The New Trend: Catalogers Turning Private

Eyebrows raised when San Francisco-based gifts cataloger RedEnvelope filed for an initial public offering with the Securities and Exchange Commission in June. Several years ago, industry observers would have greeted the news with little more than a polite nod. After all, dozens of catalogers, including Delia’s, Coldwater Creek, and J. Jill Group, had gone public in the late 1990s.

But during the past 12-18 months the trend has reversed. Formerly public catalogers such as Lillian Vernon Corp., Concepts Direct, Successories, Zones, and Varsity Brands have gone or are going private.

For several of these catalogers, such as Lillian Vernon and Successories, going private resulted from a sale of the company. Nonetheless, whereas 39 U.S. companies went public in the second quarter of 2002, according to Newark, NJ-based Thomson Financial, only five did so in the second quarter of this year.

Retreating from the public eye

The public-to-private trend is a pullback from the Internet boom, which saw investors go gaga over the slightest inkling of an online connection. For companies, going public meant obtaining capital without borrowing from banks (see “A Lower Cost of Capital,” p. 23) and being able to sell additional stock to fund future growth.

But to get the benefits of being public, “the company has to attract institutional investors,” explains Coy Clement, president of East Greenwich, RI-based catalog consultancy ClementDirect. “That generally means the company must be at least several hundred million dollars in sales and be followed by a number of investment analysts.” If the stock is held only by individual investors, Clement says, the price tends to seesaw more dramatically.

Of course, even companies with plenty of institutional investors saw their stock prices plunge with the the bursting of the Internet bubble nearly three years ago. For example, New York-based teen girls apparel cataloger Delia’s fell from $19.25 a share in November 1999 to close at $0.71 this past July 3. And when Lillian Vernon was taken private in July (following the purchase of the company by a private equity fund managed by New York-based Ripplewood Holdings and New York-based media management firm ZelnickMedia), shareholders were paid $7.23 a share — little more than half what the stock was trading at four years ago.

A shrinking stock price, of course, means the company has less money to play with. And once the key advantage of being a public company — easy capital — vanishes, the disadvantages become more onerous.

Take Wall Street’s obsession with the next quarter’s results. “Wall Street takes a narrow view” of public companies, says David Hochberg, spokesperson for Rye, NY-based Lillian Vernon. At public firms, he says, “management ends up making decisions based on the short term, when in reality it might make better sense to take a long-term, broader view of the company.” Next year the gifts and housewares mailer plans to cut catalog circulation, which in all likelihood will reduce sales. “If we were still public, Wall Street would penalize our stock,” Hochberg says.

Another obstacle is the Sarbanes-Oxley Act of 2002, which created severe penalties for corporate officers of publicly traded companies who sign off on falsified documents such as financial statements. Even for honest companies with nothing to fear, the Act is an administrative headache, forcing management to spend time and money on the paperwork necessary to ensure compliance.

Corporate accounting disgraces and the stock market’s meltdown have also increased the number of complaints against public companies. Quincy, MA-based J. Jill, for instance, was recently hit with a batch of class-action lawsuits in which shareholders allege that the company’s executives misrepresented the financial health of J. Jill to investors last year to artificially inflate the stock price. According to the Washington-based Administrative Office of the U.S. Courts, 1,237 new securities class actions were filed in the year ended Sept. 30, 2002. It’s likely that the number of securities class-action suits will increase thanks to high-profile scandals such as those involving Enron.

And finally, being public isn’t cheap. Legal fees, accounting insurance for company directors, Securities and Exchange Commission filing fees, and the production costs of an annual report and quarterly earnings reports add up. Hochberg estimates the costs at a minimum of $250,000 annually.

Mal Appelbaum, president of New York-based financial advisory firm Appletree Advisors, says the expenses of being public can run even higher. For a midsize company with $2 million in EBITDA, (depending on the size of the company) being public can easily cost up to $500,000 a year.

“Being a publicly traded company can be a distraction and draining on management,” says Appelbaum. “You have to be able to court the analysts, appear at conferences, and deal with thousands of minority shareholders, which is often counterproductive.”

Concepts Direct, which mails the Colorful Images, Linda Anderson, Snoopy Etc., and Music Stand gifts and stationery catalogs, cited costs as one reason for going private in May. “Current market conditions do not warrant the significant annual costs and regulatory burdens on the company associated with being a reporting company,” chairman/CEO Phil Wiland said in an April statement. “We anticipate that our legal, accounting, and administrative costs would increase substantially as a result of recently enacted [Sarbanes-Oxley] legislation, and we believe it is prudent to utilize the projected cost savings to enhance the financial performance of the company.”

That Longmont, CO-based Concepts Direct couldn’t gain attention from stock analysts, coupled with its stock price’s languishing below $1.00, no doubt fueled its decision to go private. If sales are lagging and losses mounting, it’s not easy to drum up interest in a company — public or privately held.

Besides, a profitable company seeking funds for expansion or acquisitions would probably find it easier and less expensive to borrow from a bank today than several years ago, says Kevin Silverman, a retail analyst at Chicago-based ABN Amro Asset Management. Interest rates are down, so “the cost of being private has never been lower.”

In praise of public

Nonetheless, counters consultant Clement, while the public market is certainly “not as richly priced as it was in the ’80s and ’90s, it’s still better than private money.” This is especially true regarding company valuations. Privately held catalog companies have been selling on average for four to six times pretax cash flow, he says. In comparison, public companies have been priced at 12-20 times after-tax earnings.

Much of this has to do with the prestige and credibility associated with being a public company. Because publicly traded companies are required to publish quarterly information about finances, prospective investors, clients, and employees can easily access the data. “This is particularly valuable when competing against private companies,” Silverman says.

These factors may explain why RedEnvelope is zigging when so many other catalogers are zagging. (Because the company is in a quiet period pending the public offering, executives were unable to comment.) But several observers speculate that there are other reasons too.

As a private-equity-funded company, Clement says, RedEnvelope is driven by an internal rate of return (IRR). The longer one owns an investment in a private company, the higher this valuation needs to be. Since most investors want annual IRRs of 25%-45%, it often makes sense for them to sell sooner rather than later. (That’s a key reason equity funds and other financial owners generally put companies up for sale three to five years after buying them.)

“It’s not hard to believe that an aggressive private equity investor [in RedEnvelope] would want to cash out,” Clement says.

Silverman agrees: “It’s most likely that they simply need to go public to simultaneously satisfy 5-10 serious investors who need a liquidity event.”

Founded in 1997 as Web pure-play, the company relaunched as RedEnvelope in October 1999 and mailed its first print catalog in 2000. For the year ended March 30, the company’s sales totaled $70.1 million, up 26% from $55.8 million the previous year. Within the same period RedEnvelope pared its net loss 45%, but it still lost $7.7 million. In its preliminary prospectus RedEnvelope did not specify how many shares it plans to offer or estimate a price for the proposed offering, but it will be registered on the Nasdaq exchange with the symbol REDE. W.R. Hambrecht & Co. will underwrite the initial offering.

Industry pros contacted for this story indicate that few publicly traded catalogers garner enough attention to warrant being public in the first place, let alone a company that has yet to demonstrate a period of sustained profitability.

Still, Ken Packer, managing partner of Waukee, IA-based Financial Advisory Partners, says that investors may be enticed by the recovering Dow and Nasdaq along with RedEnvelope’s solid Web presence.

Clement is also optimistic. “If the economic outlook for holiday and next year looks good,” he says, “RedEnvelope’s IPO could price out pretty well.”

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