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The Henley Maneuver: It Helps the Rich Get RicherDecember 19, 1988 REMEMBER synergy? Back in the conglomerate-loving 'Sixties, the theory was that, when two companies merged, the whole was worth more than the sum of its parts: 2 + 2 = 5. In the 'Eighties, this has been turned upside down. Now, the whole seemingly is worth less than the sum of its parts. Consider the Henley Group, formed in December 1985 when Allied-Signal gladly bid farewell to 35 mostly unrelated businesses. Since then, Henley has made a lot of rapid-fire, complex financial transactions, all ostensibly designed to enhance shareholder value. Not all stockholders have shared alike, however. Henley's strategy has been particularly lucrative for two men who, together, own just 2.75% of its shares: Chairman Michael Dingman and President Paul Montrone. Henley is the brainchild of the charismatic Dingman, a former investment banker with a genius for building businesses and coming out on top. In the 'Seventies, he built Wheelabrator-Frye. In 1983, he sold it to Signal Cos., where he ended up as boss. Later, Signal sold out to Allied Corp. This time, Dingman landed the No. 2 spot. In 1986, when Allied-Signal spun off to its shareholders the grab bag of businesses and assets (often called "Dingman's dogs"), that had been renamed the Henley Group, Dingman moved on again, becoming honcho of the new outfit. Concurrent with the spinoff, Henley came to market with a huge initial public offering: 60 million shares at $21.25 apiece, netting the La Jolla, Calif., company more than $1.2 billion. Henley, at year-end 1987, had 16,500 employees, $5.5 billion of assets (consolidated), $3.5 billion in revenues and a net worth of about $2 billion. Its operations are primarily in process engineering, design and construction services, the manufacture of chemicals and other industrial products and the distribution of health and scientific goods. Henley also owns energy systems (including refuse-to-energy operations) and real-estate, equipment-leasing and financing businesses. Some key units: Wheelabrator Technologies, Fisher Scientific, Henley Manufacturing and Signal Landmark. It also owns 40% of Itel and 50% of Pneumo-Abex. With a billion-dollar war chest, Henley has embarked on a spree of stock buybacks (since its inception, it's repurchased $1 billion of its shares), spinoffs, divestitures, acquisitions, investments, attempted takeovers, leveraged buyouts and reorganizations. Its corporate blueprint is ever-changing. Where once there was one Henley, there will soon be five publicly traded interlocking companies, as a result of a restructuring now under way. The various maneuvers at Henley Group, particularly those involving its partial spin-off of Henley Manufacturing, haven't sat well with some shareholders. Result: Nine lawsuits-all of which have been tentatively settled-were filed against Dingman and Montrone, Henley Group and Henley Manufacturing, their boards of directors and Lazard Freres, a Henley Group financial adviser. The suits made many allegations, all revolving around one charge: that key executives of Henley, aided by the other defendants, enriched themselves at the expense of other shareholders. So far, the whirlwind of activity at Henley has failed to produce a bonanza for shareholders generally. A shareholder who paid 21 ¼ at the initial offering 2 ½ years ago now has a package of stock worth 27-28. (Someone who bought Henley Group at the offering now also has 1/16th of a share of Fisher Scientific and 1/20th of a share of Henley Manufacturing for each Henley share he purchased.) Not exactly a stunning return. The official reason for Henley's billion-dollar share repurchase is that the market consistently has undervalued the company's stock, as well as Henley's underlying assets. What can't be disputed, though, is that Henley Group lost $426 million in its first year of operations and $278 million in 1987. (In this year's first nine months, it lost $11 million.) Dingman accurately points out that conventional income statements don't give a realistic picture of Henley's value. Echoes Norman Ritter, a company spokesman: "We're a transactional company with a constant turnover of inventory." Still, that transactional nature has made it difficult for outsiders to make a realistic evaluation, and Henley certainly hasn't tried to make it easier for them. Even its most recent annual report is a paradigm of minimal disclosure. In that 1987 document, the non-financial text amounts to just two brief pages of large print recapping Henley's financial transactions. There's no description of its various companies, their financial performance or their prospects. Dingman does mention Henley's $1 billion investment in Santa Fe Southern Pacific stock, which it bought last year in connection with a $10 billion takeover attempt that didn't work out. Dingman predicts that, in view of Santa Fe's vast assets, this will yield significant value for Henley shareholders. So far, though, it hasn't. The company got $700 million in dividends from Sante Fe before selling its stake in that company to Itel this year, in exchange for 40% of Itel and $827 million in cash. But once one figures in the original purchase price, legal costs and the value of certain assets that were transferred to Itel, Henley does not appear to have made much on its Santa Fe dealings. In the annual, the chairman also states: "We have emphasized cash flow and the underlying value of our equity." Since cash flow from operations amounted to a measly $49 million last year, one can only assume that "underlying value" is where the action is. But Henley's $5 billion grab bag of "undervalued" assets merits not even passing comment in the report. Queried as to why the annual is so unrevealing, Dingman replies: "We live in a litigious society. It's impossible to put out an informative document because they can sue you. We're built for the professional investor." In any case, Dingman apparently does see "undervalued" assets. (Montrone, by the way, chose not to discuss his Henley dealings with Barron's.) Immediately after its IPO, Henley began its stock repurchases. They have continued over the years, at an average price around $24, about 20% above the $20 Henley netted on the IPO. Was the issue underpriced in the first place? Through a spokesman, Dingman replies: "The market, not the investment bankers or Henley priced the Henley IPO. We have repurchased shares when they were a good value." But why was Dingman willing to sell $1.2 billion of new stock at a price below what he was willing to pay thereafter? In this regard, it's worth reviewing Henley's equity purchase plan -- 28 pages of fine print approved at a special stockholders meeting on Nov. 21, 1986. The plan gave key executives of the company the right to purchase-by putting 10% down and borrowing the remaining 90% from the company-a 5.2% interest in Henley and certain of its operating units. The avowed aim was to give managers an incentive to boost the value of Henley's businesses. As outlined to shareholders in a letter more than a month before the special meeting, operating management was to receive up to two-thirds of the total participation; corporate management, the rest. Under the program, Dingman received 1,050,000 Henley shares at $21.25 each. These cost him about $2.13 apiece in cash-the rest was financed by a Henley loan with simple interest at 6.53%. It's important to note that this was a "non-recourse" loan. In other words, even if the price of the stock plummeted to zero from $21.25, Dingman couldn't lose more than the $2.13 he put up; the company would absorb the rest of the loss. Originally, the loan was to be repaid after seven years. But this was reduced to 4 ½ years, as part of the settlement of a class-action suit prompted, in part, by this arrangement. The bottom line: Dingman was risking only $2.2 million to control $22 million of Henley shares. Since, at the time, he owned almost $7.5 million of Henley stock, one might have thought he already had sufficient incentive to do well. According to the initial prospectus, Dingman was to get a $550,000 annual salary. But by the year ending in 1987, his cash compensation had almost doubled, to $1,085,000, despite Henley's losses and the lack of any sizable return to shareholders. Asked about the equity purchase plan, Dingman says that it was meant to encourage risk-taking: "You need young people to put their house on the line," he avers. And he adds: "Because of our equity purchase plan, management and shareholders are on the same footing." Let us turn now to the case of Henley Manufacturing. On Dec. 14 of last year, Henley spun off 45% of Henley Manufacturing to its shareholders by giving them one Henley Manufacturing share for each 20 Henley Group shares they owned. This transaction, because of the manner in which it was structured, helped Dingman and Montrone make almost $25 million each-more than 40 times their "investment"-in less than a year. Other senior executives made over $15 million on the same deal. This profit has come directly at the expense of Henley's other shareholders. Here's what happened: Henley Manufacturing is a diversified manufacturing company, formed by Henley Group to own and operate certain existing Henley businesses that make and sell industrial chemicals and other products. Although Henley Manufacturing is in cyclical businesses, its fortunes were improving dramatically when the spinoff occurred. In 1984, 1985 and 1986, the company lost about $54 million (after a $90 million restructuring charge is taken into account). But in 1987, it racked up pre-tax profits of $39 million and net income of $1.86 a share. In addition, Henley Manufacturing also sported an impressive balance sheet at year-end 1987: $110 million in cash, $19 million in Pullman stock, $25 million of assets held for disposal, and $40 million of long-term receivables and other assets. Debt totaled just $44 million. All told, tangible book value was $388 million, or $37.30 per share. Surely Michael Dingman and Paul Montrone (who are, respectively, chairman and president of Henley Manufacturing, as well as of Henley Group) and Henley Group's other directors were aware of Henley Manufacturing's intrinsic value when they approved the spinoff. Like its parent, Henley Manufacturing has an equity purchase program, too. But it differs from Henley Group's in a key respect-the split isn't two-thirds to operating management and one-third to corporate management. The prospectus for the Henley Manufacturing spinoff notes that "substantially all" of the 900,000 shares available for issuance under its program were being offered to just nine Henley Manufacturing managing directors (the title the Henley Group and Henley Manufacturing use for key executives). These nine also happened to be managing directors of Henley Group. They were to get this bonanza even though, the prospectus made clear, "No executive officer of Henley Manufacturing will devote all of his working time to Henley Manufacturing's business." Under the plan, Dingman and Montrone each received 340,700 Henley Manufacturing shares-681,400 combined-or 76% of the total offered. Dingman, who, as noted, is paid over $1 million a year by Henley Group and who had already gotten 1,050,000 Henley Group shares under the parent company's equity purchase program (and who owned other shares as well) also was to receive about 75,000 Henley Manufacturing shares in the 1-for-20 distribution. Yet the board saw nothing excessive in letting him buy another 340,700 shares with just 10% down. (Interestingly, both Dingman and Montrone later replaced their non-recourse notes for these shares with promissory notes that made them personally responsible for their loans' full value. Why? Through a company spokesman, Dingman said it was done "in order to establish a holding period for capital gains" that might accrue from the deal. Which seems to indicate that he and Montrone were pretty sure of making a bundle on their transactions.) Dingman's and Montrone's hefty stock grants mean that, even if Henley Group falters, they can still make huge profits, so long as Henley Manufacturing does well. Other shareholders manifestly lack that protection. In essence, the two top executives of Henley Group received 6% of Henley Manufacturing just because it was partially spunoff. Furthermore, when Henley Group spun off 45% of Henley Manufacturing, the latter was granted an option to purchase the 55% interest in it retained by Henley Group. Henley Group hired Lazard Freres & Co. to determine whether the distribution was in the best interests of Henley and its shareholders, and to estimate Henley Manufacturing's fair market value. The opinion of Lazard-which in the past three years has received over $10 million for advising Henley on various transactions and earned additional fees for underwriting various Henley securities-would help determine the exercise price of Henley Manufacturing's option to repurchase the 55% interest retained by Henley Group. It also would play the major role in determining the exercise price of shares granted under the equity purchase plan. The option's price, in turn, would affect Henley Manufacturing's future valuation. In a Dec. 14, 1987, letter to Henley Group's board, Lazard wrote that the distribution was in the best interests of Henley and its shareholders, and that the fair market value was approximately $19 a share. Lazard stated that:
Henley Manufacturing's senior management, which, of course, includes Michael Dingman and Paul Montrone, must have painted a rather bleak picture of Henley Manufacturing for Lazard to say the fair market value was only $19 per share, or $198 million. Indeed, Henley Manufacturing's financial statement for the year ending 1987, just 17 days after Lazard's fairness opinion was dated, shows, as noted, a company in pretty rosy shape. Cash and securities totaled at least $130 million, and long-term receivables and assets held for disposal were another $65 million. Tangible book value was $388 million, or $37.30 per share-more than double the $19 value placed on the stock by Lazard. The Lazard opinion, and the concurrence of the Henley Group's board, paved the way for a purchase price of $19.90 a share for Henley Manufacturing's option, and a price of $17.75 for each of the 681,400 shares granted to Dingman and Montrone via the equity purchase plan. Receiving a significant amount of stock for $17.75 a share with a book value over $37 isn't bad. But to calculate the true benefit to Dingman and Montrone, one has to take into account Henley Manufacturing's option to repurchase the 55% of its shares owned by Henley Group. If Henley Manufacturing had exercised this option on Dec. 31, 1987, it would have spent approximately $115 million for Henley Group's holdings. Since the option price was almost half net worth, Henley Manufacturing's book value would have jumped to $58.87. Henley Manufacturing could have financed this repurchase with cash on hand. Clearly, this $59 represents an approximation of the intrinsic value of Henley Manufacturing at the time, taking into consideration the $19.90 per share repurchase option. Nonetheless, Dingman and Montrone received 681,400 shares at $17.75 each for which they paid about $1.78 per share in cash and the rest in a note. The profit on the $1.2 million they actually put up is now about $50 million. How could Lazard have valued Henley Manufacturing at 30% of its adjusted book value and four times 1988 earnings? How could Lazard state that it was in the best interests of the shareholders to do a transaction in which management (Dingman, Montrone and the seven other managing directors) paid a combined $1.6 million for an option to buy-for 30% of its book value -- 16% of a company worth $283 million? A Lazard official admitted to Barron's that his firm originally had valued Henley Manufacturing "substantially higher" than $19 a share. But he argued that the final figure must be understood in the context "of the financial climate" of the period immediately following the Crash. But why do the deal at all when the market is weak? The official speaks reverentially of Dingman: "Anything he has touched has done extraordinarily well for the shareholders. {One purpose of} the equity purchase plan was for Michael to become part of Henley in a bigger way. His employees have made out great; they've all become rich. Michael is an extraordinary person." Outside directors of Henley Group and Henley Manufacturing didn't object to any of this. (One of those directors is Carla Hills, George Bush's pick for U.S. Trade representative.) The outside directors are paid well to protect the shareholders' interests. Each receives $45,000 per year, a generous retirement package, and a one-time grant of 5,000 shares. Two of Henley Group's outside directors, Philip Beekman and Arthur Temple, also serve on Henley Manufacturing's board, meaning they pull in $90,000 a year from their directorships and have received 5,000 shares of Henley Group and 5,000 of Henley Manufacturing. Total value: $585,000. (Dingman and Montrone also are on the boards of both companies.) Temple, the chairman of Temple-Inland, didn't return phone calls from Barron's. Nor did Carla Hills. But Beekman said: "In general, we wanted to hold out a big carrot for management" to do well. But didn't Dingman and Montrone already have a big carrot? And wouldn't it be a rather generous incentive to let someone buy stock at 30% of its value? Beekman's response: "You've got a good point, but in today's world, it seems you have to give something really big. We also relied on the Lazard opinion {about the stock's value}; we hired them to do a job." Dingman apparently had no objection to Lazard's $19-per-share valuation for Henley Manufacturing. Queried about this, he says: "After the stock came out, it didn't do a damn thing," as if that somehow proves that the $19 valuation was correct. Could savvy dealmaker Dingman have had no idea that Henley Manufacturing's true value approximated its adjusted book value of $59 per share? Is it possible that the Dingman who is famed for spotting undervalued assets couldn't tell that Lazard's $19 valuation was $40 too low and would convey a large profit to him? Regardless of what Dingman thought the stock was worth 12 months ago, he now apparently thinks it's worth at least $90 per share. On Dec. 2, New Hampshire Oak, a holding company he and Montrone own, made an $80 takeover offer for the 49.3% of Henley Manufacturing it didn't own. Three months earlier, New Hampshire Oak had acquired 1,889,140 Henley Manufacturing shares for $103.9 million, or $55 per share. The shares were bought from Toufic Aboukhatera -- friend of Dingman's -- and Said Khoury. As a result, Dingman and Montrone beneficially owned 24.4% of the company, or 50.7% when the $19.90 repurchase option is exercised. These dealings were the inspiration for litigation, including a class action filed last month in Delaware Chancery Court by 11 shareholders of Henley Manufacturing. In essence, they contended that the spinoff was a means for Dingman and Montrone to enrich themselves at other shareholders' expense by gaining control of the company. Among other things, the plaintiffs alleged that the pair depressed the earnings of that company before it was spun off, making it appear less valuable than it really was. They also claimed that Aboukhater and Khoury bought and illegally "parked" a controlling portion of the stock for Dingman and Montrone. The company disclosed last week that nine suits against it have been settled, pending court approval. In connection with the settlements of seven of these actions, New Hampshire Oak upped its Henley Manufacturing bid, which expires on Jan. 12, to $90 a share. The two other suits had challenged the legality of the repurchase option. The plaintiffs had argued that, since Dingman and Montrone effectively control Henley Manufacturing, they could use the repurchase option to block anyone else from bidding for Henley Manufacturing. Asked why he, rather than Henley Group or Henley Manufacturing, had bought the controlling block of stock, Dingman replied: "The seller called me up when he had 20%. He said, 'The stock is $29, and I want out-at $55!' The board didn't want it. We'd be paying way above market, which is greenmail. The lawyers wouldn't let either company touch it with a 10-foot pole." But Dingman's lawyers obviously had no qualms about his buying the stock, despite his corporate roles. "Look," he says. "Life is full of conflicts. I'm a stock buyer and a stock player. I buy assets and keep them." It's now clear that New Hampshire Oak is structuring its takeover of Henley Manufacturing as a highly leveraged transaction. Why didn't Henley Group do an LBO of Henley Manufacturing instead, so that all shareholders could participate? "Henley's purpose isn't to do leveraged buyouts," Dingman responds. Yet, the ink is only four months old on the $1.2 billion Pneumo-Abex LBO done by Henley Group and Wasserstein, Perrela. It isn't hard to see how Dingman and Montrone can structure a pretty neat LBO for Henley Manufacturing. At $90 per share, they will have to pay approximately $500 million for the whole company. Henley Manufacturing's book value, adjusted for the $19.90 stock repurchase, is about $320 Million, so there are plenty of hard assets to borrow against. The company has $100 million in cash, as well as other assets that can be liquidated. Pre-tax operating earnings for the first nine months were around $60 million, which should give lenders some comfort. If these lenders will commit about 90% of the purchase price (as they did in the Pneumo-Abex deal), all Dingman and Montrone have to do is put up $50 million or so. Where does this come from? Remember the 681,400 shares they received from Henley Manufacturing's equity purchase plan? That stock is now worth $61.3 million, and their profit is almost $50 million; enough to complete the LBO and still have some change left over for cigars. What's ahead now for Henley Group? In Dingman's words: "Henley is going to be run like it has been run-or liquidate. It's a conservative investor's play." But still a complicated one. Its most recent plan is a reverse spinoff (which constitutes a dividend for federal tax purposes) that will create two public companies: One is Wheelabrator Group, a holding company whose principal asset is Henley's 60% stake in Wheelabrator Technologies. The other is the "new" Henley Group, which will own all other "old" Henley's assets. An owner of one share of the "existing" Henley Group will in effect swap it for 0.225 shares of "new" Henley and one share of Wheelabrator Group. It should also be noted that "new" Henley will own 12% of Wheelabrator Group, and Wheelabrator Group will own 10% of "new" Henley. There will be 21.6 million "new" Henley shares outstanding and the company is authorized to repurchase up to 10 million of these. Many analysts expect the company to begin these repurchases in early 1989. As in the past, the executive officers of new Henley (Dingman, Montrone, etc.) will devote less than all of their working time to company business. The prospectus also states that new Henley may make investments in leveraged buyouts and that certain executive officers may be allowed to buy up to 15% of these deals. Guess which officers? Asked whether spinoffs really increase the value of a holding company, Dingman says, "There is no real answer. It's a complicated thing. . . . If you mix apples and pears {as Henley has} people call it ambrosia and discount it." Although corporate ambrosia may be cheap these days, it has sold at a premium many times in the past. And Michael Dingman, corporate builder and wheeler-dealer extraordinaire, clearly likes to have his ambrosia and drink it, too. |