Perspectives. The End of the Public Company As We Know It

Transcription

1 Perspectives The End of the Public Company As We Know It

2 The End of the Public Company As We Know It The avalanche of initial public offerings in recent years has obscured an intriguing and potentially significant countertrend. Even as many new start-up businesses are going public, many traditional publicly held companies are moving in precisely the opposite direction. They are going private, replacing public equity with private equity and debt, often in alliance with private equity firms. Private buyouts, as measured by number and dollar volume, are at their highest levels since the LBO heyday of the late 1980s. According to one recent estimate, 49 deals valued at $6.88 billion were announced in the first quarter of 2000 almost four times the dollar amount of deals announced in the first quarter of Many of these deals involve small and midsize companies. According to recent press reports, however, much bigger and betterknown companies the Borders bookstore chain, the printing company R.R. Donnelley & Sons, and Continental Airlines, to name just a few are exploring the buyout option, too. In addition, Seagate Technology, the world s largest disk-drive maker, recently announced 1. See Steven Lipin, Nikhil Deogun, and Kara Scannell, Raiders of the Lost Decade: 1980s-Style Mergers Return, Wall Street Journal, March 29, 2000, pp. C1 and C24.

3 that it would go private in a $20 billion transaction. Most observers interpret the trend as a natural reaction of low-technology companies that have lost out in the recent bull market. Although this explanation is accurate as far as it goes, the real story is much more interesting. Long-term changes in the structure of financial markets are presenting traditional companies those that make or sell tangible products, whether for other businesses or for consumers with new choices and the opportunity to pursue new kinds of financial strategies. These changes will continue even after the current bull market cools down. The New Cash Cows The companies taking advantage of privatization tend to have three things in common. First, they are highly productive and generate significant amounts of cash. More than a decade of investments in information technology and capital-goods spending in the manufacturing sector has finally paid off. These investments are allowing companies to post continual productivity gains equal to or greater than the rate of price attrition in their markets. As a result, real margins are increasing, and average cash-flow return on investment (CFROI) is at a 50-year high. Although this trend is well under way, it is far from over.

4 It will receive a major boost as business-tobusiness e-commerce allows companies to wring improvements from not just individual factories but the entire supply chain. Second, these companies have modest growth prospects generally equal to GNP or, at most, to GNP plus 2 percent. As a result, there is an imbalance between the cash they are generating and the opportunities they have to plow that cash back into the business as new investments. In fact, these companies have grown so productive that their markets can no longer absorb the de facto increases in capacity that continual productivity improvement creates. Third, as these companies pile up cash, they are penalized with low price-to-earnings ratios. This fact reflects a major shift in what public equity markets value specifically, a greater emphasis on future growth prospects as a contributor to total shareholder return. It also demonstrates the growing understanding on the part of investors that a public corporation is a relatively risky and inefficient vehicle for accumulating cash. The New Private Equity In the past, a company facing such a combination of circumstances would have diversified in search of new growth. And yet today, few traditional modest-growth companies can

5 get away with aggressive diversification. Active investors dislike corporate diversification, preferring to make their portfolio decisions themselves. Typically, public markets pummel any company that announces a major diversification strategy. An alternative approach is to acquire other companies in the same business for instance, buying an analogous company operating in another part of the world. Indeed, the globalization wave in many traditional businesses is driven more by this specific financial logic than by any compelling strategic imperative. In effect, companies are using their excess cash to take other companies private, thus liquidating the shareholders of the acquired company rather than their own. But more and more companies are choosing to go private themselves. When they do, they discover that they can take advantage of large private-equity pools that amount to hundreds of billions of dollars in investable funds. Private equity firms, such as Clayton, Dubilier & Rice, Texas Pacific, and Berkshire Partners, and the private equity divisions of investment banks, such as Goldman Sachs and Donaldson, Lufkin & Jenrette, are awash in liquidity. What s more, although many trace their origins to the LBO wave of the 1980s, these firms have evolved from being predators to becoming masters of the friendly takeover.

6 These firms no longer buy companies in order to gut them and immediately sell the pieces back to the public markets. Indeed, many are convinced that they can outmanage the market and create value even above the 20 percent acquisition premium they often have to pay. They can do so because they have the freedom to manage aggressively the financing, tax payments, and reinvestments of these companies in ways that would not be acceptable to a major publicly traded corporation. In short, private equity has become an efficient, profitable, and permanent alternative to the public equity markets. Financial Deconstruction The rise of private equity has broad implications for senior executives. Managers need to recognize that they now have a choice in equity markets. Creating the right fit between assets and owners has become a critical strategic challenge. Many companies that currently are traded publicly do not need the public equity markets to raise cash. And their business economics do not match the preferences of public investors. For such companies, remaining public may mean chaining themselves to an inappropriate capital structure that forces management to waste energy and, eventually, lose frustrated senior executives. Conversely,

7 going private may be an opportunity to align the business to financial structures and ownership models that are more appropriate to the dynamics of their business. But in some situations, the choice may not be a simple either/or. Different parts of a company may require different equity models. If so, there is an opportunity to deconstruct the business financially. Some units say, an e-commerce venture with great potential for future growth may thrive in the public markets, whereas other, more traditional units may have the financial structure, tax base, and cash flows more suited to private equity. Seagate s recent announcement is one version of this financial-deconstruction strategy. The company s privatization deal includes a complex transaction in which Seagate shareholders will be paid in the stock of a software company in which Seagate owns a 33 percent share. Although the software company has revenue equal to only one-tenth that of Seagate, its market value is many times that of Seagate s core business. The deal is a way for Seagate to unlock the value of its ownership stake in the software company, pay its shareholders in a way that minimizes both their tax burden and that of the company, and allow executives to focus on the core business. As more and more traditional companies invest aggressively in building dot-com busi-

8 nesses, this kind of financial deconstruction may become a trend. For example, the industrial wholesaler W.W. Grainger could take its traditional MRO supply business private even as it takes its parallel dot-com business public. Or thinking more radically, a major auto company such as Ford could take its highly productive manufacturing assets private, while leaving its brand, marketing-and-sales, and product-development organizations public. No one knows just how far the privatization trend will go. But it s clear that public ownership is no longer a given. What s more, the privatization trend is only one aspect of an even broader transformation of the traditional public company. The rules of ownership are being rewritten. As the forces of deconstruction redraw industry boundaries, they are restructuring how different types of economic activity are owned and managed, by whom, and to what end. Larry Shulman Larry Shulman is a senior vice president in the Chicago office of The Boston Consulting Group and leader of the firm s Strategy practice. You may contact the author by at: shulman.larry@bcg.com

9 The Boston Consulting Group, Inc /00

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11 This article is the seventh in a series of Perspectives on the strategic implications of deconstruction. The previous titles are: The Deconstruction of Value Chains, by Carl W. Stern How Deconstruction Drives De-averaging, by Philip Evans Patterns of Deconstruction: The Orchestrator, by David C. Edelman Patterns of Deconstruction: Layer Mastery, by David C. Edelman Patterns of Deconstruction: The Navigation Challenge, by David C. Edelman Failure to Compete Revisited, by Todd Hixon To request copies or to comment on these or other Perspectives, please contact BCG by at imc-perspectives@bcg.com.

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