16 Sep 2015
DELISTING: MOTIVATIONS BEHIND PRIVATISING COMPANIES

by veristrat

Entrepreneur’s generally dream of scaling up their ventures and aims towards successful listing of their entities. However, the world of private and public companies is entirely different and the transition from one to another is a cumbersome process. An IPO helps a private company “to go public” by issuing shares, hence IPO’s have become the most preferred route towards successful exit by various early stage investors.

However, sometime companies are motivated to transition from public to private, known as “Delisting”. It is a process by which securities are permanently removed from the stock exchanges and hence are no longer traded. Delisting can be classified into two types:-

Compulsory – This is a penalising measure whereby securities are permanently removed when they are not able to comply with the requirements set out in the listing agreement within the prescribed time frames.
Voluntary – In this the listed entity decides on its own to remove their securities permanently from stock exchange.

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Voluntary delisting generally happens when the company is undergoing restructuring; promoters need to increase their stake or is in the process of being acquired by another entity. Hence, a company offers its shareholders a premium to the traded price and as the transaction is off the exchange, investors are generally rewarded with capital gains. However, there could be multiple reasons behind taking the privatization route for a listed company. Some of these are examined below:-

1- Trading of securities in public domain provides them liquidity however there are tremendous regulatory and corporate governance laws that are needed to be complied. Hence, these activities can shift management’s focus from expanding and move towards compliance of government regulations. As a result, delisting can save money and thereby reward investors with higher net income.

2- As stocks are more driven by sentiments rather than fundamentals, hence markets rewards and penalises investors in the same way. Sometimes, shareholders are driven by short-term interests and are not looking to hold the stock for long term period, often resulting in sell-offs on fears. Hence, when a company has to change its strategy or is undergoing restructuring process, it has to take the private route to value creation. For Example- Computer maker “Dell” has to revive the company as the tech-industry has undergone changes. Hence, for surviving in the ever changing technology world, they have to be creative, however, experimentation does not lead to successful outcomes in short time, and therefore the idea to go private would help them sustain their long term strategy as suggested by its founder.

3- Sometimes investors are motivated to take advantage of the brands value, which was recently seen in the case when Heinz was acquired by 3G Capital-a private equity group and Berkshire Hathaway Inc. for approx. $28 billion. Investors like companies that are able to sustain margins over a long period and hence can pay significant premium over its pre-acquisition sale price. And after acquisition is completed strategies like lower budgets, re-alignment and shift in corporate culture are undertaken which thereby increases bottom line of the target and hence creating more value.

4- Companies also save on taxes when they change their corporate structures. Thereby changing the corporate structure from a C-Corp to LLC or S-Corp, the owners avoid double taxation on dividends. As an S-Corp does not pay taxes at corporate level, therefore, a company can pass through its profits or losses to the owners’ personal income statement and hence being private offers opportunities to reduce taxes.

5- When companies are undervalued in public markets, taking them private helps stock prices move closer to their intrinsic value. Undervaluation often occurs when the investors’ are reluctant to see past a business’ short-term performance or the company is being taken over by a third party. For Example: Blackstone Property Partners have recently acquired Excel Trust REIT listed on NYSE, for approx. $2 billion. The group is following this strategy as they believe US REIT Index is 15% low as compared to its 2007 peak.

6- Also due to the large size of most public companies, it is normally not feasible for an acquiring company to finance the purchase single-handedly, hence easy availability of credit often prompts Private Equity firms to go for LBO’s, as funds can be sourced at lower rates. Vice-versa when credit markets are tightened, debt becomes more expensive and there will be fewer take-private transactions. For Example: In 2007, Blackstone bought Equity Office Properties for $39 billion; mainly due to the property market valued relatively cheaper and finance was also readily available.

However, majority of these transactions are opportunistic in nature as these depend upon the economic environment hence management need to decide the corresponding route to be chosen to take advantage of the scenario which forces change in their managerial behaviour whereby they take initiatives such as divesting non-core business, downsizing and upgrading technology. Therefore, take-private transactions are feasible alternative for many public companies as long as debt levels are reasonable and the company continues to grow its free cash flow thereby creating long-term value for its shareholders.

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