Buying a 'shell' company can be cheaper alternative to IPO route.

When most talk about "shell companies," or "buying a public shell," there is usually a hint of nefariousness in the air, possibly because of the unfair association with the classic "shell game."

Too, many companies in the past have purchased shell companies to short-circuit SEC regulators, or pull some sort of financial chicanery.

But buying a public shell can be a perfectly legitimate, and smart, move for many private company owners, says James McKillop, managing director at Santa Monica-based BKL Capital, a consulting firm.

Why not just go public through an initial public offering?

First, an IPO is an expensive proposition, with no guarantee of success, says McKillop (although in 1996, it seemed that almost anything offered flew). "A full-blown IPO can cost $300,000 or more," says McKillop.

Also, in going public, some large fraction, or perhaps a majority, of the stock must be sold to outsiders - the investing public. Not every business operator wants to do that.

But McKillop says he can usually organize the purchase of and merger with a shell company for $50,000 to $100,000.

The process is fairly simple - just find a public company selling for a few cents a share, and make a tender offer for the majority of the stock. Change the board, insert your own, and you're ready to fly.

Of course, in going the IPO route, a company can raise capital, if the public buys - so the shell option is for companies not seeking growth capital in the short-run, says McKillop.

In the longer run, the record of being public and posting results can help raise capital, he said.

McKillop claims that a large fraction, perhaps one-fifth, of the stocks traded on the Nasdaq small-cap exchange are actually companies that purchased shells, but the public doesn't know it.

Nasdaq officials last week said they don't know and don't keep stats on the topic.

One advantage to a company going public, and thus posting public earnings and having regularly audited financials, is the huge premium the market accords to public vs. private companies, says McKillop.

"If a private company becomes public, it can become worth two to 10 times more, because of the p-e ratios accorded public companies," McKillop says. (The p-e is ratio of a company's stock price to its annual earnings per share. Thus, if a company earned $1 a share in 1996, and its stock is trading at $10, it has a p-e ratio of 10.)

While 10-fold increases in a company's worth upon going public may be a very extreme case, most investment bankers agree that far higher valuations are bad for public companies.

The S&P 500 (a broad gauge of the overall market) is trading at close to 20 times earnings - enough to make even the most private of individuals ponder the rewards of Wall Street.

One reason for the premium is that investors in public companies get the comfort of reported results and a verifiable track record, plus liquidity. And liquidity is perhaps the greatest comfort an investor can have in this world.

How does McKillop, a former Merrill Lynch broker, avoid the fly-by-night operators who just want a shell so they can quickly sell shares in something that may not be kosher?

"Make sure you've got a company that is auditable, so you can see exactly what they got," he says. Wise words for any investor.

McKillop says the strategy of buying a shell company makes sense for companies with more than $5 million in sales.

Roberts' new roost

We see that Fredric M. Roberts of the Westside-based F.M. Roberts & Co., has signed on as the investment banker-advisor to Koo Koo Roo Inc., the fast-food franchise which also owns the do-it-yourself ceramic shops chain named Color Me Mine Inc.

We asked Roberts last week if Koo Koo Roo is for sale, given that the company's news release states a merger is one option Roberts had been hired to investigate.

"Absolutely not!" says Roberts. "This company is potentially a buyer, not a seller."

Roberts is known for his days on the National Association of Securities Dealers board, as well as being the investment banker on many California deals.

Koo Koo Roo is one of those companies you can't keep out of the news.

As is noted often in financial circles and publications, Michael Milken, as well as his associates and family, are frequent customers, and Iacocca Partners owns a hefty stake.

That's Lee Iacocca's partnership, which includes luminaries such as lawyer Robert Shapiro, singer John Denver and actor John Malkovich.

But Milken is not an investor. Archon Capital Partners, which had Milken financial backing, did not buy half, as it once planned to do, reported Rob Kautz, Koo Koo Roo CFO.

Ken Berg, Koo Koo Roo chairman, and Kautz say Roberts has been hired to look at raising money for the acquisition of smaller fast-food chains, which could be converted to Koo Koo Roos.

Too, they are hoping to get some analyst coverage as a result of Roberts' involvement.

But for all the glitz, name-recognition and money-raising, Koo Koo Roo has laid an egg where it counts - on Wall Street.

In one of the great bull markets of all time, Koo Koo Roo stock trades sideways in the $6-to-$8-a-share range.

The market, of course, wants to see black ink, but Koo Koo Roo is in an expansion mode, which costs money. The chain has never made money.

Full-fledged new stores cost more than $1 million to open, says Berg. Now the chain has 29 stores, and 10 related coffee houses, as well as 16 Color-Me-Mine ceramic shops - all company-owned.

Still, the market says, "show me the money."

When does Koo Koo Roo start posting black ink, as in cents per share?

"Later, later this year," says Berg. "But we'll have positive cash flow (earnings before depreciation) before then, probably in the second quarter."