Special Interests: Management Proposes An LBO for Formica
April 10, 1989
unreasonable to expect a company's managers and directors to look
out for its shareholders. After all, the law actually requires them
to put stockholders' interests ahead of their own. That's
something to keep in mind when considering the proposed
management-led buyout of Formica Corp. That proposal has inspired
many other offers for the company, and one thing is clear: No matter
what happens, the management group will be a big winner.
Formica is a
venerable brand name, dating back to 1913, that has almost become a
generic term for high-quality decorative laminates, used mainly in
countertops and cabinets. In May 1985, a group led by management and
Shearson Lehman purchased the company (which by then had become part
of American Cyanamid) in a leveraged buyout for $189 million, using
just $14 million of equity, at a price of $2 per share. Two years
later, Shearson underwrote a public offering at $11.75 per share that
raised about $50 million.
At the time,
Formica's balance sheet was rather shaky. But the proceeds from the
offering, along with two years of retained earnings, have pretty much
remedied that problem. Formica's debt-to-equity ratio stands at 1:1
now, vs. 6:1 a few years ago. At the same time, Formica's business
prospects seem bright. In 1988's final quarter, the company netted
$5.8 million on $111 million in sales; a year earlier, it made $4.2
million on $112 million. For the full year, aided by the sale of
Australian and New Zealand subsidiaries, earnings leaped to $34.1
million, or $2.60 per share, on $432 million in sales, vs. 1987's
$11.7 million, or $1.03, on $413 million.
All in all, Formica
is an attractive target.
On Aug. 4, 1988,
First Allied Investors reported a 9.9% interest in Formica, stating
that it had hired a financial adviser to offer counsel on a takeover.
Formica's board promptly approved a poison-pill arrangement to make
a hostile acquisition difficult.
On Sept. 29, First
Allied told Formica that it was prepared to offer $20 a share.
Considering that the stock had been trading at $13.50 before First
Allied's intentions were known, this didn't appear to be a bad
opening gambit. But the next day, Formica rebuffed the bid, saying it
was "in the best interests of the company and its stockholders to
continue as an independent public company."
At about the same
time-late September-a representative of Dillon Read met with Ilan
Kaufthal, who is a managing director of Wertheim Schroeder and a
Formica board member. They discussed the possibility of arranging an
LBO for Formica. Kaufthal relayed the conversation to Vincent
Langone, Formica's president and CEO. On Oct. 4, Langone, who is
also a member of Formica's board, met with representatives of
Saratoga Partners, Dillon Read's LBO fund.
Formica was publicly affirming its desire to remain independent,
senior management, aided by an outside director, began secretly
structuring its own deal to take the company private. For the next
three months, a group of senior managers met with the investment
bankers to discuss and refine their proposed LBO. Along the way,
Saratoga agreed to carve out 20% of the deal for management. Some
executives were luckier than others. Langone will get half of the
total set aside for insiders.
In early November,
both Dillon Read and Wertheim signed confidentiality agreements
regarding information they had been given or were to receive. It
appears that Formica's board wasn't informed of this. Question:
Did management exceed its authority and misappropriate corporate
information to further its own interests?
Great American Realty bought First Allied's 9.9% block and said it
would buy up to 15% of Formica.
On Nov. 21, Vincent
Langone met with outside directors Stephen Bershad and T.J. Dermot
Dunphy, and discussed various plans he had for the company, including
an LBO. About a month after this, in late December, Langone finally
told Bershad exactly what was going on-that management and Saratoga
planned to acquire the company, and that they were consulting with
Kaufthal. Bershad contacted the other directors and, on Jan. 16,
Shearson was hired. A board meeting was scheduled for Feb. 3.
At the meeting,
Langone's group, using the name FM Acquisition Corp., offered to
acquire Formica for $18 a share in cash -- $2 less than the First
Allied offer that had been spurned "in the best interests of the
shareholders." Furthermore, the proposal specified that Langone's
group would receive $12 million if a higher offer were made. If the
agreement was terminated for any reason, the group would get up to an
additional $5.5 million for expenses. Finally, in what might be
viewed as something of a poker bluff, the bid was good only until 9
a.m. on Feb. 6 -- just three days away.
By the evening of
Feb. 5, a special committee of disinterested directors found it
couldn't recommend the proposal, owing to the "expenses"
reimbursable to the investor group. The group then revised its offer,
lowering its reimbursement and fees to $10.5 million (about what
Formica earned in 1987) if things fell through or a higher bid was
made. Shearson delivered an oral opinion-apparently, there wasn't
time to come up with a written one-pronouncing the deal fair, and
shortly after midnight, the board unanimously approved it. Despite
the hectic pace-the rush to judgment, the lack of a written opinion
and the late hour-the directors found time to approve "termination
agreements" for the management investors, so that if a "change in
control" knocked them out of the picture, they would receive three
times their salary and other pleasant benefits.
Largesse was spread
all around. Shearson will receive about $2.8 million in fees.
Wertheim Schroeder, Canadian Imperial Bank and Dillon Read will rake
in $18.5 million. Dillon's parent company, Travelers Insurance,
will tender its 8.5% stake in Formica, purchase bridge notes and
perhaps take a piece of the equity action in the LBO. Total fees and
transaction costs in this $266 million deal: $29 million.
At issue is not
whether management faced conflicts of interest. As the prospectus
blandly states, the opportunity to do an LBO on Formica "may have
presented the management investors with actual or potential conflicts
of interest…" The issue is whether management breached its
fiduciary duty. Some shareholders who think so have filed a
class-action suit in Chancery Court in Delaware, where Formica is
incorporated. They're seeking to have the LBO plan blocked or
sweetened. Any management-led LBO is fraught with inherent conflicts
of interest. This appears especially true in this case, since the LBO
was brewing while the company was opposing a higher offer.
Also of concern is
the use of confidential corporate information as the means to
accomplish management's goal. All parties involved-investment
bankers, banks, LBO funds, etc. received this. In conjunction with
what was learned from conversations with insiders, many corporate
secrets were spilled that weren't available to other shareholders
or potential acquirers.
This whole series of
events raises many questions:
- The board
already had refused to consider a $20 offer and had a 15% holder
waiting in the wings. Why did it rush to accept an $18 bid?
- Did management
breach its fiduciary duty by secretly plotting the deal and using
confidential corporate information for its own purposes?
- Why did the
board agree to pay $10.5 million in fees to the management-led bidder
if a better offer came along?
- In Shearson's
analysis of the bid, it appears that a leveraged recapitalization of
the company could give shareholders almost as much cash and still
allow them to retain their interest in the company. Yet, this wasn't
explored further. Why?
- The special
committee that approved the deal consisted of three people, including
Stephen Bershad, chairman of Vernitron. Recently, when Vernitron made
a $25-a-share offer for Kollmorgen, it had to overcome a "poison
pill" provision. Bershad stated that "Kollmorgen shareholders
deserve the opportunity to make their own choice about Vernitron's
cash merger offer." Didn't he think Formica's shareholders also
should have a chance to determine which-if any-offer was
The answers remain
elusive. Formica's board members, as well as a corporate spokesman,
wouldn't talk about the tender offer with Barron's.
As of last week,
however, the owners of Formica's approximately 13 million
outstanding shares apparently hadn't tendered enough to approve FM
Acquisition's bid, which was to have expired on March 31 but was
extended that day to April 7. Formica has been receiving other bids,
too, including one from an industrial concern, which it didn't
identify. Like First Allied's, it's for $20 a share-another
indication that management's bid is on the low side. At least six
other potential bidders have signed confidentiality agreements. Of
course, they may not have four months, as managements did, to prepare
their bids, and arrange financing-no easy task because more than
half of Formica's assets and revenues are located outside the
United States. One thing is certain: None of them will get $10.5
million for losing.
What, then, is
likely to happen? Perhaps Langone's group will come back with a
better bid, if that becomes necessary. Perhaps the company will do an
about-face and remain public by paying a large dividend or buying
back shares. Or maybe, just maybe-but this kind of thing rarely
happens-shareholders will throw up their hands in disgust, revolt
against this type of behavior and elect a new board.
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