This article was first published in the January 2012 UK edition of Accounting and Business magazine.
Individual Restaurant Company, which operates 33 outlets, including the Piccolino and Bar + Grill brands, floated on the London Stock Exchange’s AIM market in December 2006. But last year, the company’s majority owners, who include Malcolm Walker, founder of the Iceland supermarket chain, decided to take the company private. They formed a new company called W2D2 which made a successful bid for IRC.
In recent years, they have not been alone. There has been a steady stream of companies turning their backs on the public markets. Three years ago, research conducted by BDO Stoy Hayward found that around one-third of public companies would consider a public-to-private transaction in ‘the next few years’.
The research also revealed that half of institutional shareholders would be receptive to a public-to-private arrangement. BDO Stoy Hayward’s John Stephan says: ‘I think we would get a similar picture today with a little more optimism about being on the market.’
Many companies battered by three years of recession, and faced by unforgiving shareholders looking for decent returns, are concluding that life would not only be simpler, but possibly more successful, if they weren’t always having to look over their shoulders at what reaction the markets take to their every move.
It was certainly the view of Walker, who believed that taking the company private, in an offer which valued it at £5.67m, would help IRC tackle the tough trading conditions produced by the economic downturn. In its last reported financial year (to 31 December 2010) IRC’s sales had slipped 3.4% to £51.3m and EBITDA had fallen 14% to £4.3m. At the time of the take-private, Walker noted: ‘We feel that the best option for the business is to take the company private in order to help take IRC back to growth.’
IRC is typical of companies with small capitalisations that find the supposed benefits of being a public company, such as easier access to capital and higher profile, are not always borne out in reality. Directors also become frustrated that markets under-value smaller companies. In Stephan’s research only 16% of companies with a market cap below £15m felt that they were fairly valued by the market. That rose to just 38% for companies with a market cap of between £30m and £99m.
‘Below £100m, it seems to be less viable to be on the market,’ says Stephan. ‘With small caps in particular, liquidity seems to have gone out of the market.’ The problem is that analysts and fund managers don’t tend to focus their attention on smaller companies, especially when, as in IRC’s case, the ‘free float’ of shares is below 50%.
Public-to-privates among smaller quoted companies are a growing trend, agrees Richard Weaver, a partner in the capital markets group at PwC. ‘They are finding that the negatives of a listing outweigh the benefits.’
One of those negatives is the cost of listing, even on the more lightly regulated AIM market. There are costs associated with meeting corporate governance requirements, such as appointing non-executive directors, investor relations advisers and submitting accounts that meet the requirements of a public market.
These vary depending on company size, but even at a lower level on the AIM market there is unlikely to be much change out of £250,000 each year.
‘As a private company, you can typically be more agile and flexible,’ says Weaver. ‘You can make certain decisions more quickly than a public company.’
So, after having gone through all the effort and expense of floating on a stock exchange, how does a company reverse the process? In some cases, it will make the public-to-private transition as a result of mergers and acquisitions (M&A) activity – where a public company is acquired by or merges with a private firm.
Examples in the past 12 months include Romag, a supplier of photovoltaic glass whose assets were sold as part of a pre-pack administration to Gentoo Group, and Wellstream, a specialist in flexible pipelines for the energy industry which was bought by the US’s General Electric for £800m.
But when an existing management team is taking an independent company private, it will need to gain agreement from the non-executive directors that the take-private is in the interests of shareholders.
In the case of IRC, chairman Robert Breare said that the board wasn’t able to give a firm recommendation for W2D2’s offer of 9.5 pence a share. But he warned minority shareholders: ‘Given the controlling stake already held by the [W2D2] consortium, such a liquidity event might not be available in the future on similar terms.’
Stephan points out that a take-private decision involves the board asking some fundamental questions about the future of the business. ‘You need to be asking: what’s in the best interests of shareholders and how can we best create shareholder value?’ he says.
Time to talk
He advises directors to talk to shareholders early in the process. ‘If shareholders are looking for an exit, they need to explore the options open to them.’ It shouldn’t take up too much valuable management time to gauge the views of shareholders – especially in the case of small-cap companies, where there may be only a small number of major ones.
But he warns that, when a private-to-public transaction kicks off, it can prove time-consuming for the senior management team, especially the chief executive and CFO. ‘A take-private can be disruptive for management and obviously you’ve got to be running the company at the same time,’ he says.
If you’re going to run a successful public-to-private transaction, you’ve got to have a good growth story, advises Weaver. ‘You need to be able to see the case for it in terms of faster decision-making – for example, by not being encumbered with the class one rule.’ (Class one transactions, as defined by the UK Listing Authority, are decisions that require shareholder approval.)
Stephan agrees that a good growth story is important in gaining shareholder acceptance of a public-to-private. ‘You must have a robust plan to begin with – a strategy to deliver value,’ he says. ‘It’s pretty unlikely that you’d get one of these transactions done just by saying that you’ve got a steady earnings stream and you can pay down debt.
‘Then you’ve got to have a price that works for shareholders. On the one hand, you’ve got to have a price you can put a funding structure to. On the other, it has to be a price that the independent directors on the board could recommend to shareholders. It is a meeting in the middle of what is fundable but is also fair and reasonable for shareholders.’
Given the steady traffic of companies from public to private, shouldn’t more boards have had second thoughts about their original flotation before they went ahead?
‘I think there are undoubtedly some companies where there is some management or owner hubris and reputation involved,’ says Weaver. ‘They want the status of having a big share in a listed company but have not fully evaluated the consequential effects. Maybe they’re a little dazzled by the prospect of being the part owner of a listed company without recognising that it’s got its downsides.’
Peter Bartram, journalist
CASE STUDY: GSH GROUP
GSH Group, a £250m-turnover technical facilities and energy management company, delisted from the London Stock Exchange’s AIM market in 2009. It had been quoted on the market for just four years. So why the reversion to private ownership so soon after the original high hopes of the flotation?
‘From very early on we felt a disproportionate amount of resources, both financial and in terms of senior management time, was spent on meeting the needs of the City when this could have been better spent on meeting the needs of clients,’ says Ian Davidson, who is now GSH Group’s chairman as well as holding the CFO post.
‘Of course, we were listed during a time when there was considerable volatility on the stock markets and the fluctuation in GSH shares bore little relevance to the company’s actual performance, which continued to be strong and profitable.’
During its period on AIM, GSH’s share price oscillated from a high of around £5 to a low of £1. ‘When the market is looking good, you go over the top but when the market starts to shrink, you over-shoot the other way,’ Davidson says.
GSH had hoped to benefit from what Davidson calls ‘a general perception of scale’ by being listed. The firm felt this would be especially helpful when it was dealing with overseas clients. It accepted that it would need a corporate governance regime, complete with non-executive directors and board committees, such as a remuneration committee, appropriate to a public company.
But although the firm gained some benefits, Davidson complains: ‘We also experienced an increasing concentration on short-term performance in order to meet the City’s expectations.’
This, the board felt, didn’t suit GSH’s business model which focused on incremental growth. ‘Our business focuses on long-term client contracts with an assessment of profit and cash generation over the whole contract period,’ explains Davidson. ‘Needing to make the numbers add up each year can be at the expense of long-term investments in, for example, training, IT or developing client relationships.’
Davidson cites the fact that the company runs one of the UK’s largest apprentice schemes. ‘We have always placed great emphasis on training and developing our young starters – the dedicated long-service employees of the future.’
So what was the reaction of minority shareholders when the board announced that it was planning to delist? ‘In truth, it was pretty negative,’ Davidson admits. ‘They felt they’d bought into a vision of growth but they’d seen their shares go down.’
A key bone of contention was that there was no offer to shareholders to buy out their shares at the time of the delisting. The minority shareholders would be left with no active market to trade their shares. Subsequently, the board made an offer to shareholders of £1.90 a share. ‘The board wanted to be fair and made the offer at an independently verified fair price,’ says Davidson.
In the three years since it happened, has the delisting proved the right decision? Davidson has no regrets. Turnover has grown from £220m at the time of delisting to around £260m now.
Davidson says that the take-private has enabled the company to jettison some of the corporate governance bureaucracy which had slowed down decision-making without lowering standards. There are now no non-executive directors or board committees. Instead, there is a streamlined structure based around two group directors and a managing director for each of the company’s three main markets – Britain, Europe and the US.
‘As a public company, decision-making was not as fast as we would have liked it to be,’ he says. ‘Now, we can make fast decisions because there are no separate committees to sit there and debate things.’
And the cost of the delisting process? Davidson ‘wouldn’t argue’ with an estimate of £200,000 to £300,000 excluding management time.