The Popular Game Of Going Private
By John Greenwald
In the world of high finance, where billion-dollar deals can be struck between cocktails and dessert, the hottest play these days is a once obscure transaction known as the leveraged buyout. In such operations, corporate officers are turning publicly held firms into private businesses that are free from the demands of short-term investors and the unwanted attention of corporate raiders. In the process many of them are making vast profits for shareholders and themselves.
All that is needed to play this lucrative game is mountains of borrowed money--or leverage, in financial jargon--which lenders seem eager to provide. A record $10.8 billion was spent to take companies private in 1984, vs. just $636 million in 1979. This year's pace is even more furious.
One of the largest and most ambitious buyouts yet was proposed last week by executives of R.H. Macy & Co. (fiscal 1985 sales: $4.4 billion), the eleventh-biggest U.S. retailer. Led by Chairman Edward Finkelstein, a group of top officers offered $70 a share, or $3.58 billion, for Macy's stock that had been selling for about $50 a share. The Macy's executives were working last week with the Wall Street firm of Goldman Sachs to line up virtually all that money. The high buyout price, apparently designed to repel rival offers and avoid a bidding war for the company, drove up the value of other retailing issues as investors speculated that a wave of buyouts was about to break over the department-store industry.
Indeed, merchandising firms are much in vogue with acquisition-minded managers. One day after the Macy's announcement, officers of Household International agreed to pay $700 million for the Chicago-based conglomerate's retailing units, which include Coast-to-Coast hardware and the Ben Franklin variety chain. Even small Wieboldt Stores, a 102-year-old Chicago concern, last week announced a $37.4 million deal that turned the firm into a private company.
Consumer-product companies have been going private as well. Mary Kay Ash, chairman of Mary Kay Cosmetics, last May began a $300 million buyout of her company. In August, San Francisco-based Levi Strauss, the largest brand-name clothing maker in the U.S., was acquired for $1.48 billion by a group headed by corporate executives and descendants of the company's founder.
Some skittish firms turn to buyouts to escape unwelcome suitors. "Management has often used them as a weapon to defend against hostile takeovers," says Burton Malkiel, dean of the Yale School of Organization and Management. Directors of Storer Communications, a major cable-TV operator, voted last summer to take the company private for $93.50 a share, rather than accept a $95-to-$96 bid from Comcast, a smaller cable company. Revlon pursued a similar path last month when it arranged a complex $1.8 billion transaction that would break up the cosmetics firm but keep it out of the hands of Pantry Pride, a Florida retailer. Revlon suffered a setback last week when a court struck down its plan to sell two divisions for a bargain price of $525 million as part of the proposed deal. The ruling allowed Pantry Pride to continue its take-over effort.
Management buyouts are evolving into offensive weapons too. "They can be viewed as offers made by internal raiders," notes Alfred Rappaport, professor of accounting at Northwestern University's Kellogg School of Management. In one snarled battle, investors, led by the former chairman of a Beatrice acquisition, offered nearly $5 billion for Beatrice, which last month rejected the bid. Now Beatrice (fiscal 1985 sales: $12.6 billion) may be turning to outsiders for help. Said one Chicago lawyer: "Their investment bankers are burning up the phone lines looking for a white knight."
Beatrice last week received word of a different kind of proposal that the firm may wish to ponder. It came from Warren Avis, founder of the Avis car-rental company. The entrepreneur, who sold Avis in 1954, said he wants to buy it back from Beatrice, which has owned the business for little more than a year. Avis said he has assembled a group of private, international investors who hope to acquire the auto concern, which operates in more than 100 countries and is worth an estimated $400 million.
Management buyouts are hot and growing hotter because they have so far produced countless winners and few if any losers. A typical deal involves bankers, institutional investors, Wall Street firms that specialize in buyouts and the managers of acquired companies. To start a transaction, the executives turn to Wall Street experts to arrange financing. "We look for three things," says Leonard Shaykin, managing partner of Adler & Shaykin, an investment house that specializes in buyouts. "They are consistent past profits, predictable future profits and quality management."
Once he decides to work on a deal, Shaykin makes the rounds of banks and large investors like pension funds and insurance companies, which put up the loan money. Banks are leery of lending to foreign countries, oil drillers and other risky debtors, but they are happy to provide up to 70% of the cost of a buyout because of the large fees and lucrative interest rates that such business brings. The rest of the credit comes from selling so-called junk bonds--IOUs with relatively poor quality ratings--and other securities that offer high yields. Like the banks, investors count on getting their money back from earnings of the acquired firm or from the sale of its assets. "Lenders look for a business that is very stable," says a California moneyman. "The company ought to generate lots of cash."
When the buyout is completed, the company is owned by the participants in the deal. The management group, which invests its own money, often comes away with perhaps 20%. The big investors may get ownership rights for 45%. The remainder is usually held by the investment firm that brought the partners together. It also collects around 1% of the total value of a buyout, plus consulting and other fees. Buyouts invariably increase the value of the stock that executives had before the deal. Afterward the managers generally hold far more of the private company than they did of the public one and can collect hefty dividends on their shares. All of the owners can also gain mightily if the company later decides to sell stock to the public again. It may do that to raise more cash than it can get as a heavily indebted private firm. If the corporation does go public, the offering price will reflect such factors as the value of the company's assets and the price that shares of comparable firms are fetching on the open market.
A near legendary windfall was made in a public offering by William Simon, Treasury Secretary in the Nixon and Ford Administrations. In 1982 a Simon-led group of investors put up $1 million of their own money and borrowed $79 million to buy the Gibson greeting-card company from RCA. They turned Gibson into a private firm and reorganized its operations. Then, just 18 months later, they sold $290 million worth of the company's stock to the public. Simon alone earned more than $15 million and wound up holding shares in Gibson worth about $50 million.
To be sure, there are solid business reasons for taking a company private. Once freed from the need to satisfy Wall Street stock analysts and short-term shareholders, who often demand ever rising profits each quarter, corporate leaders can focus on long-term goals. Says Dean Meadors, a spokesman for Mary Kay Cosmetics: "Going private gives us the opportunity to get out of the fishbowl and to make marketing decisions in a longer time frame than a public company has. Sometimes you need to invest in the future, and sometimes the future is more than 90 days away."
The popularity of buyouts has received an added boost from the U.S. tax code, which permits investors to deduct the interest on their debts. That makes heavy borrowing attractive, since debtors can use IOUs as tax shelters and thus charge part of their cost to Uncle Sam. "Our tax laws clearly encourage this kind of activity," says Yale's Malkiel.
The spate of buyouts has raised fears that companies may be crushed by their huge debts if interest rates climb or the economy falls into a recession. Other critics call going private a waste of scarce capital. "As a financier, I regard it as an easy way to get rich," says Martin Whitman, president of M.J. Whitman & Co., a Manhattan investment firm. "But as a citizen who loves his country, I think there are better and more productive uses of the nation's money supply than to create debt to pay off stockholders."
Yet the debt-laden deals have their defenders. "I don't think leverage is a bad thing," says John Makin, director of fiscal-policy studies at Washington's American Enterprise Institute. "Very few people would own a house without it. It is a very important tool of modern finance." At a time when corporate raiders are on the rampage and Wall Street has become obsessed with short-term gains rather than long-term strategy, buyouts are often just good business. --By John Greenwald. Reported by Raji Samghabadi/New York and Elizabeth Taylor/Chicago BIG PRICE TAGS
Leveraged buyouts, completed or being negotiated
[This article contains a table. Please see hardcopy of magazine or PDF.]
Company
Date of transaction
Value in billions
Beatrice
In process
$4.91[*]
R.H. Macy
In process
$3.58[*]
Continental Group
Nov. '84
$2.75
Storer Communications
In process
$2.5[*]
Revlon
In process
$1.83[*]
Union Texas Petroleum (50%)
July '85
$1.7
Levi Strauss
Aug. '85
$1.48
Northwest Industries
July '85
$1.37
City Investing (3 subsidiaries)
Dec. '84
$1.25
[*] Highest offer to date
Source: Mergers and Acquisitions
With reporting by Reported by Raji Samghabadi/New York, Elizabeth Taylor/Chicago