Plan to Take Wherehouse Private Sparks Threat of Suit by Bondholders
Some of Wherehouse Entertainment’s bond holders, facing the possibility of millions of dollars in losses, are threatening to sue the Torrance retailer over a plan announced this week to go private to escape a hostile takeover bid by Shamrock Holdings.
Thomas Revy, managing director of Froley, Revy Investment Co., one of Wherehouse’s largest bondholders with $8 million worth, said Thursday that his pension management firm in Westwood notified Wherehouse that it opposes the plan to go private and may sue to try to force the company to try to redeem the bonds at face value.
Revy said he has contacted holders of about $25 million of the $50 million in convertible bonds Wherehouse has issued, and he said they plan to join him in protesting.
The dispute stems from a disclosure on Monday by Wherehouse that Adler & Shaykin, a private investment firm in New York, would acquire the company in a leveraged buyout. Wherehouse would be bought by a new company formed by Adler and Shaykin, WEI Holdings, at $14 a share, or $118 million for Wherehouse’s 8.4 million shares of common stock outstanding.
In a leveraged buyout, a company’s assets are pledged as collateral and money borrowed to finance the transaction is paid back with cash generated from operations or from the sale of assets.
Wherehouse sought Adler and Shaykin as a “white knight” in an attempt to end a two-month hostile takeover bid by Shamrock, a Burbank investment company owned by Roy E. Disney, nephew of the late Walt Disney, and his family. Wherehouse rents videocassettes and sells records, tapes, compact discs and computer software through 212 stores.
Wherehouse executives did not return telephone calls Thursday. Executives from Adler & Shaykin could not be reached for comment and a spokesman for Shamrock said the company had no comment.
The dilemma facing bondholders is this: They hold $50 million worth bonds that can be converted into 1.81 million shares of common stock at $27.60 a share. That $50 million, if converted, would be worth only about $25.4 million at the $14-a-share price Adler and Shaykin plans to pay.
It is unclear how many bond holders may convert their debt into common stock. The only alternative for investors is to hold the bonds, which pay a relatively low 6.25% annual interest rate until they mature in 2006, or sell them in the open market at the current price of about 50% of face value.
In addition, the bonds could become increasingly risky for those who elect to hold them because of the debt Adler & Shaykin is taking on to buy the company. Indeed, Standard & Poor’s, the bond rating service, said this week that its rating for the Wherehouse bonds is expected to fall from single-B to a riskier triple-C if Adler & Shaykin’s bid succeeds because Wherehouse will have to use substantially more cash to pay debt.
Wherehouse agreed when it issued the bonds to buy them back at face value in the event of a hostile takeover. Revy said that although Adler & Shaykin is buying the company in a friendly deal, he believes the bonds should be bought back because they resulted from Shamrock’s unfriendly bid.
“We view this as a result of a hostile takeover. It never would have happened if Shamrock hadn’t showed up,” Revy said.
Keith E. Benjamin, an analyst with Silberberg, Rosenthal & Co. in New York, said he is waiting to see the financial details in Adler & Shaykin’s tender offer before he makes a recommendation to his clients who hold the bonds.
He said a number of his clients who hold the bonds are irked; he predicted that some bond holders may sue as Froley, Revy is threatening to do. He said, however, that company directors appear to be on firm legal ground because their obligation was to get the best price for holders of Wherehouse’s common stock.
“It does seem likely there will be some legal action, but everybody I talk to doesn’t seem to think there is much of a case,” Benjamin said.
He said the company may elect to settle at some point with bond holders by buying the debt back at less than face value, but at more than holders would receive if they converted the bonds.
A convertible bond such as the one issued by Wherehouse allows an investor to loan money to a company in exchange for a bond that typically carries a lower interest rate than other corporate bonds.
Pitfalls of Convertibles
The investor, however, gets the right to convert the bond into shares of stock. Investors accept the lower interest rate when they believe the company’s stock price may rise considerably, making their investment ultimately worth much more.
The Wherehouse case shows the pitfalls of investing in convertible bonds, especially in the wake of the October stock market crash. When Wherehouse bonds were issued in 1986, the company’s stock was selling at about $22 a share. But it quickly dropped to less than $7 a share after a string of disappointing earnings results and because of the stock market crash.
