Another Embarrassment For Kkr?

It's a familiar tale: A fixture of Corporate America works for years to put its house in order. Then, a crafty dealmaker from Wall Street arrives, threatening to steal the company for a pittance.

The script may be familiar, but the casting is decidedly against type. The beleaguered voice of entrenched management is none other than that of Kohlberg Kravis Roberts & Co., which once feasted at the top of the Wall Street food chain. And Henry R. Kravis' adversary is no stranger: He's Leon D. Black, head of Apollo Advisors LP. Black, 43, was a onetime ally of KKR who helped arrange financing for many of its deals.

KKR and Black are entering the final months of a pitched battle for control of Walter Industries Inc., the Tampa-based conglomerate KKR acquired in 1987 only to see it seek refuge in bankruptcy two years later. On July 13, Black and Lehman Brothers Inc., Walter's biggest bondholders, formally presented a plan to end Walter's five-year sojourn in Chapter 11. If accepted by the bankruptcy court, the proposal could let Black wrest control of Walter Industries from KKR, eliminating KKR's 91% stake.

It's not just money at stake. If Black manages to outfox KKR, it would be another blow to the legendary leveraged buyout firm. KKR's luster has already been dimmed by troubles at its largest holding, RJR Nabisco Inc. "Kravis has been top-of-the-heap for so long, and to have an upstart like Leon Black outmaneuver him has got to be a source of chagrin," says Harvard B-school investment banking professor Samuel L. Hayes III. "This is the pits. It doesn't get any worse than this." KKR, Black, and Lehman won't comment.

OUTRAGED. Walter Industries wasn't supposed to be KKR's Waterloo. In 1987, the LBO firm acquired Jim Walter Corp., which builds homes, makes building materials, and mines coal, for $3.1 billion, including debt. Walter's stock had been depressed by nearly $2 billion in claims against its Celotex Corp. unit, which had manufactured asbestos. KKR figured it could buy the company for a bargain price, sell off the asbestos unit--and its thorny lawsuits--and book a hefty profit. Ironically, Black, then an investment banker at Drexel Burnham Lambert Inc., helped KKR create the junk bonds to finance the LBO. Drexel is said to have received in excess of $60 million in fees for its efforts. Lehman collected about $8 million as an adviser to Walter.

But the asbestos claimants went after Walter's deeper pockets, anyway. Their suit created a financial crisis for Walter Industries and KKR. Because of a court-imposed freeze on assets, KKR couldn't sell off Walter's assets to pay down debt. And the litigation so depressed the price of the bonds issued to finance the LBO that it was impossible for KKR to reset interest rates high enough so the bonds would trade above par, as promised to bondholders. Walter had little choice but to take refuge in bankruptcy.

Now, almost five years later, Black and Lehman have outraged KKR by offering a plan to take control of Walter. Together, they have acquired $429 million worth of Walter bonds, mostly at deep discounts that sources say ran as low as 20 cents on the dollar. As the largest creditors, they propose settling with asbestos claimants for $525 million, finally removing the legal cloud over the company. The money would come from about $600 million in interest that bondholders say Walter, while in Chapter 11, still owes because it was solvent on an operating basis. Then Black and Lehman propose swapping their existing bonds for a combination of new debt and voting control of the company. KKR's stake would be wiped out. Not a bad deal for Black and Lehman, since Walter's operations remain healthy. With 1994 revenues expected to be about $1.3 billion, creditors value it at more than $2.5 billion.

But KKR is battling back. It is offering a dueling reorganization plan that would keep Walter in Chapter 11 until the asbestos claims have been litigated and appeals exhausted. Bankruptcy Judge Alexander L. Paskay ruled in April that Walter isn't liable for any asbestos claims. The claimants have since appealed, but KKR contends Walter will win again and that bondholders aren't owed any interest after all. KKR's plan would give the firm a controlling 70% stake in Walter.

SOLE SUPPORTER. Black and Lehman's plan already has the support of every major creditor. Bondholders are incensed over what they regard as a five-year interest-free loan to KKR. And they also fear asbestos claimants could ultimately win. So far, KKR's only supporter is Walter's management, which owns 9% of the company. Bank lenders back both plans. Both plans will be mailed on Aug. 5 for a vote. The tally will be in by Sept. 23.

Since it already has the backing of the more-powerful creditors, the Black/Lehman plan will likely be approved overwhelmingly. If Judge Paskay ultimately approves the proposal after holding a separate hearing on the bondholder interest issue, KKR has only one remaining out. The firm can try to convince the judge that the plan is not "fair and equitable" because it would strip Walter shareholders, most notably KKR, of all their equity to pay off the asbestos litigants. The settlement "is an outrageous sum to pay for what the judge has said is worth zero," says Michael Crames, the company's attorney. KKR also argues that Black and Lehman have little right to complain, since both acquired their Walter bonds at only a fraction of face value.

Of course, KKR doesn't have much actual cash invested in Walter Industries, either. Its original investment was about $145 million. KKR itself put up only about $1.5 million of that; the rest came from the state pension funds, college endowments, and other institutions that invested in KKR's 1986 fund. Shortly after the deal was completed, KKR extracted nearly $35 million in investment banking fees from the company and wrote down its investors' stake to zero in 1989

If KKR can defeat the plan put forward by Black and Lehman, avoid asbestos liability through the appeal process, and deny the contested interest payments, one source says KKR's equity in Walter could be worth more than $600 million. Aby amount KKR is able to salvage from its unhappy Walter experience will come as an unexpected boon to Henry Kravis--and his investors.


AUGUST, 1987 KKR announces a $3.1 billion buyout of Jim Walter Corp.

APRIL, 1988 KKR sells off the company's Celotex subsidiary, which faces billions in asbestos claims. Asbestos claimants later sue the parent anyway.

DECEMBER, 1989 With asbestos suit pending, KKR can't sell assets to raise cash and pay debt or persuade creditors to reset interest rate on company's bonds. Company files for Chapter 11.

1989-91 Lehman Brothers and Leon Black begin acquiring debt, becoming the largest unsecured creditors. They later propose settling asbestos claims, despite KKR objections.

APRIL, 1994 Judge rules company not liable for asbestos claims. Asbestos litigants appeal.

JULY, 1994 Dueling plans are offered to bail Walter out of bankruptcy. KKR vows to fight asbestos appeals and retain majority stake. Black's group proposes settlement, liquidating KKR's holding if it objects.


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