When billionaire dealmaker Robert M. Bass and his partners got a hankering for the food business three years ago, they dusted off a familiar recipe: find an undermanaged company, sprinkle a few crumbs of equity into a stew of debt, and voila--a classic 1980s-style leveraged buyout. At $1.1 billion, their LBO of Specialty Foods Corp. was the biggest of 1993. It brought the top-shelf dealmakers businesses making everything from bread and sausage to kosher pickles--and a chance to turn low-rent brands into money machines.
But instead of savoring an easy payoff, the Texas mogul and his investors are trying to get out from under the deal. Applying the storied LBO formula a bit too liberally, Bass larded the company with excessive debt. Now, as he moves to bust up the food conglomerate, which has $2 billion in sales, his exit strategy looks risky. A handful of operating units he put on the block in June might fetch less than the rich multiples of cash flow that he and his partners hope for. And a plan to sell or spin off the remaining bread and cheese businesses within a few years depends heavily on a big drop in commodity prices--hardly a sure bet. In the meantime, debt service is siphoning off returns and handcuffing growth.
Specialty Food executives predict those challenges will be overcome. "There is a home plate in sight, and we're in scoring position," says Robert B. Haas, the Bass-backed investment banker who serves as the company's chairman. Yet the equity investors, led by Bass-controlled Keystone Inc. and Acadia Partners LP, may wind up with little to show for their $125 million cash investment. While loans from Chemical Bank are secured by company assets and senior debt holders have little to fear from the bust-up plan, Specialty's least-senior junk debt trades at a steep discount. "It's not a company that's free and clear. It's dicey as to how much they can recover," says Thomas N. Haag, manager of the $700 million Lutheran Brotherhood High-Yield fund, which recently sold Specialty's subordinated debt in favor of its senior securities. The market values that subordinated debt at about 65 cents on the dollar.
UNDISCOVERED GEM. Companies have had a field day buying businesses in their industries with stock buoyed by the bull market. They can then generate economies of scale by integrating new operations into their own. But LBO players don't have a ready-made acquisition currency, nor do they come to the table with existing operations in the same business. They use leverage and run the risk of overpaying--as in the case of Specialty, which wrote down one-third of its goodwill at yearend. It now expects to sell off some of its divisions, probably to companies in the same business. "There are strategic buyers out there that can do more with these businesses than we can," says Paul J. Liska, who became Specialty's chief executive in January.
Back in 1993, the Bass group thought it had found an undiscovered gem in Specialty Foods. The company had virtually no public profile. The seller, Belgian holding company Artal, had cobbled together a large hodgepodge of U.S. food businesses in the previous decade. Artal initially sought to sell only a single unit, Metz Baking Co., but the Bass group persuaded Artal to sell all eight of its food businesses.
At the outset, Specialty's parent seemed to offer it every advantage. The veteran Haas, of Haas Wheat & Partners in Dallas, pulled off the deal's financing without a hitch, in spite of debt levels exceeding eight times cash flow. To carry out an aggressive cost-cutting plan and jump-start undermarketed brands, the company paid top dollar for high-powered executives. Half a dozen came from Kraft Foods Inc., the nation's largest food company, including former Specialty Foods Chief Executive Thomas Herskovits, a powerhouse who had headed Kraft's dairy and frozen-food operations.
By early 1994, Herskovits was installed as CEO and Specialty was primed for a cost-cutting spree. The company got rid of middle managers at the operating units and worked feverishly to integrate businesses. Specialty's $750 million Stella Foods Inc. cheese unit, for instance, had five separate sales forces, managements, and ledgers.
Yet from the beginning, one operating woe or another undermined the company's growth. First, the cheese business ran into trouble. Its management had difficulty coordinating milk purchases while trying to combine its various businesses. As well, an across-the-board price increase alienated customers and hurt top-line growth.
Problems then emerged at H&M Food Systems Co., which makes precooked meat products such as sausage for restaurant chains and food manufacturers. Early in 1995, a competitor lured away H&M's biggest customer, Pizza Hut. Meanwhile, falling meat prices hurt profits. H&M's contracts with customers allow it to recover only its costs plus a fixed percentage markup. So in a falling market, the dollar markup is less.
As meat prices fell, grain prices soared, damaging the bakery units. In addition to Metz Bakery, the company owns Mother's Cake & Cookie Co. Metz markets brands such as Healthy Choice and Taystee breads. Competition was taking its toll: In-store bakeries were making fresher products. And overcapacity gave the upper hand to companies with greater flexibility and lower fixed costs.
By the end of 1995, it was obvious that Specialty Foods would miss its sales and earnings targets by a mile. While its cash flow had expanded by some $30 million since 1993, to $157 million, sales had been roughly flat at $2 billion. An operating profit of $83 million in 1994 gave way to a 1995 loss of $165 million as the company wrote down goodwill.
In the wake of such results, Herskovits stepped down on Jan. 12. He was replaced by Liska, another Kraft alumnus who had joined the company as chief financial officer soon after the buyout.
Liska has his work cut out for him. Granted, the company now has a lower cost structure, higher-caliber management, and better marketing. But in a superscript10-Q filing on May 14, Liska warned that the company's cash flow might be insufficient to meet debt obligations and that credit covenants could be violated if business conditions didn't improve.
TOUGH MARKETS. On June 6, Merrill Lynch & Co. put Specialty's smaller holdings up for sale. Liska says the response has been "overwhelming." But H&M remains troubled. And even the most attractive property for sale, Mother's Cake & Cookie, won't bring a huge payoff, predicts analyst Kevin A. Eng of Grantchester Securities, the high-yield arm of Wasserstein Perella Securities Inc.: "There is nothing that commands a premium."
The remaining bread and cheese businesses offer some promise for Bass and his investors. By taking big writedowns, Specialty has set up those units to show better results. It is hoping to beef them up with add-on acquisitions financed with some of the proceeds from the planned asset sales. Then, if commodity prices reverse, the bread and cheese businesses could become candidates for initial public offerings or sales.
For now, though, Specialty must grapple with tough markets and intense competitive pressure. Gobbling up Specialty Foods was no problem for the dealmakers surrounding Bass. Spitting it out is another story.