DID LAIDLAW STRIKE FOOL'S GOLD?
When Donald K. Jackson took over as chief executive of Laidlaw Inc. in August, he had every reason to look ahead with considerable cheer. Founded in the late 1950s, Laidlaw had evolved from a small trucking company into a waste-management powerhouse and big school-bus operator. As one of Canada's fastest-growing companies--revenues climbed ninefold, to $1.7 billion, during the `80s--Laidlaw attracted an ardent following among investors in Toronto and New York. But soon after he settled in, Jackson thrust himself into an unusual role for a new CEO--that of corporate sleuth.
Jackson hopes to unravel a tangled mystery surrounding ADT Ltd., a $1.2 billion, Bermuda-based provider of security-alarm systems and the world's largest car auctioneer. During the tenure of just-retired Laidlaw Chairman and CEO Michael G. DeGroote, the company invested some $1 billion in ADT and now owns a 29% stake. Initially, ADT turned in dazzling results. But since Jackson started casting a gimlet eye on ADT's books, alarm bells have been ringing at Laidlaw.
An internal investigation by Laidlaw has raised troubling questions about ADT's financial practices. The conflict burst into public view on Apr. 1 when Laidlaw sued ADT in U. S. District Court in Manhattan, alleging that ADT's soaring financial results--pretax profits rose thirteenfold from 1983 to 1989--may have been partly "illusory."
The suit also charged that ADT had engaged in a series of "rigged transactions" in which the company allegedly shuffled assets back and forth between controlled subsidiaries to book huge gains. In a press release, ADT Chairman Michael A. Ashcroft, a 45-year-old British financier, called the suit an "unwarranted attack on the integrity of ADT and its management." Nonetheless, the company quickly initiated settlement talks. Ashcroft declined repeated interview requests by BUSINESS WEEK.
DOUBLE STANDARD. Jackson recently dropped the suit after Ashcroft agreed to his demands for the creation of an independent audit committee and seven seats on ADT's expanded board of 15. ADT says the whole matter is over. However, a number of ADT shareholder suits already have been filed and consolidated in Manhattan. Meanwhile, Jackson vows: "We're going to open the doors and let the sunshine in."
Unfortunately for Jackson--and Laidlaw investors--he's probably not going to like what he finds. Laidlaw claimed in the lawsuit that recent ADT annual reports, audited by the Bermuda office of Deloitte, Haskins & Sells (now Deloitte & Touche), have greatly overstated profits. Deloitte's Bermuda office said it would be "inappropriate" to comment on the flap, as ADT's accounts are now audited by Coopers & Lybrand. Coopers says it stands by its 1990 "unqualified" audit opinion of ADT.
Still, there are unresolved issues aplenty arising from the Laidlaw suit. For instance, ADT reported profits of $922.2 million from 1986 to 1989. Portions of those results were based on British accounting rules. But ADT's recent filings with the Securities & Exchange Commission reveal that the company earned only $115.2 million during the same period, if worked up by standard U. S. accounting rules. The different accounting methods do produce discrepancies. Still, the 88% gap seems extremely large, says Laidlaw.
One thing is clear, though: ADT's financial position is deteriorating rapidly. On Mar. 18, ADT reported that its net income had fallen a startling 43%, to $182 million, in 1990. Much of this was the result of a large drop in a category called "other income," which wasnot explained. Another enigma is what happened to more than $100 million in cash and marketable securities. ADT reported that these assets declined by $800 million in its 1990 annual results but offered a detailed explanation for less than $700 million of that drop.
At issue here is much more than arcane accounting principles. The market value of Laidlaw's ADT investment has plunged by more than $400 million, and Jackson conceded that the company may be forced to take a huge write-off later this year to cover the downturn. The ADT mess is already hurting Laidlaw. In April, the company reported that its net income plunged 96%, to $2.7 million, during its second quarter, largely as a result of the drop in ADT's earnings and Laidlaw's share of a $53.3 million extraordinary loss taken by ADT. Complicating matters are the U. S. and Canadian recessions, which have squeezed margins at Laidlaw. Investors are jittery: Laidlaw has shed about a third of its market value since February.
OFFSHORE MOVE. DeGroote declined to discuss ADT's current woes. Yet he says he was originally attracted by ADT's leading position in the security and car-auction businesses. Ashcroft also benefited personally from his relationship with Laidlaw. Just before DeGroote's retirement, Laidlaw's board worked out a deal under which the company bought Ashcroft's personal shares in ADT for $34.1 million. Laidlaw even granted him the unusual option to repurchase the shares at the same price, adjusted for financing costs, through mid-1993. If the shares appreciate markedly, Ashcroft would be able to capitalize on the gain without bearing any risk.
It wouldn't be the first time Ashcroft cut a smart deal. In 1977, he acquired a 25% stake in an obscure tent company, Hawley Group Ltd. He soon proved a prolific dealmaker and developed powerful friends. He enjoys close ties to top Conservative Party figures, and he's an acquaintance of Princess Diana.
In 1984, Ashcroft moved Hawley from London to the balmier regulatory climate of Bermuda. Then, in 1987, he spent $715 million to gobble up ADT, the No. 1 player in the U. S. security-alarm business and renamed Hawley after it. Ashcroft clearly called the shots. According to Laidlaw's suit, DeGroote was ADT's only "independent" director.
Perhaps if there had been more outside scrutiny, ADT's financial reports wouldn't be so puzzling. In its lawsuit, Laidlaw alleged that ADT improperly improved its balance sheet and income statement by transferring assets in and out of its 48%-owned affiliate, Sechura Inc., a Canadian holding company. One example: Laidlaw alleges that at the end of 1986, ADT sold to Sechura its 28% stake in Attwoods PLC, a waste-management company based in Britain that it had acquired that same year for $27 million. Yet six months later, Sechura resold the Attwoods stake to ADT in a transaction valued at $63.5 million. Although no cash changed hands, the value of the Attwoods stake more than doubled on ADT's books. According to Laidlaw's suit, ADT allegedly booked profits on similar deals.
Under U. S. accounting rules, companies may not realize gains on the transfer of assets to subsidiaries because of a potential conflict of interest. But British standards allow such gains if the affiliate is less than 50% ewned. Still, Laidlaw contended in the now-dropped lawsuit that ADT used these transactions to pump up reported profits. And, indeed, ADT recently took a $95.7 million write-off on its stake in the affiliate. Sechura says "ADT never exercised improper or undue influence" in this deal.
TERSE REPORTS. While there's nothing apparently illegal about ADT's accounting practices, Jackson is pressing Ashcroft to adopt more stringent accounting methods. And once ADT's independent audit committee sorts through the company's books, perhaps Laidlaw will understand what caused the drop in the company's cash position. Laidlaw would also like to get more details about the integrity of ADT's earnings. In recent years, ADT reported huge earnings gains with precious little explanation. In 1989, some 40% of its $290 million in pretax income came from "affiliates" and "other activities."
For his part, Jackson is confident these issues will soon be "properly vetted." He's upbeat about ADT's long-term prospects, given the boom in demand for electronic security-alarm systems. And despite Laidlaw's recent setbacks, the garbage-hauling business has strong growth prospects in the U. S., its No. 1 market. But until Laidlaw finishes unraveling the curious case of ADT's books, this corporate detective story may yet reveal a few unpleasant plot twists.William C. Symonds in Toronto and Mark Maremont in London