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Has Sam Been Minding The Store?


Finance: REAL ESTATE

HAS SAM BEEN MINDING THE STORE?

He is in New York, maneuvering for control of the huge Rockefeller Center office complex. Or he is in Japan, trying to convince Japanese banks to sell him some of their U.S. real estate. Then again, he could be in Chile, motorcycle-riding with a bunch of buddies known as Zell's Angels.

Peripatetic doesn't begin to describe Sam Zell. The charismatic Zell has amassed a fortune over the past three decades by spying value in assets others have spurned. He heads an empire that sprawls across 16 industrial and service companies, 6 large real estate partnerships, a huge buyout fund, and 2 public real estate investment trusts. Corporate holdings churn out $12 billion in revenue; real estate holdings total $5 billion.

Yet as his holdings have multiplied, it's becoming clear that Zell's seemingly on-the-fly, one-man-band management style isn't working as well as it should. Returns at some of his holdings are languishing. He is now working to install a broader management team that will free him to spend more time on what he does best: buy undervalued assets. "I can make more of a contribution if I'm not on the line," he says.

MISSED OPPORTUNITIES. Zell is the first to acknowledge that scouting out bargains, both in the corporate arena and in real estate, will be tougher in coming years. "I still think the world is full of opportunities, but I don't see massive opportunities for huge deals," he says. "Investments require lots of discipline and managerial skill. Cowboys can't play anymore." But he still plans on being a major player. Right now, he is in the midst of raising up to $500 million for a new real estate fund with Merrill Lynch, and he has spearheaded a $1.1 billion bid for Rockefeller Center Properties.

But shoring up management is task No.1, to improve the spotty performance of a number of Zell entities. Zell is chairman or chief executive, or both, of a dozen companies in his panoply of holdings. One of his biggest challenges is dealing with the private Zell/Chilmark Fund, a $1 billion buyout fund targeting public and private companies that was launched in capital-squeezed 1990. One former executive says Zell missed several early investment opportunities because he was scrambling to deal with debt-laden companies he had built up in the 1980s.

Several of the fund's investments seem to be winners. Drugstore chain Revco D.S., mattress maker Sealy Corp., and Jacor Communications Inc., the radio group, are performing well.

But there have been some embarrassments. The fund's investment of $260 million in Broadway Stores Inc., a West Coast retailer that emerged from bankruptcy in 1992, was nearly wiped out this summer as the company came close to the edge again. Broadway was rescued by Federated Department Stores, and the fund was paid in Federated stock, which is now valued about 20% less than the fund's initial investment in Broadway Stores' stock. Another difficult investment is Midway Airlines, which has consumed $30 million of the fund's money. "It makes money some months and others it doesn't," says David M. Schulte, head of merchant-banking operation Chilmark. "It will either be very good or very bad."

While Zell/Chilmark's 15% returns sound good to the average investor, pension funds and other large investors expected annual compound returns north of 20% from the 10-year investment. "We're only in the fifth inning, but they have a lot to do to get to 20%," says William F. Quinn, president of AMR Investment Services Inc., the pension arm of AMR Corp. While he says it is "very realistic" to think that the fund could hit the higher targets, "now is the time to focus on improving earnings and getting the reengineering process going."

The performance of the Zell/Merrill Lynch funds, which target distressed properties, is also a mixed bag, although all are well ahead of real estate benchmark indexes. Zell and Merrill have raised $1.5 billion in real estate funds since 1988. The internal rate of return on Fund I, which raised $410 million in 1988, approaches the low double-digits, says a knowledgeable source. The $450 million Fund II, which came out in 1991, has performed far better. Robert I. Helliesen, a pension-fund consultant with Dorn, Helliesen & Cottle in Berkeley, Calif., says that for the three years ending June 30, 1995, it has returned almost 15% compounded annually. Zell places its returns closer to 30%. But the $682 million Fund III has suffered from a more competitive market. Helliesen says it returned just about 10% over the past year, though Zell places its return closer to 20%.

Fund IV will come online just as a real estate recovery is fueling a scramble for properties, boosting prices. "The competition that Zell has now for troubled assets is incredible," says Donald G. Rundbolm, a senior director at KPMG Peat Marwick. "Buyout funds will have a harder time putting the money out--and they'll get more modest returns."

Management troubles have also buffeted some of Zell's other holdings. At first, Manufactured Home Communities (MHC), a real estate investment trust (REIT) that went public in 1993, looked like a home run. But a large acquisition left it saddled with overhead, sparking an earnings slide that sent the stock from 24 in mid-1994 to 16 1/2 on Nov. 1. "Sam and the management were guilty of not watching the store," says Michael Kirby, a principal with institutional REIT research firm Green Street Advisors. "Effectively they doubled the size of the company, while the CEO, Randall Rowe, was working part-time."

Zell is moving to quell some of these troubles. Earlier this year, he shuffled MHC's management, moving Rowe to another entity, and stepped in as acting CEO. Performance has improved as a result. But Kirby says management remains an issue: "Is this just another of Sam's entities within his big organization that gets short shrift on the management front? Can Sam be CEO of this while he's out trying to buy Rock Center and run 25 other companies?"

SIGNS OF RETOOLING. In an effort to assure investors that he is not stretched too thin, Zell is handing over more responsibility to two trusted lieutenants. One is Rod F. Dammeyer, an executive who oversaw the buildup and subsequent unbundling of Itel Corp., now called Anixter International Inc., which was one of Zell's first corporate investment vehicles. The other is in-house lawyer Sheli Z. Rosenberg. "When we were significantly a private group of companies, Sam was the key," says Rosenberg. "Now that we are significantly public, we have a fiduciary obligation to demonstrate we aren't a one-man show."

Another sign that Zell is retooling the way he manages his empire came late this October. Investors in the Zell/Chilmark Fund shifted management control away from Schulte to a Zell-led group. Dammeyer will be the point man. Part of the explanation lies in the differing aims of Zell and Schulte: Schulte wants to raise another fund; Zell wants to improve and add on to the existing portfolio. "The greatest opportunity in the U.S. is in relatively micro deals," Zell says.

He also says there's still opportunity in commercial real estate, betting that, in contrast to previous boom-bust cycles, developers and lenders won't rush to throw up scores of new office buildings. Not everyone is so sanguine: "Banks have short memories," says Michael Evans, national director of E&Y Kenneth Leventhal Real Estate Group. "And we're already seeing speculative developments across the country."

Sam Zell made most of his money when assets were cheap, when there were few buyers and plenty of sellers. It will be very interesting to see how a man known as the "grave dancer" copes at a time when the market for assets is very much alive and kicking.

The Zell Empire

PROSPERING

ANIXTER INTERNATIONAL (AXE) Integrated network and cabling firm formerly known as Itel. A strong performer. Owns 30% of Antec.

VIGORO (VGR) Acquisitive $1 billion fertilizer company becoming a major producer and distributor across North America.

MIXED

REAL ESTATE INVESTMENT TRUSTS (REITs) Equity Residential Properties Trust (EQR) owns apartment complexes in 30 states; Manufactured Home Communities (MHC) owns manufactured housing in 20 states. Both face performance challenges.

ZELL/CHILMARK FUND Private, $1 billion fund pursues corporate turnarounds. Zell is taking management control to boost lackluster returns. Stronger holdings include Jacor Communications, Revco D.S., Sealy. Weaker companies: Midway Airlines, Quality Food Centers, Bell Sports.

ZELL/MERRILL LYNCH REAL ESTATE OPPORTUNITY PARTNERS Series of private funds has $1.5 billion to invest in distressed real estate properties. Performance varies widely among the three funds. Fourth fund, now being marketed, aims to raise $500 million. But it will face sharply increased competition for the shrinking number of lucrative deals.

STRUGGLING

AMERICAN CLASSIC VOYAGES (AMCV) Owns two overnight cruise lines. Just now recovering from big cost overruns and delays on bringing new ships to market.

ANTEC (ANTC) International communications technology company suffering from a sales slowdown and higher operating and interest expenses.

CAPSURE HOLDINGS (CSH) Holding company for specialty property and casualty insurance subsidiaries. Management is strong, but company's markets are soft. Having trouble finding acquisition to buy with excess capital.

DATA: BUSINESS WEEK, EQUITY GROUP INVESTMENTS INC.By Richard A. Melcher in Chicago and Suzanne Woolley in New York


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