Swooping Down To Snatch A Fortune

Michael Embler squeezed a windfall out of ailing HealthSouth. Did he go too far?

How far is Michael J. Embler willing to go in the high-stakes game of vulture investing? Co-managing $32 billion in assets, the 40-year-old senior vice-president at Franklin Mutual Advisers LLC has made millions by buying the cheap debt of beleaguered companies such as MCI Inc. (MCIA ) He usually invests as trouble breaks, bets a company will recover, then bags a big profit. Often, Embler has to put a company's management in a financial headlock, banging tables and threatening defaults to ensure that he gets paid. Still, most of his investments in stumbling companies have caused little controversy.

Until now. In March, Embler and a group of bondholders demanded a big payment from HealthSouth Corp. (HLSH ), the scandal-plagued Birmingham (Ala.) hospital chain. The rehab specialist quickly fired back, charging in a lawsuit that the bondholders were engaged in a "bad-faith attempt...to enrich themselves unjustly." Embler & Co. argued that HealthSouth had violated its bond covenants, so they were entitled to accelerated payments on a big chunk of their bonds. "The company was unable to meet its contractual agreement with bondholders, and unfortunately the issue involved litigation," says Embler. The two sides settled on June 8; the bondholders won a $41 million payday, of which his firm gets $13 million.

Now the Alabama Securities Commission is looking into allegations made by shareholders that Embler's tactics were improper. Embler declines to comment.

HealthSouth is a typical Embler target. It's digging out from Securities & Exchange Commission and Justice Dept. charges that it fraudulently inflated earnings by at least $2.5 billion from 1996 to 2002. It's unable to file financial statements until next year, pending a complete review of its books, putting it in technical default on its bond covenants.

Embler had invested in various HealthSouth bonds in the past. But in January he decided to focus on one class of bonds -- those due in 2012 with a 7.625% coupon. He poured at least $225 million into them by the end of February, on top of the $75 million worth he already owned. A group of bondholders he led bought millions more. That gave them far more than 25% of the issue, the threshold at which they could have the company declared in default. On Mar. 11, Embler threatened to demand more than $300 million in accelerated payments, permitted under the bond covenants because financial statements hadn't been filed.

"RUSSIAN ROULETTE"

The hardball tactics provoked an equally tough response. HealthSouth was turning around smartly, generating $650 million in cash over the past year, and it had made all of its interest and principal payments on time since August. What's more, Embler knew about the technical default when he invested, according to court documents, and therefore, the company argued, he shouldn't get any special payment. So later the same day Embler made his demand, the company went to Alabama state court for a restraining order against him, calling his actions a "dangerous game of Russian roulette" because his group could force the company into bankruptcy.

Saying they smelled a shakedown, shareholders, who are usually wiped out in a bankruptcy, also jumped to HealthSouth's defense. They contacted the SEC and the Alabama Attorney General and complained to the board of Franklin's parent, Franklin Resources Inc. (BEN ) in San Mateo, Calif., about Embler's demands. Franklin declines to comment on the case.

But bond covenants are rather clear. In addition to the settlement, Embler and his group keep all of their bonds and continue to receive their regular interest payments. The bondholders did agree not to push for default now or in the future.

Each side says the battle was a tough -- but fair -- bid to maximize returns for its shareholders. "It was all about money," says new HealthSouth Chief Executive Jay Grinney. For Embler, bagging the money may require tough-guy tactics, but that's just how he plays the vulture game.

By Brian Grow in Atlanta

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