EASY CASH MAY MEAN HARD TIMES
Byline: Thomas J. Ryan
NEW YORK — Money is easy to get these days, but the easy money is building a base for troubles ahead.
Loans, both in bank debt and high-yield bonds, are becoming riskier, according to experts in distressed situations — both vulture traders and liquidators.
Their predictions of trouble ahead were issued at a Financial Forum luncheon discussion last week sponsored by WWD. The panel was made up of two speculators/vultures and three consultant/liquidators.
Representing the speculators were Peter M. Lupoff, senior vice president for high-yield trading at Lehman Bros., and Leah A. Hartman, senior vice president and principal of Credit Research & Trading, Greenwich, Conn., a firm specializing in distressed situations.
The consultant/liquidators were represented by Robert C. Sager, president of Gordon Bros., Boston; Paul Buxbaum, president of Buxbaum, Ginsberg & Associates, Encino, Calif., and Alan Cohen, chairman of Alco Capital Group.
“There’s way too much cash in our world,” said Lupoff. “There’s way too much cash in the banks looking to make loans.”
Competition among banks to use this money is driving banks to hand out large amounts of money to unproven firms at low rates, according to Lupoff.
As a result of these riskier bank loans, Lupoff expects a surge in defaults in the next few years, as these unproven firms fail in running their businesses and run out of money to pay off the loans.
“There’s a tremendous amount of competition among finance groups, and somewhere along the line, there’s going to be some problems,” said Cohen.
Besides bank debt, which is secured by assets, high-yield debt has become a riskier bet, according to Hartman.
Hartman said many subpar firms are receiving fat loans at relatively low rates, and these firms will have a hard time keeping up their payments on the loans should the current vibrant economy stall.
“The yield is presuming the growth rate that some of these companies have been able to achieve in the last year or two with a positive economic cycle will continue indefinitely. Once the cycle turns, they won’t be able to handle it,” Hartman said.
Lupoff concurred: “We have a really favorable economic cycle where people feel good about themselves, they got jobs, they spent money on electronics two years ago and have been buying apparel at retail for the last two years. But it’s just a matter of time before the cycle turns.”
Moreover, experts in distressed firms said the expected bankruptcies will be more troublesome than even the spate of leveraged buyout based bankruptcies the late Eighties, highlighted by the Chapter 11 filings of such retail giants as Federated Department Stores Inc. and R.H. Macy & Co.
Lupoff said that companies like Federated and Macy’s had solid core business, but were forced into bankruptcy because they were unable to handle a debt load they took on in the LBOs. The upcoming bankruptcies are expected to involve weaker businesses.
“The difference between today and five years ago is that, five years ago, these were fundamentally sound businesses. Federated and Macy’s were real franchises. These days, companies that are able to borrow money at attractive rates and borrow too much are fundamentally weak companies in need of operating turnarounds,” said Lupoff.
Hartman said management now has to deal with restructuring the balance sheet as well as trying to dramatically rebuild operations.
“It used to be called good company/bad balance sheet, and now it’s bad balance sheet/bad company,” Hartman said. “So you need managers to come in and say, ‘OK, manufacturing needs to be split from retail,’ and you really work and spend a lot of time fixing the business as well as fixing the balance sheet.”
Lupoff noted that, for example, J. Crew Group Inc. is being sold for a rich 11 times cash flow, while the standard multiple on such a retail purchase is around eight. The price, according to Lupoff, sounds particularly high, considering Crew’s recent launch into retail is expected to be its major growth vehicle going forward.
He noted that many catalog firms in the past have had trouble expanding into retail, and he suspects Crew will not find it easy standing out in an already crowded retail market.
“You want to differentiate yourself in a market where the store is no longer the superstar, the designer is,” said Lupoff. “It just sounds risky to give 100-cent dollars to that buyer. So if those deals are getting done, there’s going to be plenty to do in a couple of years.”
Already, some firms in bankruptcy proceedings are attempting the expensive process of trying to turn around operations while also reworking financings, including Montgomery Ward & Co., Barneys Inc., Bradlees Inc. and Caldor Corp.
Montgomery Ward, with $3.6 billion in unsecured claims, is the largest retail bankruptcy since Federated’s and Macy’s.
Hartman said Ward’s will have a very difficult time turning around.
“The business itself is extremely weak,” Hartman said. Ward’s repositioning program is to pinpoint its price points between and a discounter and retailers such as J.C. Penney and Sears, but Hartman expects Ward’s will be hard pressed to maintain these price points in a downturn in the economy.
“When the economic cycle turns down, you’re going to get a squeeze between those two price points in our expectations,” Hartman said.
Hartman also said it will be “extremely expensive” for Ward’s to change an image and expects shoppers will be left perplexed.
“They know what a Sears is, they know what a Penney’s is, and they know what the discounter offers them. Trying to develop your own niche in between them is confusing.”
Hartman said the one thing Ward’s has going for it is General Electric, which owns Ward’s and gets a steady earnings stream from Ward’s credit-card operations.
“I think GE will prop it up longer than it should be,” Hartman said. “If it fails miserably and the company needs to be liquidated, I think most creditors would be thrilled to see a liquidation begin sooner rather than later and walk away with cash in their pockets, even though it might be a lesser recovery as a percent base of their claim.”
She expects with GE’s continued support, Ward’s will emerge from bankruptcy after Christmas 1999, either as a reorganized Chapter 11 or a liquidation.
Turning to another retailer in bankruptcy proceedings, Robert Sager, at Gordon Brothers, said Barneys also lost its cachet and is having a harder time standing out.
“I ask myself what’s Barneys’ competitive advantage going forward, and I don’t see any. You can buy Armani anywhere you want now,” said Sager. “Whenever I look at a business, my very first question is, ‘What’s its competitive advantage?’ Sometimes it’s technology, sometimes it’s location, sometimes it’s great buyers; but I don’t see that in Barneys.”
Sager said Dickson Poon, whose company, Dickson Concepts, has put in a $240 million bid for Barneys, may be able to make Barneys unique again.
“He’s done a pretty good job with lots of other businesses, but it’s going to require a very different approach than we’ve seen over the last several years.”
Sager said finding an identity is a chronic problem among troubled retailers.
“Most of the companies we work with we ask, ‘What’s the competitive advantage?’ And most often, there isn’t one.”
Besides more problematic bankruptcies, vulture firms also expect a less-aggressive stance in the future toward the pricing of distressed claims, largely because buyers got burned on recent deals.
Hartman said these recent sales of bankruptcy claims were also puffed up by surplus money in the market chasing new investments.
“There’s too much money chasing too few goods,” said Hartman.
For example, claims for Barneys, which now are being bid at about 30 cents on the dollar, were as high as 83 cents on the dollar during the summer of 1996. Prices for claims in Caldor and Bradlees were as high as 60 cents on the dollar, but now are being bid in the teens.
“It’s going to cause a shakeout in our world,” said Lupoff. “The investment community that is overpaying for these situations today will probably not be there down the road. So there will be less capital chasing the worst deals a year or two hence, and there’s going to be a real defining point as to who’s competent in this business and who was just along for the ride for the last five years.”