Off the Street

Stricter rules and wary investors are prompting more companies to exit the public markets.

Similarly, Greenville, Tennessee-based Landair Transport Inc., a $106 million (2001 revenues) firm bought out by its founder and the COO in March, specifically cited the increased costs of complying with both Sarbanes-Oxley and the rules adopted by the National Association of Securities Dealers, adding that “such increased regulation would place additional burdens on management that would further distract them from managing the business operations of Landair.”

A backlash against such additional burdens is not surprising. “The intersection of all this stuff — more disclosures, more internal controls, and a stronger audit committee — is frequently in the CFO’s office,” observes Stephen D. Poss, an attorney with Boston-based Goodwin Procter LLP, who adds that another word for intersection is “crosshairs.” For smaller public companies, where the CFO is sometimes a one-man finance department, the new regulations, certifications, and the spectacle of finance chiefs doing perp walks may be a powerful deterrent to staying public.

Or perhaps there is a deliberate effort to scare companies away from the public markets. “I wouldn’t be surprised if someone at the SEC is thinking, ÔWe need to make being a public company so expensive and onerous that we get these smaller companies off the screen,’” says Poss. “And that’s not necessarily a dumb way of thinking.”

Market Correction?

What Poss and others suggest, and depressed stock prices seem to confirm, is that the trend toward going private is actually an appropriate market correction. “At the height of the bull market, there were approximately 18,000 publicly traded companies,” declares Scott Larson, assistant professor at the business school of Chicago’s National-Louis University. “Investors threw money at certain segments of the public equity markets at unsustainable levels, so the implied cost of equity in the more-speculative segments of the market dropped to near zero.”

Larson doesn’t blame those companies for pursuing the practically free capital offered by the public equity markets during the 1990s. But now that that bubble has burst, he believes that “the same sort of analysis that CFOs apply to determine whether to buy back debt or shares ought to be applied to determine whether they should still be public.”

While some CFOs are clearly doing just that, he says, others are reluctant, or dismiss the out-of-pocket expense of being public as minimal when compared even with their depressed market cap. That’s the wrong calculation. In addition to increased compliance costs, Larson explains, the cost of being public includes the cost of equity — that is, the return shareholders expect from their stock.

But with hostile or frightened investors fleeing to large, blue-chip stocks — or exiting the market themselves — the trading liquidity that gave stocks additional value and kept the cost of equity low has disappeared. Three years ago, thin trading drove certain industrial companies out of the stock market. In 2003, that problem afflicts the market’s entire bottom tier. “Today, it really isn’t very attractive to be a public company of under $500 million market cap,” notes Chicago-based managing director Michael Murphy of Minneapolis-based U.S. Bancorp Piper Jaffray Inc., whose research focuses on small-caps that are likely takeover targets or going-private candidates. Analysts ignore thinly traded stocks, denying them the very coverage they need to attract investors, and many once-hot initial public offerings are finding themselves as “forgotten as last year’s prom queen,” says Goodwin Procter attorney John LeClaire.


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