Corporate Finance – Keeping it private

The announcement on 22 April that Coutts Consulting plc has been taken back into private ownership raises once again the question of whether the flow of public to private deals of the past couple of years will turn into a flood.

Two factors have come together to make a move back to the private company sector seem an attractive option for many smaller quoted companies. One is the sheer volume of private equity money, especially from the still booming US economy, looking for somewhere to invest. The other is the attitude of fund managers, who are showing a distinct lack of interest in smaller quoteds unless they are in glamorous sectors such as biotech or the internet.

In the early and mid-1990s, private companies were falling over one another to float themselves off. A desire to join the big league may have played a part in this, but the real benefit of flotation was supposed to be the access it would give to large quantities of private and institutional capital for investment and expansion. The irony is that it is that same need for new investment that is now driving many companies back into private hands.

One reason why smaller plcs have fallen out of favour is simply that a large portfolio of small holdings requires more management effort than the same funds invested in a smaller number of large companies. This has been compounded by the growth in tracker funds and increasing globalisation, which makes small UK plcs look even smaller. Lack of interest by fund managers leads to a lack of liquidity and, since that makes it more difficult to sell stock, it becomes a good reason for not buying in the first place – a vicious circle that can further erode the liquidity and value of shares.

This may balance itself out in time, especially if it creates bargains, but at the moment it is creating a problem for private owners of large holdings looking to exit.

The corporate finance and due diligence adviser for the Coutts Consulting deal was PricewaterhouseCoopers and, according to Duncan Styles, a new company adviser who worked on the deal, one reason why managers and majority shareholders are turning back to private finance is the conviction that they are undervalued.

While Styles believes that smaller companies – with equity values of less than about £200m – have fallen out of favour with fund managers, he cautions: ‘Although venture capitalists are running their slide rules over hundreds of such companies, the truth is that most of them are valued correctly by the market’.

There may be many plcs, especially those valued at less than £30m, which have come to regret their marriage to the public market, but the complexity and risks of arranging a public-to-private deal mean that for most a divorce will be hard to arrange.

Nevertheless Charles Milner, corporate finance partner at KPMG, believes that interest in public-to-private deals is more than a market fashion.

‘We shall see public companies going private for the foreseeable future,’ he predicts. ‘The venture capital market is very sophisticated and has a great deal of money to invest.’

Milner reckons 200 to 300 companies are being looked at as candidates for public-to-private deals. Recent deals included Thorn plc at £980m, Willis Corroon at £851m and UK Safety plc, with a market valuation before a deal was proposed of around just £1m.

Whatever the size of the company, a public-to-private deal can never be simple, as it cuts across two very different market sectors. ‘We ensure that the partner team has expertise of the private equity market place combined with expertise of undertaking transactions in the public arena,’ Milner says. ‘This combination is essential to success.’

Every case is different. Chris Graham was part of the team at 3i that set up the Coutts Consulting deal. He says: ‘We felt Coutts was undervalued for a number of particular reasons. Apart from general market sentiments against smaller businesses, there has also been a move against recruitment businesses. Although Coutts is an outplacement consultancy – the precise opposite – we felt this perception had adversely affected the share price.’

By focusing on just one company at a time, a private equity investor can afford to devote far more time and effort to it than a fund manager keeping track of even a small portfolio. On the other hand, putting together a deal for a complete company takes a lot longer than buying or selling a block of shares. The gestation period for the Coutts Consulting deal was about nine months and included a series of steps.

The first step for Coutts’ management team was to set up a separate company, Atlas Holdings, to buy the company. A public-to-private deal is similar to any other takeover bid, but there must be a division between the executive directors and managers who want to take over the company and the independent directors. The first step for Coutts’ independent directors was to appoint their own adviser, BT Wolfensohn, to seek out the best deal for the shareholders.

3i was first approached in August and commissioned its own market report.

According to Stuart McMinnies, a member of the 3i team, this is the stage at which many deals fall through. He says: ‘Although hundreds of companies are being examined for potential public-to-private deals, probably only a finite number will take place. When the market gives a company a low rating it is usually for a good reason.’

Coutts, however, did look attractive and undervalued, so Atlas was funded with £500,000 from management, just under £23m from 3i and the balance of £40m from the Bank of Scotland.

The next step was an offer letter to more than 1,000 Coutts’ shareholders.

Coutts shares had been standing at 28p and the first offer was for 41p, a premium of 46% which valued the company at £28.9m. Getting the offer price right is the key to a successful deal, and premiums typically range from 40% to 50%. A public-to-private deal can in theory be pursued with only a simple majority of shares but in practice, because of the high gearing of most deals, the banks usually insist on acceptance by the holders of at least 75% of the company’s shares.

The Coutts deal did include one unusual and, for private equity houses, possibly ominous feature. On 7 April, 3i raised its offer to 47p a share.

This was reported to be the result of pressure from institutional shareholders, particularly fund manager Scottish Value, which by late March had increased its holding to 23.6% – enough to block any deal it didn’t accept. The new offer yielded undertakings for 78.9% of the shares by the end of that week. On 22 April, 3i was able to confirm that the holding company now owned over 90% of the shares and had completed the deal.

Opinions vary about the likely future scale of public-to-private deals.

Styles says: ‘For the most part, those that are going to happen are already being looked at.’ He expects a continuation at the present level for another year or so, and a more selective number of deals thereafter.

Milner’s view is slightly more bullish. He says: ‘There will be an ongoing flow of public-to-private transactions, certainly for the foreseeable future.

People are learning all the time and we can foresee growth as the process becomes better understood.’

Public-to-private deals do carry certain risks. One of these is that it may not be easy for the new owners to sell the company on when there is very little prospect of another flotation. An even greater risk is that, once a company is in the spotlight, a rival bid may emerge. If their own holdings are not large enough to block a rival, the management team or a founder trying to gain greater control of their company’s destiny could find themselves losing it altogether.

The future of public-to-private transactions will depend most of all on the mood of the market.

Smaller companies are out of favour with the institutions, but that may change. In the first quarter of 1999, the FTSE Small Cap Index rose by more than 15%, compared with only 10% for the FTSE-100. That may be in part an adjustment, but small plcs may have a brighter future than it appears.

That does not mean that public-to-private deals are necessarily a reflection of short-term thinking. As Styles says: ‘The taking private of a quoted company should not be considered short-termism if in private hands the company has access to funds which as a plc it was denied.’

Financial logic, however, may not be the only factor. Andrew Lloyd Webber and Richard Branson may well have had sound business reasons for taking The Really Useful Group and Virgin Group plc back into private ownership, but it would be a bold commentator who assumed that sentiment plays no part in such decisions.

David Thomas and Peter Williams are freelance journalists.

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