The Fall Of A Timber Baron

Harry A. Merlo never thought it would end like this. Late one Friday in July, the 70-year-old chief executive of Louisiana-Pacific Corp. was summoned to a meeting of the Portland (Ore.) lumber company's board. Assembled was a somber-looking collection of close friends, including famed test pilot Chuck Yeager and loyal business associates dating back 20 years. The meeting was brief: Directors asked Merlo and his top two lieutenants to resign immediately. "It was a complete surprise to him," says one Merlo associate present. "Harry was devastated."

The boardroom coup marks a stunning reversal for Merlo. As recently as this spring, the still-vigorous CEO was basking in the glow of a seemingly flawless rise from son of poor Italian immigrants to fabulously successful lumber tycoon. In 22 years at the helm, Merlo had made over LP: By relentlessly pushing subordinates to boost production and making risky bets to develop new products, the hard-charging former Marine had built once-modest LP into a $3 billion empire. And thanks to a new process for making wood substitutes that Merlo had pioneered, 1994 income hit a record $347 million.

An admiring board rewarded Merlo generously: His 1994 salary and bonus hit $5 million, even as LP provided him with such perks as use of company jets, a 107-foot yacht to sail the Pacific, and an estate in the tony West Hills section of Portland. Over the years, Merlo also amassed 2 million shares--a 1.8% stake now worth $48 million.

But Harry Merlo's luck was already running out. For years, there had been troubling reports that LP's wood substitute--its most profitable product--was defective when used as exterior siding. But even as warranty claims piled up, the charismatic Merlo calmed his handpicked board with promises of improved production techniques.

STACK OF SUITS. Far more difficult to explain away was news in April that the company was all but certain to be indicted by a federal grand jury in Colorado for environmental violations and fraud involving its manufacturing processes. That has sparked a dozen shareholder lawsuits. At the same time, the stack of homeowner lawsuits alleging flawed siding was growing fatter, while a 1993 lawsuit charging Merlo with sexual harassment had never been resolved.

Meanwhile, increasingly antsy shareholders had sent LP's shares tumbling from an all-time high of 44 in early 1994 to 22 last spring (chart, page 92). Finally, David E. Nelson, a principal with Investment Counselors of Maryland Inc. and one of LP's biggest shareholders, sent Merlo a letter requesting a meeting. But Nelson says Merlo never responded to the letter or to repeated phone calls. Nelson began to draft a letter to the board, but never had a chance to send it. With questions piling up, the board had hastily launched an internal probe. The result: Six weeks after the Colorado indictment came on June 15, Merlo was out of a job, along with his two top aides, James Eisses and Ronald L. Paul.

"WEED" TREES. Merlo declined to speak with BUSINESS WEEK. But friends say he is bitter and feels betrayed. Merlo "lived and breathed" Louisiana-Pacific, says Portland businessman and longtime associate Gerry Pratt. "He still talks about `my company."' The interim CEO, longtime board member and former LP Chief Financial Officer Donald R. Kayser, says the move was wrenching yet unavoidable. Others are harsher. "Exposing the company to such losses and litigation is just inexcusable," says director Bonnie Guiton Hill, who is dean of the University of Virginia's business school. An environmental specialist invited onto the board by Merlo in 1993, Guiton Hill is the only board newcomer, and she spearheaded the investigation.

Trouble first came in 1990, when scores of homeowners in humid Florida began complaining that LP's siding quickly became waterlogged and deteriorated in the rain. Thousands of individual claims were eventually consolidated into three class actions. LP has now settled one suit--agreeing to pay for repairs that could total $30 million--while the other two are pending. Although LP no longer sells siding in Florida, problems were only beginning. The company quietly settled similar charges with the Minnesota Attorney General, while another 10 class actions around the country remain unresolved.

Ironically, Merlo's problems stem from a product that had been his biggest triumph--a cheap plywood substitute known as oriented strand board (OSB). Merlo had vigorously championed OSB, which is made from paper-thin slices of small trees that are glued together with resin, starting in 1980. While other forest-products companies worried about the diminishing supply of big trees from which plywood was cut, Merlo bet that by using "weed" trees that others spurned, LP could create a substitute. The risky move paid off, and OSB became hugely popular. The product, which comes with a 25-year warranty, fueled LP's bottom line for the last decade. By 1994, OSB accounted for 25% of revenues and roughly 35% of profits.

At first, builders used strand board only for floor and roof sheeting. For such applications, it has performed well and been widely copied. But Merlo overreached in 1985 when he decided to market a version of OSB as siding in place of the usual cedar. Just a few years after installation, the material began to deteriorate, according to the spate of class actions and state and federal investigations. Unable to withstand humidity, the siding boards have rotted and cracked. In moist climates, houses have sprouted mushrooms and other fungi. "I can poke my finger through it," says Portland homeowner Steven Eklund. "It's a real mess."

Kayser denies that the siding is flawed, and LP continues to sell it in most states. He says the company will "aggressively fight" the growing litigation while striving to improve quality. "If there is a problem, we'll fix it," he says. "We never claimed to have zero defects."

Still, as the problems were mounting, directors grew increasingly anxious over rising payments for defective products: $5 million in 1993, $10 million in 1994, and $7 million in this year's first half. After years of denial, when Merlo finally admitted that the litigation would hit LP financially this spring, investor support dried up. "All of a sudden, what had not been a material problem became one," says Nelson.

Yet even the news in April of the pending indictment alleging problems at the company's Montrose (Colo.) plant didn't appear to worry Merlo. With typical bravado, he offered to resign. The eight-member board--which, besides Merlo, included three current or former company executives and Merlo's hunting buddy Yeager--insisted he stay. "We refused, and he knew we would," says one director.

But with Guiton Hill increasingly pushing the board to act--and directors' growing fears that they would be liable--that soon changed. With Merlo's consent, the board hired San Francisco law firm LeBoeuf, Lamb, Greene & MacRae to prepare a report on the alleged problems at Montrose. But Guiton Hill also chaired an outside board committee that authorized investigating attorney Charles B. Renfrew to conduct a more far-reaching probe. "The days of rubber-stamping are over," Guiton Hill says. "When problems reach the breaking point, you have to take action."

AUTOCRATIC STYLE. When the grand jury indictment finally came on June 15, the pressure on Merlo mounted. The 56-count charge suggests a company rife uith environmental violations and sorely lacking in quality-control measures. The indictment alleges that plant managers and employees at the Montrose plant tampered with pollution-monitoring devices, at times turning them off completely. The grand jury also charged that Louisiana-Pacific routinely cut corners in manufacturing: It allegedly sold low-grade strand board to contractors, then fraudulently substituted higher-quality samples when industry auditors came to certify the boards were of the quality required for home construction.

LP has pled not guilty to the allegations. Renfrew, a retired federal judge and former federal prosecutor, won't comment on what his investigation turned up. Interim CEO Kayser declines comment, except to say, "We are vigorously defending ourselves." And he insists there is "no linkage" between the charges and Merlo's ouster. Instead, he says, Merlo was ousted because Renfrew's confidential findings revealed "serious problems with management practices and style."

Those findings centered on what company sources say was the increasing damage caused by Merlo's aggressive, autocratic style. Despite the company's rapid growth, former executives describe an entrepreneurial manager who, together with his two top lieutenants, continued to make all key decisions. Merlo pushed relentlessly for ever higher productivity and ever lower costs--and instilled a demanding, performance driven culture. At one Texas plywood plant, for example, a sign on the wall read: "Work, or get your ass kicked." Although success was well-compensated, promotions were rare. "Merlo hates titles and organizational charts," says one former top exec. "He ran Louisiana-Pacific as if it were a small startup." That may have been a virtue early on, but Merlo's refusal to build stronger middle management led to poor controls--especially worrisome when coupled with pressure for better numbers. Says Guiton Hill: "Management was very, very, very thin."

Others defend Merlo as a gifted if abrasive visionary whose downfall was sped by his flamboyant manner. Pratt and others say Merlo had long rankled the insular Portland business community by avoiding the country club set. Says Pratt: "They didn't like his style."

Instead, the perennial bachelor raised eyebrows with his opulent lifestyle: He threw lavish parties at his $900,000 company-owned estate or on the yacht, using LP's private jets to fly in celebrity guests such as tenor Luciano Pavarotti. And friends acknowledge that Merlo was known for hiring stunning women as his assistants; even today, "he never goes anywhere without a tall attractive blonde on his arm," says Portland businessman Edward Pietz. That led to further trouble: In mid-1993, an ex-assistant to LP's CFO filed suit against Merlo for sexual harassment, alleging the company hired top assistants only if they were "young, strikingly attractive, and likely to acquiesce to sexual advances by the CEO." Merlo and the company refuse to comment on the allegations, and the suit is pending.

Kayser says Merlo's lifestyle never interfered with work, and he denies that the harassment charges were a factor in his ouster. Still, within a month of Merlo's leaving, the company planes and yacht went on sale as "underutilized."

Kayser is left with the unenviable task of setting LP back on track. The company recently restated its second-quarter earnings, reducing them by $16 million, to $26.3 million, to build reserves for growing claims and legal expenses. "Our priority is to bring all this litigation to an early closure," he says. Analysts estimate the company's liability could reach $300 million or more.

In the meantime, Kayser has broken LP into smaller units, added extra management, and hired a head of compliance. He hopes to name a new CEO by January. As for Harry Merlo, he has remained mum. Supporters say that with extensive other interests, including stakes in a local semiconductor manufacturer and a software house, he will remain a player in the Portland business scene. And, some locals speculate, he may try to seize back control of "his" company with a hostile tender offer. Just in case Kayser and his newly vigilant board didn't have enough worries.

When Harry Met Trouble

1980 Louisiana-Pacific CEO Harry Merlo launches "oriented strand board," an inexpensive plywood substitute. By 1985, LP markets OSB as exterior house siding, and OSB becomes company's top-selling product.

1990-1994 Thousands of homeowners in Florida complain that LP's siding deteriorates in the humid climate. Three class actions are filed. One has been settled; the others are pending.

1991-92 Minnesota Attorney General sues LP over defective siding. Company settles, agrees to pay for repairs. By yearend LP has paid $22 million to settle OSB claims nationwide.

AUGUST, 1993 An ex-employee sues Merlo, alleging sexual harassment. Merlo and the company refuse to comment, and the suit is pending.

MAY-SEPTEMBER, 1995 With 12 class actions alleging defective OSB siding, LP's liability could hit $300 million. As litigation mounts, LP's board launches internal investigation.

JUNE, 1995 Colorado grand jury indicts LP and two plant managers for environmental violations and fraud involving OSB. With OSB now accounting for 25% of LP's $3 billion sales, the stock tumbles to 22 from all-time high of 44 in 1994.

JULY 3 LP's board announces Merlo's ouster and begins search for replacement.


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