An Lbo That Went Over Like A Soggy Teabag

Can Wasserstein salvage its stake in Britain's Isosceles supermarkets?

Europe had never seen anything like it before--nor has it since. Eager to make their mark in Europe, two U.S. dealmakers began slugging it out in 1989 over Britain's Gateway PLC, a lackluster 830-unit supermarket chain. After a three-month battle, a group led by Wasserstein, Perella & Co. outpointed Kohlberg Kravis Roberts & Co. by pushing the price up 35% over the initial offer, to $3.3 billion.

But now, Wasserstein Perella's brash victory in the Old World is proving rather hollow. Laden with debt taken on at the market's peak, the renamed chain, Isosceles PLC, with $5.5 billion in sales, is being squeezed by free-spending and well-heeled rivals such as J. Sainsbury PLC and Tesco PLC. Interest charges--the chief legacy of the buyout--will wipe out estimated operating profits of about $323 million for the year ended Apr. 25. Now close to breaching loan agreements with the banks, Isosceles executives and investors are locked in financial restructuring talks--the second round since interest on some $555 million in debt was deferred 18 months ago.

DEAD WRONG. For Wasserstein Perella, the battle this summer is to salvage its $350 million investment, easily the largest chunk of its $1 billion leveraged-buyout fund. Isosceles has been "a disappointment," admits one Wasserstein Perella executive. Joining Wasserstein around the negotiating table is an international cast of investors, which includes lenders such as Chemical Bank, General Electric Capital, and Industrial Bank of Japan, along with equity players such as British investment managers Mercury Asset Management and 3i. The discussions are said to be amicable so far--but could heat up if unsecured creditors demand a chunk of the equity held by Wasserstein and others.

Together, in the frenzy of the go-go late 1980s, the investors made several key miscalculations. Above all, the notion that British food retailing is a nice stable business throwing off oodles of cash--in other words, an ideal LBO candidate--has proved dead wrong. Britain's longest postwar recession hit even the food industry. Yet surprisingly, new stores, from discounters to specialty outlets, are now opening up.

Of the investors, Wasserstein has the most at stake, both financially and in terms of reputation. It has taken a beating in the British media and among its competitors in the City of London. "They will not be seen as shrewd investors," says one City buyout rival. But Wasserstein Managing Director Michael J. Biondi objects. "There has been a bit of an attempt to gang up on the colonials," he says. "In the U.S., this would just be another deal."

To shore up Isosceles, investors will have to compromise. Isosceles wants interest charges eased. In return, it would agree to repay some principal early, if it can raise cash through asset sales. On-again, off-again plans to peddle its Herman's Sporting Goods Inc. chain in the U.S. and its F.A. Wellworth & Co. food retailer in Northern Ireland to pay down loans are now back on again.

MONEY WRANGLES. Wellworth, a profitable 33-unit chain, is expected to be taken public this autumn. The real challenge is Herman's Sporting Goods, acquired in 1986 for $414 million and doing no more than breaking even before interest and taxes. Two years ago, Isosceles turned down an offer for $300 million, and now several sources who have looked Herman's over say that it will be lucky to get half that amount.

Some equity investors, including Mercury, are beginning to cut the value of their stake in Isosceles on their books. Although Wasserstein, with 40% of the equity, has yet to do so, insiders concede it's inevitable. The only question is: How much? As a yardstick, the small piece of Isosceles equity that is publicly traded is quoted at between 92c and $5.55, a fraction of the $46.25 that Wasserstein paid for each unit of its investment. Some analysts think Isosceles' equity may be virtually worthless.

Unfortunately for Isosceles, the money wrangles are undermining what some analysts and competitors see as a valiant effort to remake itself. From a midmarket supermarket chain, Isosceles has become something of an innovator, with a new chain of Somerfield fresh-food shops and its Food Giant discount stores. And operating margins have nearly doubled since the buyout, to 6%. "We're piling up profits," says Isosceles Chairman Ernest H. Sharp, "but they are going into our bankers' pockets." Still, he believes the prognosis is promising, provided there is "a sense of realism from everybody." If only that had applied back in the summer of '89.

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