Why more companies go private via buy-outs
Last month the world's largest apparelmaker, Levi Strauss & Co., announced plans to retire from public life. No, Levi's jeans aren't going to fade away. But the company is hip-pocketing its stock. It's going private.
And another former Wall Street darling, Mary Kay Cosmetics, also plans to redo its corporate makeup in private.
Both companies will join the swelling ranks of publicly held corporations (Uniroyal, Denny's, Storer Communications) leaving the limelight through leveraged buy-outs (LBO). Last year a record 60 major companies went private this way. In the first half of 1985 the pace remains strong, though somewhat abated.
In a typical LBO, top management buys out the public shareholders and finances the deal by borrowing money against the company's assets or future earnings.
To buy back its stock, Levi Strauss will pay $1.45 billion and must sink an estimated $150 million a year in interest for five years. That's about 40 percent of operating profits -- just for interest.
So why go private? What motivates management to load debt on the company just to take it out of public hands?
Often, it's not one reason but many. The time, cost, and hassles of dealing with inquisitive shareholders and Wall Street analysts are frequently cited. That kind of scrutiny -- especially when a company is struggling -- can pressure management into short-term strategies just to pacify this constituency.
``You find yourself managing your business to analysts' expectations,'' says Bob Tyre, vice-president of acquisition services at Booz-Allen & Hamilton, a consulting firm. ``A public firm has less flexibility to manage long term.''
In fact, Mary Kay spokesman Dean Meadors says being private gives a company ``the freedom to make long-term strategic decisions -- maybe at the expense of short-term profits.''
Levi's president, Robert D. Haas, has made similar statements, but also said recently that going private was a ``way to ensure that the company continues to respect and implement its corporate values and traditions.''
Levi Strauss is noted for its attention to community involvement and concern for employees.
But a prolonged slump in blue jeans sales has pushed it to close 23 plants and cut 6,500 of 44,000 employees. ``They felt that if they'd been private, they might not have fired as many people to get costs down quickly -- to please shareholders,'' says Edward F. Johnson, a Prescott, Ball & Turben analyst.
But others say that the real motives behind most LBOs are primarily economic, that the ``free-from-short-term-pressure'' rationale is simply icing.
Bulent Gultekin, an associate finance professor at the Wharton School, says: ``It's not so much getting out of the public eye but an economic decision. Let's say a company can be bought for $100. [In an LBO] you can borrow $99 of that and put up $1 of your own money. Hopefully, earnings are sufficient to pay the debt in five years. You end up owning the company -- by using other people's money.''
Of course, the best time to buy stock -- including your own company's -- is when the price has fallen. ``It's almost a maxim that you go public when the company appears to have a greater value than it does in fact. And you go private when the stock market undervalues your company,'' says Bob Tyre at Booz-Allen & Hamilton.
Both companies have seen their stock tumble over the past several years. In 1983 Mary Kay hit a high of $44 a share. Then earnings collapsed. With a rebounding economy, its part-time sales force shrank as it found better-paying jobs -- just as the company was investing to expand. The stock fell to $9.
Prudential-Bache analyst Nancy Hall is one of the few Wall Street savants predicting that Mary Kay is on the rebound. Management is offering $11 in cash and $8.25 in bonds paying 15 percent in five years. Shareholders are expected to vote on the offer in late October.
Ms. Hall calls the Mary Kay step ``a smart management move. They're buying the company at a very cheap price, before the Street recognizes the company is turning around.''
Many analysts say Levi's business is already turning around. In the last year its stock traded for as low as $24 and rose to $35 shortly before management offered $50 a share for all of it. Some wonder why management didn't buy back its stock when it was cheaper. Mr. Johnson at Prescott, Ball & Turben explains that Levi's was simply out looking around for an acquisition. ``Then they realized Levi Strauss was the cheapest company they could buy, and started buying their own stock.'' Eventually, managemen t put together the buy-out offer.
Richard W. Madresh is senior vice-president at Security Pacific Business Credit, which has financed some $800 million in LBOs. He sees four basic motives behind LBOs: (1) A large conglomerate will spin off a subsidiary to its management because the subsidiary is weak or just doesn't fit into its strategic plans; (2) companies go private to evade a corporate raider (as Uniroyal did) or to protect themselves from a potential raider; (3) companies with only a few major shareholders may sell out to manageme nt for estate-planning purposes; ``Every day companies come on to the market because the owners are getting older [and want to liquidate their holdings],'' Mr. Madresh says; and (4) there are the profits to be made if a flabby company goes private, gets into shape, and goes public again. To some extent, investment bankers push the cycle. ``The investment banker says we'll take the company private, run it more efficiently, more profitably, then take it public again and make a killing in the market,'' he expl ains.
Madresh cites Gibson Greeting Cards, which went public again just 18 months after going private. ``The owners and lenders made something like $60 million on a $1 or $2 million investment.''
One final, very human reason for going private is offered by Mary Kay's spokesman: ``It's their life. Mary Kay and Richard [her son, the president] like the idea of family ownership -- of having it be theirs.''