What is Privatization?
Privatization, or a “take-private” transaction, refers to the acquisition of a publicly-traded company where the target’s shares are de-listed from a public exchange post-closing.
How Privatization Works in M&A (Step-by-Step)
In M&A, privatization describes a transaction where a public company is taken private and its shares are then delisted from a stock exchange.
Once the “take-private” transaction closes, the shares of the target are no longer traded in the open markets and the formerly public company is now officially a private company.
Usually, the target of a take-private transaction is an underperforming company that has fallen out of favor with the public markets, i.e. its share price has suffered a steep decline.
Given the negative market sentiment and long-term outlook among investors, an investor – most often a private equity firm, a financial sponsor – can view the reduction in valuation as an opportunity to acquire the public company at a discount and realize a profit at a later date.
Since public companies are still worth far more than private companies—even after sustaining a substantial drop-off in their valuation—the investor is frequently a consortium of investors or a publicly traded company, as opposed to an individual investor.
Take-Private LBO Transaction Structure: Private Equity Firms
To reiterate from earlier, a private equity firm (PE) typically participates and has a critical role in a take-private transaction as either 1) the lead investor or 2) a co-investor backing the deal in most cases, which is partly because of the need to raise a significant amount of debt capital to finance the transaction.
The occurrence of take-private deals tends to coincide with dry powder piling up on the sidelines among private investors, i.e. the build-up of unused capital raised by investment firms waiting to be deployed.
“Take-Private Deals Are on a Record Pace” (Source: Institutional Investor)
Privatization: Benefits of Going Private Transactions
Becoming a public company is a significant achievement that provides many benefits, such as access to more capital and providing existing investors with a liquidity event.
However, there are drawbacks to the decision to go public, which tend to become most apparent for underperforming companies.
- SEC Reporting Requirements: Public companies must abide by strict reporting requirements, in which financial reports must be periodically filed with the SEC detailing their recent financial performance (e.g. 10-Q, 10-K).
- Public Scrutiny: The required transparency opens a public company up to widespread scrutiny, whether it be from its shareholders, equity analysts, or negative media coverage. The continuous pressure placed on public companies to beat estimates on financial metrics such as earnings per share (EPS) and revenue can serve as a distraction that hinders management’s long-term decision-making.
- Short-Term Oriented: One of the unintended consequences of the quarterly reporting requirements is that public companies become more near-sighted. Critical decisions can be made for the sake of upholding the current share price post-quarterly earnings reports to avoid displeasing shareholders, rather than what might be truly “best” for the company over the long run – albeit that would be a subjective measure, with many side considerations.
- Loss of Control → The management team of a public company is obligated to make decisions in the best interests of its shareholders, i.e. the partial owners in the company. If enough of the shareholders disagree with the management team’s past decisions and vision, they can vote them out.
Types of Privatization: Buyout Deal Structures
There are three types of take-private deal structures:
- Leveraged Buyout (LBO) → A private equity firm (or a group of PE firms) acquires the public company and privatizes it. The purchase price is funded using a significant amount of debt raised from banks and institutional lenders. Over the holding period, the returns on the LBO primarily stem from the pay-down of debt using the company’s free cash flows (FCFs) and implementing operational improvements before then exiting the investment. For example, BMC Software was taken private in 2013 by a group led by Bain Capital and Golden Gate Capital.
- Management Buyout (MBO) → The existing management team of a public company decides it would be better off as a private company. Like a traditional LBO, private equity firms are typically actively involved, especially in providing funding. The distinction here is that management is often the one that initiates the proposed transaction and takes the lead in justifying the rationale behind taking the company private. In addition, management will roll over equity into the post-buyout company (and continue to run it), with the intention of returning to the public markets someday. The MBO of Dell, led by founder Michael Dell and private equity firm Silver Lake, is a well-known example.
- Strategic Acquisition → The public company is acquired by a corporate acquirer (or individual entity), frequently in a tender offer. If the offer is not accepted or the existing management (and the board of directors) refuse to accept the friendly takeover offer, the acquirer can still gain control of the company in a hostile takeover. For example, Dell acquired data storage provider EMC in 2016, alongside its financial backer, Silver Lake.
Privatization Transaction Example: Twitter and Elon Musk (2022)
A 13-G filing in March 2022 revealed that Elon Musk—the co-founder and CEO of Tesla—owned a 9.2% stake in Twitter, effectively making Musk its largest shareholder.
Musk was initially offered a board seat, which he declined, only to later unexpectedly announce his intent to purchase Twitter.
In response to the tender offer, Twitter unsuccessfully attempted to fend off the acquisition, using the poison pill defense tactic to dilute Musk’s stake and make the purchase more costly.
Musk continued his efforts to pursue the acquisition in a hostile takeover, and Twitter eventually announced it had entered into a definitive agreement to be acquired by Musk in late April 2022.
The takeover was estimated to be worth $44 billion, with an offer value per share of $54.20 in cash, with financing provided by banks such as Morgan Stanley and Bank of America.
In an odd sequence of events, Musk took a sudden U-turn and tried to pull out of the deal, citing claims of fraud over the supposed number of “bots” on the platform.
The entire ordeal seemed to be on course to be settled in Court—as Twitter filed a lawsuit to force Musk to stick to his initial acquisition agreement—until Musk sent a letter formally re-stating his intention to honor his initial agreement at the original $54.20 per share right before a scheduled deposition.
Elon Musk closed his $44 billion purchase of Twitter on October 27, 2022, and the shares of Twitter were soon after de-listed.
Twitter Stock Price Pre-Delisting (Source: TWTR)