TIME: Almanac 1990/1990 Time Magazine Compact Almanac, The (1991)(Time).iso/time/081489/08148900.013

Text File | 1990-09-17 | 9KB | 158 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