| close this window |
| Source: | LOHAS Weekly Newsletter |
| Published: | Friday, October 01, 1999 |
General Nutrition Cos.’ (GNCI) quarterly earnings conference call on Aug. 5, 1998, was numero uno among a string of disappointing earnings announcements in the sector, reflective of the fact that 25+% growth rates were no longer sustainable. In the past six months, price levels appear to have stabilized and trade now within a range of 25% to 75% of the early-August 1998 levels. Industry insiders (i.e., senior management at VMS companies) acknowledge the slowdown in business activity; most, however, would argue that the extent to which their stock prices have been penalized is unwarranted. The issue of stock price and shareholder-value creation remains a major concern for the CEOs of these companies. Attempts by some of them to create value through stock buyback programs have thus far yielded little impact on prices.
Enter Herbalife. On Sept. 13, Herbalife (HERBA, HERBB) announced its intention to no longer remain a public company (see story, pg. 3). The primary reason cited for this decision was the dismal public market valuation of the stock, which in management’s view is unlikely to change in the near-term. The company is building in certain international markets a presence that is expected to have a longer than normal gestation period and hence could adversely impact earnings.
Simply put, this “going private” transaction entails Mark Hughes, founder and CEO of Herbalife, and affiliates, to acquire the entire public float of the company by utilizing its debt capacity.
Aside from prestige-related factors, a publicly traded stock serves three primary purposes: (1) it’s an acquisition currency for M&A transactions; (2) it facilitates additional avenues to raise capital, and (3) it provides liquidity to shareholders. I would argue that at current stock prices the level of importance of each of these considerations is greatly diminished. The combination of low stock prices of potential acquirers and high valuation expectations of targets renders stock unattractive as an acquisition currency, because of the dilution implications thereof.
Raising additional equity in the public domain is challenging at best, in view of the low appetite for VMS stocks by institutional investors, which is predicated on their adverse investment experience. Also, virtually each of the bellwether-sector stocks have significant “insider”—founding family—ownership, who are generally not interested in selling at current price levels.
A major challenge of being a public company is managing the expectations of the public shareholder constituency. Performance in the growth-stock category, under which VMS is classified, is primarily measured by growth and earnings momentum. The ground rules for the VMS sector are changing and consequently, strategic investments in infrastructure, managerial talent, marketing, product development, etc., may be imperative for
success in the longer term. Such investments—most of which are subtle—will impact the near-term earnings trajectory and could have stock-price implications.
Accordingly, it can be argued that the going-private alternative should receive serious consideration, since the burden of being public far outweighs the benefits in the current context.
Though a good solution in theory, going private may not be a viable alternative for the majority of publicly traded VMS companies, for the following reasons: (1) Herbalife has no debt on its balance sheet. All other things being equal, this gives it the capacity to take on a higher amount of debt. In contrast, most of the other public VMS companies have debt outstanding. (2) The impact of the market slowdown has been relatively less on multilevel-marketing (MLM) companies. Herbalife’s net income for the quarter ended June 30, 1999, was 20% lower than for the comparable period last year. In comparison, other public companies that sell products primarily through traditional channels were down 33% on
average, with certain companies down more than 50%. Accordingly, Herbalife’s relatively stable earnings track record enables it to take on greater leverage than the peer group. (3) Since a number of the other VMS companies have lower insider ownership than does Herbalife, the size of the public float that needs to be tendered for would be relatively larger and consequently makes a transaction more difficult. In substance, Herbalife’s well-suited profile to undertake such a transaction facilitated a sizeable premium of 70%, one which would be hard for other companies to match.
In conclusion, a going-private transaction does not appear to be the much-needed panacea for public VMS companies. Until one is found, investors will continue to remain focused on earnings track records and on senior management at the companies delivering results.
Nikhil Puri is an investment banker at Lehman Brothers in New York.