So you want to go public?

By Stan Luxenberg

If you like roller coasters, you'll love Wall Street. Just ask the Mursteins of Medallion Financial.

It was the worst of times. Last September, with war on the horizon and corporate earnings lackluster, the Standard & Poor's 500-stock index dropped 10% of its value, after having peaked on August 22. But not all stocks dropped. Shares of Medallion Financial Corporation, a lender to the taxi industry, rose from less than $3 in August to $4.80 by the end of September. Why? Who knows? As investors have learned too well recently, markets don't always behave rationally.

Welcome to the unpredictable world of public stock ownership. The Murstein family of New York, which controls Medallion, took the company public in 1996, and since then shareholders have faced a roller-coaster ride as the stock has climbed and crashed several times. Still, Andrew Murstein, Medallion's 37-year-old president, insists he has no regrets about selling stock in the business, which was started by his grandfather and reported $39.3 million in revenues in 2001. “Going public can be risky, but it has enabled us to grow much faster than we would have otherwise,” he says.

With markets so unsettled, initial stock offerings have faced cool receptions lately. But going public may be the right long-term goal for some family businesses. “Sometimes the public market is the cheapest source of equity capital,” says François de Visscher, a partner in de Visscher & Co., an investment banker for family companies in Greenwich, Conn. When markets are strong, investors will pay premium prices for public shares, especially if the capital is being used to fund a company with strong growth potential. Family businesses that have used public equity to finance healthy expansion in recent years include J.M. Smucker Co. and Comcast Corp., the cable television giant controlled by the Roberts family.

But going public can often prove disappointing. Public shares usually perform poorly when family members stage an initial offering simply as a vehicle for cashing out. New offerings also tend to sag when the family retains a big block of stock. “When there are only a limited number of shares trading publicly, then the stock might not attract much interest, and the valuation will be weak,” says de Visscher.

Under any circumstances, going public imposes costs and burdens. Suddenly a family must operate in the public eye, explaining actions to Wall Street analysts. The business must spend money to hire lawyers and accountants needed to make public filings. A company that once functioned for the benefit of the family must become concerned about cutting costs and rewarding shareholders. Some families simply can't make the transition to operating in the spotlight. And of course some get corrupted by their proximity to all that public money. The Rigas family, founders of Adelphia Communications, have been charged with using the company as their personal piggy bank. The Waksals, who ran ImClone Systems—and became famous for their friendship with Martha Stewart—have been accused of insider trading.

For the Mursteins, going public represented an opportunity to transform a small local business into a national operation. The company was founded by Leon Murstein, who immigrated from Poland to New York in 1937 and began driving a taxi. Leon soon was able to pay $10 for a medallion, the license required to operate a taxi in the city. Thriving in his new hometown, he began buying more medallions and taxis. Eventually Leon bought a garage that resembled the fictional operation portrayed on the 1970s hit TV show Taxi. In the business, drivers paid the owner a percentage of their fares as rent for the cars.

Alvin Murstein, Leon's son, joined the business at age 18 in 1952, becoming chief executive in 1974 when his father retired. Alvin, a soft-spoken entrepreneur who originally trained as an accountant, remains CEO today at age 68. Beginning in the 1970s, Alvin often brought his son Andrew to the garage, where the youngster tasted work at an early age.

Andrew says he learned much from his first encounters with drivers, most of them immigrants who spoke imperfect English and were desperate to make their way in America. The drivers typically worked 12-hour shifts and were required to turn in their cars at the end of the time. Some would finish late, having squeezed in one extra fare and earned a few more dollars. As one of his first jobs, Andrew collected money from the cabbies and listened to their excuses for tardiness.

“Some said they had to help a policeman catch a burglar or deliver a baby in their cab,” he recalls. “I eventually learned that most of the excuses were phony. But the real lesson was that these immigrants are extremely hard-working, and they're willing to work long hours to get ahead.”

The business grew steadily, and by the 1970s the Mursteins owned more than 150 taxis and medallions. Then some rough spots appeared in the road. As New York's economy stagnated, crime rose and cab driver muggings increased. About a quarter of the family's taxis sat empty because no one was willing to drive.

“We faced a severe manpower shortage,” recalls Alvin. “We weren't making any money operating cabs, so we needed to do something to salvage the investment.”

Faced with mounting debts, Alvin began selling medallions to drivers and was surprised to find eager customers. There was good reason for the demand: New York City had fewer than 12,000 taxi licenses circulating in the 1930s, and that number had barely increased over the years, even as demand for taxi rides climbed. Anyone seeking a medallion had to purchase one from an owner—and pay the market price. By 1970, the going price had risen to about $20,000. Few immigrant drivers could afford that sum, so most sales went to fleet operators or to drivers who could obtain financing.

Alvin figured those hard-working immigrant cabbies were a good risk, so he lent several drivers the money to purchase his medallions. Like the 19th century's great “merchant bankers”—the Rothschilds, Barings and Hambros in Europe and the Seligmans, Kuhns, Loebs and Goldmans in America, who began as merchants extending credit to their customers—Alvin Murstein soon discovered that financing drivers was more lucrative than employing them. The idea for Medallion Financial was born. In addition to selling his own licenses, Alvin provided financing for drivers making purchases from other people. In 1986, the company expanded to finance dry cleaners and other immigrant businesses.

Initially, the Mursteins relied on their own capital and bank loans. Then Alvin gradually found a network of some 100 private investors who were willing to finance his operations. These were accountants and lawyers who knew the Murstein family and believed the business was sound.

While his father expanded into financing, Andrew obtained an MBA at New York University and worked on Wall Street as an investment banker. There he gained an appreciation for the power of public equity. He was particularly impressed with deals known as roll-ups. In these, a company would raise cash through a stock offering; then it would purchase small, inefficient businesses and build them into a giant that benefited from economies of scale. A classic success of the type was Waste Management, which bought up family-owned garbage dumps and assembled them into a national powerhouse.

Andrew joined his father in 1990 and began thinking about how Medallion could grow. A big obstacle, he believed, was the steep cost of funds. In the 1990s, the company was borrowing money at the prime rate, then about 8%, and lending money to drivers at rates of about 10%. If Medallion could improve its credit rating, the company could lower its cost of borrowing to 6%, doubling the profit margin. Wearing a crisp white shirt and tie and talking confidently like the investment banker he once was, Andrew explains the strategy he developed. “I thought that if we became a large public company, we could have a very low cost of funds,” he says. “We could grow rapidly and take market share away from our competitors.”

Alvin approved Andrew's plans. He continued to hold veto power over investments, but encouraged his energetic son's bold ideas. The company went public in 1996, and for four years the strategy worked flawlessly. “When we first went public, everyone was excited,” says Andrew. “The employees watched the stock price every day. But now the novelty has worn off, and most employees have stopped following the stock price closely.”

With the shares soaring above $20, Medallion used the high-flying stock to acquire 15 companies, mostly finance companies that made loans to taxis and other small businesses. Some of these operations were located in New York, but other purchases were in Boston, Chicago and other cities around the country.

As Andrew had hoped, Medallion came to be seen as a diversified national company. Credit agencies raised its ratings, and Medallion's profit margins exploded. When Andrew promptly started another new business—offering advertising on taxis—Wall Street analysts applauded. “Analysts said this was a great business, and the advertising business showed tremendous promise,” recalls Andrew.

Then as the stock market began to dip in 2000, life became harder for Medallion. Banks, worried about rising defaults, tightened their credit standards and raised rates on small businesses. The terrorist attacks in September 2001 made institutions particularly nervous about loans to businesses in New York. Instead of paying two percentage points below the prime, Medallion began to be charged two points above. That extra cost destroyed Medallion's profit margins.

Suddenly Wall Street analysts began finding flaws in its business plan, saying that taxi advertising might be risky after all. One analyst, Robert P. Napoli of US Bancorp Piper Jaffray in Chicago, says that because of Medallion's weak earnings, its shares sell at a discount to the price of many small finance stocks.

But Andrew remained convinced that the difficulties were only temporary. At its core, he believed, the medallion business remained sound. Over the years, Andrew notes, the company has loaned $1 billion all told to the taxi industry and never sustained any losses. That's due to the peculiar nature of the market for medallions. With little increase in supply of the licenses, their price has steadily risen and now surpasses $200,000. Demand for medallions remains strong regardless of the national or local economy. In the past year, prices of New York medallions have climbed 15% as out-of-work immigrants have rushed to find a job that always pays. And if an illness or other problems sideline a driver, he can usually sell his license at a handsome profit, instead of defaulting.

On rare occasions, drivers do default on loans, but these cause only brief problems for Medallion Financial. “If someone defaults on a loan for a building, it can take the lender years to repossess the property,” says Andrew. “But if someone defaults on our loans, we send an independent company to pop the medallion off the car hood right away, and that taxi is out of business.”

But these nuances eluded most bankers. With banks unmoved by his appeal for lower interest rates, Andrew searched for cheaper financing sources. In September 2002, he announced the deal that boosted the company's stock price: a line of credit from Merrill Lynch that would help to lower some financing costs by three percentage points. The lower costs would immediately translate into higher profit margins.

While the Merrill Lynch deal goes a long way toward solving the financing problem, Andrew is looking toward a more comprehensive solution. He has applied for a charter as an industrial loan bank, an institution that can issue certificates of deposit and make loans to companies. That way, instead of depending on the whims of bank loan officers, Medallion's financing cost would be whatever rates investors demanded for certificates of deposit sold by Merrill Lynch or other brokers.

Today the Mursteins own about 16% of the company, a stake worth about $14 million at current prices. That's down from a peak value of $70 million. But Andrew insists he's not disappointed with the decision to go public. “I would rather own 1% of a terrific multimillion-dollar company than have 100% of a small company,” he says.

In the absence of other big shareholders, the Mursteins' 16% stake is sufficient to exercise control of the company. An acquirer could try to take the company away from them, but hostile takeovers—always rare to begin with—are extremely rare these days when financing is hard to find. Besides, it's unlikely that anyone would make a hostile bid for a business that owns few concrete assets and requires knowledge of an arcane market. To be sure, a friendly acquirer could offer to buy the company, but he'd have to pay a substantial premium. Executives of public companies are required to act for the benefit of all shareholders, and so they must consider acquisition offers. If the Mursteins did accept a friendly offer, they'd lose control of the company—but they'd probably come out extremely rich.

The Mursteins do add a note of caution for other family business owners who may consider going public. Dealing with regulators and Wall Street analysts can take considerable effort, they warn. Andrew says part of the reason the Mursteins could cope with the pressures of operating in a public arena was that the family expanded gradually, first taking on private investors. “We already had experience with outside investors,” he says, “so we were comfortable about making disclosures.”

“You can't spend your life focusing on the stock price,” says Alvin Murstein. “You've got to run the business the best way you know how. If the company succeeds, the stock price will go up, and things will work out.”

Stan Luxenberg is a financial writer who lives in New York.

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Winter 2003

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