In the News
On April 25, 2022, Elon Musk announced a bid to buy Twitter. Musk will pay stockholders a total of about $44 billion at a rate of $54.20 per share. Twitter will be a private company once the transaction is complete.
An initial public offering (IPO) is the transaction that turns a privately held company into a publicly traded one. Companies trade on stock exchanges like the Nasdaq and New York Stock Exchange (NYSE) once their IPO is complete.
However, public companies don’t have to be public companies forever.
Sometimes, private entities want to buy whole companies off the public market. This can be done with a take-private transaction, or privatization, which is the exact opposite of an IPO. After being taken private, shares of the company no longer trade on public exchanges.
You own shares of Apple, Amazon, Tesla. Why not Banksy or Andy Warhol? Their works’ value doesn’t rise and fall with the stock market. And they’re a lot cooler than Jeff Bezos.
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But what exactly is privatization, how does it affect shareholders, and why would anyone want to take a public company private?
What Is Privatization?
Privatization is a transaction in which all outstanding shares of a publicly traded company are purchased by a private party. That party may be a private equity firm, a small group of investors, or an exceptionally wealthy individual.
Once all of the company’s shares have been purchased, the public stock is removed from stock exchanges in a delisting process. Shareholders are paid for their shares, typically in cash, after which the shares no longer trade on the public stock exchange.
Privatization is the ultimate liquidation event for investors for two reasons:
- All Shares Are Purchased. The private equity firm or party acquiring the company purchases all outstanding shares of stock at the same time.
- Premium. The vast majority of privatization transactions happen at a premium. This means you’ll get more than the price the stock traded at before the announcement of the transaction.
How Does Privatization Work?
Privatization starts with a tender offer from a private entity. The offer is generally submitted to the company’s board of directors in writing and priced above the company’s current market value.
The company’s board of directors reviews the offer and determines whether it’s in the best interest of shareholders.
This review has two possible outcomes. The company can accept the offer if the board of directors believes the valuation is fair and in the best interest of investors. If the board doesn’t believe the transaction to be in the best interest of its shareholders, it can reject the tender offer.
Here’s how the process plays out in both situations:
If the Offer is Accepted
In the event that the offer is accepted, the company and the buyer announce the deal. In most cases, a date for a vote will be given in the announcement. The vote gives shareholders a say in whether the acquisition takes place.
If the majority of shareholders vote for the take-private transaction, the private party pays all outstanding shareholders the agreed-upon price per share. The company will be delisted from public exchanges following the close of the transaction, and the company will effectively become a private business.
If the Offer is Rejected
In most cases, a negotiation process starts when an offer to take a company private is rejected. If the two parties eventually agree on a price, the offer is accepted and the process above begins.
If the two parties can’t agree on a price, a hostile takeover may be the next step.
In a hostile takeover, the private entity goes around the company’s board of directors and addresses shareholders directly. The private entity will force a vote if it can persuade the majority of the company’s shareholders to accept the offer. The board of directors may ultimately have no choice but to move forward with the transaction.
What Happens to Stock When a Public Company Goes Private?
When a public company goes private, its stock is immediately delisted from all public exchanges. Although the stock may still exist, all shares will be held by the private entity that acquired the company.
What Happens to Shareholders When a Company Goes Private?
If you own shares of a company that’s going private, you’re in luck. When the transaction closes, you’ll get a cash payment to your brokerage account based on the share price of the transaction.
For example, if you own 100 shares of Twitter, you’ll receive $5,420 when Elon Musk completes the transaction to take the company private. The math is simple. Musk offered $54.20 per share. Multiply the offer price by the number of shares you own (100) and you come to the total payment you can expect to receive once the transaction closes.
What Happens to Private Shareholders When a Company Goes Private?
Private shareholders take control of the company when it goes private. These shareholders, rather than public investors, will share in the price appreciation and profits the company generates moving forward.
Sticking with the example of Musk purchasing Twitter, once the transaction closes, Musk will own all shares of the social media giant. This means he will decide how the company operates and will be the beneficiary of any price appreciation or profits from the business.
Watch for Privatization Rumors
Investors pay close attention when there’s any insinuation of a take-private transaction, and for good reason. These transactions are massive liquidity events that tend to result in a significant return of value for investors.
When any hint of privatization is rolling around the market, investors tend to dive into the affected stock.
This is a dangerous action that can lead to significant losses, however. Take-private and other acquisition rumors are often used in pump-and-dump schemes to artificially inflate stock prices. In many cases, once the excitement fades, innocent stockholders are left holding a bag of losses.
In some cases, a company’s leadership may take a stab at a take-private transaction and announce their intentions. For example, Musk announced he was attempting to take his electric vehicle company Tesla private in August 2018.
However, even investing following these types of announcements can be dangerous.
When Musk made his announcement, Tesla’s stock skyrocketed. The stock saw such extreme volume that the Securities and Exchange Commission (SEC) halted trading to avoid excessive movement in the stock’s market price.
Ultimately, Musk never took Tesla private. To make matters worse, the stock was down from over $70 per share following the announcement to around $61 per share just 10 days later. By September 7, 2018, the stock was trading in the low $50 range. Investors with short-term hopes of a take-private transaction were left holding the bag.
Sure, there are ways to make money by trading on the high volatility that follows take-private rumors, hopes, and dreams, but high volatility equates to high risk. You should only attempt to tap into this volatility if you have extensive trading experience.
Privatization FAQs
Sure, take-private transactions happen all the time. But few demand a spotlight quite as bright as Musk’s privatization of Twitter. With the news hitting the tape, more and more people are learning about these types of transactions.
Of course, the learning process always comes with at least a question or two. Here are answers to the most commonly asked questions about privatization:
What’s the Difference Between a Public Company vs. a Private Company?
Publicly traded companies are traded on public stock exchanges like the NYSE. These companies are owned by the investing public, and any investor can buy into them. That is, as long as there are stockholders willing to sell their shares.
Public companies face stiff regulatory requirements in order to protect the investing public. Moreover, public companies are at the mercy of shareholders. When the boards of directors of these companies want to make major changes, like adding a new board member or making an acquisition, they propose the actions to shareholders. Then, shareholders vote on whether to accept or reject the proposal.
Privately held companies are companies owned by private entities. They may be owned by a single individual, a family, a group of investors, or a private equity firm. Private companies don’t deal with such stringent government regulations because they’re not owned by the general public. Moreover, the private entity that owns the company makes all the decisions about its operations.
Why Would a Public Company Go Private?
There are multiple reasons a public company may choose to go private. Most importantly, private companies face less regulatory scrutiny than public companies. At the same time, these transactions typically offer shareholders, including the company’s management team, a premium return on their investments.
It’s also worth mentioning that maintaining a publicly traded company is difficult work. Management teams are at the mercy of their shareholders and must turn to them when big decisions are being made. Moreover, public company reporting requirements take quite a bit of time and financial resources to meet.
Going private takes the headaches of being a publicly traded company off management’s shoulders. This frees up both time and money that can be used toward the growth of the company, rather than maintaining a solid relationship with investors.
Should You Buy a Company’s Stock After a Private Buyout Is Announced?
Retail investors often flock to stocks when buyouts are announced, and buying a stock after an announcement could be a lucrative investment. The key isn’t when you buy, it’s how much money you pay for the stock.
For example, a couple of days after Musk announced the planned acquisition of Twitter, the price of the stock was sitting at around $48 per share. That’s well below the $54.20 offer. If all goes well, investors who buy in at the $48 price point stand to make a meaningful profit.
However, there’s one major risk to consider before diving in. Acquisitions require both shareholder and regulatory approval. Moreover, the company being acquired must pass intense audits by the purchasing party. If shareholders vote against the transaction, regulatory agencies step in, or something goes wrong with an audit, the transaction could be blocked and the stock may fall.
What Major Companies Have Gone Private?
Well-known companies go private from time to time. Some of the most notable take-private transactions outside of the recent Twitter transaction include:
- Dell. In 2013, the computer maker Dell went private in a $24.4 billion deal.
- Burger King. In 2010, the fast-food chain Burger King went private in a $3.26 billion deal.
- Hilton Worldwide. The Hilton hotel company went private in 2007 in a deal worth $26 billion.
Final Word
Privatization is usually beneficial for all parties involved. Investors are paid a premium on the shares they own, while the private party gains full control over the company in question.
However, news surrounding these transactions can also be dangerous for beginner investors.
It’s easy to get wrapped up in the high-flying movements following any insinuation of privatization. Unfortunately, diving in often leads to beginners hitting their heads!
You shouldn’t buy a stock solely based on the coming privatization of the company unless you’re an experienced active trader. Anything can happen, and if the deal falls through, your investment will likely lose value.