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7.22.99  
Public Offering, Private Doubts
The Dunkleys did an IPO for one company, but held tightly to the other

The offices of William M. and Susan K. Dunkley are where you would expect them to be. He's chairman and CEO, she's president, and they sit in the corner of an L-shaped, single-story building in Plymouth, Minn., near Minneapolis. But these corner offices are about more than status. The corner literally divides the Dunkleys' business life in two. To the right is the headquarters of New Horizon Kids Quest Inc., a publicly held company that operates children's entertainment centers. On the left is the home office of New Horizon Enterprises, a privately owned chain of day-care centers.

Life wasn't always so disjointed for this couple, who hold the same titles in both companies. For 28 years, they built the private New Horizon Enterprises into a successful, Minnesota-wide operation in the low-margin business of full-time day care. Then, in 1995, they split off the entertainment component in an initial public offering.

Few small-business owners straddle the public and private realms, but the Dunkleys wanted to experience the benefits and burdens of public ownership before giving up control of New Horizon Enterprises, too. That ambivalence had a price. The public company was too small to issue the shares needed for an active market in its stock, and the Dunkleys are disappointed in its performance. While the current mania for new issues makes it seem otherwise, an IPO is not always like a winning lottery ticket. But the stock proceeds did help them expand their business and take risks they would otherwise have avoided. So was it a mistake? You decide.

The private New Horizon had its roots in a church basement where Susan Dunkley--a former elementary school teacher--started a nursery school in 1971 while her husband was in law school. As William, who also has a business degree, started his practice, the couple launched a chain of day-care centers. By the early 1990s they were pulling in some $35 million in revenues.

That's when Lyle Berman, then CEO of Grand Casinos Inc. in Minnetonka, Minn., approached the Dunkleys seeking a quality child-care provider willing to open pay-by-the-hour entertainment centers for gamblers' kids. The Dunkleys were reluctant until they learned that gamblers sometimes left children in cars or hotel rooms so they could hit the tables. Says Susan: ''People are going to gamble, [so] if we can make an environment where the kids are separated from the gaming and safe and having fun, we could do a service.''

Also, the Dunkleys saw a business opportunity, since many casinos were turning into ''family resorts.'' With most of the financing provided by Grand Casinos, they designed a center that featured a climbing structure, Lego blocks, and other activities. The first Kids Quest opened at the Grand Casino in Hinckley, Minn., in 1992. Within two years, New Horizon Enterprises, in partnership with Grand Casinos, opened six more centers.

With the Kids Quest centers thriving, the Dunkleys began thinking about taking their business public. Some major brokerage firms, including Lehman Brothers Inc., were excited about the idea. But the Dunkleys were nervous about putting everything they had worked for into a public company subject to a raft of new costs and regulations. ''We had heard horror stories about being public,'' Susan says. So, having heard investment bankers call the Kids Quest operation ''the sizzle'' of the deal, the Dunkleys thought: Why not give investors just the sizzle? They decided to spin off Kids Quest and use public financing to pay for its growth--a two-pronged strategy that included opening traditional day-care centers in new states.

However, going public with the small operation meant there were fewer shares to sell, and, because the Dunkleys and Berman wanted to keep control, there would be a small ''float''--that is, shares available to the public. The Dunkleys own 25% of outstanding shares and the company Berman runs, Lakes Gaming, a spin-off of Grand Casinos, owns 26.6%. The IPO involved 1 million shares at $5 per share, compared with an offering of $30 million if the private company had been included. Too small for big brokerages, the IPO was handled by Equity Securities Trading Co., a Minneapolis boutique specializing in small, or ''micro-cap,'' issues.

Things started out well. Issued in November, 1995, the stock hit $12 within six months, then settled at $7 to $8. The company plowed the proceeds into new centers; today there are 19 Kids Quest facilities. IPO funds also helped the public company acquire and develop traditional day-care businesses in Boise, Idaho, where it now operates 14 centers. Last year, the company chalked up $15.6 million in revenues and netted $21,508. The private company has grown more slowly, adding five centers since 1995 for a total of 49. (Annual revenues top $35 million. It's profitable, but the Dunkleys won't disclose earnings.)

The public company's growth is due, in part, to its ability to take risks the private one--and its 100% owners--can't. For instance, the Idaho day-care centers have been unprofitable far longer than expected. ''We have lost $2.5 million in Boise,'' says Troy Dunkley, executive vice-president and the founders' son. ''We wouldn't have had that to lose in the private company. We would have been out of business.'' But the downside of public ownership has been just as evident. Being public is costly-- from the $750,000 IPO to the $250,000 annually for documents, auditing, and accounting. That would be all right if the stock did well. But since the second quarter of 1998, the stock has been trading on the NASDAQ SmallCap Market below $3 a share. Few people are surprised. The market wants to see regular earnings increases, and Kids Quest has been growing unevenly.

Another problem: The float is too small for institutional investors such as pension and mutual funds, so Kids Quest can't benefit from the stabilizing effect they have. Yet, with its stock in the doldrums, Kids Quest can't do a secondary offering to replace the exhausted IPO proceeds. Instead, the company has borrowed more and leased more equipment than it otherwise would have--supplementing fairly strong cash flow. Also, the company's stock options, given to employees as incentives, are pretty much worthless at exercise prices of $4 and higher. ''We've created a business nobody else has and expanded it,'' says William Dunkley, 50. In the public markets, ''it doesn't seem like there's justice.''

While the Dunkleys expand the business for the long term, they feel the market's pressures. But on the private side, they enjoy freedom from short-term concerns. ''The private company still has its privacy and can do what it wants to do,'' says Kevin Greer, who recently left as CFO of both companies.

Despite disappointments, the Dunkleys did benefit from this public-private hybrid. Although they each spend half their 80-hour weeks at New Horizon Kids Quest, they spare the company the expense of their salaries, getting paid by the private company. The public company uses the private one's resources on an as-needed basis (keeping track for accounting purposes), and they combine their buying power. The Dunkleys wouldn't mind taking the company private again because they think it is undervalued, but they can't afford it. Their long-range plan is to merge the companies and do a secondary offering. So they are determined to make the company, and the stock, a success.

Meantime, the new CFO, Patrick R. Cruzen, says he will try to stir interest among analysts and brokers. And some shareholders still believe. Pete Monson, an investment exec at Global Financial Group in Minneapolis, still buys shares because it's a ''good value. They could be a takeover target down the road.'' That might make it all worthwhile.

By Hilary Rosenberg

This article was originally published in the July 19, 1999 print edition of Business Week's Frontier. To subscribe, please see our subscription policy.


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