Public markets are sometimes a double-edged sword: Many companies enjoy access to capital, but others complain regulatory compliance costs are just too high

October 31, 2005

For young and growing companies, initial public offerings are a bit like climbing a mountain: a long, harsh toil to reach a distant summit.

But planting a flag at the peak isn't enough. To make the journey worthwhile, companies must stay there.

The payoff can be enormous, in the form of ready access to capital. But operating at such a high altitude requires careful footing. And the effort costs more than some can afford.

"It's a double-edged sword," said George Farra, co-founder of locally based Woodley Farra Manion Portfolio Management Inc. "There are great benefits, but at least in this environment today, there are much higher costs."

Every company's growth is based on its ability to secure money for new projects and investments. When they need cash, some firms simply reinvest their own profits. Others issue debt in the form of corporate bonds, or take on loans from banks.

The alternative is to sell equity, or stock shares. Private companies can and do sell equity from time to time. But finding investors-and setting a fair price for the shares-is easier in public markets like the New York Stock Exchange or the NASDAQ.

An initial public offerings is a one-time event. But the need to access capital is not a one-time proposition. Once they're listed publicly, companies can raise money by issuing new shares whenever they see fit.

Kite flying with cash

Take locally based real estate investment trust Kite Realty Group. Shares in Kite have been available on the NYSE since the company's IPO in August 2004. At that time, Kite sold 18.3 million shares at $13 each, raising $237.9 million.

The price has fluctuated since and, on Sept. 16, hit an all-time high: $16.52. That was Kite's opportunity to raise even more money for growth. On Sept. 17, Kite announced it would sell another 8.5 million shares of its stock in a secondary offering.

By the time the shares went to market, they fetched only $15.01 each. But it was enough to raise $127.6 million-or a $121.2 million profit after Kite paid off the syndicate of investment banks that prepared the stock issue.

Kite Senior Vice President and Chief Financial Officer Dan Sink said his company plans to use the money in the near term to pay off outstanding debt. In the long run, the money will make it possible for Kite to finance its promising pipeline of real estate projects.

"As we looked out over the next 12 to 18 months, we have a significant amount of development opportunities," Sink said. "We wanted to make sure we had a flexible balance sheet so we could capitalize on what we had out in front of us."

Sounds great for Kite. But why would all the investors who already hold Kite stock be willing to see the value of their shares diluted? Each new Kite share issued means an old share is a slightly smaller proportion of the company.

Or at least that would be true if Kite's value remained the same. Instead, investors are counting on Kite to grow. As the pie gets bigger, their slices will be worth more.

Richard Moore, an equity analyst who follows Kite for KeyBanc Capital Markets, certainly sees the logic. Kite has $200 million worth of potential projects in its development pipeline, Moore said. Kite couldn't have fueled its aggressive growth plans on profits alone, he said, or even through debt.

The market agreed and bought Kite shares at a rapid clip.

"We like the story quite a bit," Moore said. "There's very high demand for the shares."

Paul Adornato, equity research analyst for New York-based Harris Nesbitt Corp., also follows Kite. He agreed with Moore's assessment.

"They have some very attractive development opportunities. They do a very good job with the retail tenants," Adornato said. "They're seen as one of the better developers in the REIT space these days."

Clearly the public markets are great, when skies are blue and climbing conditions are clear. But when storm clouds gather, even strong public companies have trouble hanging on.

Wabash banks on change

Lafayette-based truck-trailer maker Wabash National Corp. knows the perils well. Public since 1991, Wabash National has seen many ups and downs in the market. Just since the start of September, its stock has slid from about $21 per share to just over $17.

On Sept. 26, Wabash National announced its intention to buy back up to 2 million shares before Sept. 15, 2007. Peter Nesvold, equity analyst with New York-based Bear Stearns, said Wabash National is trying to tell Wall Street its prospects are still good.

"It signals they have confidence in their business plan," Nesvold said. "But the market right now is concerned with deep cyclicals in trucking. To a large degree, they're getting lumped in with other names. It's a tough market to have even a small slip of footing."

So far, Wabash National's stock hasn't bounced back. But the company may never spend the $34 million or more it would need to buy back 2 million shares. Farra noted that the stock repurchase plan is optional.

If Wabash National's industry or the economy in general sours, the plan will likely be called off so the company can preserve its cash.

"A stock buyback has an element of Swiss cheese about it," Farra said.

For some companies, the benefits of the public markets are no longer worth the increased costs of complying with Sarbanes-Oxley Act regulations.

"Tapping the public market is a benefit, but if you're a company or industry where you can't capitalize, you've taken on all that cost for nothing," said Christopher Hirschfeld, vice president and managing director of locally based Goelzer Investment Banking. "If [the stock is] not going to be of interest, you've got to consider the decision [to remain public]."

Deregister decision

City Savings Financial Corp., parent company of Michigan City-based City Savings Bank, is a recent Indiana example. Formerly traded on the Over The Counter Bulletin Board, City Savings this summer decided to deregister from the Securities and Exchange Commission.

The company will no longer have to file period SEC reports, or meet the commission's high accounting standards.

"The advantages of continuing as an SEC registrant are far outweighed by the disadvantages," City Savings Financial CEO Thomas Swirski said at the time. "City Savings Bank incurs significant accounting, legal and administrative expenses associated with the SEC's reporting requirements. These requirements are expected to increase greatly due to recent legislation."
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