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Marv Davis Offers Advice on Middle-Market Restructuring
Monday, 21 June 2004
By Terry Brennan

Thomas Holt Sr. is a legend in maritime shipping. He built a trucking and shipping empire and successfully took on the International Longshoremen's Association. But when his Holt Group Inc. defaulted on $140 million in unsecured notes, the maverick shipping executive had to follow in the path of so many other smaller companies: File for bankruptcy protection.

From the time Narberth, Pa.-based NachmanHaysBrownstein Inc. was hired as Holt's financial adviser in 2001, it found itself in the middle of a bankruptcy that involved no reliable financial data, a shipping price war, the murder of a Gloucester City, N.J., port supervisor, warring ILA locals at the Port of San Juan and a byzantine corporate structure, with 25 bankrupt units under the senior Holt and two dozen more nonbankrupt ones under his three sons.

"It was really complicated since all the accounting was controlled by the Holt family at the nonbankrupt companies, and they were diametrically opposed to us in the filing," recalls Thomas Hays III, an NHB principal who, as interim CEO, fired the senior Holt. "The violence in New Jersey and San Juan made it all very touchy, and it all seemed to be happening at the speed of light due to the need for an emergency sale of the assets.

"We found that more than $30 million due to the bankrupt companies was being illegally withheld by the nonbankrupt, family-controlled businesses," Hays says. "The $30 million owed the company would have gone a long ways to help solve the cash crunch, but we had to sell the assets and then convert to Chapter 7 liquidation."

While violence and skullduggery isn't the usual fare in middle-market bankruptcies, intrigue and complexity often are. There is a paradox to these kinds of workouts. While middle-market companies generate sales of $500 million to $1 billion, their bankruptcies and out-of-court restructurings are often far more tangled than those of much larger corporations.

That's because troubled middle-market companies typically have a centralized management structure, a single plant and often a single product. They have fewer options for survival than larger, more diversified corporations.

At the same time, middle-market workouts have gotten a lot more competitive. As the cycle on large (not to say mega) bankruptcies tops out, more restructuring firms are vying to do middle-market rescues.

Besides NHB, noninvestment banks that typically compete for middle-market restructuring mandates include Bridge Associates LLC , Carl Marks Capital Advisors LLC, Crossroads LLC, Glass & Associates Inc. and Grisanti, Galef & Goldress I LLC, among many others.

And larger firms are moving into the middle market too. New York-based Alvarez & Marsal LLC says that roughly 80% of its turnaround work is tied to companies with less than $1 billion in sales. Annapolis, Md.-based FTI Consulting Inc., which topped non investment banks in The Deal's latest bankruptcy league tables, started a unit two years ago to court troubled middle-market business and was going to ramp up from six professionals to 15, says Daniel Scouler, who was heading the effort. But Scouler recently left the firm to start his own Chicago restructuring boutique, Scouler Andrews LLC.

Restructuring firms trying to make middle-market inroads also have to contend with an echelon of smaller, local competition. The vast majority of the restructuring specialists in the 7,000-strong Turnaround Management Association work in small- or middle-market restructuring. "Most TMA members are single-shingle guys or small firms helping out local companies or troubled firms in their immediate region," says John Brincko, president of Brincko Associates Inc. in Los Angeles, a boutique with 10 restructuring advisers.

Another factor: With capital markets open again, larger troubled companies are finding it easier to raise money, which means they are hiring large investment banks that have access to the markets. That's putting noninvestment bank advisers at a competitive disadvantage and sending them into the middle market. "We're seeing more competition in the middle market from firms that typically do larger restructurings," says Dennis Simon, managing principal at Crossroads. "These firms are doing more middle-market turnarounds, since smaller companies don't have access to capital and the need for investment banks."

He cites his own firm as an example. Sixty percent of Crossroads' business is in the middle market now; a year ago, it was 40%. "All the firms seem to be doing work these days for smaller companies with revenue in the $300 million, $400 million and $500 million range," he says.

There's clearly a need for sophisticated advice in this market, Simon says. "It's more of a managerial operational leadership role, because middle-market managers usually know how to [run a company], but they don't know how to lead," he says. "There's usually fewer layers of lenders and vendors, and you don't get the multiple tranches of debt that's often publicly traded in bigger restructurings."

The restructuring work to be done with middle-market companies tends to be more internal than external, especially because so many of them are either family-owned or closely held. That creates a distrust of outsiders that's not as common in public companies.

"There's more personality issues and a greater need to use psychology because these managers often feel it's their business and you're an intruder," says Warren Feder, a partner at Carl Marks, who notes that lenders typically call in restructuring firms in middle-market situations, often against the wishes of the owner-operator. "The owners typically think they're the only ones who know how to run what they consider to be their business and believe they could turn it around with just a little more money and a little more time."

There are common denominators that run through both larger restructurings and those in the middle market, such as embattled management, says Deborah Hicks Midanek, managing partner in New York at Glass & Associates. "There's frequently a frozen management that has gone into the bunker and stopped communicating, and you need to find people who can fix the problems and communicate the fix to others," she says.

But as Tom Hays found out with Holt Group, private or family-owned companies often have murky financials, since they haven't been required to make public filings. "You often have to rebuild the company from the bottom up in the sense that you have to dive in and really get to quickly understand how the company operates," Midanek says. "Then you have to adapt the company to the market while finding out how much cash there is and who needs to be paid immediately and who can wait."

Reorganization success can be elusive. Carl Marks' Feder says a larger percentage of middle-market companies end up becoming Chapter 7 liquidations. "Many that go into bankruptcy end up liquidating because there's often very little financial meat on their bones and far fewer financial options than the larger companies," he says.

Just to add to the stress, many owner-operators whose companies end up restructuring are personally liable for their financing. "It's a rare bank that will lend to a small business without personal guarantees because they don't want the owner to bolt on them before they get paid," Feder notes. Carl Marks, he says, usually uses two to four staffers to help fix the company's operational side and another two to four on financing.

Restructuring assignments become even more personal when family ownership is involved. Glass & Associates' Midanek saw that when she led a four-member team in an out-of-court restructuring of waste hauler Rumpke Consolidated Cos. in November 2001. Rumpke had 100 family members working for it. "Analyzing the problems at Rumpke was easier than making sure the family owners there would buy in to our plans to fix what was wrong," she recalls.

Friction erupted among senior management when an outside COO was highly critical of the founding co-CEOs. The lender had installed the COO to protect its interests, and he backed a previous adviser's assessment that the business had grown beyond the founders' ability to run it. Midanek believed family members, including the co-CEOs, could turn the company around with help from an outsider. But just a few days into the restructuring, a lender came forward with a term sheet demanding the sale of $25 million of assets.

The Glass team urged the family to accept certain changes. "We identified six or eight areas and presented alternatives and then told them they would make the decisions and we would only be their coaches," she says. Both the family and the lender gave their blessings to the plan, but the COO didn't. So the Rumpke family managers decided to tap restructuring team member Jack Glass as interim COO and then identified company assets that would be sold.

With middle-market restructurings, more of the work is hands-on, notes Anthony Schnelling, a managing director at Bridge Associates, which has 30 staffers. "The chief restructuring officer or interim CEO will jump right into the middle of things and delve into all the details to a much greater degree," Schnelling says. "You still get involved in all the issues in a larger turnaround, but you would assign a lot of the detailed work to others on your team."

He cites an assignment at $50 million-in-sales Sentry Technology Corp., an electronics surveillance company, a few years ago. "There were a lot of regulatory issues in the U.S., as well as in Canada and Europe, that I personally had to get involved with," he says. "I would have delegated that work to a separate regulatory officer if it were a larger turnaround."

Fears about Chapter 11 becoming a haven for asset sales and not rehabilitation reverberate in the middle market. "There's less flexibility, particularly in the middle market, because secured lenders today are liened to a larger percentage of the assets and have a greater incentive to sell," says Schnelling.

But rehabilitations are possible. "You must quickly develop ways to cut expenses without cutting off revenue streams and without sacrificing whatever strategic advantage the company has," says Marvin Davis, co-managing partner at Grisanti, Galef & Goldress in Atlanta.

Davis was interim CEO at specialized wax maker Petrowax LLC in Bradford, Pa., when the $150 million company filed for Chapter 11 in the early 1990s. Petrowax then bucked the general rule that only 10% of bankrupt middle-market companies survive by emerging as a profitable business in 15 months. "The original concept was to refine a waxy crude material and then sell the highly specialized microcrystalline wax," Davis says. "The problem was they shipped the crude from Utah all the way to Pennsylvania and didn't worry too much about the rest of the barrel."

What was in the rest of the barrel turned out to be gold. Davis discovered that the market for the discarded residue was potentially more profitable than the microcrystalline wax. The company acquired new equipment to add more value to the process as it uncovered new markets for the previously ignored leftovers. "All of a sudden, gross margins shot up enormously, and Petrowax turned around from $3 million in monthly losses to a $2 million monthly profit in nine months," he says. The company emerged from bankruptcy six months later.

"You always find some jewels within a company, and I found one, the lab director who had an M.B.A., who I later tapped as vice president of operations," Davis says. "He understood finances as a chemical engineer with an M.B.A., and he really helped because he knew some insider ways [to do things] that can be so helpful for cost savings."

That personal touch is often lost in giant restructurings. In the middle market, it's often the key to success.

Marvin Davis

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