Buying Public Companies
“At the end of the day, public companies need to answer to their shareholders, which has a different level of scrutiny and responsibility that is not present in private companies.” – Doretta Mistras.
“The world is getting smaller, and there’s a lot of convergence across industries. What was considered non-competitive five years ago is now considered competitive.” – Pranjal Gambhir
In this episode of the M&A Science Podcast, Pranjal Gambhir and Doretta Mistras, both Managing Directors, Global Investment Banking, Healthcare at Citi, talk about how to buy public companies.
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Buying a Public vs. Private Company
DM: There are a lot of aspects of it that make it somewhat similar.
With the public company, a lot of information is already out there. Companies are required to disclose things through their filings.
They have public shareholders and therefore, there’s a certain level of scrutiny and disclosure that exists in public companies that you don’t have in private companies.
What that means is that there’s often a lot more access to information and the actual negotiating of the contract can be a little bit easier because you don’t necessarily need to have the same level of diligence in the contract and there’s a public valuation out there as well.
The fastest M&A deal I’ve ever worked on, we’ve been able to engage with a target, agree on a price, and announce something within two weeks.
That is not normal, but that is in the realm of possibility in extreme cases. But on the other hand, you do have to answer to shareholders. And because of that, you have fiduciary duties and other representatives and people you need to account for it which could add some complexity as it relates to options that a private company doesn’t necessarily need to have.
Significant differences between public and private companies
- Transparency of information
- Fiduciary responsibility to report any material event to investors
- Independent views on public companies
- Rules and governance and securities law
- Answers to shareholders
DM: We’ve seen a dramatic decline in valuations broadly, especially around growth stocks and a question that we get all the time is when will stocks season?
With a public company, there’s actually a mark out there. Anecdotally, public companies tend to be a little quicker to reset to that new norm. And our data, we’ve done a lot of analysis around this and our data suggests that it usually takes about six months for stocks to season. Private markets actually take longer.
Formalities of reviewing the offer
PG: The CEO of a private company doesn’t have that fiduciary responsibility because they do as well. It’s just not as formulaic and process-oriented as it is for a public company. Because in a public company situation, you can get under more scrutiny.
You have to make sure you’re not starting to roll. You are telling the board at the right point or time thing. Telling that all the members of the board or the right one was with the board involving all the parties and going through this innovative formulaic way is not the case in private companies.
DM: Oftentimes, it’s also driven by how many shifts owner, how many quote-unquote shareholders or owners you have, and private companies tend to be a little more concentrated versus when you’re a public company, you have a lot of shareholders where the board is representing though.
Common Challenges of Buying a Public Company
PG: The first one is valuation. Most public companies will have an internal view of the intrinsic value. The most sophisticated companies do this on a yearly basis with their board.
The market value changes depending on what’s happening in the microenvironment. We already talked about we’ve seen a massive increase in valuation. And the public market valuation at times does not match what you have as your intrinsic value so you at least have a public mark out there.
The challenge is always trying to find what is the common ground. With public companies, actually, it becomes a little easier because you have a public mark out there; that is your threshold.
If you look at that public mark or today’s price for 52 weeks or the last three years, you can do all of that analysis.
With private companies, it’s the venture investors, the owners, the institution is over there. And they look at it as more expectation of amount money they put in and amount of time they put in and what’s that? What’s the risk-reward outcome here? So I would say that’s the nuance.
Regulations and Antitrust
The world is becoming smaller and smaller. In a week, there’s convergence across industries. What would be considered not competitive five years back, certainly is considered competitive today across different industries. So antitrust is a real issue.
Geography and Politics
If you’re taking over a public company and that public company is located in another location, such as your operation, that brings along its own complexity because you’re trying to delist a company from the stock exchange in that company. It brings across some different complexities and takeover laws, etc.
Confidentiality and leaks
DM: Confidentiality and leaks can have a significant impact and pose a challenge when you’re dealing with public companies, especially if you’re dealing with a situation where there’s a big stock component to the deal. So it’s incrementally more important to keep things quiet in those situations.
Everybody’s always trying to uncover the of nets the deal and announce it. Sofortunately, or unfortunately, it’s just in the nature of our industry. I do not abide by it, but in select situations, leaks are done on purpose sometimes.
If you’re nervous about the stockholders’ reaction you would leak the deal, to see what the reaction kind of potential could be. People trying to make headway in terms of negotiations, try and leak the deal to force somebody’s hand.
And a lot of the time, leaks are driven by just, I think unfortunately squeaky comments and wheels, but sometimes they’re actually done for, unfortunately as a kind of negotiating tool in certain situations.
It’s oftentimes a symbiotic relationship, but at the end of the day though, my view is that the number one thing you have to clients is their trust. And the last thing anyone wants to do is break that trust because your kind of reputation is number one.
And if you don’t have your reputation then there’s no point in being in this job, but there is the finance community is a very small community. And people have and try and share general information.
Sometimes it’s very general when it’s done in a very constructive way, but people like to know the news, It’s gossip for finance. There’s always a lot of potential to put around it.
The market share threshold of the antitrust to allow a deal
DM: It depends on the situation. Especially in this administration, the threshold and the scrutiny around deals have increased significantly. And a lot of that has to do with the stance that M&A is not a constructive thing for the economy, etc.
So the administration has generally taken a much more stringent view on M&A. Now they’re more focused on certain things. Historically, it’s been in control of power. So when it’s a kind of only a three or four-player market and the top two players combine, which potentially creates a competitive disadvantage, but that has now broadened into even vertical.
How do you think about vertical integration and if you vertically integrate, does that create a competitive disadvantage?
So, the view around what constitutes antitrust has broadened. One, that forces companies, to think a little bit more carefully about how they approach M&A.
And it also has caused them to be a lot more careful in terms of what you put on paper internally as it relates to M&A because the government doesn’t necessarily have a view. They often rely on what you are saying around it. And so being very careful and methodical about what people put on paper, as it relates to M&A is ultimately important.
And then also just acknowledging that it will take a lot more time for deals to get done in this environment. So, making sure that whether it’s the drop-dead date in the contract or how you structure things allows for that incremental time to account for incremental scrutiny.
Navigating the boardroom
- Know the audience
- Avoid surprises
- Get to the point
PG: Once you’re getting into the boardroom, someone is putting their neck on the line and saying, these are our advisors and they know what they’re talking about.
So preparation and knowing the room are extremely important. We spent a lot of time thinking about who was going to be in the room, and preparing for it. And frankly, at the end of the day, the goal is what are we trying to achieve? And what are we trying to solve here? What is the right answer?
Because a lot of people are placing a judgment of whether they spend some money or not spend money on what we see.
So preparation, understanding of your subject, and understanding of what you’re doing are very important, you need to be a credible source as soon as you step into that room.
Second is you need to know who are the key decision makers here. So you need to know the boardroom a little bit. You can’t surprise people. At times, it’s not just the CEO, it’s the audit committee chair, it’s the chairman of the board.
You have to have as many conversations as possible, know where everyone’s touchpoints are, know what everyone cares about, and all the materials you intend to cover.
It’s really a fully comprehensive approach because at the end of the day, you have to walk out of there as an advisor, as someone who’s credible, and has done their work before coming into the board room.
You can focus on one person, but you can’t alienate others. It is a board for a reason. Everyone’s voice counts, everyone’s vote counts, and you have to make sure that you’re addressing everybody.
DM: It’s important to know the audience. Often, boards will set up committees related to M&A, and it’s important to approach it methodically. The last thing you want is surprises.
It’s important to preview things ahead of the meeting. Obviously, things pop up, but if there are big surprises that come up, a lot of that falls on the CEO who tends to have a very good relationship with key members of the board, whether it’s the lead independent director, the chairman if it’s somebody different, etc.
PG: There’s no special magic, just to the point and getting into the key takeaway. Too much detail is not helpful, but at the same time you can’t have not done enough analysis.
DM: We see it two ways. One is to actually force to say we think this company is undervalued or we think there’s a lot of strategic value here. It’s being mismanaged, or there’s a great kind of value here. So we think you should sell it yourself.
Alternatively, it can also come up if you announce a big M&A deal and you have a shareholder that does not like the deal, an activist can jump step in and try and prevent that deal from happening.
And we have seen activists have a lot more capital, and get a lot more influence over the past several years. And especially we’ve seen a real pickup in activism especially this year where you have what you’ve seen valuations come down.
Communicating with shareholders
DM: One is just through issuing reports on the internet. The advent of social media has also produced a forum to be able to just broadly disseminate information because it’s as much of a public perception story as it is an individual investor story.
The more formalized way depends on how contemptuous it gets. A lot of companies prefer to settle on the private, right? An activist doesn’t necessarily go public on day one, they’ll try and engage with a company in a private setting, and see if they can reach some sort of negotiation.
If things potentially escalate, then it might go public. But they could issue proxy board seats, but there are actually companies out there like solicitors and stopwatch firms that can also help in terms of reaching out to potential shareholders.
The last piece is you’d be surprised at how much talking activists do even before they are put in positions. So they might be reaching out to shareholders to the top, the big shareholders, before they even approach you to formulate their point of view.
DM: An activist tends to be a fund that has a specific point of view on a company and they want them to do something different. And that can range from capital structure such as we think you’re inefficiently deploying capital, and you should be returning more capital to shareholders.
We don’t like what you’ve been doing in M&A a there’s a sum of the parts, kind of play to be unlocked here. We think you should separate or you should sell yourself.
And then there’s governance, which is we don’t like how you’ve been running or perhaps the board is too old or they’ve been there for too long.
We think you can run the company more efficiently, increase margins, etc.
So an activist tends to be more of a financial investor that takes a position in a company to effect change.
Disclosures When Buying a Public Company
DM: It ultimately depends on the jurisdiction and that’s where it’s important to know and do the work to know where the company is domiciled.
The US tends to be a little more flexible regarding disclosure. But when you’re in other countries, for example, the UK, Netherlands, etc, it can get a lot more complicated both in terms of timing of when you need to disclose things.
We work very closely with the company, with lawyers, etc to make sure that we’re abiding by the rules because it can play a material impact ultimately on how you think about that disclosure.
The Most Important Thing to Consider When Buying a Public Company
PG: The most important thing you have to consider is the value to the existing investors. The board is a representative of the public investors. They will act based on what they think is right for the broader investor and investors in the company.
When you come to the table you have to bring value, which you think will pass muster. The second important thing is around the strategic rationale of a transaction. Does it make sense to take this company? It’s a public company buying another public company, does it make sense for those two companies to come together? Is one plus one equal to three? What are synergies? All that has to pass muster in the public investor’s eyes.
Many times where you see leaks and the stocks trade are down for both companies or one of the companies involved, and that’s because the market is basically saying we don’t like this.
As bankers, our job is to test that and say, what is it transactional rationale? How do you communicate that to an investor?