Two of the best performing IPOs in the past year are Michael Kors (NYSE:KORS) and Five Below (NASDAQ:FIVE), businesses at very different ends of the retail spectrum. With both up more than 100% since their respective IPOs, it’s understandable for privately held retailers to be champing at the bit. But being a public company isn’t always what it’s cracked up to be — just ask Mickey Drexler of J. Crew. There are downsides to being in the spotlight.
IPOs don’t happen in a vacuum. They exist because investors, institutional or otherwise, won’t participate in private deals if they don’t have an exit. You can’t expect people to commit their hard-earned cash to a long-term hold, no matter the potential, without the prospect of a substantial return. In the past, the IPO was one of the few ways an entrepreneur and early investors could obtain liquidity for their shares. Now there is a secondary market for private companies — Facebook (NASDAQ:FB) traded quite nicely for several years on SecondMarket — that allows for the buying and selling of stock not publicly available. According to Cogent Partners, an investment banker to the private equity community, the annual volume in the secondary market in 2011 was $25 billion, one of the busiest years on record. (Given Facebook’s troubles since its IPO in May, you have to wonder if it wouldn’t have been better to continue trading on the secondary market.)
According to PricewaterhouseCoopers, companies tend to underestimate the time and cost of going public. A survey it did of CFOs of public companies that had gone public in recent years found 48% of the finance executives were surprised how costly it was to put together an IPO. First, there are the direct costs like the legal, auditing, accounting, underwriting and other miscellaneous expenses of the IPO itself; then there are the ongoing costs of investor relations, human resources and external reporting. It’s a huge expense pulling off an IPO … and once you’ve done that, Sarbanes-Oxley ensures it remains that way (unless you have revenue less than $1 billion).
PwC’s survey results found that in addition to the 5%-7% the underwriters take for selling the deal, the average company incurs $4.7 million in costs related to the IPO, another million to convert to a public company and then $1.5 million (Henry Blodget suggests it’s at least $5 million) in recurring costs to remain a public company. Mattress Firm (NASDAQ:MFRM), a Houston-based mattress retailer, went public in November 2011. Its costs, including the underwriting fees, were $10.4 million, or 10% of the $105.6 million in gross proceeds. When you look at the costs associated with going and being public, a sale to a strategic buyer does seem like a better, cheaper alternative.
So, the two main reasons a private company would go public are to create liquidity for existing shareholders and to raise additional cash for future expansion. The big negative is clearly the cost. But businesses have other reasons they might hesitate to go public. Using four popular retailers, I’ll examine what those reasons might be.
Trader Joe’s is a great grocery store. It isn’t the biggest by any means, but it’s certainly one of the best anywhere, and its customers are fiercely loyal. Its Manhattan stores generate sales per square foot in excess of $1,500, almost double those of Whole Foods (NASDAQ:WFM) at $870. Trader Joe’s was acquired in 1979 by Aldi Nord, the German grocery store chain owned by the late Theo Albrecht. The billionaire and his brother Karl built a grocery empire despite being extremely reclusive. Aldi is now owned by their charitable foundations. Spinning off Trader Joe’s would bring attention to the foundation — a reason many companies go public, but not a likely course of action for the family and its foundations.
Those living in the Seattle area have come to know REI over the past 70 years. Recreation Equipment Inc. was founded as a consumer co-op for outdoor enthusiasts in 1938. Profits are returned to members based on their spending habits. The largest consumer co-op in the nation, it has stores coast to coast. After the mess that occurred in 2011 with Diamond Foods (NASDAQ:DMND) over its botched Pringles acquisition, the former walnut cooperative is the poster child for why cooperatives shouldn’t go public: Some things are better left alone.
American Girl is a division of Mattel (NASDAQ:MAT), the world’s largest toy company. Mattel acquired the doll maker in 1998 for $700 million, or 2.3 times revenue. In 2011, it generated $113.1 million in operating income from $510.9 million in sales. Since being acquired, American Girl has added 14 retail shops where young girls can get to know the brand better. While on the surface it would make a good candidate for a carve-out, ultimately the brand has increased revenues by less than 4% annually since its acquisition by Mattel. With good operating margins, the best move is probably just to maintain the status quo.
Lastly, Maine’s iconic retailer L.L. Bean is celebrating its 100th anniversary in 2012. With sales of $1.52 billion, it didn’t open its first store outside of Maine until 2000. It now has stores in other parts of the U.S., Japan and China. Owned by the descendants of founder Leon Leonwood Bean, the company has been run by a non-family member since 2001. The flagship store is open 365 days a year, 24 hours a day, and there are no locks on the doors. If L.L. Bean were a public company, how long do you think it would be before some shareholder demanded they cut the hours and put locks on the doors? The biggest downside of going public is you have to answer to impatient shareholders, which makes for rash decisions.
Companies may think they can get an injection of cash without fundamentally changing their business practices, but sadly that’s not the case. I have one word for retailers thinking about going public:
It’s just not worth it.
As of this writing, Will Ashworth did not own a position in any of the stocks named here.