March 1 2003 by Jennifer Pellet
In the summer of 2001, Deltek Systems CEO Ken deLaski was flummoxed. Just five years after the proud day his software firm raised $17.4 million in a Nasdaq IPO, it found itself at the bottom of a freefall. Deltek’s share price had plunged to $4 from a high of $24.50. The 20-year-old company found itself caught in the tech bubble pop, despite a strong customer base and healthy cash flow. For deLaski, who co-founded the company with his father and still held a large ownership stake, the stock’s drop was a one-two punch, slamming both his personal wealth and the reputation of his business.
“Who I am as an individual is very tied up in this company,” he says. “And it felt like there was a negative stigma. We were a really good company, but because our stock was in the tank all the time, it felt like we were just not doing very well.”
Rather than continue to duke it out in an irrational market, deLaski decided to get out of the ring. In May of 2002, after raising the necessary funds and winning board and shareholder approval, he and his father took the Herndon, Va.-based company private. The effort took considerable time and money-legal bills alone topped $2 million and the deLaskis paid a hefty $7.15 a share to buy back their company-but for deLaski it was worth every penny. “I’m so happy to be private that I don’t think I will ever feel we paid too much,” he says.
Two years ago, such a sentiment would have seemed backward. Yet, these days, more and more CEOs are thinking like deLaski. With reporting requirements growing more onerous, scandal-hungry media watching CEOs’ every move, share prices in the tank and options long gone, the grass over the private picket fence is looking greener.
“A number of our clients, particularly mid-market ones, are beginning to ask questions about it and think about it, if not actively pursue it,” reports Gregg Polle, managing director of Salomon Smith Barney and global co-head of mergers and acquisitions. He sees depressed stock prices fueling interest in the public-to-private route. “Valuations are lower, so the numbers are more likely to work on a buyout,” he points out. “Also, a lot of mid-size players are trading at a discount to their peers and as a result can’t do acquisitions or raise capital on the same terms. When that happens, you start to wonder if there’s a benefit to being a public company.”
Harvey Seegers wondered about that, too. In June 2002, Seegers-then president and CEO of General Electric Global eXchange Services-was safely ensconced in a power post at one of Wall Street’s behemoths. Then GE spun off the Gaithersburg, Md.-based information technology services unit, selling a 90 percent stake to buyout firm Francisco Partners for $800 million. The move let the 12-year GE veteran fly solo, running the now-private IT company as a stand-alone operation at an opportune time. “Right now it’s tough to be a CEO because we’re all getting lumped in with a few bad apples,” he says. “Being a private company for a few years while investors cool down and until the good managers and CEOs can restore trust and confidence, will be a good thing.”
Freedom, but also risk
The private sector can also bring greater operating freedom and access to capital, along with the prospect of a big return down the line. “GE has deep pockets, but it also has a tight zipper on those pockets,” adds Seegers. “Being private enables us to undertake riskier initiatives than GE would allow us to do.”
Seegers expects to use his newfound autonomy and investor backing to be more aggressive in making innovations and strategic acquisitions, positioning Global eXchange Services for a lucrative IPO within three to five years. But he knows there are risks. “You don’t abandon financial measurements,” he says, “but if you can prove that having a couple of quarters of relief will add value to the business, you can do it and you don’t need a lengthy explanation to analysts and shareholders.”
Whether a company should consider going private “all depends on [its] financial and competitive situation,” adds Polle. “The best candidates for management-led buyouts are companies with very strong cash flow that can afford the debt they will take on in a private transaction.”
The real dangers of a buyout attempt often surface after the management team puts a proposal together and brings it to the board. An offer on the table puts a public company into play-with no guarantee that the original bidder will win against any newcomers who enter the fray.
“You can have your company sold out from under you,” cautions Polle. “If someone else is willing to pay 50 cents a share more, they will get the business. Whether you would have a role, or want one, will be unclear.”
That’s exactly what happened when the management of Renaissance Worldwide tried to buy out the Waltham, Mass.-based IT services firm. The stock price had dropped from $30 to 40 cents, so CEO Drew Conway’s offer of $1.65 a share seemed a healthy premium. But when the public documents were filed, John Chuang, CEO of competing firm Aquent, spotted an opportunity. “We got into a bidding war,” says Chuang. The fierce competition for ownership soon grew all-encompassing. “We were constantly on the phone with our legal counsel, our investment bank and our financing partners. I had incredible cell phone bills during that period.”
After much back-and-forth, Chuang’s company won with a $2-per-share bid-and Conway was shown the door. “That’s what can happen,” says deLaski. “It’s a scary thing and a lot of people don’t want to take that risk, but you have to just say, €˜If that’s what happens, so be it.’”
When management attempts a buyout, there’s always that risk, says Ed Smith, a partner at New York City-based Chadbourne & Parke, a law firm that provides legal counsel in buyout transactions. But such situations are relatively rare, he adds, usually happening only when the initial bidder is getting such a good bargain that newcomers are tempted to jump in and try to outbid the insiders. “If you’re going in with a low-ball price, there’s more of a risk that it will be topped,” warns Smith.
The consequences of too high an offer are equally dire, leaving the new company saddled with debt. “A company will certainly be in a more precarious financial situation in the early days of a buyout,” says Polle. “They have all this debt, management’s wealth is at stake and it remains to be seen whether they can survive, much less thrive.”
But the potential rewards can be worth the risks. Take BET Holdings. In 1998, frustrated by the valuation Wall Street was placing on the company he had founded and taken public in 1991, CEO Robert Johnson led a drive to privatization, grabbing a 63 percent ownership stake in the $1.2 billion transaction. Two years later, Johnson sold BET to Viacom for a cool $2.3 billion.
Even those who have no intention to sell see an upside to the move. “Going private is absolutely something that many companies should consider,” says deLaski. “What’s the point of being in business just to watch our stock price stay at $3.50 for the next three years? Let’s take it off the table and grow the company so we can either invest it in the business or pay ourselves dividends-or hopefully both.”
Keeping the Books Open
Operating in the shadow of debt isn’t the only fallout buyout teams face in the wake of going private. Skepticism and uncertainty from customers and employees is common, says Dan Love, director of the emerging growth market division at Ernst & Young. He suggests companies allay concerns by continuing to disclose financial data as if they were still public. “Customers like the transparency of being able to look at the balance sheet,” Love says. “It will help if you continue to follow that discipline and act like a public company.”
Harvey Seegers, CEO of Global eXchange Services, agrees that without strong communications, going private can have negative connotations. “If you don’t take control of the message, somebody else will do it for you,” he says. “During and after the process, you have to communicate, communicate, communicate with all constituencies, including your management team, employees, customers and analysts.”
As a newly private company, Global eXchange opened its books to reassure potential customers that all was well. “They want to see that we have a healthy balance sheet,” says Seegers. “When we were part of GE that was taken for granted.”
Deltek Systems’ reputation took a similar hit, with customers expressing concern that the firm was retreating into privacy to hide financial woes. “People tend to think the worst,” says CEO Ken deLaski. He overcame initial skepticism by issuing detailed financial statements starting the first quarter Deltek went private and adopting an open book policy with employees.
If handled well, the internal result from a public-to-private route can actually shore up morale. Employees may be happy to trade worthless options for incentive-based cash bonuses or equity stock options in a newly private entity-and be more committed as a result.
Some companies even find it easier to recruit as a private company. “We almost think of ourselves as a $400 million startup,” says Seegers. “We’ve got revenue, customers and good, free cash flow. We’re trying to supercharge the segment. And that attracts a higher quality person than we saw before.”