A Weak Stock Price Hurts Your Company Finances Not Just Your Ego
Second in a series on the problems of going public
It has to be one of the biggest letdowns an entrepreneur can experience:
After months of hard work -- and hard cash out the door -- you float your
first block of stock on the public market, and the price tanks.
The problems that come with a weak stock price are one of many reasons to think long and hard before leaving the cocoon of private ownership. (See the previous story in this series, "A Cold Look at Going Public.") And you're more likely than
not to have such problems. On Nov. 9, 72.8% of the 713 companies with
revenue under $15 million that went public from 1995 to mid-August,
1998, were trading below their offering prices, according to CommScan, a
research group in New York.
A cheap stock price isn't just a blow to your ego. It's a blow to your
company's finances. If you planned to merge with another company by swapping
stock, you'll give away more of yours, assuming the cheap price doesn't
make the target resist your advances. When your stock is undervalued, it's
also a poor draw to new investors, undermining a key reason for being public -- the ability to raise funds by issuing new stock. Even if you manage
to launch another issue, people who paid more for the stock are likely
to be angry. You'll probably have to issue a more expensive security, such
as preferred stock, which earns dividends at a fixed rate. Preferred stockholders
get paid before common shareholders, and unpaid dividends accumulate.
A sunken stock price can also dishearten employees who hold stock options
as incentive compensation. "A stock price becomes a very personal thing,
like a rating," says Kathleen Smith, a portfolio manager at Renaissance
IPO Fund in Greenwich, Conn. "When your stock price is down, it's
like nobody loves you."
The worst of it is that you may not be doing anything really wrong with
your company. It's just that investors have short-term expectations for
earnings and share prices. Moreover, if your sector is hit by bad economic
news, your stock price is likely to be dragged down as well. Those factors
are often hard to reconcile with an entrepreneur's long-term strategy.
But your shareholders will punish you if they feel you're not responding
to their expectations.
Says Dennis Rourke, a managing director at San Francisco-based Nationsbanc
Mongomery Securities: "Investors scrutinize quarterly numbers. And if you
miss one line, you could lose half of your market cap." Market capitalization
is price per share times the number of shares -- the market value of your
company. If the stock drops too much, analysts may drop coverage of the
company. Stock priced below $1 can be delisted from Nasdaq's national market
and may have to trade on the OTC Bulletin Board, a subscriber service for
stocks that don't meet exchange-listing standards. Without research coverage
and a Nasdaq listing, your company is trading in a black hole. And it can take
years to build the price back up.
SMALL ISSUE BLUES. The problem is particularly bad for small companies whose stock
is scantily owned by institutional investors -- and that's almost any company
that issues less than $10 million in shares. Three hundred and fifty three
companies that went public from 1995 to 1998 fell into that category,
according to CommScan. Institutional investors are particularly desirable
shareholders, because they are more interested in the long-term prospects
of a company than retail buyers, and they provide a base of support for the stock.
However, "institutions won't buy a deal that's less than $10 million in
size, because they can't get out," says Renaissance's Smith.
Most sizable investment banks won't even do IPOs under $10 million,
and many demand issues that are at least $40 million. Yes, investment banks will handle
small companies, but only those with big growth prospects that will be
reflected in the offering price. "We don't look at revenues. We look at
estimated market caps," says Michael J. Kollender, a banker at Josephthal
& Co., a New York-based regional investment bank.
So companies that raise less than $10 million are stuck with both retail
buyers and small underwriters that have no research departments to bolster
the stock. "I've seen companies that go public with small boutique underwriters
raise just enough funds to get by and suffer later because the underwriter
is not there to support the stock," says Bob Fish, a partner at PricewaterhouseCoopers,
who advises emerging technology corporations.
Boutique underwriters lack the resources of larger investment banks that would allow them to weather a serious financial or internal problem. That's what Robert Soloff, chief executive of Sonics
& Materials in Newtown, Conn., discovered. He visited 20 underwriters, many of whom
turned the company down because the offering the 29-year-old maker of ultrasonic
welding equipment wanted to do was too small. The underwriter Soloff hired --
Monroe Parker Securities in Purchase, N.Y. -- closed its doors early
this year. Sonics was left without a primary market maker in
its stock, which has dropped from $3.50 a year ago to less than $1 a share.
The upshot is, many smaller companies go to market before they
are developed enough to offer institutions predictable earnings or a large
enough "float" of stock in the market. This means that investors can't get out of their position in your stock readily: There aren't enough shares,
and trading isn't frequent enough to establish a realistic price.
After all, liquidity and price transparency are two big reasons most
investors put their money in publicly traded companies, not private companies. Tomorrow, we'll examine the problems of having too few shares on the market.
By Hilary Rosenberg in New York