The market was recently a buzz in relation to what was initially pipped to be one of, if not, the biggest initial public offering (IPO) of 2017. Wesfarmers, who were looking to float one of the jewels in its portfolio crown, high performing company Officeworks through a dual track process, however is no longer considering an IPO due to the current market conditions surrounding retail stocks and lower than anticipated returns.
For many private business owners ‘going public’ by listing on a stock exchange has traditionally been considered the ultimate goal. Increasing cost and compliance burdens associated with an IPO have, however, resulted in many business owners opting to implement a dual track process.
So what is actually involved in a dual track process when they do occur? A dual track process involves following the steps towards an IPO while simultaneously pursuing a private trade sale. The technique is used to create competitive tension between the market and private investors in a bid to increase sale value.
Interest from an acquirer is likely to heighten market interest in the IPO especially where there may be potential for a takeover further down the track. On the other hand, a keen acquirer may be willing to pay a premium for the business in a private trade sale if there is a perception that the business may go public. The acquirer may prefer to take advantage of the opportunity now rather than running the risk of an expensive takeover after the business has successfully floated.
The practice of using a dual track method was very popular during the bullish market of the 1990s when emerging IPOs were highly anticipated and often oversubscribed. In today’s more cautious market the dual track process is enjoying a comeback. Where the technique had previously been used to enhance sale value, it is now being used as a method of securing a sale. As with many of the current merger and acquisition practices, increased private equity activity has contributed towards the dual track process’ revival as investors want to ensure a successful exit.
The dual track process can be used as a method of proving the credibility of financial information and the worth of the business. Due to the nature of private business acquisitions, suspicion on behalf of the acquirer can arise. A trade sale is usually a one-off transaction and as such the acquirer must gather as much information as possible during the due diligence process prior to purchasing the business. Where the seller is parting from the business there is often an assumption that the quality of the business may be misrepresented in order to derive the maximum sale price. Any problems within the business may only be discovered post-acquisition, thus the acquirer may be hesitant to purchase the business. As such sellers of good quality businesses are often at a disadvantage; the value of the business may be discounted to account for the acquirer’s risk. There is a clear information divide between the seller and the purchaser.
Following the route to an IPO can go some way towards filling this information gap. The rigorous disclosure required of a business in order to first register for and then list on a stock exchange can indicate credibility in the business’s financial statements. Moreover, the pursuit of an IPO can send a number of clear signals to the market in regards to the value of the business. The ability to withstand the financial costs associated with listing and the mere fact that the seller is willing to undergo the onerous task of pursing an IPO may be indicative of quality. Furthermore, even a cold IPO market may have a positive outcome for the seller. A business that is willing to undertake an IPO in an unreceptive market may be considered confident and of a high quality.
In addition to presenting the business in a positive light to the market, the implementation of a dual track process may have a number of advantages for the seller including:
- An increased chance of exiting the business. In conditions where an IPO may not be ideal, a trade sale can be used as a back up;
- Greater control over the sale process as prospective acquirers are encouraged to make an offer prior to the floating date of the business; and
- Potential for a higher sale price as prospective acquirers are motivated to bid higher in order to provide an appealing alternative to an IPO
Another recent example of a dual track process was clothing retailer, Retail Apparel Group, whose major shareholder is private equity group Navis Capital. Having gone through a dual track sale with both potential trade and financial buyers as well as an IPO, where Navis would retain a stake in the IPO, in May 2017, Navis accepted an offer from South Africa’s The Foschini Group for $302 million.
The decision to accept a trade buyer was based on the poor sentiment towards new listings, the tighter retail market with several retailers going in to administration and fears of what Amazon’s entry into Australia would do to local retailers, and the knock on effect that this was having on listed retail shares. In this case the vendor, Navis was able to exit their investment in full, and it was reported Navis made 3-times money on their investment. A single track process may not have achieved the same result.
Conducting the Dual Track Process
For the seller, whether listing the business on the stock exchange or selling in a private trade sale the desired outcome is the same: to divest of the business at the best possible price. An IPO and a trade sale are, however very different transactions. Preparations for an IPO focus on the business, business strategy, its management team, financial track record and other metrics important for a successful IPO including Earnings per Share and estimated Dividend Yield. While a trade sale focuses on some of these factors, a clear distinctive focus is on the owners – both the departing owner who (as outlined above) would like to make a profitable exit and the new owner who must consider how best to develop the business, as well as a more rigorous financial due diligence given that some private companies would not have the corporate governance that would be required when going though the IPO process. The steps towards an IPO and trade sale are also very different. As such the process must be carefully structured and executed. View a typical Dual Track Process Diagram here.
It is clear from the diagram that implementing two simultaneous transactions can be time consuming and costly. There are, however, certain synergies between the steps in an IPO and a trade sale which can be achieved. The underwriter’s due diligence for an IPO, for example, may have the same scope as the vendor’s due diligence for a trade sale. Similarly, the information required for the IPO product disclosure document will resemble that used for the trade sale information memorandum. To make the most of these synergies and conduct a well structured dual track process it is recommended that the seller appoints an advisor experienced in both IPOs and trade sales.
The key to running a successful dual track process lies in the planning and timing. It must be determined in advance how far the two transactions will be allowed to run parallel to one another. Though a dual track process can increase the profit on the realisation of the business, allowing the transactions to run on too far may cause damage to the business. If an IPO were to be withdrawn due to adverse market conditions or a lack of market interest this may have a negative impact on a potential trade sale. If negotiations break down on the side of a trade sale, on the other hand, issues of confidentiality may arise and adversely affect any future listing. Additionally, it is important to consider the potential challenges involved in the dual track process which may include:
- Increased costs associated with running two transactions;
- Substantial loss of managerial time; and
- Potential for executives and management to become de-motivated due to the possibility of lost jobs resulting from a private sale.
If well structured, however, a dual track process can maximise the value of the business on exit. In a 2003 study of over 9,500 privately owned firms in the US conducted by James Brau of Brigham Young University and Ninon Kohers of the University of Florida it was found that private companies pursing a dual track process achieved a 26% premium when compared to those that were sold outright. For any business owners seeking to implement a dual track process it is crucial that the owners and management team are prepared and dedicated to the project. The process must be effectively managed with clear objectives and an unambiguous timeframe.
So where does the role of the CFO come into play during a dual track process?
Demonstrating and articulating the growth story remains the most critical part of a CFOs role during the exit process. Their influence can be transformational to the business. They should be working in close coordination with the key legal and financial advisers to formulate a clear plan from the very beginning that gives the dual track process its best chance for success.