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Special Interests: Management Proposes An LBO for FormicaApril 10, 1989 IT'S NOT 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. Thus, although 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? Shortly thereafter, 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 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. |