Beware the cost of going public

Back in the 1980s a physics graduate named Cris met a "quant" guy named Greg and the two founded a company to write options trading software called Devon Systems. Both their "quant" work - applying complex formulae to value financial instruments - and their gut instincts convinced them that the fastest way for start-ups to grow was to go public or be acquired by a publicly-traded company. They chose the latter and allowed Devon Systems to be acquired.

Fast forward a decade and a half and Cris and Greg are both executives working in Pennsylvania. Now, however, the gents have switched philosophies, believing that private ownership is better than public ownership. What is more, they are betting billions on that proposition.

The Cris in the story is Cristobal Conde, SunGard chief executive. Last week he announced the technology vendor's $11.3bn (£6bn) sale to a private equity consortium - history's largest technology buy-out. Greg is Gregory Bentley, former chairman of SunGard's audit committee and a member of the SunGard board of directors that approved the deal.

Mr Bentley took a moment a few days ago to chat about his views on the private-public trade-off. SunGard's shares in recent years have tended to sell for a lower price than those of some rivals. Perhaps SunGard would produce more value in the long term if removed from the short-term spotlight of quarterly expectations. As he notes, it turned out "investors who would not pay more than 17 times earnings for SunGard stock seem to be willing to spend 24 times earnings for the same business through private equity firms". The deal hangs a scary amount of new debt on the company. But that "seven times" difference is also important. It could represent a quant guy's quantification of the value to an investor of SunGard's not being public.

Moving away from SunGard, Mr Bentley reviewed the regulatory burden on publicly traded technology companies. Sarbanes-Oxley, the 2002 reform legislation, imposes new rules, including a requirement that senior executives declare whether financial controls are adequate. But a much bigger problem is the interpretation of the law - by courts, colleagues and regulators. The law's broad and ambiguous language, for example, widens public companies' vulnerability to class actions. Stock exchanges now demand more independent directors on boards - a demand that is hard on quirky, insider-oriented technology culture. Accounting rules for public companies are a problem. Some software companies, for example, are gradually switching their sales regimes from that of the one-off licence contract to a subscription arrangement that encourages longer-term relationships between vendor and customer. This switch seems wise but making it requires companies to forgo revenues in the short term. Then the market slams them. In short, Sarbanes-Oxley is not the only factor when a company makes the public-private choice. But it plays the role of an additional weight applied at the tipping point.

Mr Bentley's views come not merely from general observation or SunGard experience but also from time at a company of his own. After Dover Systems, he joined his four brothers in a family business. Bentley Systems makes software for architecture, engineering and construction of infrastructure projects - the Swiss Ré "gherkin" building in London, the Olympic Stadium in Sydney - and utilities. The company grew tenfold in a decade, creating 1,600 jobs.

By the early part of this decade, SunGard was considering an initial public offering. After all, US securities law says that companies with more than 500 shareholders must be subject to many of the same rules as exchange-listed companies. Soon Bentley would cross that line. Why not, therefore, go public? Going public would bring capital and allow Bentley to continue sharing wealth with talent.

It was in this period, however, that Mr Bentley chaired SunGard's audit committee. From this perspective he could see that going public had benefits. But not enough to make up for the costs. The new demand for independent outsiders in management could be fatal for Bentley. The Bentley brothers started working together as teens, on trucks and go-carts. To this day, most of their ideas come out of conversations among the brothers. It remains "implausible", Mr Bentley says, that founders would relinquish control to the extent now demanded by regulators. The Bentleys decided they preferred to grow in private.

It would be ridiculous to say that going public is never worthwhile - recent IPOs demonstrate that. Still, the SunGard and Bentley stories suggest two investment classes may be solidifying. On top there are those in the know - hedge funds; start-up technology geniuses and their early employees; Bain Capital; Kohlberg Kravis Roberts and other private equity firms and investment banks that participate in deals like SunGard's. And their legal advisers.

Down below there are those who are less in the know. The routine investors who may participate, but relatively late and through layers of intermediaries. This is an outcome the opposite of what was intended with recent reform. The irony is large and you do not have to be a quant guy to see it.

© Copyright 2005 Financial Times

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