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Gander Mountain: Case study in challenges facing small public companies

Despite a dramatic turnaround in earnings, Gander Mountain intends to go private after a nearly six-year run as a public company. The reality: It simply doesn’t fit the current market’s public model.

Gander Mountain (NASD:GMTN) showed a robust earnings turnaround in its recent Q3 results, after posting losses the previous two quarters and a positive year-over-year comparison.

Gander reported a profit of $ 3.2 million, or 13 cents per share, compared with $800,000, or 3 cents per share, in the third quarter of last year.

Yet the company had earlier announced its intention to take its shares off the public market — “deregistration,” in Wall Street parlance — after a nearly six-year run as a public company.

Why would a public company with sales in excess of $1 billion across 118 stores in 23 states, and self-described as operating “the nation’s largest retail network of stores specializing in hunting, fishing, camping, marine and outdoor lifestyle products and services” choose to go dark?

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“We believe our status as a public company has not only failed to benefit our shareholders materially, but also places an unnecessary financial, management and competitive burden on us,” the company said in its filing with the Securities and Exchange Commission.

117 companies trying to go private this year
So far this year, 117 companies have filed papers with the SEC to go private, some because they are being acquired or merging with another entity, and some — as Gander Mountain says in its filing — because “the significant tangible and intangible costs of our being a public company are not justified … we have not been able to realize many of the benefits that publicly traded companies sometimes realize.”

Now the company is awaiting SEC approval of its plan for a complicated reverse/forward stock split designed to reduce the number of shareholders below 300, the threshold required to go private. Under the proposal, shareholders with fewer than 30,000 shares are to receive $5.15 per share, requiring a maximum payout of about $23.9 million to cash out those shareholders, the company estimates.

Key insiders stand to substantially increase their ownership stake. David Pratt, chairman of the Board and interim CEO at Gander Mountain, is also part of the Gratco Group, a major lender to Gander. Ronald and Gerald Erickson, who are part of the Holiday Group, also a major lender, are also directors at Gander Mountain. After the transaction, the three executives will increase their collective beneficial ownership of Gander Mountain common stock from about 76.2 percent to 95.4 percent, according to the company.

4 shareholders trying to stop the change
Four shareholders have sued Gander Mountain, as well as Holiday Group and the Gratco Group, in Ramsey County District Court to try to stop the transaction, force a shareholder vote, win damages and force “disgorgement of unspecified benefits,” according to the company filings.

After Gander’s initial public offering in 2004, the business — burdened with high debt used to expand from 65 stores to the current 118 — struggled to make a profit.

As a result, in recent years, the stock price has traded in the single digits, well below the IPO price of $20. During the spring and summer of 2008, a special committee of Gander’s board, working with bankers from Lazard Middle Market LLC, tried to solicit interest from 104 third parties to conduct a going private transaction, without any takers. The board concluded it “lacked attractive strategic alternatives.”

While the company was unwilling to speak about the transaction, much can be gleaned by reading its public filings with the SEC.

Cost is one primary consideration, according to the company filings. The firm estimates annual cash cost savings of about $1.6 million before taxes. The savings would come from about $280,000 in audit-related fees, $250,000 in legal fees, $275,000 in fees related to Sarbanes-Oxley Act compliance, $350,000 for directors and officers insurance, $230,000 in board of director fees and meeting costs, and $245,000 in public company filing fees, investor relations costs and other items, such as printing and stock transfer fees.

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In addition, the company claims it lacks “an active trading market (for Gander common stock) due to our small market capitalization, concentration of ownership and limited public float.” This has limited the company’s ability to use its stock for acquisitions, and to attract and retain employees, as well as provide exit opportunities for shareholders, the company said.

In the past two years, the stock on average has traded just more than 50,000 shares a day, in contrast to more than twice that volume since going public in 2004.

The company expects “greater operational flexibility by being able to focus on our long-term operations without emphasis on short-term quarterly results … and may benefit from not having to reveal detailed financial and operational information to the public and our competitors.”

Legislation can be a factor
The Sarbanes-Oxley Act of 2003 (SOX), which created significant new reporting and compliance requirements for companies, has been studied as a major factor in smaller companies’ decisions to go private.

University of Minnesota finance professor Ivy Zhang found SOX contributed significantly to wiping $1.4 trillion off the value of the stock market and that investors also were particularly sensitive to the outsized cost impact of SOX compliance on smaller companies. Another group of researchers found smaller firms and those with greater inside ownership have shown higher rates of going private in the post-SOX period, compared with the period before the legislation.

But not all the research blames SOX or compliance costs. Several researchers — including Tracy Wang, also at the University of Minnesota — while acknowledging that cost savings are real, argued that “going dark could be a way for controlling insiders, i.e., managers and large owners, to avoid the outside scrutiny that comes with, or is greatly facilitated by, SEC reporting.”

There are market realities at play as well.

Attracting Wall Street research coverage has become increasingly difficult for smaller companies, particularly following the separation of research and investment banking earlier in the decade, which essentially broke the dominant business model for equity research.

A further complicating factor for Gander is the high insider ownership, often viewed as a positive by the street. However, too high an insider ownership limits the public float and eliminates the “takeover premium” investors are willing to pay for a company that could easily be put into play. As a result, Gander has struggled to attract research coverage, a key element for achieving an institutional investor following.

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The rise of computer-driven algorithmic trading has also left smaller companies by the wayside in today’s market.

Some market participants have estimated that as much as 75 percent of a company’s average daily trading volume is driven by computer algorithms unconnected to any fundamental investment activity in a company. With high insider ownership and limited float, Gander Mountain simply does not fit the current market’s model for an actively traded publicly listed security.