Can Private Companies Outperform the Publicly-Helds?

Sure they can, and here’s one that does (from a subscriber-only article in The Wall Street Journal last weekend):

WICHITA, Kan. — Meet Charles Koch. Philosopher, engineer, self-trained economist, libertarian activist, philanthropist — and the CEO of Koch Industries, a $60 billion, 80,000-employee empire, which just recently became the largest and most profitable privately held company in America.

But you’ve probably never heard of it.

Neither Charles Koch nor his firm are household names. Mr. Koch (pronounced “coke”) has managed to live in relative obscurity despite being one of the richest men on the planet, with a net worth estimated at $14 billion. He is a man of modesty who craves none of the fame or public adulation that seems to preoccupy other members of the billionaires’ club.

….. Back in 1967, when Mr. Koch was in his early 30s, he became the reluctant president of the family business, then a $177 million, medium-sized oil firm. He recalls: “My father threatened that he was going to sell the company if I wouldn’t come back home to Kansas from the East Coast and run it.”

Nearly four decades later, that family company is a global conglomerate with net annual sales that exceed the GDP of many small nations, and it includes a diverse range of businesses supplying everything from jet fuel to plastic, asphalt to beef, toilet paper to lumber. It owns many familiar brand names such as Dixie cups, Stainmaster carpet and Brawny paper towels. The firm’s financial performance numbers have been positively gaudy, with a rate of return on investment that has outpaced the Standard & Poor’s 500 at least tenfold under Mr. Koch’s stewardship.

“We couldn’t have achieved the profitability we have,” Mr. Koch insists, “if we had been a public company. No investor would have been patient enough to allow us to build a firm oriented toward long-term growth and profits.” This is one of Mr. Koch’s bugaboos regarding the deficiencies of modern corporate management. He notes, “The short-term infatuation with quarterly earnings on Wall Street restricts the earnings potential of Fortune 500 publicly traded firms. Public firms are also feeding grounds for lawyers and lawsuits.”

He then confidently predicts: “Regulatory laws like Sarbanes-Oxley will only increase the earnings advantages of private firms. I would suspect that there will be more of these private company takeovers of publicly traded companies.” He’s referring to his blockbuster $21 billion purchase of Georgia Pacific last November, a Fortune 500 forest and paper company.

If Mr. Koch is right about the re-emergence of private corporate structures, it is a very big deal for the near-term future of financial markets. The hyperactive trend of the past decade to take companies public may be shifting into reverse gear. The Georgia Pacific deal, which was the largest acquisition of a publicly traded company by a private firm in U.S. history, would seem to confirm Mr. Koch’s thesis. “Since the Georgia Pacific purchase,” he tells me, “other publicly traded companies have come calling, asking whether we would be interested in taking them private, too.”

This creative forward-thinking should come as no surprise, because Mr. Koch is immersed in the ideas of liberty and free markets. Whereas the bookshelves of most of America’s leading CEOs are stocked with pop corporate management and “how to succeed” books, Mr. Koch’s office is a wall-to-wall shrine to writings in classical economics, or, as he calls it, “the science of liberty.”

The article wanders into other areas, but I want to stay with the public-private debate.

I believe Mr. Koch’s company is the exception instead of the rule. There is no doubt that there are definite difficulties involved in being a public company, and it’s getting worse instead of better. But instead of blithely assuming that going private will be the answer, and that the economy will suffer no harm from it, consider these shortcomings you often see at other private companies — shortcomings that I believe on average cause the typical significantly-sized private company to underperform similarly-sized pubic peers:

• Lack of professional management, or professional management that is willing to stay around without having a marketable ownership stake.
• Business continuity if a founding owner has no family members available or capable of taking the helm.
• Weak to non-existent boards of directors or advisors, and therefore a lack of outside-the-box ideas.
• Complacency, where a private owner might be perfectly satisfied staying at a certain level of business, while the equity markets demand growth. There’s nothing inherently wrong with complacency, but if everyone was that way, the economy would slow a great deal.
• All too often, a willingness on the part of private owners to drain their company dry, leaving it undercapitalized and unable to take advantage of new opportunities.

I’m sure there are some I have missed on the positive and negative sides. Feel free to add yours.