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07-11-2015, 08:55 AM
(This post was last modified: 07-11-2015, 08:56 AM by greengiraffe.)
When public companies mimic private firms
Warren Buffett of Berkshire Hathaway and Jeffrey Bezos of Amazon shun short-term gains for long-term performance
SLOW BURN: An example of a public company that behaves as if it were private is Amazon (left). While the company has grown exponentially over the last 20 years, it has invested heavily, often sacrificing profits in the process. Investors who are bullish on Amazon's stock assert that the investments will one day produce industry-beating returns.
PHOTO: BLOOMBERG
NOV 7, 20155:50 AM
IT was one of the biggest rebukes of the public markets in recent memory - and it may not be the last. In October, just two years after Dell's management took the company off the stock market to make it a private company, Dell announced one of the biggest technology acquisitions ever.
Being a publicly traded company is often thought crucial for raising large amounts of capital. But Michael S Dell, the founder and chief executive of the company, expects to raise as much as US$40 billion to finance its purchase of EMC, the data storage and software company.
Investors are also throwing money at companies that have never been on the public markets. Uber, the young ride-sharing company, has managed to raise US$8 billion without showing its books to the world, for instance.
In fact, there is evidence that companies are avoiding going public - or like Dell, withdrawing from the public markets - even though the stock market is supposed to provide the lowest cost and most responsive place to raise money.
Currently, 5,303 companies are listed on the US stock exchanges, down 35 per cent from 8,160 companies some 20 years ago, according to data from Weild & Co.
Economists and stock market experts often place much of the blame for the decline on new regulations that have been introduced over the last 20 years. These, they say, increase the costs and burdens of being public for many companies.
But three academics, puzzled by the drop in stock market listings, recently carried out research that suggested another cause: Companies may be avoiding the stock market so they can be free of the short-term pressures that can undermine corporate performance over time.
The paper's authors are John Asker, a professor of economics at the University of California, Los Angeles; Joan Farre-Mensa, an assistant professor at Harvard Business School; and Alexander Ljungqvist, a professor of finance at the New York University Stern School of Business. Their standout finding is that "private firms invest substantially more than public ones on average, holding firm size, industry and investment opportunities constant. This pattern is surprising in light of the fact that a stock market listing gives firms access to cheaper investment capital," the paper states.
The inference is clear. Freed from the obligations of being public - disclosing quarterly results, making earnings projections and dealing with investors' reactions to disappointments - corporate executives may feel they can take the risk of investing more. Ambitious investment projects can bring unexpected hits to earnings and periods of greater uncertainty, the sorts of things that can cause public shareholders to sell now and think later. But a private company can plough ahead, more or less regardless.
The researchers found that private companies not only invest more than public ones, but also that they are more responsive to changes in investment opportunities. Other researchers had reached somewhat similar conclusions. But Asker, Farre-Mensa and Ljungqvist said they were able to go further because they had access to "a rich new database" of private company financial information assembled by the firm Sageworks, which gave them a comprehensive look at how such companies behave.
Still, public companies may not want to talk to their bankers about going private just yet.
For one thing, it may be dangerous to draw too many lessons from recent deals and trends. After Dell went private, its financial performance has hardly been strong. And the ease with which private companies can raise money may just be a temporary phenomenon that goes away when markets become more cautious.
Long-term bent
Also, shielded from the limelight, owners of private companies may treat their firms as personal fiefdoms. And away from the scrutiny that comes with the public markets, young technology firms may be able to play down or cover up flaws in their businesses.
Perhaps more important, there is a third way. A public company can simply behave as if it were private.
Some of the most beloved companies on the stock market try to mimic private firms. Often, this approach requires a chief executive who has a strong long-term bent and could not care less about the ups and downs of public markets. Such executives might of course include well-known figures such as Warren E Buffett of Berkshire Hathaway and Jeffrey P Bezos of Amazon. But analysts say plenty of other executives, often in the less glamorous reaches of corporate America, aim for the long term.
Take Charles Fabrikant, chief executive of Seacor Holdings. Seacor focuses on providing equipment to the offshore oil and gas industries. As the company has navigated many vicious energy cycles since it went public in 1992, its stock has risen more than 800 per cent, compared with nearly 400 per cent for the wider market. It does not give out earnings guidance or hold quarterly conference calls.
"You need to think like a private owner," Mr Fabrikant said in an interview. "You can't make an investment with the expectation that it will produce the returns that you hope for in quarters, or semesters, or sometimes years." Another company off the beaten track is Middleby, based in Elgin, Illinois, whose core business is making ovens for restaurant chains. Its stock is up over 800 per cent in the last 10 years, more than 10 times as much as the market over the same period.
"These guys are the antithesis of 'We've got to hit the number this quarter,'" said C Schon Williams, an analyst at BB&T Capital Markets. "They don't give guidance. It goes back to this being a long-term game." But do public companies that aim for the long term actually outperform other public companies?
Amazon has sat at the centre of this debate for years.
The company has grown exponentially over the last 20 years. It has invested heavily over that period, often sacrificing profits in the process. Investors who are bullish on Amazon's stock assert that the investments will one day produce industry-beating returns, while critics argue that such returns should have materialised by now, given that the company is not exactly young anymore. Amazon is still reporting a relatively meagre amount of net income.
Still, the bulls seem to be gaining the edge. Analysts have a yardstick that they say does more than others to determine the fundamental performance of a company over time. It is free cash flow, or the actual cash generated by the company's operations after subtracting what it spends on investing in its own business.
For the 12 months through the end of September, Amazon's free cash flow totalled US$5.4 billion, a 400 per cent increase from the US$1.07 billion in free cash flow that the company recorded for the 12 months through the end of September 2014. Amazon's free cash flows look weaker if the money spent on lease payments is included. But even with this adjustment, Amazon's cash flows are surging. At the very least, Amazon does not appear to be as profligate as the sceptics say.
Berkshire Hathaway is a big test case for the notion that the long-term approach produces better results.
Buffett is famous for buying companies outright and allowing their existing managers to chart a course for themselves. "Most of our managers are independently wealthy, and it's therefore up to us to create a climate that encourages them to choose working with Berkshire over golfing or fishing," he wrote in Berkshire's latest annual report.
Within the walls of Berkshire, they are theoretically insulated from short-term pressures.
Many companies in the Berkshire stable compete with stand-alone public companies, making some comparisons possible. In 2010, for instance, Berkshire acquired the railroad Burlington Northern Santa Fe. From 2010 to the end of 2014, its operating income grew by 11 per cent, exactly the same as the average rate for five of its US and Canadian peers, according to an analysis by The New York Times.
Burlington Northern's average revenue growth over the same period has been slightly higher than that of the peer group (8 per cent vs. 7 per cent), but its operating profit as a percentage of revenue, or its operating margin, was slightly lower. The margin for the company was 29 per cent, compared with 31 per cent for its peers. Still, Burlington Northern may have the edge, at least for now. Recent railroad traffic figures suggest that it is pulling away from the others this year.
Berkshire's enormous insurance businesses lend themselves to a similar exercise. Geico, the auto insurer, became a wholly owned subsidiary of Berkshire in 1996. But being part of Berkshire may not have made Geico significantly more profitable than some of its closest rivals.
Combined ratio
Analysts measure an insurer's profitability with something called the combined ratio, which measures a company's insurance payouts and its expenses as a percentage of the premiums paid by its customers. The further the ratio is below 100 per cent, the better. Geico's 10-year average combined ratio is 92.9 per cent, according to an analysis by AM Best. That's a very strong result, but the average ratio of Progressive, a rival of Geico, is marginally better at 92.6 per cent, according to AM Best.
Still, as a Berkshire company, Geico has grown faster than many of its rivals to become the second-largest provider of private passenger insurance. And part of Geico's growth is a result of its willingness to spend huge sums on marketing. Its annual advertising bill is well over US$1 billion.
Long-term-focused managers at public companies often have a belief system that helps keep their goals clear and tunes out unhelpful noise. At Berkshire, that comes in the form of "intrinsic value," which Buffett describes as "an all-important concept that offers the only logical approach to evaluating the relative attractiveness of investments and businesses".
Mr Fabrikant of Seacor has to try to invest wisely in assets whose values can swing wildly through the booms and busts of the energy sector. "It requires patience and understanding potential changes in the market and in technology," he said. "And it requires understanding the current cost of capital and the future cost of capital, and a deep understanding of what it would cost to replace that asset." Even so, Mr Fabrikant would rather not have had to deal with the demands of going public. "If I could do it over, yes, I would be private," he said. NYT
Warren Buffett of Berkshire Hathaway and Jeffrey Bezos of Amazon shun short-term gains for long-term performance
SLOW BURN: An example of a public company that behaves as if it were private is Amazon (left). While the company has grown exponentially over the last 20 years, it has invested heavily, often sacrificing profits in the process. Investors who are bullish on Amazon's stock assert that the investments will one day produce industry-beating returns.
PHOTO: BLOOMBERG
NOV 7, 20155:50 AM
IT was one of the biggest rebukes of the public markets in recent memory - and it may not be the last. In October, just two years after Dell's management took the company off the stock market to make it a private company, Dell announced one of the biggest technology acquisitions ever.
Being a publicly traded company is often thought crucial for raising large amounts of capital. But Michael S Dell, the founder and chief executive of the company, expects to raise as much as US$40 billion to finance its purchase of EMC, the data storage and software company.
Investors are also throwing money at companies that have never been on the public markets. Uber, the young ride-sharing company, has managed to raise US$8 billion without showing its books to the world, for instance.
In fact, there is evidence that companies are avoiding going public - or like Dell, withdrawing from the public markets - even though the stock market is supposed to provide the lowest cost and most responsive place to raise money.
Currently, 5,303 companies are listed on the US stock exchanges, down 35 per cent from 8,160 companies some 20 years ago, according to data from Weild & Co.
Economists and stock market experts often place much of the blame for the decline on new regulations that have been introduced over the last 20 years. These, they say, increase the costs and burdens of being public for many companies.
But three academics, puzzled by the drop in stock market listings, recently carried out research that suggested another cause: Companies may be avoiding the stock market so they can be free of the short-term pressures that can undermine corporate performance over time.
The paper's authors are John Asker, a professor of economics at the University of California, Los Angeles; Joan Farre-Mensa, an assistant professor at Harvard Business School; and Alexander Ljungqvist, a professor of finance at the New York University Stern School of Business. Their standout finding is that "private firms invest substantially more than public ones on average, holding firm size, industry and investment opportunities constant. This pattern is surprising in light of the fact that a stock market listing gives firms access to cheaper investment capital," the paper states.
The inference is clear. Freed from the obligations of being public - disclosing quarterly results, making earnings projections and dealing with investors' reactions to disappointments - corporate executives may feel they can take the risk of investing more. Ambitious investment projects can bring unexpected hits to earnings and periods of greater uncertainty, the sorts of things that can cause public shareholders to sell now and think later. But a private company can plough ahead, more or less regardless.
The researchers found that private companies not only invest more than public ones, but also that they are more responsive to changes in investment opportunities. Other researchers had reached somewhat similar conclusions. But Asker, Farre-Mensa and Ljungqvist said they were able to go further because they had access to "a rich new database" of private company financial information assembled by the firm Sageworks, which gave them a comprehensive look at how such companies behave.
Still, public companies may not want to talk to their bankers about going private just yet.
For one thing, it may be dangerous to draw too many lessons from recent deals and trends. After Dell went private, its financial performance has hardly been strong. And the ease with which private companies can raise money may just be a temporary phenomenon that goes away when markets become more cautious.
Long-term bent
Also, shielded from the limelight, owners of private companies may treat their firms as personal fiefdoms. And away from the scrutiny that comes with the public markets, young technology firms may be able to play down or cover up flaws in their businesses.
Perhaps more important, there is a third way. A public company can simply behave as if it were private.
Some of the most beloved companies on the stock market try to mimic private firms. Often, this approach requires a chief executive who has a strong long-term bent and could not care less about the ups and downs of public markets. Such executives might of course include well-known figures such as Warren E Buffett of Berkshire Hathaway and Jeffrey P Bezos of Amazon. But analysts say plenty of other executives, often in the less glamorous reaches of corporate America, aim for the long term.
Take Charles Fabrikant, chief executive of Seacor Holdings. Seacor focuses on providing equipment to the offshore oil and gas industries. As the company has navigated many vicious energy cycles since it went public in 1992, its stock has risen more than 800 per cent, compared with nearly 400 per cent for the wider market. It does not give out earnings guidance or hold quarterly conference calls.
"You need to think like a private owner," Mr Fabrikant said in an interview. "You can't make an investment with the expectation that it will produce the returns that you hope for in quarters, or semesters, or sometimes years." Another company off the beaten track is Middleby, based in Elgin, Illinois, whose core business is making ovens for restaurant chains. Its stock is up over 800 per cent in the last 10 years, more than 10 times as much as the market over the same period.
"These guys are the antithesis of 'We've got to hit the number this quarter,'" said C Schon Williams, an analyst at BB&T Capital Markets. "They don't give guidance. It goes back to this being a long-term game." But do public companies that aim for the long term actually outperform other public companies?
Amazon has sat at the centre of this debate for years.
The company has grown exponentially over the last 20 years. It has invested heavily over that period, often sacrificing profits in the process. Investors who are bullish on Amazon's stock assert that the investments will one day produce industry-beating returns, while critics argue that such returns should have materialised by now, given that the company is not exactly young anymore. Amazon is still reporting a relatively meagre amount of net income.
Still, the bulls seem to be gaining the edge. Analysts have a yardstick that they say does more than others to determine the fundamental performance of a company over time. It is free cash flow, or the actual cash generated by the company's operations after subtracting what it spends on investing in its own business.
For the 12 months through the end of September, Amazon's free cash flow totalled US$5.4 billion, a 400 per cent increase from the US$1.07 billion in free cash flow that the company recorded for the 12 months through the end of September 2014. Amazon's free cash flows look weaker if the money spent on lease payments is included. But even with this adjustment, Amazon's cash flows are surging. At the very least, Amazon does not appear to be as profligate as the sceptics say.
Berkshire Hathaway is a big test case for the notion that the long-term approach produces better results.
Buffett is famous for buying companies outright and allowing their existing managers to chart a course for themselves. "Most of our managers are independently wealthy, and it's therefore up to us to create a climate that encourages them to choose working with Berkshire over golfing or fishing," he wrote in Berkshire's latest annual report.
Within the walls of Berkshire, they are theoretically insulated from short-term pressures.
Many companies in the Berkshire stable compete with stand-alone public companies, making some comparisons possible. In 2010, for instance, Berkshire acquired the railroad Burlington Northern Santa Fe. From 2010 to the end of 2014, its operating income grew by 11 per cent, exactly the same as the average rate for five of its US and Canadian peers, according to an analysis by The New York Times.
Burlington Northern's average revenue growth over the same period has been slightly higher than that of the peer group (8 per cent vs. 7 per cent), but its operating profit as a percentage of revenue, or its operating margin, was slightly lower. The margin for the company was 29 per cent, compared with 31 per cent for its peers. Still, Burlington Northern may have the edge, at least for now. Recent railroad traffic figures suggest that it is pulling away from the others this year.
Berkshire's enormous insurance businesses lend themselves to a similar exercise. Geico, the auto insurer, became a wholly owned subsidiary of Berkshire in 1996. But being part of Berkshire may not have made Geico significantly more profitable than some of its closest rivals.
Combined ratio
Analysts measure an insurer's profitability with something called the combined ratio, which measures a company's insurance payouts and its expenses as a percentage of the premiums paid by its customers. The further the ratio is below 100 per cent, the better. Geico's 10-year average combined ratio is 92.9 per cent, according to an analysis by AM Best. That's a very strong result, but the average ratio of Progressive, a rival of Geico, is marginally better at 92.6 per cent, according to AM Best.
Still, as a Berkshire company, Geico has grown faster than many of its rivals to become the second-largest provider of private passenger insurance. And part of Geico's growth is a result of its willingness to spend huge sums on marketing. Its annual advertising bill is well over US$1 billion.
Long-term-focused managers at public companies often have a belief system that helps keep their goals clear and tunes out unhelpful noise. At Berkshire, that comes in the form of "intrinsic value," which Buffett describes as "an all-important concept that offers the only logical approach to evaluating the relative attractiveness of investments and businesses".
Mr Fabrikant of Seacor has to try to invest wisely in assets whose values can swing wildly through the booms and busts of the energy sector. "It requires patience and understanding potential changes in the market and in technology," he said. "And it requires understanding the current cost of capital and the future cost of capital, and a deep understanding of what it would cost to replace that asset." Even so, Mr Fabrikant would rather not have had to deal with the demands of going public. "If I could do it over, yes, I would be private," he said. NYT