lawyer with Sills Cummis Epstein & Gross in Newark, N.J. As a result, many of these smaller public companies can't get access to the capital markets nor can they use their stock as currency to make growth acquisitions or provide management incentives in the form of options.

There are several additional benefits to private ownership: decreased legal and accounting costs, increased focus on long-term business goals instead of quarterly financial targets and daily stock performance, reduction of potential personal liabilities and elimination of the need to disclose sensitive business information-a competitive disadvantage. Going private also can provide liquidity, offering public shareholders an opportunity to sell their shares (without driving down stock prices) at premiums that are still over recent market prices, Crane notes.

One of the key reasons to convert from public to private is the access gained to private equity investors like Zelnick, who are experts at running companies for improved results, and who look toward the longer term. In a turnaround, "the numbers don't look that pretty in the first few quarters," says Tom Holland, director of private equity at the San Francisco office of strategy consulting firm Bain & Co. He says private investors are "more forgiving" than public ones in giving "patience and time for a company to get back on its feet." Increased financial incentives and pride of ownership for top management are factors that weigh in favor of going private as well.

Sometimes, it becomes necessary when the stock price just won't budge, no matter what you do. Dole Foods CEO David Murdock found that efforts to cut costs, diversify its business and invest in additional businesses had little impact on the company's share price. So he acquired the 76 percent of Dole stock that he and his family didn't already own for $1.4 billion and assumed $1.1 billion of debt, taking the $5 billion company private in March 2003.

For most smaller companies, the reason to get out is that there's "no sense or advantage to remain public," says Joseph Bartlett, of New York law firm Fish & Richardson, who estimates there are about 8,000 publicly traded U.S. companies in this "orphanage area" of having no analyst coverage. With Wall Street not yet restaffing its ranks of depleted analysts to track stocks, many of these companies may remain orphans for several years.

Another factor driving smaller companies to opt out of public listings is that the fixed costs and time required to comply with the new regulations falls disproportionately on them, Crane says. Bartlett pegs the price at $1 million or more per year.

Tony James, vice chairman of the Blackstone Group, an investment banking firm, says he expects more firms to go private as the full impact of complying with Sarbanes-Oxley kicks in. A remaining psychological hurdle is giving up the presumed prestige of running a publicly traded company, he says. "For CEOs, that is the toughest thing to do-to know in their heart that they are not going to reach the market cap they want and that it is not worth the cost to stay public," he says.

Going private is not easy, either in terms of expense or time. Bartlett says it takes six to nine months and costs $1 million in fees for lawyers, accountants and bankers. Zelnick, the private equity investor, estimates that the fees for going private are about 2 to 5 percent of the purchase price although for "larger deals, it is less." The fees go toward such things as filing a proxy statement to solicit shareholder approval, filing a tender offer statement, appointing a special committee of the board and an outside financial adviser to evaluate the fairness of an offer and decide whether or not to recommend the transaction to the public shareholders.

In the typical going-private scenario, a controlling shareholder (often a private equity investor) or a management-led team acquires the outstanding public shares. A private equity investor can offer broad knowledge and experience and play a hands-on role in advising a CEO on management and financial strategies. The investor can also open doors to new customers and to synergies with other companies in the portfolio. Unlike most large institutional investors in the public markets who make or lose money off trades, private equity investors make money when value is added to the "investee" company and they "exit" it at a profit through an initial public offering, an acquisition or a merger. Usually, an exit takes no more than five years.

Top management benefits along with the private equity investor. In a privately held company, the "management has an opportunity to fare well if the company performs and the rewards are much more directly tied to performance of management," says investment banker James. He points out that the management team usually owns more of a privately held company and in many cases is the controlling shareholder. "For sleepy management that is not performance oriented," he says, "going private is not such a good idea."

Tony James of the Blackstone Group says deals like Prophet 21's are the kind that investment bankers dream of. "Private equity investors look for results and play the role of helping to produce those results, and if necessary, change management. Most of the time you evaluate the team and you bet on the management team," he says. "When they win, you win."

Private equity investment firm Summit Partners has recently placed a bet on Ned Bennett, CEO of online brokerage firm optionsXpress. The Boston-based investor forked over $90 million last December to get a seat on the five-member board and a minority stake in the firm that Bennett and a partner formed three years ago. While Bennett and his partner had to give up some equity to the new investors, the partners got cash to step up the firm's expansion plans and to spend money on TV commercials. And they got advice on strategic issues from Summit, an experienced private equity investor.

Bennett says Summit advised them on how to structure joint ventures- having control is key, for example-and introduced them to other portfolio companies, which led them to a solution on how to prevent identity theft online. Summit also counseled the company on how to improve operations by relocating to states or cities with tax incentives and such benefits as reduced transit costs for employees.

Still, even Bennett can't quite get over the feeling that being public is somehow more prestigious for a CEO. "Every executive worth their weight in marshmallows would love to take a company public," he says. "We do talk about it, but we have decided to remain private. If there is a way to enhance our shareholder value above and beyond, then we will be forced to embrace that direction." But his guess is that may take several years, and for now he's benefiting from the company's newfound independence.

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