TIME: Almanac 1993/TIME Almanac 1993.iso/time/081489/08148900.013

Text File | 1992-09-23 | 8.9 KB | 174 lines

                                                                                BUSINESS, Page 50

LBOs: Let's Bail Out


If the economy goes south, debt-heavy buyouts could go under

By John Greenwald


    Like the giant truck-trailers that carry its name across
U.S. highways, Fruehauf Corp. was once an American institution.
But to escape a corporate raider, Fruehauf in 1986 went private
in a leveraged buyout that sent the company into a skid from
which it never recovered. After borrowing $1.5 billion to
repurchase its stock from shareholders, the Detroit company
frantically sold one division after another to lighten its debt
burden. To no avail: when it completes the sale of a subsidiary
that makes wheels and brakes later this summer, Fruehauf, which
had 1986 revenues of $2.7 billion and ranked among the 150
largest U.S. manufacturers, will be an empty shell existing in
name only.

    The demise of Fruehauf dramatizes the problems that could
befall a growing number of leveraged buyouts as the U.S.
economy softens. Touted as one of the hottest financial plays
of the go-go 1980s, LBOs zoomed in annual volume from about $250
million in 1980 to nearly $45 billion last year. The buyouts
included household names like R.H. Macy, Beatrice, TWA and
Safeway Stores. In such deals an investor group, often headed
by a company's own executives, uses bank loans and high-interest
junk bonds to buy a firm and take it private. Almost without
exception, the group immediately slashes costs, lays off workers
and sells divisions to reduce debt; the managers may eventually
reap huge profits by selling the streamlined company back to
public investors.

    But leveraged buyouts place enormous strains on even the
largest corporations. While all debt-laden acquisitions are
risky, LBOs replace the stock on corporate balance sheets with
loans that must be repaid, leaving executives with little room
for error. "Running an LBO is different from running other
companies," says Wilbur Ross, a senior managing director of
Rothschild Inc., a New York City investment firm. "The reaction
time at LBO companies has got to be a lot quicker, because they
must generate cash fast enough to beat those interest-payment
deadlines."

    LBOs invariably lose money at first because heavy debt
charges soak up their earnings. RJR Nabisco, which went private
last December in a record $25 billion buyout, last week reported
a staggering $309 million loss for the second quarter. Reason:
$1.05 billion in interest and debt expenses. In announcing the
loss, RJR Nabisco said its basic food and tobacco operations,
which include Nabisco cookies and Winston cigarettes, performed
strongly; the company added that its program to sell assets was
ahead of schedule. RJR Nabisco has already sold more than $2.5
billion of businesses, including most of its European food
operations.

    While no more than 5% of LBOs have so far been failures, an
economic downturn could sharply raise the number of casualties.
Warned Manuel Johnson, vice chairman of the Federal Reserve
Board, in a June speech: "If there were a significant negative
shock to the economy, high debt levels could lead to a
succession of bankruptcies, causing a crisis of confidence."
Johnson estimated that roughly 40% of all leveraged deals are
in cyclical industries that are "more likely to run into trouble
in the event of a severe slump."

    Government reports last week revealed new signs of economic
weakness, prompting worries that the current slowdown could
turn into a full-fledged recession. Although the Labor
Department said on Friday that the U.S. unemployment rate dipped
slightly, from 5.3% in June to 5.2% in July, the Government's
Index of Leading Economic Indicators, its chief forecasting
gauge, showed its fourth drop in five months. Another closely
watched barometer, which measures new orders and inventory by
the nation's corporate purchasing agents, fell to a six-year
low.

    Leveraged buyouts could be in trouble during a downturn for
many reasons. Investors in some LBOs may simply have paid too
high a price or accepted overly rosy projections about their
ability to repay debt. Other buyouts might flounder because
investment bankers arranged the deals with more concern for the
fat fees they produced than for the soundness of the
transactions, according to critics of Wall Street. Some studies
in LBO failure:

    FRUEHAUF. The company's troubles began after takeover
artist Asher Edelman launched a $1 billion hostile bid.
Following the advice of Merrill Lynch, Fruehauf acquired
Edelman's 10% stake at a profit to the raider of $120 million.
Some 70 Fruehauf executives then joined forces in a leveraged
buyout. But when the trailer division slumped in 1987 as
cost-conscious truckers cut back on new orders, Fruehauf had to
strain to meet interest payments, which had climbed to $101
million a year. As other divisions faltered, Fruehauf embarked
on desperate cost-cutting moves and fire sales that have
hollowed out the 71-year-old company. "They paid way too much,
and then their markets turned against them," says George Malley,
a former head of the trailer division.

    Victims of the collapse included Ronald Yoder, 37, who lost
his job as a crane operator when Fruehauf shuttered its Fort
Wayne, Ind., trailer plant in 1987. Yoder, who is married with
a 17-month-old son, now earns about a third less than the
$11.47 hourly wage he was paid at Fruehauf and receives no
health insurance from his present employer. Says he: "Sure, I
got another job, but I can't save a dime. We wanted to have
another baby, but we can't afford it. I didn't know what an LBO
was until a couple of years ago. They said that a lot of people
got rich. Well, I wasn't one of them."

    REVCO D.S. Back in 1986 it was the largest U.S. drugstore
chain. Revco plunged into an LBO that year after Herbert Haft,
chairman of the Dart Group of retailing companies, made a bid
for the Twins burg, Ohio-based firm. With advice from Salomon
Brothers, Revco chairman Sidney Dworkin led a $1.3 billion LBO
financed largely by junk bonds that paid more than 13% interest.
The company then expanded its line of merchandise to include
video players and electronic appliances in the hope of boosting
business. Bewildered customers began shopping elsewhere, and
Revco fell short of its sales and earnings targets. Revco became
the largest LBO to seek bankruptcy-court protection last year,
after a creditor demanded accelerated payments on $100 million
of junk bonds.

    SINGER. The defense contractor and former sewing-machine
maker had annual sales of nearly $2 billion before raider Paul
Bilzerian acquired the company in a $1.1 billion buyout in early
1988. Faced with interest payments of more than $120 million a
year, the new owner sold eight of Singer's twelve divisions in
an astonishing three-month blitz. Bilzerian, who is appealing
a June conviction that found him guilty of violating tax and
securities laws in previous takeover attempts, cut the Singer
work force from 28,000 to about 3,800. While many of the
employees simply switched owners, up to 9,000 may have lost
their jobs. "I think what happened is tragic," says Edward
Damon, who was vice president for corporate planning. "What's
left of Singer is not even a shadow of its former self."

    Not all leveraged buyouts have dismal consequences. Steven
Kaplan, a finance professor at the University of Chicago
business school, argues that the debt burden of an LBO
frequently "stops managers from pursuing stupid strategies." In
a two-year study of 76 leveraged buyouts that occurred between
1980 and 1986, Kaplan found that most produced handsome returns
for investors. But such studies can track only short-term trends
because LBOs are a recent development. Says Abbie Smith, a
University of Chicago accounting professor: "The real question
is, How risky are LBOs?  All the research so far has been
constrained by the relatively short periods of time involved in
buyout studies."

    Aside from a brief wave of concern about corporate debt
that swept Washington after the RJR Nabisco deal, Congress has
paid little attention to LBOs. In order to show the impact of
the buyouts, Massachusetts Democrat Edward Markey plans next
month to introduce a bill in the House that, among other things,
would require companies that go private in LBOs to file public
reports for five years.

    Such reports may prove unnecessary as the outcomes of many
leveraged buyouts -- one of the chief financial legacies of the
Roaring 1980s -- become obvious. Says Rothschild's Ross: "1990
and 1991 will be graduation day for many LBOs. Most will
graduate, some with honors. Others will be dropouts." More than
anything else, the course of the economy over the rest of 1989
could determine how long the list of delinquents will be.


-- Thomas McCarroll/New York, with other bureaus