Donald Kelly Gets Egg On His Face

Donald P. Kelly once struck just the right chord with investors. The stocky dealmaker helped craft one of the most successful leveraged buyouts ever when he and his partner, Kohlberg Kravis Roberts & Co., bought Beatrice Co. in 1986, then netted $3 billion for themselves and other shareholders by selling off the pieces. So when Kelly teamed up with Salomon Brothers Inc. to buy Envirodyne Industries Inc. for $720 million in 1989, investors flocked to the deal.

Many of them now regret they followed Kelly into this one. Swamped with debt, Envirodyne on Feb. 3 skipped $14 million in interest payments. To recover, management has proposed a debt-restructuring plan that some bondholders say has just a 50% chance of keeping the Chicago maker of such down-to-earth stuff as sausage casings and plastic utensils out of Chapter 11.

TOUGH LUCK. Envirodyne has been on precarious financial footing since Kelly arrived. To complete the company's leveraged buyout, Kelly and several partnerships he controls put up just $2 million for 3.6% of the company. Salomon kicked in $38 million for a 69% stake, then sold 4.9% of Envirodyne to a division of Continental Bank Corp. for $2.7 million. And Artra Group Inc., which owned 26.3% of Envirodyne before the buyout, swapped its stock for a 27.5% share in the private company and $75 million in cash. Both Kelly and Salomon have recouped most of their investments through fees paid by Envirodyne: Kelly pulled in $2.83 million and Salomon $20.1 million in 1989 alone. Kelly, who is Envirodyne's chairman and chief executive, also collects a $400,000 annual salary.

With such a thin layer of equity, "everything had to go just right," notes Daniel Smith, portfolio manager of Van Kampen Merritt's high-yield fund. Envirodyne hasn't been that lucky. The company had trouble passing along higher costs on its petroleum-based products, for instance, when oil prices soared before the gulf war. And in late 1990, an Envirodyne product used to wrap fresh meat was discovered to contain traces of benzene. Margins took a drubbing, as the company scrambled to woo leery customers. The result: Operating cash flow in 1991 fell 6%, to $106.6 million on sales of $552.5 million, says Bruce Klein, an analyst for Donaldson, Lufkin & Jenrette Securities Corp.

Things are expected to improve this year, thanks to solid sales of core products and new manufacturing capacity in Europe. But long-term debt keeps climbing, from $719 million in 1989 to about $850 million now. The cash squeeze reached a crisis this month, when Envirodyne faced drawing down all of its remaining cash and tapping out its credit lines to make $33.3 million in lease and interest payments--including the $14 million due Feb. 3. Says a source close to Envirodyne: "It's a classic example of good company, bad balance sheet."

Now, with both his reputation and the company at stake, Kelly seems determined to forge a deal. Envirodyne has asked bondholders of its two subordinated issues to forgo interest payments valued at a total of $120 million for the next three years in exchange for 50% of the equity, says a company spokesman. Kelly couldn't be reached for comment.

SHARE THE PAIN. Bondholders have plenty to say about the proposal, little of it pleasant. "We don't like the plan because the senior debtholders aren't giving up anything," says James Woods, chief investment officer for Security Benefit Life Insurance Co., which holds $3 million worth of Envirodyne's most junior debt issue. Moreover, Woods wants shareholders to share more of the pain. He proposes that they turn over at least 63% of their equity, while some creditors are calling for as much as 80%.

Others fret that the plan is just a short-term fix, since it only delays interest payments instead of eliminating debt. "Unless you solve that problem, it doesn't appear to me to be fixing the long-term capital structure," says Evan I. Mann, an analyst for Dillon, Read & Co. Says an Envirodyne spokesman: "We are willing to listen to alternatives. Nothing is carved in stone."

Wall Street is betting that the company will carve out a deal. Since announcing the interest-payment freeze, the company's three debt issues have each lost just a few points. On Feb. 12, they were trading at 43% to 57% of par value. Still, there's little chance that Kelly can emerge from the deal unscathed. That could make it tough to find investors ready to go along next time. Says one bondholder: "He won't be a pied piper anymore."