Public-To-Private Deals: Bigger and Tougher

Public-to-private deal volume rose more than 34% between 2004 and 2005, according to Buyouts. But the deal values rose by an even greater margin. Public-to-private deal values rose by as much as 289%, with approximately $18 billion in values in 2004 jumping to more than $69 billion in value last year. While the number seem outrageous, it’s important to note that three deals—Hertz, SunGard Data Systems and Toys “R” Us—account for about half of last year’s figure.

Perhaps last year’s big deals have really brought the public-to-private strategy into the spotlight. All three of last year’s big deals were highly publicized due to the high—profile firms that bought the companies and the fact that these public-to-private deals now rank as the second, third and fifth—largest buyout deals (respectively) ever. The $11.3 billion public-to-private deal for Wayne, Pa.-based SunGard Data Systems was led by Silver Lake Partners and included $500 million investments from Bain Capital, The Blackstone Group, Goldman Sachs Capital Partners, Kohlberg Kravis Roberts & Co. (KKR), Providence Equity Partners and Texas Pacific Group. The Carlyle Group and Thomas H. Lee Partners dropped out due to pricing concerns.

KKR was joined by Bain and Vornado Realty Trust in last year’s $8.8 billion buyout of Toys “R” Us. Lead investor Clayton Dubilier & Rice (CD&R) joined co-sponsors the Carlyle Group and Merrill Lynch Global Private Equity to buy Park Ridge, N.J.-based car rental giant Hertz away from the Ford Motor Co. (NYSE: F) for $15 billion. The winning bidders beat out a competing bid by a group that included Bain, Blackstone, Texas Pacific and Thomas H. Lee.

While only 10 public-to-private deals totaling about $6.8 billion closed in Q1 2006, many more deals are in the works, which points to 2006 being a very busy year for taking public companies private.

One of this year’s most active public-to-private investors is shaping up to be The Blackstone Group, which has been involved in five such deals this year alone—two of them as part of a consortium. Blackstone has joined AlpInvest Partners, The Carlyle Group, Hellman & Friedman, Kohlberg Kravis Roberts & Co. and Thomas H. Lee Partners in a bid to acquire global information and media company VNU. The agreed upon price tag for this transaction is $10.3 billion, including the assumption of debt.

During the first quarter Blackstone Group completed the acquisition of MeriStar Hospitality Corp., a Bethesda, Md.-based hotel real estate investment trust, for approximately $2.6 billion. Acquisition financing was provided by Bear Stearns, Bank of America and Merrill Lynch. Lehman Brothers advised MeriStar on the deal.

Other firms doing notable deals in last quarter include Silver Lake Partners, which is taking Serena Software Inc. private in a $1.2 billion deal. Merrill Lynch, Lehman Brothers and UBS are providing the leverage for the deal. Leonard Green & Partners agreed to acquire The Sports Authority for approximately $1.3 billion; that deal is scheduled to close sometime in the second quarter.

Firms involved in public-to-private deals think that the current trends of larger and larger public-to-private deals are going to continue. But so far, going private has been a more solid option for smaller companies that don’t have the bandwidth to deal with the high costs of being public and are more likely to find themselves undervalued or ignored by public market analysts and investors.

“There are continually short-term earning pressures on public companies,” says Lisa Kro, principal and CFO with Goldner Hawn Johnson & Morrison, which has done four public-to-private deals over its lifetime. “The [public] market does not award the long-term view. Private equity takes a longer view.” In Q1 the Minneapolis-based firm closed a deal to take Transport Corporation of America private.

Private equity firms are also taking a closer look at acquiring public companies as more and more competition for deal flow floods the market. “More and more private equity firms are interested in looking at these as a deal source,” says Joe Heinen, a vice president with Goldner Hawn. “Several years ago there may have been fewer private equity firms interested in the space or considering the deal source.”

SOX Lives

One factor that has been helping motivate public companies to go private has been the onset of Sarbanes-Oxley regulations, which adds significant costs to doing business. But while the appeal of going private may be widening as Sarbanes-Oxley requirements impose greater regulatory burdens on public companies, industry insiders caution that Sarbanes-Oxley is not the raison d’etre for going private. “Sarbanes-Oxley itself is not the reason to go private,” said Silver Lake Partners Principal Joe Osnoss, speaking at the Buyouts Symposium East conference in early March. “If that’s the only reason you’re going private, you’ve got something else to worry about.”

Michael Papile, a managing director with Boston-based advisory firm Covington Associates, agrees that Sarbanes-Oxley is not going to start a stampede of public companies going private, but adds that at least it has encouraged put-upon public companies to have discussions and consider private equity and other alternative capital structures. “The topic of going private has led to some other transactions, which has been good for the M&A market in general,” he says.

Depsite the enthusiasm, ther are serious challenges that may work to hinder public-to-private deals. One is that taking a public company private is not an easy thing to do. It is very time consuming, requires shareholder approval that may never materialize, and may cause shareholder revolts often in the form of lawsuits. It is not a process for the faint-of-heart, especially since there is no guarantee that the transaction will even get done. “It’s not inconceivable to think that this is going to take a year from start to finish,” says Papile. “There are plenty of companies that when we run the financial metrics they look like a very viable transactions on paper. When you start getting into the process and how time consuming it is with no guarantee of the intended outcome, the procedural requirements have made many of them think twice about it.”

Another challenge is that smaller and middle-market companies may be finally getting better values on the public market. While historically there was always a disconnection between the valuations and the large cap stocks and the smaller cap stocks, that doesn’t necessarily hold true in today’s market. Improved public market performance will keep many companies public that otherwise would have considered going private.

But whatever the challenges, public-to-private deals are going to continue to appeal to public companies and the private equity firms that want to buy them. “Anyone [in a previously public company] who’s gone through the process, while it has its ups and downs, they’re glad they did it,” says Papile. “Their life after tends to be a more positive environment than what they’re used to, presumably with a support of a financial partner that shares their vision for the company.”

Kro agrees. “They’re certainly not without their challenges, but if you’re in private equity, I think most firms have got to be looking at them. I don’t see them ending any time soon.”