Deals of the Year: Public-to-Private –

Bears in the wild don’t have too many natural enemies. Drought and poachers are the biggest threats to the world’s bear population. However, teddy bears are much more vulnerable. The Shelburne, Vt.-based Vermont Teddy Bear Co. found that the costs of being a public company weren’t worthwhile, especially when they could forage for private equity. So the teddy bears from Vermont decided to turn their back on the bulls and bears of Wall Street and go private after almost 12 years on the Nasdaq.

Boston-based Mustang Group led the investment of Vermont Teddy Bears that included capital from Middlebury, Vt.-based FreshTracks Capital and members of the company’s management team. Mustang paid $6.50 per share to take the company private in a transaction valued at $47 million. The deal was announced last May and completed Sept. 30, 2005.

Vermont Teddy Bear President and CEO Elisabeth Robert says that the company’s eagerness to go private was a result of a combination of factors. “We recognized that our stock price was undervalued. We also had a number of inside shareholders who were looking for liquidity,” she says. Also, the requirements of Sarbanes-Oxley put an expensive burden on companies, particularly those that are more modest in size like Vermont Teddy Bear, and there were more regulations on the way. “The prospect of having to enact section 404 [regulations] was onerous on a company like ourselves,” says Robert.

The company hired Boston-based advisory firm Covington Associates to take it private. Founding Partner Chris Covington says that the company was a natural candidate for being brought private. Vermont’s last goal was to be able to invest in its own infrastructure down the road without incurring the wrath of a public market fed on quarterly earnings reports. “We were hoping to get [Vermont Teddy Bear] out of the tyranny of quarterly earnings,” says Covington.

There were a number of obstacles that Covington faced while working with private equity firms trying to get the deal done. “A certain number of firms didn’t get the we want to be in Vermont’ model,” says Covington. With all the outsourcing components that go into today’s private equity deals it was hard to find private equity firms that realized the company’s Vermont location was an integral part of its corporate culture and appeal. Addtionally, despite its not being located in Bangalore or Guangzhou, the company operated at relatively low costs and in the high-end gift market.

Covington initally approached FreshTracks on the deal. FreshTracks was interested, but since it only manages an $11 million fund, it knew it had to find a larger partner. It approached Mustang Group with the idea of putting a bid together.

According to Carson Biederman, the Mustang Group’s managing director who spearheaded the deal, and his colleague Ben Coes, the group liked the deal because of Vermont Teddy Bear’s competitive position and growth potential. “This deal wasn’t about the company being public,” says Coes, “it was about the company itself. The ability of the company to achieve its prospects was better suited as a private company than a public company.”

So negotiations got underway, but quickly came to a halt during the company’s busy Valentine’s Day season. Valentine’s Day can account for more than one third of the Vermont Teddy Bear Co.’s annual business, and the company goes from about 300 employees to about 3,000 for that period of time. It’s a time when top management, all the way up to the CEO, must get out from behind their desks and pack toy bears for shipment. Negotiations were breifly put on hold. The seasonality of the business was another obstacle that turned away some potential private equity buyers. According to Robert, none of the bidders except Mustang were prepared to finally commit to the deal until they saw the results of the 2005 Valentine’s Day season.

Adding to the complication of getting the deal done was the fact that while 12 shareholders controlled 75% of the company’s stock, there was a small faction of investors that opposed the move to take the company private and filed a lawsuit. They contended that shareholders were not getting full value from the deal. However, Mustang says that while the suit is still pending, it did not inhibit the deal very much. Other deal insiders say that such suits are typical and more indicative of today’s litigious atmosphere than reflective of any defect of the deal.

“The impediments in getting private in smaller cap companies are really the transaction costs of the deal and shareholder fragmentation. If you have a very widely held stock it’s going to be less attractive for a potential acquirer,” says Coes.

Mustang believes that more public companies will see the benefits of becoming private and while it has no plans to focus on the sector, it expects to see more in the future as small companies try to borough their way out from under increased regulations. “There’s no question that the cost to small cap public companies are increasing without any benefit. The motivations to go private are definitely increasing,” says Coes.

Biederman agrees. “There’s definitely a benefit to the management team that is freed up to try to grow their company privately and focused on long term shareholder value and not quarter-to-quarter. That’s something that’s hard to calculate but is a definite value,” he says. “That’s something we’ll see not only at Vermont Teddy Bear but that is available to managers of other public companies that want the freedom to grow but don’t want to have to worry about every quarter’s statement and managing to those.”