Public-to-private deals are on the increase in the UK yet it's not all doom and gloom for small caps
Howard Robinson has had his fill of the City. The chairman of S Lyles, a UK-based carpet manufacturing group, is in the process of finalizing a deal that will allow him and his fellow directors to take the 87-year old company private, away from the ravages of the stock market. The deal will value his company at around £3.6 mn – a slight premium to its current stock market capitalization – on the basis of a turnover last year of £18.6 mn and pre-tax profits of £652,000.
S Lyles is not alone. By the end of September nearly 40 companies had delisted from the London Stock Exchange this year, compared with 25 in the whole of 1998 and just seven the previous year. A recent study by KPMG Corporate Finance found that public-to-private (PTP) deals accounted for a 50 percent share of the UK's private equity market activity for the first time in the third quarter. That's up 38 percent on the previous quarter and 26 percent on the same period last year. Clearly, despite protestations from the London Stock Exchange that the majority of UK delistings are due to takeovers, some small caps are feeling disenchanted with their experiences as listed companies. And this is regardless of a fillip in the overall performance of the small cap sector in the UK over the past few months and a third quarter surge in new issues. Many smaller quoted companies still feel well and truly shunned.
Out in the open
'We've found that it can actually be a disadvantage having a publicly-quoted value,' says Robinson, who has found his acquisition strategy increasingly frustrated by his company's visible low value and his investors increasingly frustrated by a lack of exit opportunities from the stock due to the stock price. He believes that his company's exit from the market is almost 'the inevitable coming home to roost,' due to the nature of its business and a corresponding lack of interest from institutional investors. The company, he points out, suffers from 'the triple whammy' of being: small; a manufacturer (an exporting manufacturer, to boot); and in textiles. Such a profile doesn't exactly make S Lyles flavor of the month.
'I can see their reasoning,' says Robinson. 'We've had every possible thing working against us and it just isn't worth their while to monitor an investment in a company of our size.' S Lyles' largest institutional investor holds around 15 percent of the company's equity. In liquidity terms that's an extremely difficult investment to get out of, but it still only amounts to around ÂŁ400,000. 'As the funds have got bigger they're just not interested in such piddling little investments.'
Nor is the situation good for management morale. When Robinson and his colleague Bill Ainsworth, managing director, took over the firm in November 1995, they faced a company losing money hand over fist. 'It was on its knees,' says Robinson. In the four years since, they have turned the company into a profitable concern; yet they find that their 1995-priced stock options are still below the waterline.
They go for ego
Mike Stevens, UK head of management buy-out services at KPMG Corporate Finance, appears to have little time for such sob stories. 'The market is not stupid in the way that it values these companies,' he comments. 'Many companies have been going to the market as an ego trip rather than for the right reasons. They don't understand quite how demanding the market will be or the level of constraints put on listed companies.'
Stevens, who spends most of his time working with private companies, notes that he has seen a lot of management teams from small, publicly-traded companies seeking to go private in the last couple of years and has been 'massively unimpressed'. In his opinion, it all comes down to the quality of the individual companies and of their management 'Those companies that have clear vision and direction will end up finding a market [for their stock]. Clear vision is demonstrated by clearer growth than their competitors.'
At the end of the day, Stevens says, there has to be some sort of spark there which warrants a level of interest from institutional investors, otherwise you can forget it. However, the delisting option is no easy way out, either. He stresses to all directors considering the going private option that it is an expensive, time-consuming process which may not come to fruition as easily as they thought. 'A company in that situation has responsibilities to investors. It can't just decide not to be listed.'
Stevens does acknowledge that listed small caps face some real challenges in the current environment, despite his harsh 'the market will strike the right price' approach. Like many others, he points to the continuing drive toward market tracking funds as a source of potential difficulty for those at the lower end of the market capitalization scale but again stresses: 'There will go on being interest in certain small cap companies that meet the characteristics of potential high-growth.'
In the driving seat
Jamie Borwick isn't the sort who gives up easily. As chief executive of Manganese Bronze, the company that makes London's famous black cabs, he has found himself at the helm of a rather high-profile small-cap company. He has also made a bit of a name for himself on a number of government and trade-sponsored committees aimed at helping smaller-cap companies attract investor attention.
Yet earlier this year Borwick found himself looking into the prospect of taking Manganese Bronze private when the company dropped out of the All-Share Index. He recalls that many institutions were forced to sell out as they were tracking the index. Even many of those who were not index-trackers per se were using the index as a benchmark. Lack of liquidity was forcing the price lower and he wanted to be able to offer a rather better alternative to shareholders.
However, when the independent directors recommended against the move at the indicative pricing because of the long-term prospects, the company resolved to grit its teeth, sit tight and stay on the market. Borwick notes that one shareholder remarked to him that 'when they blew a raspberry, the company emulated its [taxi-driving] customers and did a U-turn.'
Gradual slope
So what is the root cause of the current small-cap malaise in the UK? According to Borwick, 'It's a gradual slope involving indexation, more people looking at companies on a worldwide basis than heretofore, and smaller companies being judged on a European rather than a British scale.'
He recommends that these small companies should take heed of a working paper released by the Treasury last year which noted that 'private investors are of great importance to smaller companies although they may be considered a nuisance by larger companies.' Borwick was himself a member of the committee that produced the working paper and he argues that its proposals would really help the fortunes of smaller companies in the UK. 'The Treasury welcomed it at the time,' he says, 'but I was rather disappointed because it wasn't fully implemented afterwards.'
As for Manganese Bronze, it is doing all it possibly can to encourage retail investors and customers to inject a little bit more liquidity into its stock. 'We've recently started putting our institutional presentations up on our web site [www.manganese.com],' reports Borwick. But he still believes that the UK government could really help move things along for all smaller companies.
So what about giving some general advice to smaller companies on the issue of whether it is right to take their companies into the private realm or not? Borwick isn't biting – each case must be looked at on its own merits, he says. He does stress, however, that times change rapidly and what sounds like the right deal today could well turn out to be just the opposite in six months' time.
Perhaps Howard Robinson's own experience with S Lyles can help crystallize the decision. He notes that while the ongoing costs of maintaining a listing are large, you know that they are coming and have (hopefully) allowed for them.
On the other hand, the financial cost of delisting is one heck of a big charge to absorb. 'It's real and here and very soon. It's a huge bill to contemplate.' So, provided that all goes to plan over the delisting, would Robinson consider going back to the market a few years down the line? 'It's very doubtful,' he says, adding that the threshold is rising: what institutions consider to be the minimum market cap for a smaller listed company keeps on going up and up. 'It's now at about ÂŁ300 mn.'
Robinson notes that, even in his wildest dreams, he cannot really foresee the company growing to that size over the next few years. Even successful carpet manufacturers cannot pile on growth at that rate. No matter what yarn they spin.