A Stitch in Haste

If you want to see someone hell-bent on proving himself an ignoramus, then look no further than Michael Kinsley:

So free-market capitalism has decreed three different values for this company [taken private through a leveraged buyout]. One is set by the stock market: the value of all the company's outstanding shares, or "market capitalization." One is what the private investors are offering -- usually a bit more than the market cap. And one is what the private investors sell the company for a blink of an eye later -- which is usually a lot more than the other two. Which of these numbers is the true capitalist price? Which one represents the most sublime interaction of supply and demand?

This is, of course, utter nonsense.

Let's look at Kinsley's three supposedly inconsistent values for his hypothetical taken-private company:

1. The publicly traded price -- the "market cap" -- is indeed the net result of all the supply and demand curves for all the company's equity and debt securities by all the current and potential investors (and the company itself). Nothing exciting there.

2. The private price, which as Kinsley notes is usually higher than the publicly-traded market cap. But this is exactly what ought to happen and is a "contradiction" only to the financially illiterate. Two quick and easy explanations jump out. First is the control premium: owning (and therefore controlling) 100% of a company is not the same as owning "one million times one one-millionth" of that company through passive ownership of stock (which, recall, comes with no control over the day-to-day operations of the firm). Owning an asset that you fully control is more valuable than owning an asset that you do not fully control. This is not a difficult concept. Second is the regulatory cost of "listing" a company (i.e., having it trade publicly on stock exchanges). If you have investors, then you need to print annual reports, have shareholder meetings, staff an investor relations office, etc. Oh, and that pesky little Sarbanes-Oxley law. A private company has lower costs, ceteris paribus, than its publicly traded counterpart, and can therefore operate more profitably, ceteris paribus. Hence a private bidder can and should be willing to pay a premium to the publicly traded market cap. This is not a difficult concept.

3. The turnaround price. Two simple analogies should suffice here. First: You buy a home for $200,000, fix it up for $50,000 plus your own labor and effort, then sell it for $300,000. This is a "pricing contradiction" -- how? Second: Consider the same analogy, except it's a restaurant and you not only fix it up but also change the menu based on your own entrepreneurial research and risk-taking. The restaurant is a hit, profits increase and you sell out at a profit. This is a "pricing contradiction" -- how?

Those who are desperate to find flaws or contradictions in capitalism often end up inventing them, since they are rarely to be found. Kinsley's dumb rant is no different.

More thoughts from Liberty Papers.