A Pair of Deals: One Shoe Fits, the Other Doesn’t
L.A. Gear Inc. needed help--and found it in financier Roy Disney’s bankroll and patience.
Orion Pictures Corp. needs help too. But instead of winning confidence and cash from its biggest investor--who just happens to be the richest man in the country--Orion is trying to wiggle its way out of its debt jam, offering to exchange its bonds for a new load of funny paper.
What does Wall Street think of the two approaches? L.A. Gear stock jumped $1.25 to $11.75 on Tuesday, after Roy Disney’s $100-million investment was announced. Orion stock, by contrast, has plunged to $5 from $9 since its restructuring plan was unveiled a week ago.
The L.A. Gear/Disney transaction is the kind of deal that many experts had believed would dominate in the credit-tight 1990s: A distressed but still-solvent firm wins financial and managerial help from an intelligent, cash-rich investor. Both sides see the wisdom and potential payoff in taking a long-term view, and in working together.
Meanwhile, Orion’s solution is straight from an outdated 1980s textbook. Investor John Kluge, who owns 68% of Orion and whose $5-billion wealth makes him the richest man in America by Forbes magazine’s estimates, won’t put new cash into the movie producer. Instead, he wants Orion’s bondholders to take the hit by giving up interest payments for seven years.
Orion’s plan just won’t fly, Wall Streeters say, because it brings nothing new to the table. But with Roy Disney’s help, L.A. Gear at least has a fighting chance of rejuvenating its athletic shoe franchise.
Everybody knows that there are plenty of L.A. Gears out there. The debt excesses of the ‘80s have really come home to roost in this recession, and thousands of companies suddenly need help. Just check out the accompanying chart of corporate bond defaults since 1980.
At the same time, there are supposed to be many individual and institutional investors dying to pump money into distressed but still-salvageable businesses, in the hope of reaping spectacular pay-backs by leading a turnaround.
Yet in practice, L.A. Gear/Disney-type deals--smart, long-term thinking aimed at stabilizing a company before it sinks into an abyss--are the exception rather than the rule.
Why? Partly because turnaround-investors are more timid than they originally advertised themselves to be, says George Putnam, editor of the Turnaround Letter in Boston. Some investors want only a “sure thing” for their turnaround dollars, even though that is a blatant contradiction in terms. “They’re looking for IBM with a head cold,” Putnam says.
Others, though, say the problem is rooted in a lingering sense of disbelief about the gravity of corporate America’s troubles. “The agenda is huge,” says David Schulte, a Chicago-based investor who specializes in corporate turnarounds. “We’re finding a ton of (distressed) situations.” But when it comes to negotiating an investment, he says, “people aren’t yet ready to do the deal.”
Schulte is a partner with legendary investor Sam Zell in the Zell-Chilmark Fund. A year ago, the fund raised a stunning $1 billion to invest in turnaround companies. As of today, however, not a single penny has been invested.
Potential investors are eager to put their money to work, Schulte says, but he complains that “rationality has not yet settled into” the deal process. Managers of troubled firms have to be realistic about the price that a white-knight investor is likely to exact for financing a turnaround, Schulte says. It won’t be cheap.
L.A. Gear is a good case in point: Management will effectively surrender a 30% stake to Roy Disney and his investors for the $100-million infusion. That is a big chunk of the action.
Rather than meet the demands of potential investors, Schulte says that distressed companies and their various constituencies--bondholders, bankers and others--often view Chapter 11 bankruptcy as the preferred route, “never understanding the full horrors of that process.”
Consider the viewpoint of a troubled company’s bank lenders. If they push the firm into bankruptcy, they at least open up a new profit opportunity via “debtor in possession” loans. Once a company enters Chapter 11, new loans can become quite profitable, because they move to the front of the line in terms of credit rank.
From individual investors’ point of view, however, Chapter 11 is almost never preferable. “It’s a rare bankruptcy where existing shareholders even hold their own,” Putnam says. In most cases, they’re wiped out.
For that reason, average investors ought to hope that more managers of distressed companies begin to look realistically at what it will take to restore their businesses to health. There are cash-rich investors out there who are ready and waiting to work with companies that need help. But they aren’t going to do it for a bargain price.
However much of the company that a white-knight investor may demand, though, odds are that it will be more favorable for existing shareholders in the long run than if creditors succeed in pushing the firm through bankruptcy’s trap door.
Help Wanted One measure of the financial distress of corporate America is the level of bond defaults. Lastyear, companies defaulted on more than $25 billion worth of bonds, as debt loads became increasingly unmanageable. The trend since 1980: Source: Bond Investors Assn.
