Conseco's Morning After

Steve Hilbert was living large as the company stumbled

It was Memorial Day weekend in 1997 and Stephen C. Hilbert, then CEO of Conseco Inc, was hosting his annual Indy 500 bash at his Carmel, Ind., mansion. It was a party like no other, says one guest. Hired limousines dropped off Wall Streeters and Conseco's top brass. By the pool, guests waited patiently in a lengthy receiving line to shake hands with Hilbert, his wife Tomisue, and Chief Financial Officer Rollin M. Dick.

The festivities continued the next day in Conseco's box seats at the race track. Guests were served champagne and croissants as they cheered on Conseco's sponsored Indy team, led by racing legend A.J. Foyt. It seemed Hilbert, whose stock had quadrupled to $40 over the prior two years, could do no wrong.

Three years later, Hilbert has left Conseco, an insurance company with $8.4 billion in revenues that he founded in 1979. On April 28, Hilbert, 54, and Dick, 68, announced they were terminating their employment. It's still anyone's guess, of course, how Hilbert will be remembered: as a financial genius who took Conseco's stock from a split-adjusted 43 cents in 1985 to a peak of $56 in 1998, or as a slick salesman who took a company to dizzying heights, with lots of leverage, but finally stumbled after buying Green Tree Financial Corp., a mobile-home and subprime equity lender, in 1998 for $7.6 billion. Conseco now has big debts, and some analysts question whether the company can survive. Its stock now trades below $5. Neither Hilbert, nor his wife Tomisue, nor Dick responded to requests for interviews.

Currently, the company faces more than 20 lawsuits claiming, among other things, that it withheld pertinent financial information from shareholders. The company said it plans to defend itself vigorously against these suits.

Conseco is now chaired by Thomas H. Lee, head of the Boston leveraged buyout partnership bearing his name. David V. Harkins, a Thomas H. Lee Co. partner, is CEO. In December, 1999, the partnership invested $500 million in preferred convertibles at $19.25. As to suggestions by some analysts that Conseco is in financial disarray, Harkins says: "Unequivocally, that is not true."

Hilbert's imprint on the company remains strong. Stories abound about the complex former CEO's larger-than-life style. He has been married six times, wears expensive Bijan suits, and entertains lavishly in his Carmel mansion. For one of his parties, he hired, from his own pocket, Kool & The Gang to entertain his guests. But he's also known as a local boy who made good and donated millions to causes such as the Indianapolis Symphony Orchestra and the Saint Vincent Hospital Foundation. Says F. Duke Haddad, the foundation's executive director: "[Hilbert] is one of the most friendly, genuine people you'd ever meet. Whether you're a multimillionaire or a janitor, he has respect for you and remembers your name."

BIG QUESTIONS. So what led to Hilbert's downfall? Some point to his personal life. "It was like a light switch," recalls Kevin Cogan, a onetime Indy 500 race car driver and former board member of Bankers Life & Casualty Co., a Conseco subsidiary. "Virtually overnight, Hilbert went from being a grounded Midwestern kind of guy, a sort of a normal fellow, to one with chauffeurs and bodyguards with hearing devices and carrying guns. It all stems from him deciding to date and marry a [young woman]," says Cogan. His wife, Tomisue, was a dancer in her twenties at the time.

Downfall aside, Stephen Hilbert's story is that of a latter-day Horatio Alger. The son of a maintenance worker and telephone operator, Hilbert left Indiana State University without graduating and bootstrapped himself up from selling encyclopedias door-to-door to founding one of the largest insurance companies in the country.

His business strategy proved very effective, at least in the beginning. Hilbert began buying bloated life insurance companies with cash raised by issuing debt. Then he canned large numbers of employees and streamlined the back-office systems at companies he bought. However, Hilbert's tightwad approach apparently didn't apply to Conseco's own executives. The company leases five corporate jets and a helicopter. In 1995 Hilbert, long one of the highest-paid CEOs in the country, invested $20 million of Conseco's money in a theme restaurant venture, founded by magician David Copperfield, which quickly failed. Conseco says that this investment is not a write-off because the real estate still has value.

Conseco prospered in the decade through 1998. The stock price rose an average of 46% a year, while earnings per share grew 37% annually over the period. Hilbert's record inspired awe, and fear, on Wall Street. After all, Conseco bought 20 companies in 10 years, issued dozens of different types of bonds and preferred stock, and generated hundreds of millions in fees for banks and securities houses. Upsetting Hilbert could be risky.

Bear, Stearns & Co. discovered that when one of its bankers gave Hilbert a price estimate for the part of Bankers Life that Conseco did not then own, but wanted to buy. According to Cogan, Hilbert thought the price too steep and, enraged, wrote a letter personally attacking the banker and asking Bear, Stearns CEO Alan C. Greenberg to fire him. Horrified, Cogan sent his own letter saying the personal attacks were groundless: "Steve was characterizing this guy as overbearing and pompous. But in fact, the banker couldn't have been more respectful. To go after him personally was just totally wrong."

Despite its 17,000 employees, and huge appetite for buying companies, Conseco was always considered a two-person shop. Hilbert and CFO Dick were regarded by the financial community as the masterminds. "You never saw Hilbert without Dick," says one analyst, who asked not to be named. "Hilbert was the front man, and Dick was like a jovial grandfather-type who you could find working at his desk at 7 a.m on a Sunday morning." Dick was seen by some on Wall Street as the brains behind Conseco's complex structure.

CONFUSION. Analyzing Conseco was certainly not a job for amateurs. Initially, Conseco put the debt it used to buy companies on its own balance sheet. But in the early 1990s, it switched to using off-balance-sheet vehicles, such as leveraged-buyout funds, to make acquisitions. In those years, Conseco would temporarily consolidate some companies on its own income statement in one quarter, only to remove them in another.

"There was not one analyst who could figure out the [expletive] earnings to save his life," said one hedge fund manager who asked not to be named. Indeed, in 1995 insurance expert Jospeh M. Belth, editor of the Insurance Forum, an industry newsletter, confessed that "...we do not understand [Conseco's] complex, aggressive, and controversial accounting practices." In the late 1990s the company returned to buying companies on its own balance sheet. Conseco's auditors, PricewaterhouseCoopers, said it does not comment on clients' affairs.

Baruch College accounting professor Abraham Briloff thought Conseco's accounting strategies "made it possible for Conseco to develop the illusion of exaggerated income and cash flow." In reality, most of the cash from the subsidiaries was strictly regulated by insurance laws that required it to be sequestered for the benefit of policyholders. "Wall Streeters blinded themselves to the underlying truth," says Briloff. According to Salomon Smith Barney analyst Colin Devine, Conseco's holding company has had a negative operating cash flow since 1997. Conseco itself removed its cash-flow charts from its SEC filings after 1997. The company, however, denies that it has a negative cash flow. "Hilbert and Dick would talk on and on about cash," says the hedge fund manager. "But it was not representative of cash flows available to the parent. Not only did they do nothing to correct the misinterpretation, but they helped create it."

While Conseco's accounting may have been difficult to comprehend, Hilbert's early strategy was not. He was a pioneer in using leverage to buy bloated, poorly managed life insurers. One of Conseco's early and extremely profitable deals was in 1987, when it acquired Western National Life Insurance Co. for $264 million, $235 million of which was borrowed. Seven years later, Conseco spun out part of Western Life to the public. Its $29 million equity investment has grown to more than $665 million, according to Schiff's Insurance Observer.

END OF THE LINE. Eventually, Conseco ran out of cheap life insurers to buy. So in 1996 it turned to health insurers. Almost miraculously, some of them reported margins that doubled after they were bought by Conseco. In reality, revenues and earnings were flat at most of Conseco's businesses. "They were in mature stagnant lines," says Salomon's Devine. Hence, to keep earnings growing, Conseco needed to buy more companies. "Basically, they were stacking deteriorating businesses on top of each other to maintain growth," says another money manager, who asked not to be named.

By 1998, Hilbert needed to swallow a really big fish to keep earnings growing fast. Green Tree seemed to fit the bill. Hilbert heralded this lender with $1.1 billion in revenues as a perfect addition to Conseco that would allow it to cross-sell a host of financial service products. The purchase price of $7.6 billion, however, would prove to be Conseco's undoing.

The denouement came quickly. In the first quarter of 2000, Green Tree reported its third big write-off in three years, this time for $554 million. Conseco was forced to put Green Tree on the block. Meanwhile, Conseco's health-insurance businesses, which had shown such promising margins just a few years earlier, suddenly took a turn for the worse. Loss ratios spiked considerably, crushing margins and validating the skeptics who had doubted that the hefty margins reported earlier were really attainable.

With earnings falling, Conseco's debt ballooned to over $9 billion, estimates Salomon's Devine. Meanwhile, officers and directors who had borrowed over $500 million in an aggressive loan program to buy Conseco stock were now underwater by hundreds of millions of dollars. Shareholder lawsuits started piling up. The stock plunged to below $10.

The day of the first-quarter results, Hilbert and CFO Dick left. Officials of Thomas H. Lee Co. moved in as Conseco's top officers. New CEO Harkins says that the Lee partners stand by their judgement of the underlying value of Conseco's insurance and finance businesses.

PAPER LOSSES. Despite his optimism, though, many analysts figure that Conseco faces an uncertain future. Even if Green Tree is sold for $4.5 billion--its book value plus debt owed to the parent--the problems are far from over. "It's questionable whether Conseco can service the remaining estimated $5 billion of debt, in the wake of recent ratings downgrades of its insurance operations," says Devine.

As for Hilbert, the jury is still out. The local Carmel philanthropic community is wondering whether their source of funds may be shut off for good. And longtime Conseco critics are wondering whether the SEC will now investigate Hilbert's and Dick's accounting practices. Meanwhile, some Conseco employees who participated in the stock-loan program have such high paper losses on their investment that they might face bankruptcy if they had to pay off their loans today.

Carmel Mayor James Brainard says that he recently saw Hilbert at a local party, adding: "He seems very up, very energetic, as always."

Hilbert's legacy at Conseco isn't so upbeat. He started the company from nothing, and he's leaving it pretty much the same way.

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