David Wessel, the always insightful columnist for The Wall Street Journal, pondered this quintessential question of our time today. If you’re an online Journal subscriber, you can read the whole piece here. He makes some curious arguments as he rambles toward the correct conclusion, that this age of every company racing to leave the public markets will end. Wessle writes, for example, that:
Part of the answer lies in financial engineering. Publicly held companies, from the standpoint of their shareholders, may be too reluctant to take on debt. Leverage can sometimes increase potential profits – despite the textbook arguments to the contrary – and debt-financed private-equity takeovers are one way to leverage corporate assets to that end.
This is all right except the textbook part. The textbook of modern financial theory actually suggests that leverage, successfully applied, will increase profit, at least on a per-share basis (which is all investors care about), and certainly will improve return on capital.
Though I really like Steven Kaplan, the University of Chicago scholar Wessel quotes, I disagree with Kaplan’s point that companies go private because their CEOs “prefer” private owners. They certainly like private owners when the buyout firms cut them in on the deal in a huge way. But that still doesn’t explain why they are going private.
The answers actually are straightfoward, and Wessel gets to them: lots of capital in the hands of sophisticated buyers and in the form of extremely attractive interest rates. When the cost of debt goes up, and it will, the velocity of the buyout biz will slow dramatically. Then the good privately held companies will go public again, and the bad ones either will get sold for less than they were taken out for or go bankrupt (and then get sold). The cycle is totally predictable. We just don’t know when the fun begins.