Buying our way out of the IPO era
In 1988, Michael Dell was a 23-year-old wunderkind who sold cheap computers directly to “end users,” which is what he called his customers. He arranged an initial public offering to raise cash and attract top-tier engineers and managers while basking in the light of transparency.
Dell was so small that the IPO wasn’t mentioned in the New York Times. At around $12 million, or $23 million in 2013 dollars, the book value of Dell’s common stock likely would have been too low to entice a modern-day Goldman Sachs, one of its lead underwriters. But Dell’s IPO was a winner. In two months, its stock price jumped from $8.50 to $19 per share. By the end of the year, it had made $159 million in sales.
Last week, Dell announced a stunning $24.4 billion leveraged buyout. If the plan manages to survive, it will allow Dell to reboot his ailing company free from the public glare. The deal is the largest of its kind since 2008, but it’s also notable because it marks the waning of the public company era.
Public companies built railroads, cars, fast-food empires, cheap PCs and many goods and services that Americans still consume. For decades, a company like Dell could take a chance at being publicly traded in exchange for an influx of cash. But if Michael Dell were starting out today, he probably wouldn’t take his company public.
The number of public companies listed on U.S. exchanges dropped to 4,977 in 2012 from a peak of 8,823 in 1997, according to the World Federation of Exchanges. The number of IPOs fell, too. A September paper released by the Securities and Exchange Commission’s Advisory Committee on Small and Emerging Companies reports that from 1980 to 2000, there were, on average, 311 IPOs a year. That number has decreased to an average of 99 a year since 2001.
The number of small companies, those with annual sales of less than $50 million, listed on public exchanges has dwindled the most. From 2001 to 2009, there were only 30 a year, down from about 165 a year in the 1980-2000 period. There are fewer tech IPOs, too. In the past six months the 10 largest IPOs have been energy and real estate companies, a cruise line and a plastics group.
This is what happens when many IPOs have been unprofitable. Mutual funds, pension funds, hedge funds and other institutional investors that rule today’s markets demand higher liquidity. Many underwriters and investors won’t go near companies with a market capitalization that is below $500 million because they can’t get the price-earning ratios of 30 to 40 that bigger companies yield with a $10 million bite.
Lots of founders don’t want to go public. Building a company out of public view is often preferred over a Groupon-like disaster. Founders can be hesitant to run a company with fund managers and shareholders on one end and equity-holding executives on the other, which creates a conflict of interest — and egos. According to a survey by the National Venture Capital Association, half of startup CEOs said they would consider being acquired, but only 7 percent said they would go the IPO route.
SurveyMonkey’s Dave Goldberg, husband of Facebook COO Sheryl Sandberg, recently structured a deal for $800 million in capital to stay private. Half is from new investors buying equity from employees and others. The rest is from Google and JPMorgan Chase, which financed debt. “Part of the reason we’re not going public is that we don’t want to measure our results on a quarterly basis,” Goldberg told Business Insider.
Even Google and Facebook are arguably “public-lite” companies. Both delayed going public, and both were almost forced to do so because U.S. law requires companies with a certain number of private shareholders of record to file quarterly as if it were publicly listed. Founders still hold the reins. Google created three share classes, including super-voting Class B stock that founders Sergey Brin and Larry Page control. Facebook has a dual-class capital structure with a special class of shares that ensures founder Mark Zuckerberg exercises control.
The costs of going public can be prohibitive. The $2 million in fees doesn’t include the $500,000 or more a year in insurance and compliance costs. The Dodd-Frank Act’s impact is still an unknown, as the Securities and Exchange Commission has yet to draft many rules, but companies will pay millions to comply. For now, regulations are killing many appetites to go public. Even the JOBS Act passed by Congress in April had provisions that encourage private ownership.
When fewer startups and small companies go public, Google, Facebook, Amazon, Apple (public companies, all) and other large firms acquire them. That leads to the founders getting lost in the bureaucracy, succumbing to the culture and management and not having control over the direction of their company and ideas. The corporate landscape ends up being less diverse, and less-prominent investors get locked out of the wealth-generating economy.
With fewer public companies come fewer jobs. According to a report by the Kauffman Foundation, if the number of IPOs had climbed steadily after 2000, there would have been 1.8 million more jobs. ITT, which was in the telephone and television business before becoming a manufacturing conglomerate, grew from 132,000 employees in 1960 to 392,000 in 1970, when it acquired Sheraton hotels, Avis Rent-a-Car and others. General Motors added 100,000 workers after it went public. AT&T added almost 200,000, according to a paper by University of Michigan business school professor Gerald Davis.
Last week, Dell said its strategy is to expand software and other computing services for large companies. It downplayed a move in the low-margin PC space, even though PC sales still make up most of its revenue. Going private is the only sane way for Dell to solve the company’s problems. The price per share today is over $5 more than when it went public 25 years ago. As Dell knows, it would be unwise to do the kind of restructuring needed in the public spotlight.
The company has a steep climb. There are already two shareholders who are against the buyout, and, if it falls apart, Dell likely will find another way to go private. The deal actually has a provision that he can fish for superior offers and back out on the cheap. Ironically, if he turns around the company, he probably will take it public again, rather than be acquired. But Dell is unusual. He’s a hands-on veteran CEO whose IPO was 25 years ago. He has gotten used to the headaches that go along with being a publicly traded company. Dell’s is a rare play that might become more common for seasoned executives of legacy companies, given brisk market conditions. But these rare moves involve companies that are ensconced in the exchanges and won’t bolster the number of listings or change the culture.
In a sense, there is a cyclical nature to the embrace or rejection of the public company. Despite a chill in IPOs following the Sarbanes-Oxley Act of 2002, the market rebounded in the mid-2000s. If regulation eases, the public company could rise again. But like Dell, it will be irreparably changed.
PHOTO: A man pushes a trolley full of Dell computers through a company factory in Sriperumbudur Taluk, in the Kancheepuram district of the southern Indian state of Tamil Nadu, in this June 2, 2011 file photograph. REUTERS/Babu/Files