Usg's Remodeling May Mean Gutting The House

It's truly a Faustian corporate tale. Back in 1988, wallboard giant USG Corp. faced a formidable takeover run by Dallas-based investors Desert Partners LP. In the end, USG's management outfoxed the raiders by borrowing some $2.5 billion for a special payout to shareholders that pushed its total debt at the time to $3.1 billion--and fended off Desert Partners. In short, USG borrowed its way out of quite a jam.

Now, three years later, there's hell to pay. On Dec. 31, faced with the prospect of defaulting on the company's bank-loan agreements, USG Chairman Eugene B. Connolly unveiled a debt-restructuring proposal that includes a major asset sale, a debt-for-equity swap, an extension of the company's onerous payment schedule on its remaining $1.8 billion in debt, and a search for an equity investor.

To pull off the restructuring, Connolly has a month to win the support of bondholders, whose securities now trade at about 20~ on the dollar. As part of the deal with the banks, USG will skip a $40 million interest payment due Jan. 15 on its $979 million in junk debt. The company will then have 30 days before bondholders could try to force USG into bankruptcy. If Connolly can't persuade them to exchange their bonds for USG stock or other paper, they could torpedo the restructuring plan. "Bondholders are not going to buy into it unless they end up with a fair amount of equity," one institutional holder warns.

Meanwhile, business is looking pretty grim for USG, the nation's largest producer of gypsum wallboard and other construction materials. Housing starts were slowing in 1988, when USG leveraged up, and have collapsed since then. To relieve debt pressures, USG has laid off 8,000 employees, slashed capital spending nearly 50%, and sold off $550 million in assets, including its Chicago headquarters. Even so, the company is now teetering on the edge of insolvency.

NO TOMAHAWKS. Connolly says negotiations with USG's key lenders--including Citibank, Bankers Trust, and Chemical Bank--have been cordial enough so far. "It's not like everybody was screaming and hollering and throwing tomahawks at each other," he says. A Brooklyn (N. Y.) native whom friends describe as scrappy, Connolly says the restructuring will give USG the wiggle room it needs to stay out of bankruptcy court.

Still, Connolly must cope with the ongoing slide in USG's core business. Gypsum, the white mineral used to make wallboard, accounts for 55% of USG's sales and 63% of profits. With U. S. housing starts now at a six-year low, gypsum prices have fallen 30% from their 1985 high of $121.87 per 1,000 square feet. Nor have they reached bottom: Merrill Lynch & Co. is forecasting a 10% drop in gypsum prices in 1991 because of the recession and ongoing weakness in the housing market. If so, USG would face an $80 million or so earnings hit this year. "This company is in a very, very horrible position," says Merrill Lynch analyst Sharyl Van Winkle.

That's hardly news to USG's battered investors. USG stock now trades at about $1.25 a share--off 72% from its 52-week high. A big loser has been the Japanese construction giant Settsu Corp., which plunked down $35.5 million in 1988 to buy a 10% stake in USG. That investment is now worth $7.3 million.

Of course, USG isn't the only gypsum company feeling the effects of the housing slump, which is expected to result in a $27 million loss on sales of $2.1 billion for the company in 1990. Rivals National Gypsum Co. and Celotex Corp. filed for bankruptcy protection last year.

Yet USG's management must share the blame for its current woes. The business assumptions underpinning USG's $2.5 billion recapitalization plan three years ago have hardly proved prescient. Although it knew the housing market was two years past its normal cyclical peak, USG projected that operating income would climb steadily through 1992. But expected 1990 income of $279 million is 42% below USG's pre-recap prediction, and few analysts see a rebound ahead. "People started to do things based on the fact that life was going to be up, up, and away," says one investment banker familiar with USG.

With things heading in a decidedly opposite direction, Connolly will have to move swiftly to keep USG above water. One immediate task will be to find a buyer for the company's DAP Inc. subsidiary, a maker of caulking and sealants, which USG bought for $127 million in 1987 and which accounted for $186 million in sales last year. USG hopes to get up to $120 million for DAP, yet given the distressed state of affairs at the company, it may have to settle for less. The banks could also push Connolly to sell USG Interiors, a growing ceiling-products unit with $625 million in sales.

GLOBAL GOALS. Meanwhile, Connolly isn't waiting for the U. S. housing market to revive. Once the financial crisis passes, he hopes to form a joint venture with an overseas partner to cash in on a stronger housing market abroad. Europe, South America, and even the Soviet Union are places where USG has been looking to do business, says Connolly. At home, USG also is trying to develop new markets such as sag-proof ceiling tiles, potentially a $1 billion market.

Connolly, a 32-year USG veteran who became chairman last May, has taken a crash course in finance to keep the company upright. When it became clear late last year that USG couldn't make a $105 million principal payment on Dec. 31 or the $40 million payment in mid-January, the company brought in Salomon Brothers Inc. and Lazard Freres & Co. to fashion a recapitalization plan. Then, Connolly won some breathing room in a mid-December meeting with 35 lenders.

Bankruptcy still looms as a threat, but both banks and bondholders say they prefer to avoid the expense and delay. A prepackaged bankruptcy--negotiated privately but presented in court for approval--is out, too, because no deal could account for USG's potential liability for asbestos in ceilings it installed in schools and other public buildings in the 1960s. Its tab could run as high as $1 billion, analysts say. Connolly will not confirm that figure, but he estimates USG is insured for about $750 million.

For now, Connolly will need some dealmaking savvy--and a little luck--to stay out of bankruptcy court. Debt may have once saved the company, but USG's management may well think twice before borrowing itself out of a fix again.