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ARTICLES
Business Week "Small Business" June 10, 2003 Trends by Karen E. Klein In Praise of the Reverse IPO When the Street spurned eMachines, the board bought out stockholders, went private, and regained a startup's freedom and fire In late 2001, eMachines' President and CEO Wayne Inouye received a notice from Nasdaq: Since the share price had fallen below $1, his outfit was about to be delisted. It wasn't that the Irvine (Calif.)-based seller of high-quality, low-price personal computers was no longer viable. In fact, eMachines had $190 million in cash on its balance sheet and minimal debt. The problem boiled down to a matter of timing: eMachines' initial public offering took place in March, 2000, immediately before the tech wreck and the start of the capital markets' three-year fall. Initially priced at $9 a share, the stock never closed above that figure. With the general decline in the market and the downturn in the global PC business, eMachines' stock plummeted during its first year as a public company. By the time Inouye learned his outfit was about to be delisted, it had bottomed out at just $0.14. FRUITLESS QUEST. Despite having sold more than 4 million PCs since it opened for business in November, 1998, things didn't look good for eMachines, a primary supplier of computers to Best Buy, Circuit City, and other national retailers. Throughout 2001, Inouye was scouting merger and acquisition opportunities, but after 55 contacts, he concluded there was simply no interest to be found. Enter Diana Maranon, founder and managing partner of Averil Capital Markets Group in Los Angeles, a boutique investment banking firm. eMachines director Lap Shun "John" Hui had been in discussion with Maranon about alternatives and, in late 2001, she suggested one: Why not take the company private? Maranon said she could arrange to have shareholders bought out for $161 million, secure $145 million in debt financing to bankroll the deal, and return eMachines to privately held status. Hui liked the sound of that. "If you're not going to be valued by the marketplace, why go through the regulations and reporting requirements of a public company?" Inouye says. "The requirements are onerous and time-consuming, and the benefit of private ownership is being able to operate without the reporting required of a public company." Going private was a relatively quick process, Inouye says, even though thousands of individual shareholders had to be contacted for what amounted to a reverse IPO. The buyout offer was presented in October, and the company was in private hands by the end of December, 2001. "DRAMATICALLY DISCOUNTED." Inouye didn't know it at the time, but eMachines may have been part of a trend that is reversing the norms of the 1990s boom: Small but solid companies -- ones that probably should never have gone public in the first place -- are returning to their roots. "The markets are so frothy during boom times that a lot of smaller companies jump into the public sector because they can get better valuations there," explains Peter Cowen of Peter Cowen & Associates, an investment bank based in Westwood, Calif. "Once times changed, they found that the markets put little value on their equity and they were being dramatically discounted solely due to their size, notwithstanding their performance. Abandoned by institutional investors, they became orphans." Marooned on the nether fringes of the microcap market, such outfits tend to have annual sales in the $20 million-to-$300 million range and as many as 1,000 employees. They come from a wide spectrum of industries, including apparel, retail, healthcare, light manufacturing, and distribution concerns. What they have in common, however, is the immense frustration that, no matter how well they perform, their stock prices show little movement because they are flying under the radar of analysts and fund managers, many of whom are prohibited from putting money into penny stocks. Meanwhile, the auditing, reporting, shareholder relations, and liability-insurance requirements can cost between $600,000 and $2 million every year -- expenses that new corporate governance requirements are likely to see increased by anywhere from 30% to 100% . And then there's the competitive disadvantage of having to disclose financial information to the public, clients, and competitors on a regular basis. STOCKHOLDER PRIORITIES. "There's a whole lot of downside and, really, no upside," Cowen says. He and Maranon teamed up late last year to focus on companies like eMachines. "We are talking to more and more companies seriously that are considering the idea of going private now, and we expect to see a surge over the next couple of years," he says. While public-sector capital has dried up, he adds, there is substantial capital to be found for quality firms among private-sector investors. The move to privatize is generally structured as a management buyout. Once approved by the board and 51% of shareholders (the majority of whom are often insiders), deals can go through in as little as three months. "Holding this stock tends to be unattractive for the shareholders because it is relatively illiquid," Cowen notes. "Arranging for a management buyout gives the shareholders a liquidity event, which is what most of them are looking for. It's a win-win for management and shareholders." The buyers have ranged from a handful of key managers to a single individual, Maranon says. "Some fund the deal with their own money and others use private-equity investment firms and banks," she says. "Whether they've been public companies for 5 years or 20 years, their share prices look like ski slopes from Jan. 1, 1999, to the present. And the future doesn't look much brighter if they stay in the market." The sliding share prices often have little to do with cash flow, a solid business model, good history, operating reserves, or proven proprietary processes. OVERLOOKED ORPHANS. "Around 75% of small-cap stocks have lost substantial value in the last several years -- some as much as 90% of their value," Maranon says, who notes that these companies become anathema to investors, no matter how strong their products, service, or growth. "Wall Street is sensitive to the top line and to size -- not to the strengths of small business," he explains. "Once they're abandoned on the markets, it's very unusual for their stock prices to come back. They wind up languishing, having to put their losses and liabilities in a public spotlight, and getting beaten up by their competitors because of it." eMachines' has about 135 employees and is expecting 2003 revenues of nearly $1 billion, Inouye says. "We have to be one of the most productive companies per employee in the computer business, since we're producing about $7.5 million in revenues per employee," he says, adding: "There aren't many companies that will be able to match our productivity." Getting back to the entrepreneurial mindset of a small, privately held business obviously brings its own unique dividends. |
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