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Leveraged Buyout Firm Profits From Restructuring Wave

March 29, 1987

NEW YORK (AP) _ Corporate America’s restructuring wave seems made to order for Clayton & Dubilier Inc.

A major thrust of the restructuring involves companies narrowing their operations and divesting lines out of step with their new ″strategic focus.″

Enter Clayton & Dubilier, which specializes in using leveraged buyouts to acquire relatively small businesses - such as subsidiaries divested by larger corporations.

In March, Clayton & Dubilier agreed to buy the industrial products group of Borg-Warner Corp. for $240 million. In January the firm acquired the business supplies unit of Unisys Corp. for $50 million, and in December it purchased the O.M. Scott & Sons Co. fertilizer business from ITT Corp. for $150 million.

Restructuring ″has created a tremendous amount of opportunities,″ Joseph L. Rice III, Clayton & Dubilier’s president, said in an interview.

Founded in 1976 by former business managers L.E. Clayton and Martin H. Dubilier, the firm initially provided ″crisis management″ advice to troubled companies.

But it turned to leveraged buyouts in 1978 when Rice, a former corporate lawyer, came aboard. Clayton left the firm in 1985 to return to consulting.

Today the firm is one of several specialists in LBOs, in which a company is acquired with mostly borrowed money that is repaid from the target company’s cash flow or asset sales.

The rest of the purchase price is the equity invested by the new owners, including the firm or firms organizing the buyout - which often use money provided by outside investors - and the company’s executives.

Clayton & Dubilier, for example, manages a pool of $160 million provided by banks, university endowments and other institutional investors.

The major attraction of leveraged buyouts is that once the debt incurred in the deal is paid off or substantially reduced, or the business is resold or again goes public, the value of the investors’ equity can soar.

A case in point is Arnold Foods Co. Clayton & Dubilier bought the baked- goods concern in 1984 for $45 million, including $5 million of equity kicked in by the firm and Arnold’s managers.

The owners, having helped Arnold expand its product line, sold the company last year to CPC International Inc. for $110 million. Subtract the initial $40 million of debt, and the equity held by Clayton & Dubilier and management sold for $70 million.

Perhaps the best-known LBO house is Kohlberg Kravis Roberts & Co., which has orchestrated several billion-dollar buyouts of large, publicly traded corporations, including Beatrice Cos. and Safeway Stores Inc.

Clayton & Dubilier, by contrast, prefers smaller deals out of the spotlight. Such deals still produce hefty returns, yet enable the firm to avoid the emotional bidding wars that can lift prices of publicly held companies well above what reason might dictate.

″I’m not a great fan of the public arena,″ Rice said. ″I think pricing tends to get out of hand.″

With smaller, private deals, ″you can be more cerebral,″ he said. ″You can sit here and say, ‘Now what is this business really worth?’ It’s a very unemotional kind of thing.″

Perhaps. But even Clayton & Dubilier made one acquisition on largely emotional grounds, a deal very much out of the firm’s character.

Two years ago Uniroyal Inc., facing a takeover threat from financier Carl C. Icahn, searched for a friendly suitor. None was found.

Then Uniroyal approached Clayton & Dubilier, and within a few months the firm joined with Uniroyal management to buy the tiremaker for $1 billion.

Rice recalled that in 1985, Joseph P. Flannery, Uniroyal’s chairman, faced losing the company after having restored it to financial health from its brush with bankruptcy five years earlier. ″I just decided from an emotional point of view that if we could do something to help Flannery, and keep the business with him, we were going to do it,″ Rice said.

Eventually, however, Uniroyal was broken apart to help pay the buyout’s debt. Uniroyal’s tire business was merged with B.F. Goodrich Co., and most of its other assets were sold.

Because of the large debt involved, leveraged buyouts frequently require buyers to divest assets.

But Uniroyal’s break-up still bothers Rice. Clayton & Dubilier prides itself on keeping its acquisitions largely intact and then helping them grow, in part by providing management advice and by giving the company’s existing managers the extra incentive of being owners.

That extra incentive is a sore point among critics of LBOs, who question why managers need an LBO, and the prospect of huge personal financial gain, to bring out the best in a company. Critics wonder why management could not have done the same for the company’s former owners, the stockholders.

Rice’s answer: ″Good old American capitalism.″

″Owners treat businesses differently than the guys who are hired guns,″ he said. ″If you rent an apartment, I know you’d treat it differently than if you owned it. The same is true in business.″

The huge debt initially facing managers after an LBO is completed also provides a tremendous discipline to run the company more efficiently, Rice said.

″You just don’t go out and spend your (the company’s) money foolishly,″ he said. ″You really start to take a hard look at what kind of capital investment pays off.″

Clayton & Dubilier, like other LBO houses, also wants to make its clients’ investment pay off, and thus does not nurture its acquisitions indefinitely.

″We don’t fall in love with companies,″ Rice said. ″I’m just a glorified money manager. I don’t think I’ve done my job until I’ve gone full circle and gotten my investors some kind of a gain.″

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EDITOR’S NOTE: James F. Peltz reports on corporate acquisitions and finances for The Associated Press.

End Adv Sunday March 29

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