You would think corporate-turnaround specialist Stephen F. Cooper could not possibly remain so busy. In January 2002 he signed up as interim CEO of bankrupt Enron Corp. His contract required him to spend at least 35 hours a week on the job, although hearing him describe the size and complexity of that task during a February 11 Wharton conference on restructuring, it has been more like a job and a half.
Then, just weeks ago, with his Enron mission winding down but not yet concluded, Cooper, chairman of corporate restructuring firm Kroll Zolfo Cooper, LLC, was hired to rescue Krispy Kreme Doughnuts, Inc. His contract says he will be working part-time; no minimum number of hours is specified. He is confident that it won’t be long before he is fielding the next corporate 911 call. The economy is rebounding and tough new corporate-governance rules are in effect, but people in his line of work can count on human nature to provide ample business. “The reforms penalize unethical behavior, but none of the new rules does anything to prevent mismanagement,” he notes.
If anything, with increasing globalization, growing worldwide competitive challenges, and the rise of ever-larger multinational corporations, Cooper expects corporate emergencies to keep pace in number, size and complexity. The assets and liabilities of today’s distressed companies are 10 times larger than they were 10 years ago, he says. The average number of employees is more than 40% higher. A decade ago, companies filing to reorganize under Chapter 11 of the U.S. bankruptcy code did business that was generally confined to the United States. Now “almost any company that files is multinational.”
It’s an outlook shared by Wharton finance professor Hulya Eraslan, who teaches a course in corporate financial restructuring. Since 2001 there has been “a huge increase” in Chapter 11 filings by companies with $100 million or more in assets, she says. About 450 companies of that size filed for bankruptcy between 1979 — the year after revised bankruptcy laws made it easier for managements of troubled companies to stick around and clean up their own messes — and 2001. In the years since, another 450 such companies of that size have filed for reorganization.
Part of that can be attributed to the bursting of the Internet bubble, which constrained access to credit, Eraslan says. Also, “because of the decreased attractiveness of stocks in general, it became very difficult for overleveraged companies to execute debt-equity swaps.” At the same time, Chapter 11 seemed to lose “the negativity it once had.” Increasingly, companies’ customers and suppliers are taking it in stride.
The turnaround business, while it has existed for years, has acquired a higher profile as the flameouts have become more spectacular. Star bankruptcy lawyer Harvey R. Miller — another speaker at the conference — made headlines in 2002 when he left as the long-time head of restructuring at Weil, Gotshal & Manges LLP to join Greenhill & Co LLC.
The Turnaround Management Association (TMA), an industry group that five years ago had 3,282 members, now has 6,953, according to spokeswoman Cecilia Green. She attributes the membership growth to new entrants into the industry as well as a TMA campaign to increase its visibility. While the improving economy has cut into the turnaround business in the last year or so, “established firms are continuing to see healthy growth,” she says. A corporate reorganization under bankruptcy court supervision is not the only way to engineer a turnaround, Green adds. Often, restructurings are done outside the court.
Five Ways to Court Bankrutpcy
Depending on the nature of a company’s troubles, a turnaround effort can focus on operational changes, such as improving efficiencies, or financial improvements, such as reducing the debt burden. His goal, Cooper told the conference, is to maximize the long-term value of the troubled company for as many stakeholders as he can, although in a bankruptcy situation, creditors typically recoup at least some of their losses and shareholders are wiped out.
The rescuers themselves have begun to draw scrutiny. When Enron hired Kroll Zolfo Cooper, the Securities and Exchange Commission objected to contract provisions guaranteeing it a $5 million “success” fee and absolving it of any fiduciary duty to the company. Those contract provisions were dropped, but in September 2004, Kroll asked a bankruptcy judge for a $25 million reward — on top of the more than $60 million it had received by the middle of that year — for producing “extraordinary results.” The judge deferred a decision until November 2005. Meanwhile, Kroll Zolfo Cooper is billing Krispy Kreme $400,000 a month for its services.
Perhaps company managements and boards of directors can try to clean up the operational or financial mess themselves. But, says Eraslan, “crisis managers are like doctors; it’s their specialty.” There are also psychological factors, she adds. “A lot of trust is lost. Your creditors don’t want to listen to you. They think you are the problem. So you bring in a third party as a mediator, and creditors are more open to listening.”
Cooper — who has worked on corporate turnarounds with Polaroid Corp., Federated Department Stores, and Laidlaw Inc. (the parent company of the Greyhound bus line), among others — predicts that “not just individual companies but whole sectors will need restructuring.” For example, “there is no such thing as an untroubled airline; there is not a single top-tier automobile parts manufacturer in the United States that is making money.”
Distressed companies usually can blame their troubles on one or more of five failings on the part of their leadership, according to Cooper.
· Some companies fail because they are slow to recognize and adapt to mega trends. These are business trends that sometimes are driven by legislative changes, such as the tax-law revisions of the mid-1980s that pulled the rug out from under businesses, such as railroads, which depended on tax shelters.
· Some fail because they wander away from their core competencies. Laidlaw’s core competency was running private school bus operations. But then it acquired Greyhound, which should have been a government-subsidized public transportation operation, and it also jumped into the healthcare swamp by buying into ambulance services.
· Unplanned growth is yet another cause of failure. Particularly in the heady days of just going public, companies allow Wall Street to create unreasonable expectations of their performance. Most get into trouble by attempting explosive growth with little operational or balance-sheet support. Another aspect of this is what Cooper calls “getting in the way of Wal-Mart.” For ideas on which companies’ stocks to sell short, he quips, “just look at Wal-Mart’s departmental expansions.”
· Most of his clients are companies that tried to deliver short-term returns instead of focusing on their long-term health. It’s another problem created by Wall Street, he says. Chief executives of these companies “take their organizations and jam steroids down their throats every 90 days. Ultimately you begin to do dumb, crazy things to please a fickle investment community.”
· Managements in denial are another critical factor in leading their companies down the slippery slope to failure. These are managements that have a tendency “(a) to be surprised; or (b) to be random-excuse generators when the proverbial you-know-what hits the fan,” Cooper says. Sometimes CEOs of these companies have failed to make timely, tough operational or financial decisions, or they allowed themselves to be lulled into complacency after initial successes.
At Enron, these flaws seemed to combine in a particularly potent witches brew. Judicial proceedings now underway against former CEO Kenneth Lay and others will determine to what degree this brew was spiked with outright fraud. At its peak, the company had 32,000 employees in more than 20 countries on five continents. Before its fall in 2001, it reported revenue of $139 billion and had a book value of $62 billion. Composed of more than 2,500 legal entities, with a highly decentralized decision-making structure, Enron was a company with “an unprecedented degree of complexity,” Cooper says. Managers “around the globe could commit hundreds of millions of dollars without having to ask for corporate permission.” Its legal structure was intended to minimize taxes and debt and maximize reported earnings.
When he entered the picture, Cooper found that it was hard for his team to get a clear view of Enron’s balance sheet. It was a company that lacked financial controls but had “an unchecked vision.” At the root of Enron’s eventual troubles was its unusual foray into trading derivatives, suggests Cooper. An energy company might reasonably be expected to go long and short on energy supplies. But Enron eventually was trading scrap paper and weather derivatives in highly illiquid markets. It led to a cash-flow crunch. Enron’s collapse resulted in a “hurricane of litigation” from bondholders, counterparties to the company’s trading activities, shareholders, employees and others.
At one point, more congressional committees were involved in investigating what went wrong at Enron — twelve — than the number of committees that probed Watergate and the Iran-Contra scandal combined, Cooper notes. The same news media that once hailed Enron as among the most creative and imaginative companies, and among the best places to work, now turned on it.
“The old Enron board was in shock, given the kudos it had received for years,” Cooper says. As the company crumbled, the broad diffusion of power within the organization allowed people to point fingers when things started to go wrong. Disorientation and confusion were on display on the very first day of bankruptcy, when 4,500 employees were fired — by email. Weeks later, with its stock nearly worthless, the company was still deducting amounts from employee paychecks for stock purchases until Cooper says he ordered a stop to it. These were hardly things to improve morale.
That was the backdrop to his advent at Enron, Cooper says.
At Enron, as in other turnaround situations, the restructuring effort had to contend with “tremendous compression” of all three types of capital — human capital, time capital and dollar capital, Cooper says. “You lose good people, and people whom you prefer to lose, stay.” There is not a lot of time to do things in well-thought-out ways because “the wild beasts of creditors want not just their pound of flesh but the whole body” quickly. And since a lot of creditors treat a Chapter 11 bankruptcy reorganization filing as “a liquidity event” — taking as much money out of the company as they can — access to capital is constrained.
Among the first tasks he undertook was to put thousands of Enron entities into three or four “boxes,” or categories, depending on how viable each of the entities was. In doing that, he was undoing a maze that Enron’s previous management had spent years creating. He says he resisted creditors who wanted to quickly sell off portions of Enron’s hard assets, such as pipelines and power generation equipment. Had these assets been sold in 2002, they would have fetched about $1 billion. When they were sold in 2004, they raised $2 billion for the company and its creditors. Company debt that was trading at 7 cents on the dollar when he arrived on the scene is now trading at over 20 cents on the dollar, he says.
At Krispy Kreme, the challenge is to rescue a brand that has a lot of legs but has been hobbled by undisciplined growth. The Krispy Kreme doughnut burst on the scene as a cult-like item. “The problem is, when anybody can get it at any time, it is no longer a cult item,” Cooper says. In one of his early acts, he ordered the company to trim its 500-member corporate workforce by 25% and get rid of a leased corporate jet.