Supply and Demand

Aramark did it this morning.  Toys R' Us did it.  Dunking Donuts, Hertz, and Burger King as well.  Retailers are doing it like crazy--Linen 'n Things, Burlington Coat Factory, Petco, Sports Authority.  Even Nieman Marcus, I think.  What is it?

They have gone private.  What does that mean and what does it mean for you?  Let's spend a little time on what it means and more time on what it means for you.  Going private is a public company being approached, or approaching, a buyout group and saying buy my shares and take me off the market.  Why would a company do that? 

One reason--it is getting creamed in the market place.  Sears and KMart are examples.  So is Toys R' Us which was getting smacked around by Wal Mart.  But these companies still have value--probably a pretty good cash flow but not up to Wall Street standards.  Then there is real estate.  Sears and KMart and Toys R' Us have a fair amount of value tied up in real estate that never shows up on their balance sheet or in their valuations.

Reason two--sick of being public.  Sarbanes Oxley, reporting requirements, shareholders--who needs it?  Probably not the overriding reason but a nice little sweetner for management.

Reason three--the contraction strategy.  Wall Street does not reward companies for shrinking but shrinking might just be the best thing to do.  Let's say you are Toys R' Us.  First a store, then another, another and pretty soon you are printing money.  Go public and the stock soars.  But need more revenue and growth so another store, and another and another.  Wal Mart wakes up and starts selling toys.  Your sales growth slows, too many stores, Wal Mart breathing down your neck.  The stock tanks.  What to do?  Cut back to the most profitable stores, lay off a bunch of people, slash staff and print money.  Right? Right but Wall Street will kill you.  But a private investor will go for it because 1) they get the company at a low stock price, 2) they don't care about Wall Street, at least for now, and 3) they don't care about bad publicity from layoffs or store closures.  Because they are private.  Demonstrate all you want, they could care less.  (Thinking about that I wonder if anybody at Wal Mart is thinking about going private--they must be sick and tired of trying to satisfy critics who will never be satisfied.)

Anyway that is why companies go private.  There is one more reason which we will go into in a minute.

What does this mean for you?  I mean it is not like you know anyone at Bain or Texas Pacific or Carlyle who will cut you in on the action.  And you don't have enough money to buy in to any of these groups. 

What is a young investor to do?  Answer--nothing.  All this activity is actually good for you because if you are investing in your 401k and in the market in general, you will be rewarded.  Why?  Because of supply and demand. 

Huh?  Simple.  When supply goes down, demand goes up.  It works for gasoline, collectibles, food, electricity.  And stocks.  When these companies go private, the supply of stock, all together class, goes down.  Supply shrinks.  And demand for the remaining stocks in circulation will go up.  Demand means higher prices which means more money for you. 

Conversely, when supply goes up, demand goes down after a while and prices go down.  Don't believe that?  Look at 2000.  The tech boom.  Anything that had .com after it was going public.  The market couldn't get enough of it until SUPPLY outpaced DEMAND.  The fact that most of the companies were ether didn't help either.  The market went into a tailspin. When you start seeing a bunch of IPO's coming on the market, get ready to run.

Because that is what most of these buyouts are about.  Slash staff (harder to do now because most companies aren't fat anymore), close stores, get cash flow up and go public, again.  Or maybe they will just feast on the cash flow.  Doubt it but don't worry about it for now.

Just be glad to see these companies going off Wall Street.  When they do, the value of what you own goes up. 

And don't feel too bad about missing out on the returns generated by the private investors.  Time magazine, the source for most of this, states the annual return for buyout funds over the last twenty years is 13.3% vs. 11% for the S&P.  A pretty big difference statistically but not overwhelming.  And you can't get in the game anyway so why worry?  Actually, you are probably in the game because pension funds and mutual funds invest in buyout funds.

But the takeaway is don't worry about the shrinking stock market.  It is good for you.  But keep your eye on when it starts to expand.  Increased supply means a drop in demand.

Told you finance was simple.