Going Private
Imagine: No Reg FD, no 10Ks, no Sarbox, no . . .
Saturday, June 3, 2006 12:01 a.m. EDT
Kinder Morgan unveiled the largest management-led buyout in history this week, with top executives proposing a $13.5 billion deal that would make the oil and gas pipeline company a closely held firm. Let's hope this event isn't lost on Congress, whose regulatory fervor is one reason many companies are fleeing the U.S. public capital markets.
Private equity is booming, and sweeping up U.S. business in the process. Fifteen years ago, a handful of private-equity firms managed a few billion; today, more than 250 firms control some $800 billion in capital. Buyouts magazine, which tracks private-equity deals, estimates that nearly $175 billion in new money flowed into U.S.-based private-equity firms last year alone, including giants such as Blackstone, KKR and the Carlyle Group.
That money has in turn been driving a spate of public-to-private deals that are growing in both frequency and size. Kinder Morgan is big, but last year also saw some gigantic buyouts, including those of Toys "R" Us, SunGard Data and Hertz. By the end of May private-equity firms had sealed more than $61 billion worth of deals, compared with $51 billion recorded at the same time a year earlier. No word yet that private-equity firms are preparing to bid on chunks of the federal government--though we can always hope.
Behind much of this trend is basic economics. Hedge funds, pension funds and endowments are all looking for new places to invest their mountains of cash, and private equity has been offering some impressive returns. Corporate management, meanwhile, far from running from these new barbarians at their gates, often see a financial upside. With capital abundant, the cost of borrowing low and return on equity soaring, why not?
But that's hardly the whole equation. At least part of the strength of private equity is a direct result of the problems besetting public markets. Public-to-private deals are in fact lengthy and costly and can lead to unpleasantness with shareholders--often via lawsuits. The fact that so many companies have nonetheless been willing to take the plunge speaks volumes about how eager they are to escape the increasing burdens of public-company regulation.
Sarbanes-Oxley has been the last straw for some, with its auditing and reporting requirements imposing major new costs, especially on smaller companies. This has already played a part in the remarkable slowdown in U.S. initial public offerings. Today's largest IPOs are taking place mainly on foreign markets, away from the reach of U.S. regulators. New York Stock Exchange CEO John Thain understands this as well as anyone, which is one reason for his $20 billion EuroNext purchase.
The Securities and Exchange Commission is promising Sarbox reform, though its recent noises suggest it won't exempt smaller companies from the rules. It might want to consider International Strategy & Investment Group data showing that 191 public companies--worth $146 billion in deal value--have gone private since June 30, 2002, shortly before Sarbox went into effect. Daniel Clifton, executive director of the American Shareholders Association, notes that the big spike came right after Sarbox's implementation, yet the dollar amount of the deals didn't rise equivalently--suggesting it was mainly smaller firms doing the exiting.
Mr. Clifton has also been studying the surging costs of regulation for public companies and has found that while in 1999 regulatory costs were about 4.8% of market capitalization, by 2002 the ratio was 9.9%. It has fallen some since. But these costs are a double whammy for smaller companies, which have fewer resources to devote to compliance costs. "It is also money that they can't use for the investments that they need to make to grow," says Mr. Clifton.
The relentless pressure of quarterly earnings is also a tyranny that some managers would prefer to avoid. Such targets have their uses in holding managers accountable. But even capable executives who fail to meet Wall Street expectations, or suffer an unexpected bump in the road, have to worry that they'll get hit with shareholder suits for even a temporary stock-price dip. It may not be a coincidence that, according to a recent survey from Booz Allen Hamilton, 15.3% of CEOs at the world's 2,500 largest public companies left office in 2005, many of them fleeing to private companies that can afford the luxury of a longer-run view.
Why should anyone care? All things being equal, it shouldn't matter whether corporations are choosing private or public equity; the more choice, the better. But it's troubling that the current trend is being driven as much by regulatory excess as market opportunity. U.S. capital markets have long been a national strength and a source of wealth creation. To the extent that broad shareholder ownership has also spread the wealth, it has been good for social mobility and boosted public support for free markets.
Whatever its other virtues, the private-equity boom is a signal that the regulatory pendulum has swung too far post-Enron. Congress might consider whether it really wants to turn U.S. public markets--long the envy of the world--into a second- or third-rate destination.
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