Finance: Leveraged Buyouts
How Formica Got Burned Out by Buyouts
Wall Street doesn't talk about the dark side of debt-financed takeovers. Here's why
If Formica Corp. were a human being, it would be flat on the couch in intensive therapy. Formica, a world leader in laminated countertops, is what you might call a corporate orphan looking desperately for a home. Over the past 14 years, Formica has been the neglected, even abused, stepchild of two conglomerate parents. It has endured three leveraged buyouts. It has weathered a seemingly endless array of owners and board members, not to mention a plethora of corporate strategies and restructurings. Its latest LBO was just last year. On Feb. 17, Formica tapped the public markets for a second time, selling $215 million of junk debt.LUSH RETURNS. Formica, one of the last survivors of the 1980s deal craze, is not alone. Other companies with a seemingly endless array of parents include Avis Rent A Car, Coldwell Banker, Consolidated Cigar, MGM Studios, and Simmons Co. (table, page 84). They and their brethren illustrate an important but overlooked niche of the booming acquisition and buyout market. While dealmakers can make a mint, the constant shuffling of corporate orphans from buyer to buyer can sometimes inflict severe pain.
For instance, Wall Street loves to tout LBO successes. The typical story: Investors buy out the existing company, typically with substantial debt, perhaps 70%. Because of the leverage, the new owners, who own the bulk of the equity, have a strong incentive to aggressively streamline operations and get rid of all the deadwood. When the company is eventually sold, because so little equity was put in the deal, the returns are magnified. Current annual rates of return to the buyout artists are around 25%--below the 35% returns of the late 1980s, but still very lush.
In Formica's case, the private investors came out very well. If you had participated in LBO No. 1 in 1985 and sold out in LBO No. 2 in 1989, when Formica's cash flow was growing at about 14% a year, you would have made four to five times your investment. And if you had held on for 10 years, you would have made $10 for every dollar that you invested.
But Wall Street doesn't usually talk about the dark side of the process. "It's not healthy for the same companies to be bought and sold," says Howard H. Stevenson, a professor at the Harvard business school and author of Do Lunch or Be Lunch: The Power of Predictability in Creating your Future. "Repeated LBOs are a disaster...you pay down debt, get new debt, new bosses, and [create] havoc within the organization."
In the case of Warren (N.J.)-based Formica, with $551 million in revenues, all three of its LBOs were done with the same man at the helm--Vincent P. Langone. But even with the guidance of a driven and highly praised CEO, the constant shuffling of owners has taken its toll. Over the years, Formica has struggled continually with oppressive debt, which deterred the company's growth. An acquisition by a division of British conglomerate BTR PLC in 1995 didn't help either. BTR made several costly strategic mistakes, battering Formica's net income and market share further.HOT LBO MARKET. All of this has had a severe impact on Formica. In the past 15 years, the market share of decorative laminates of rival Wilsonart International Inc., a division of Premark International Inc., has risen from 25% to 50%, while Formica's share has slumped from 50% to 25%, mainly due to Formica's revolving-door ownership. Says Nicholas P. Heymann, an analyst with Prudential Securities Inc. in New York, "You have basically had a complete swap of leadership in the laminate market in the past 15 years." And while Formica has lost money in the last nine out of 10 years, Wilsonart's earnings have more than tripled, says Heymann.
"I think the company would probably be bigger today than it is" without all the changes, says Ilan Kaufthal, vice-chairman of Schroder & Co., an investment-banking firm in New York. Kaufthal sat on Formica's board of directors for 10 years beginning in 1985. "In my opinion," he adds, "[the company] would have been more profitable and perhaps would have gotten further in terms of its market share."
The slew of beaten-up orphans in the marketplace hasn't stopped the LBO business from getting hotter and hotter. Buyout funds raised $54.5 billion in 1998, up 58% from 1997 and 10 times higher than in 1992, according to Buyouts magazine. To be sure, over the past few years, LBO firms have reduced the average leverage of a deal from 90% to 70% and are funding additional capital for acquisitions and internal growth. Still, with the pace of LBO transactions accelerating, the number of recycled orphans can only grow.
Prior to its turbulent saga of serial ownership, Formica led a placid life. Formed in 1913, the company was originally designed to replace the mineral mica with a laminated material for industrial and electrical uses--hence the name "for mica." By the 1930s, its decorated laminated product became a national rage in American kitchens. When Formica went international in the late 1940s, its name became one of the best-recognized in the world."ARROGANT." But by 1985, Formica had lost its sheen. It had been owned by American Cyanamid Co., a pharmaceutical and diversified chemical company, for almost 30 years. As a small division--$334 million in sales--of a conglomerate with $3.5 billion in revenues, Formica was neglected. "Formica for years had pretty significant erosion of its market position," says Kaufthal. "Competitors were aggressively stealing market share," says Alvin Levy, a retired distributor for a Formica rival. "Formica's managers were very, very arrogant."
Anxious to shed non-core divisions, American Cyanamid put several up for sale, including Formica. The company was an ideal LBO candidate: Despite inroads by competitors, it still had a strong brand name and, most importantly, steady cash flows. Langone, then a 42-year-old Cyanamid vice-president, was assigned to offer Formica to buyers, one of whom suggested an LBO. "We really didn't know much about LBOs," remembers Langone about the deal. "We were corporate guys."
But Langone and his boss, Gordon D. Sterling, liked what they learned and decided to bid for the company. They recruited as partners Shearson Lehman Brothers Capital. The Sprout Group, the investment arm of Donaldson, Lufkin & Jenrette, also participated. The price: $200 million, financed with $153 million of junk debt.
Not surprisingly, life after the LBO at Formica changed drastically. As part of a conglomerate, says Langone, "You weren't looking hard at overhead." But after taking the company private, Langone and Sterling were consumed with reducing debt. "I did worry that Formica may have been too heavily leveraged," says Kaufthal.BAD TIMING. Between 1985 and 1989, Formica managed to implement new strategies, such as expansions into Europe and Asia, says Langone. And in the late 1980s, the company added Surell--a product that competed with DuPont Co.'s Corian, a synthetic marble. Yet Langone admits that Corian still dominates the synthetic marble market. "My recollection was that very little was accomplished to diversify or leverage the Formica brand during that period," says T.J. Dermot Dunphy, CEO of Sealed Air Corp. in Saddle Brook, N.J., who sat on the Formica board from 1985 to 1989.
To help ease the debt burden, Formica in 1987 floated an IPO for 35% of the company, raising $64 million. With a chunk of debt retired, Langone planned to significantly expand the business over the next five years.
But the public company soon attracted suitors, such as Great American Realty, a subsidiary of Great American Management, and Investment Inc., a Chicago-based investment firm. With Formica clearly in play, Langone arranged a second LBO. "My motivation in life is not necessarily to buy and sell companies but to build them. But I still felt there were things I could do with the business," he says.
When Shearson and DLJ declined to participate, Langone turned to Dillon Read & Co. along with Masco Corp., a manufacturer and distributor of faucets, fixtures, and kitchen cabinets. The $400 million deal was financed with more than $300 million in debt. The timing, September, 1989, couldn't have been worse. "I didn't know soon after we closed the deal we would go straight into a recession in the U.S. for several years," says Langone.
The prolonged dreary economic conditions plus fierce price competition took their toll. Sales and earnings were lackluster. Yet Formica in 1995 was acquired by a division of BTR PLC, an ailing British-based industrial conglomerate, for $620 million.
For Formica, it was like being owned by Cyanamid all over again, only worse. The company was beset with management shakeups. Langone and Chief Financial Officer David T. Schneider were forced out. Distributors complained of poor customer service. Formica continued to lose money and its market share kept slumping. BTR refused to comment.
Luckily, BTR's ownership was not to last. Two years later, the conglomerate divested Formica along with other non-core divisions. Wall Street no longer appreciated BTR's collection of disparate businesses.
Meanwhile, DLJ had put Langone and Schneider on retainer. They were looking for another LBO, specifically a building-products company with a strong brand name. "We examined 30 to 40 companies, but we didn't find anything we really loved," says Peter Grauer, managing director of DLJ Merchant Banking.
That is, until Formica came on the block again. DLJ and CVC European Equity Partners bought Formica last May for $405 million, $215 million less than what BTR paid for it in 1995. Langone and Schneider returned to reclaim their former posts. Already distributors have noticed the change. "The service is much better under Vince Langone," says Adele Beck, owner of KB Laminate Supply Inc., a Formica distributor in Providence, R.I. Now, the new owners are working to regain lost market share.
As for the cost that 14 years of revolving ownership has taken on the company? While former director Kaufthal says he thinks Formica would have been a lot better without the constant changes, he also wonders if it would even exist today had it continued to languish under Cyanamid's control.
But of course, to Langone this is all academic. Right now, he's just hoping the third LBO will work like a charm. For more than 50 years, Formica has been enhancing homes worldwide. Now, maybe it's finally found a permanent home. Knock on wood.By Debra Sparks in New YorkReturn to top