Why Small Companies Want A Little Privacy

More and more of them are deciding that being public isn't worth the hassle

John A. Catsimatidis, chairman and chief executive of New York-based supermarket chain Gristede's Foods Inc. (GRI ), is fed up with the headaches of running a listed company valued at a mere $16 million. He is sick of begging for attention from investors and bankers interested only in the market's big boys. And he's tired of the soaring cost of complying with all the new regulations governing public companies. "We'll just take the company private," he says.

Just when investors and bankers are counting on Google Inc. to bring the good times back to the market for initial public offerings, a slew of small fry have decided that being a public company isn't really worth it. Bankers expect a record number of U.S. companies to go private this year, topping last year's 86. Three years ago, only 53 did. Some outfits aren't even bothering to go public in the first place. Says Mark A. Filippell, a senior managing director in investment banking at Cleveland-based KeyCorp (KEY ): "Many entrepreneurs no longer dream of going public because they see the hassle outweighing the potential benefit."


Life has become a lot rougher for the listed little guys. Many are ending up in the stock-market version of a no-man's-land: out of sight of most investors but forced to shoulder the same expensive regulatory burdens as big companies. As recently as the mid-'90s, when individual investors still owned the majority of stocks, it was easier to catch the eye of a bargain hunter sifting for gems on NASDAQ or over-the-counter markets. But now pension funds, hedge funds, and other institutional investors carry much more weight in the market than individual buyers -- and they're not interested in companies with small market capitalizations because it's too difficult to trade big blocks of their shares.

The result: Small companies are trading at a steep discount to larger ones. Even after a sharp rise in small-cap stocks over the past two years, the small and midsize companies making up the Russell 2000 index are still trading at just 2.16 times their book value. By contrast, the large companies in the Dow Jones industrial average are trading at 3.44 times their book value. Until 1998, there was hardly any gap.

As institutional investors increasingly call the shots, investment banks see much less of a need to provide research on small caps, depressing their share prices even more. "If you have a market cap of under $200 million, no one will watch you," says Dan T. Moore III, who decided to sell his company, Advanced Ceramics, to General Electric Co. (GE ) in November, 2002, rather than take it public. Generally, only two analysts follow any company with a market cap of $170 million to $200 million, while 14 analysts issue research reports on companies valued at more than $7.5 billion, according to a study by KeyCorp. For many small companies, the situation is worse: No analysts cover them, and in some cases, they even pay research firms to issue reports on them.

At the same time, the rising cost of staying public makes going private seem even more attractive. Chicago law firm Foley & Lardner LLP estimates that the requirements imposed by the 2002 Sarbanes-Oxley corporate-governance law, new Securities & Exchange Commission rules, and stock-exchange listing requirements have doubled regulatory outlays since 2002, to an average of $2.3 million for companies with market caps under $900 million. And "there are more costs coming down the pipeline," says Ian Cookson, a corporate finance director at Chicago-based consultant Grant Thornton LLP, as new regulations are phased in. These include requiring companies to document their internal-control procedures for everything that ends up in their financial statements.

The trend is spreading across sectors and states. Shareholders of New Roads (La.)-based Peoples Bancshares of Pointe Coupee Parish Inc. voted to take the small community bank private last December, once it became clear that it would be paying 10 times as much to comply with regulations as it did several years earlier. "The financial burden and man-hours had become unbearable," says CEO Stephen P. David. Adds William E. Balhoff, an audit director at Baton Rouge (La.) accounting and business-advisory firm Postlethwaite & Netterville: "The consequence of the legislation is that it will limit the number of companies that people will have access to buy."

Here's the twist: While small businesses feel they're being pushed out of the stock market by pension funds and other institutional investors, they're being welcomed by private-equity firms standing ready with financing raised from many of the very same institutional investors. The buyout firms are flush with cash, having raised an unprecedented $100 billion to invest in the past several years on top of easily available debt financing. "You have a combination of more private money than ever and more companies that don't see the value of being public anymore," says Steven M. Bernard, director of merger-and-acquisition market analysis at Milwaukee investment bank Robert W. Baird & Co. More than two-thirds of the deals involving companies going private since mid-2002 were management buyouts, generally funded by private-equity firms, according to Grant Thornton. In many cases, the buyout crowd plans to dress the companies up for deals, or perhaps eventually take them public again.

Armed with plenty of financing options, some smaller private companies are resisting the lure of raising quick and cheap money by going public. As a result, the average size of an IPO is mushrooming. And over the past two years, the median annual sales of a company going public have reached $164 million, up from $15 million in 1999 and 2000, according to Jay R. Ritter, a finance professor at the University of Florida. Companies such as Xcel Pharmaceuticals Inc. want to bulk up their product lines and operations before making a debut. "While we desire to be public, it's not an absolute necessity," says Michael T. Borer, CEO of Xcel, which pulled its IPO in April.

Even bigger companies are staying away from the IPO route. Arthur F. Anton, president and CEO of component manufacturer Swagelok Co., a Cleveland company that boasts roughly $1 billion in annual sales, says he gets pitches from investment bankers all the time, but an IPO doesn't appeal to him, especially as regulatory costs rise. "Our whole philosophy is built around doing things for the long term," he says. "It just becomes a lot harder to manage [if you are public]. You can't pick your shareholders."


Of course, there'S little doubt that many of the companies taken public in the late '90s should probably not have gone that route, given that many were not even profitable. And investors are certainly better off not getting trapped in publicly traded zombies. "We've gone from one extreme to another, and we're getting back to normal," says the University of Florida's Ritter.

Still, what's normal looks to be different as more small companies find happiness by remaining or becoming private outfits. Gristede's, whose stock has steadily slipped from around $3.50 to 85 cents a share on the American Stock Exchange since 1999, is in the midst of an offering to buy back its shares. Only a chance to make a huge acquisition that would catapult his company into the big leagues would tempt CEO Catsimatidis to reconsider. But then he would be a big guy, and that offers little comfort to small outfits.

By Emily Thornton in New York

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