Going Private

Mark McMillion: “I would like to know what would happen if a company bought back 100% of its stock. Are there rules against this? I understand that companies buy back their stock when they believe that action is the wisest investment of free capital. Who would own the company if they bought back all of it?”

It’s called going private. In bear markets, it happens a lot, because the big shareholders think the stock is a bargain, the company is a steal, and it’s a pain having to file all those public reports and take abuse from angry shareholders disappointed with the share price.

Simple example: In the Seventies there was a company that published a profitable magazine called Institutional Investor. If memory serves, it went public at $10. But in the bear market, with the Dow dropping to 577 in 1974, it got down to $2 or less, and so the founder of the company — who had probably been sole owner, or close to it, when he sold part of his stake to the public at $10 — now bought it back at $3. He was back to owning 100% of the stock again. And free of the expense of S.E.C. filings and an Investor Relations Department and all the rest.

A few years later, he sold the whole company to a larger company at what would have been $20 or $30 a share had it remained public.

I am fuzzy on the numbers and details — for one thing, he may have had partners — but that was the general idea. All legal, by the way.

In going private, the company has to issue an extensive document disclosing the terms of the deal. But if enough shareholders sell, the rest have to. I’m not expert in the law on this, and it may vary depending on the state of incorporation. But you can’t just say “no” and keep your 200 shares and be the only outside shareholder left.

The general rule here is that companies go private when it’s not to the long-term advantage of their shareholders.

Companies rarely go private in bull markets, because managements realize their stocks are not a bargain . . . and because in a bull market managements like the public market in which to enjoy the fruits of stock option grants and the ability to use stock to acquire other companies, motivate employees, and so on.

When stocks are high, the shrewd owner wants to be in a position to sell to the public. When stocks are low, and the public, disgusted, is willing to jump at almost any offer (3 sounded pretty good when Instituional Investpr was under 2), the shrewd owner want to buy.

You’ve heard the term “leveraged buy-outs” (LBOs)? These were rampant in the early Eighties, when the market was again in the total pits. The Dow, which had briefly topped 1000 in 1966, was bottoming at 777 in the summer of 1982, 16 years later. Managements, plus some shrewd outside investors like former Treasury Secretary William Simon, realized they could buy their stock back from the public on the cheap.

With just a few top managers and a couple of very wealthy investors (an insurance company, perhaps, and/or an LBO specialist like Kohlberg, Kravis & Roberts), all the public shares would be bought in. Much of the cash to purchase the shares was borrowed (hence the term leveraged buy-out), and with so few shareholders left, the company would be “de-listed” from the stock exchange, and there would no longer be a public market in it.

At the peak of this trend, even giant RJR Nabisco was taken private in an LBO. That saga — atypical, because the price was so rich — became the subject of an entertaining and instructive book, Barbarians at the Gate.

Once private, corporate jets would be sold off, limos abandoned, staff trimmed to the bone . . . suddenly management had a real incentive to serve the shareholders, because they were the shareholders. They cut expenses to generate cash, first to pay down the debt taken on to buy in the public shares, then to show the profits needed to allow the company to go public again in a few years (or be acquired by some larger company) at a much higher price.

Now, you may actually have known all this, Mark. Your question may have been, what happens if the company buys ALL its stock back — even from the very last shareholder? In that case (assuming the corporate by-laws and various state and federal regulations allowed this), I suppose the corporation would own itself. The directors would be responsible for it, but no one would own it . . . just as the board of directors is responsible for running the Red Cross, but no one owns it. I’m sure one or more of our fine readers will educate us on this last point, and I will share the results.

Tomorrow: Cheap Gas, Spackling With Colgate . . .