Issues & Opinions

An article today’s WSJ’s Deal Blog entitled “What Shareholders May Know That the Buyout Firms May Not” conveys an interesting story, but is, I think, inadvertently mistitled. It begins:

It seems Eddie Bauer’s shareholders really did know what they were doing when they rejected a buyout offer from private-equity firms Sun Capital and Golden Gate Capital.

In the three months since the shareholders voted down the firms’ take-private bid, Eddie Bauer’s stock has jumped more than 40% higher than the offer of $9.25-a-share. As of this morning, it was trading at $13.07. At that price, investors with, say, 100 shares in the urban-wear maker now is $382 richer.

If you think Eddie Bauer’s shareholders just got lucky, then consider Cornell Cos., whose shareholders also rejected a buyout offer, this one from Veritas Capital for $18.25 a share. Since investors voted down that deal in January, the rehab-center operator’s stock has climbed 35% and is now trading at $24.61.

All well and good for the stockholders – they exercised their right to retain their ownership of the respective companies, and they’ve not so far been proven ill-advised to have done so.

However, I don’t think this indicates that they knew anything the buyout firms didn’t. It doesn’t even indicate that they knew as much as the buyout firms, just that they knew enough to presume a buyout wasn’t the only way to improve the companies in which they held stakes. The fact that both subject companies made the same choice doesn’t, as intimated in the article, prove that they were right, that they weren’t lucky, or even that they won’t eventually regret their lack of luck.

There are several reasons for private equity buyouts, of course. They all start with assets being apparently undervalued by the market, due to poor management, poor credibility, poor operations, poor financial or ownership structure, or some combination of these factors.

If, as has at least initially proven to be the case at Eddie Bauer and Cornell, changes to strategy, tactics, and management can be effected without a change in ownership, then the stockholders are right to focus on the long term value of their holdings, and to agitate for change from within. Sometimes, perhaps often, for all I can tell, those stockholders even end up proven correct in the long term.

All well and good. But some problems, particularly those that take some time to cause damage to a company’s value (pig-headed pursuit of bad strategy, unaddressed market shifts, entry of new competitors, &c), particularly absent a healthy balance sheet (and ignoring the potential problems of a too-healthy balance sheet), can place a company behind the 8-ball, leaving no latitude to become the company they should be while simultaneously keeping their financial backers, debt & equity, happy. Sometimes, then, companies need a time-out, a respite from what one of my favorite writers refers to as the

…short term pressure of “the mob” and the “tyranny of the quarterlies”…

No amount of public stockholders simply hanging on and hoping for better days can solve such problems, and that’s a case where buyout firms can shine, no matter how much the stockholders may be supposed to know better. Many of the tactics required to wring value from an underperforming company are outside the remit of the average stockholder, and outside the wills of boards and management teams, in any event.

Since existing owners of buyout targets have every right, and perhaps a default responsibility to themselves, to initially look askance at a buyout offer, of course they’re aligned opposite the private equity firms. You could call them competitors, without even stretching the definition of the term, since they surely have competing interests.

Companies, public and private, are generally rational players in this game, and they respond favorably to buyouts only when the price offered exceeds the value they’re able to assign to the assets. The owners of Eddie Bauer and Cornell decided they weren’t offered enough to have sold – it’s as simple as that.

But this doesn’t mean they knew anything the PE firms didn’t, and might in fact indicate quite the opposite.