Ge's Finance Arm Is Showing Some BruisesTodd Vogel
It was 1986, and managers at Channel Home Centers Inc. longed to join the leveraged buyout party then in full swing. GE Capital Corp. was there to open the door, lending them the money to gain control of the chain, which then had 157 hardware stores. But the party is now over: Competition from superstores such as Home Depot Inc. and small neighborhood hardware stores has squeezed midsize Channel. By 1990, its revenues had slid by one-third, to $400 million. On Jan. 14, the company filed for Chapter 11 bankruptcy protection. And GE Capital, the far-flung finance arm of giant General Electric Co., wound up with a big unpaid loan, now totaling $268 million.
The Channel loan is just one of a considerable string of bad LBO investments that are afflicting GE Capital, which had long been renowned for its lending savvy and awesome profit margins. The bad loans are having only a negligible impact on the parent company's profits--$4.3 billion last year, up 9%. But they have raised serious questions about the elaborate system installed by the $70 billion financing concern in the 1980s to monitor LBO lending carefully and avoid embarrassments such as Channel. Now, Gary C. Wendt, the 16-year GE Capital veteran who oversees it and other GE financial subsidiaries, has drastically reduced the company's ambitions in corporatefinancing.
The problem is centered in GE Capital's corporate finance unit. In 1989, it provided 28% of GE Capital's income, but that sank to 2% last year. According to an internal GE document, earnings in corporate finance have all but evaporated--from $230 million in 1989 to $23 million in 1990. GE Capital wrote off $410 million in bad LBO loans last year for a total of $658 million since 1981. Without the write-offs, GE Capital's $1.8 billion earnings from LBO deals since 1981 would have been 37% higher. Executives close to the company project an additional $400 million in write-offs in the near future. In addition, as a favor to ailing Kidder Peabody & Co., a fellow General Electric subsidiary, GE Capital last year assumed $740 million in wobbly Kidder LBO loans.
Thanks to wise moves into such thriving areas as container leasing and credit cards, GE Capital posted a 20% earnings boost last year, to $979 million, handily offsetting the weakness in corporate finance. Reserves against loan losses stayed constant at $1.36 billion in 1990. Warren C. Jenson, GE's manager of investor relations, points out that GE Capital moved quickly to book losses on bad loans instead of letting the troubles build. For example, the company already has written off $95 million from the Channel loan. Says Jenson of the LBO headache: "Goodbye, it's over."
STERLING RATING. But is it? So far, Wall Street analysts are comfortable with GE Capital's debt, which stands at a lofty 7.8 times equity. The main reason GE Capital has retained its sterling AAA rating from Standard & Poor's Corp. is its mighty parent's clout, says Richard Schmidt, a credit analyst at S&P. GE Capital's total write-offs--including LBOs and real estate--totaled $839 million in 1990. Schmidt hopes the LBO portfolio doesn't continue to sink, which could require depletions of equity. "They're leveraged higher than we typically feel comfortable with," he says.
GE Capital's troubles are less severe than those at other finance subsidiaries of large corporations, especially those that have expanded far beyond the job of handling their parents' consumer receivables. On Feb. 27, Westinghouse Electric Corp. reported a fourth-quarter loss of $449 million and a $975 million write-off because of troubles at its financing arm, Westinghouse Financial Services Inc. The announcement came after Westinghouse called in Lazard Freres & Co., an outside investment firm, to do an internal review. GE Capital officials say that their company's diversity keeps them well insulated from such predicaments. "We've got an awful lot of things going for us, so we're not flogging ourselves," says Dennis D. Dammerman, senior vice-president for finance at parent GE.
SMALL COMFORT. GE Capital executives nonetheless are plainly worried about their situation. The corporate finance chief, Dennis J. Carey, sent out a memo in January that promised to "refocus" the organization. "We have a huge task ahead of us," he warned. As part of its cutbacks in corporate finance, GE Capital shuttered offices in Menlo Park, Calif., and Toronto last November and laid off more than 100 employees.
The tattered balance sheets of numerous other LBO financiers are of little solace to GE Capital executives. Their company has always assumed that it was immune from the sloppy miscalculations that beset less fastidious competitors. As the buyout craze gathered force, GE Capital's corporate finance unit adopted extensive ground rules to protect itself. Before making a loan, GE Capital subjects prospective borrowers to a meticulous examination. Carey once said that risk evaluators on his staff outnumbered dealmakers by 2 to 1. GE Capital also spreads the risk: Its 100 LBO loans are distributed throughout the U. S. and Europe. About 72% of its total LBO exposure is senior debt, meaning GE Capital will be first in line in the event of a bankruptcy.
For a time, the ground rules appeared to be working well. From 1987 to the present, GE Capital's corporate finance portfolio grew nearly 93%, to $8.5 billion. The corporate finance team earned approximately $100 million on the 1984 buyout of Tiffany & Co. The lender still owns 750,000 of the retailer's shares. In 1988, GE Capital helped managers buy Montgomery Ward & Co. for $3.8 billion. The new Ward owners went on to turn losses of nearly $160 million in 1981 into a $153 million profit in 1990. After some rough going, GE Capital's 18% stake in the R. H. Macy & Co. buyout is turning into a possible winner: The venerable department-store chain is cutting debt and boosting advertising, and its losses narrowed for the quarter ended Feb. 2 to $7.3 million.
Yet even GE Capital's largely successful early record was marred by misfires. In 1983, it lent $50 million to the controversial Middle East businessman Adnan M. Khashoggi to buy a small oil and asphalt company called Edgington Oil Co. Court documents say that Khashoggi withdrew up to $89 million to finance his lifestyle and other ventures. GE Capital later pressured Edgington to separate from Khashoggi, whom a California investor bought out in late 1988 after Edgington's parent filed for Chapter 11. Efforts to reach Khashoggi for comment were unsuccessful. GE Capital says no one knew until relatively recently about issues that raised questions concerning his character--such as Khashoggi's involvement with the Iran-contra affair and with Philippine dictator Ferdinand Marcos. Still, GE Capital managed to get its money back.
But as deal mania heated up, so did GE Capital's eagerness to play. While professing caution, it appears to have relaxed some of its rigorous standards. It jumped into often high-priced media and retail deals, boosting those sectors to 53% of its portfolio. Insiders say GE Capital believed that it had special expertise in these industries: in media through its ownership of NBC and in retailing through Kidder, which has specialized in retail financing. During the 1980s, GE Capital became one of the largest cable-TV underwriters in the U. S., with combined cable and other media transactions totaling $2.9 billion. "It was the hot area," says Paula Greer, associate analyst at Cable TV Banker/Broker, a newsletter. "They were very willingto lend."
Unfortunately, GE Capital found itself involved in activities that were especially vulnerable to the current recession. Some broadcast outlets that once seemed like unassailable cash cows have been slaughtered by declining ad revenues that don't cover high LBO debt. One graphic example was the 1986 management buyout of Pegasus Broadcasting Inc., which owned three U. S. TV stations and one in San Juan. GE Capital contributed $96 million, while Pegasus executives put up only $500,000. GE Capital did insist on stringent debt covenants: Unless Pegasus could maintain cash flow at certain levels, GE Capital could take over the company.
Former Pegasus President Christopher Brennan insists that everyone involved in the deal knew that the cash flow wouldn't be high enough to service such onerous debt. The plan was to recapitalize the company within three years with a junk private placement. By the time Pegasus needed to recapitalize, though, the junk market had collapsed. GE Capital had no choice but to buy out the woebegone enterprise last April. The company's top executives have left. It is now operated by a media management concern hired by GE Capital. Lenders generally don't like to take over companies. But says GE executive Dammerman: "It doesn't scare us."
GE Capital had similar bad luck when it had to take over another GE-financed TV station, WCSC in Charleston, S. C. With the station sinking under a heavy debt load, Harold Crump, WCSC president and co-owner, put it on the market and thought he had a buyer. But when Hurricane Hugo damaged the station in late 1989, the buyer vanished. That forced GE Capital to make the rescue.
'SUCKERED.' The easing of GE Capital's lending vigilance is even more apparent in its portfolio of retail LBOs. "They were taking some of the biggest risks in the industry," asserts one Wall Street investment banker who specializes in retail deals. "They got suckered a lot."
Several retailing deals beside Channel Home Centers went awry. GE Capital has been forced to send its own managers to run Shoe-Town Inc., based in Totowa, N. J., after its $168 million buyout loan in 1988 fell apart. It also stepped in at Sage-Allen & Co., a Connecticut department store. Managers had bought the store in 1987 with $42 million provided by GE Capital. But they soon withered under competition from much larger chains. Sage-Allen has closed its flagship store in downtown Hartford. GE brought in a turnaround specialist. Vendors, though, aren't convinced Sage-Allen's problems are over. "It's had troubles for a long time," says Richard Hastings, senior retail credit analyst at Solo Credit Service Corp.
With its unexpected experience in the field of LBO disasters, GE Capital has established a new business: rescuing soured deals, those of others as well as its own. It is lending money to bankrupt and other struggling companies to help them restructure. So far, GE Capital has made $2 billion in financing commitments for companies such as L. J. Hooker, Federated Department Stores, and National Gypsum. These loans are obviously risky, but they pay alluringly high interest. "I think it's a huge market," says Jeffrey H. Coats, the senior vice-president who heads the activity.
But is the new foray sufficient to beef up GE Capital's weakened corporate finance arm? Hardly. Competition is stiff in this arena: Nearly every major Wall Street firm is trying to build a bankruptcy workout business. Even if GE Capital's workout specialty takes off, it's not likely to make up for the lost earnings and write-offs from the lender's massive LBO portfolio. At GE Capital, the hangover from the LBO party throbs on.
GE CAPITAL'S FIZZLED INVESTMENTS
SHOE-TOWN GE Capital made $168 million loan for recapitalization of retailer in 1988. Losses have produced $15 million in write-offs so far. A GE-sponsored management team now runs company
SAGE-ALLEN Executives borrowed $42 million in 1987 to buy New England department store chain. Business slumped, and company closed its flagship store in Hartford. GE Capital now controls the business
CHANNEL HOME CENTERS GE Capital provided financing for management-led buyout in 1986. Since then, Channel revenues have plummeted by one-third, and company filed for Chapter 11 in January. Money owed to GE Capital: $268 million
PEGASUS BROADCASTING GE Capital lent $96 million to managers for 1986 buyout of media company, which had four TV stations and a production studio. With Pegasus' financial condition deteriorating, GE Capital bought company in 1990
MANAGEMENT CO. ENTERTAINMENT GROUP
GE's Kidder Peabody furnished $69 million in 1989 for movie company to buy Virgin Video Ltd., a U.K. video distributor. GE Capital then took over the loan. MCEG is now in Chapter 11, and GE has foreclosed on Virgin