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Opportunities and difficulties in ‘Public Take Private’ as solution to undervaluation Back  
While the undervaluation of Irish stocks provides an opening for MBOs and going private, relatively few companies are likely to be able to meet the tests of a worthwhile deal, writes Adrian Shanaher
The Irish success story: strong historic growth rates, expectations of continued strong growth for at least the next five years, falling unemployment, an expanding work force and a phased reduction in both corporate and personal tax rates. Contrast this with the under performance of the Irish Stock market over the last eighteen months and particularly its under performance since the introduction of the euro in January 1999.

Under performance of the market is primarily linked to a lack of institutional interest and a perceived low level of liquidity in Irish equities. There is no doubt about the value inherent in Irish stocks at present with most sectors trading at substantial discounts to European averages. This is true not only in the case of second line stocks but also evident in the case of front line stocks e.g. Bank of Ireland and AIB. The poor rating of Irish quoted companies comes at a time when most are experiencing strong growth and are producing returns in excess of market expectations. Therein lies an interesting paradox and represents a window of opportunity for management within some of Irelands larger quoted companies.

Opportunity now

‘Public Take Private’ (PTP) affords management the opportunity to capitalise on this undervaluation, at a time when supply of capital is plentiful and interest rates are low. In reality there is unlikely to be a better time in Ireland for management to consider a PTP transaction. A more pertinent question is why there have not been more PTP transactions.

Opportunities exist for a PTP where the company is run by a quality management team, is producing strong results and cashflows, has good growth prospects and is trading at a discount to its peers. A key determinant in assessing cashflow is the capacity the company has to increase its gearing to partially fund the transaction.

The attraction of a PTP for management is not only one of personal wealth creation. Other advantages include improved control and increased management incentivisation which should result in operational enhancement. Substantial costs can also be saved as a result of being a private rather than a public company.

Regulatory framework

The ‘Yellow’ and ‘Blue’ books dictate behavior, methodology and timeframe for all public company transactions. A complex legal, tax and regulatory environment awaits management attempting a PTP. PTP’s are therefore costly. PTP’s will typically take four to eight months to complete, all going well, and require considerable management effort. As costs associated with a PTP are high, this is not a route that is readily available to small companies. In reality there are only a handful of obvious PTP candidates in Ireland.

PTP’s also require management to deal, albeit in a structured manner, with a range of shareholders in order to procure a sale rather than a single vending shareholder. In a Public company, institutional shareholders generally have the power to decide whether a deal occurs or not and these tend to be focussed on maximising their return and therefore their exit price. Institutional investors can scupper a deal if they believe a better long-term return can be extracted by turning down management’s offer. Announcement of a PTP approach can also put a company on the radar for trade buyers who are usually in a position to pay more than management. However, to the extent that management are key to the successful operation of the business they hold some of the best cards. One way of resolving conflicts with institutions regarding exit price on PTP is to retain them as stakeholders in the PTP vehicle. There are mechanisms whereby this can be facilitated e.g. bonds etc.

Bid premia

Management considering a PTP should be aware that a bid premium is likely to be between 30% and 50% of the pre bid price. Typically senior debt providers will supply in the order of 50% of the funding necessary subject to a broad multiple of 3 to 6 times EBITDA. The balance of funding can be mezzanine or equity. Leveraged Buy Out funds can arrange the entire funding package.

Management often assume that they need access to vast personal wealth in order to obtain a substantial slice of equity. This is, in fact, untrue and often key management can secure a disproportionately large equity position for their financial investment.

Clondalkin is one of the few Irish quoted companies to go down the PTP route. By illustration their bid premium was in the order of 50% and the deal took the best part of six months to complete.

A crucial part of negotiations with the lenders and venture capitalists will be a quality business plan. This should not be a problem for incumbent management who know the business intimately.

Exit strategy

Management considering a PTP need to give careful consideration to their own exit strategy and timetable. This is something that will be foremost in a venture capitalists mind. Venture capitalists will typically seek an exit within five to seven years. While a trade sale is an obvious exit mechanism for all shareholders, it is necessary to consider, in advance, how an exit by a venture capitalists could be financed should their exit timeframe differ from management’s. It goes without saying that if the exit route is unclear, or there is unlikely to be a long term exit opportunity, fundamental questions exist about the appropriateness of a PTP. This is likely to be a significant constraint on the number of companies that go private in the future.

At Dolmen we believe that the ISEQ will rise by 20% in 2000. There is no question about the value that exists in the Irish market place. The question is how long will this window last? Management considering a PTP transaction need to be prepared for the drain that the process will inflict on their time and, unless they manage it properly, the effect it may have on the business while the transaction is pending. The main issues with PTP’s are ones of scale due to the complexity and likelihood of exit for funds providers. Both of these points will limit the number of PTP’s in Ireland. However, the benefits to management are great.

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