Bad Deal: Wesray's Sale of Simmons Mattress Co. to an ESOP (1989)
Good Deal, Bad Deal

Although Wesray had used an ESOP mechanism both to its benefit and the benefit of the employees in other deals, it overreached loading Simmons with debt it could not service.

What Went Wrong:
The structure of an ESOP opens it to abuse in a takeover situation. Although Wesray had used the mechanism both to its benefit and the benefit of the employees in other deals, it overreached loading Simmons with debt it could not service. Wesray still profited, but it looked greedy and had to give back money on four occasions.

In 1989, Wesray sold Simmons Mattress Co. to an ESOP for $249 million. This was not one of the biggest deals of the 1980s, but it was one of the most abusive. The deal was so bad for the ESOP that the principals of the deal had to give back some of the proceeds on four separate occasions over the next four years. Wesray still made more than $100 million on the deal and, though it appears the ESOP neither ruined the company nor cost employees their retirement plans, it came close to doing both.

Wesray bought Simmons from Wickes Cos. in 1986 for $1120 million. The deal was similar to many instituted by Wesray. it contributed only $5 million in equity, gave a piece of equity to top management, and sold the deal to lenders based on aggressive asset sales. in two years, Simmons retired 75 percent of the debt, selling three large plants and its international operations. All that remained was for Wesray to implement the next step in its well-rehearsed business plan: the exit strategy.

In this instance, Wesray determined not to go public or sell Simmons to a third party. it had Simmons create and ESOP and had the ESOP buy the company. This was a legal practice and it was not uncommon at the time. in fact, Wesray did the same thing with Avis, another of its LBOs. (see Chapter 5 for a profile of that deal.)

ESOPs are a favored financing tool because of the tax benefits involved. The company received tax deductions on the stock dividends that it pays to the ESOP and on the interest that it incurred to create the ESOP. Banks lending money to set up the ESOP can exclude 50 percent of the interest earned from their taxable income.

Despite the benefits, the structure also invites abuse. The seller automatically dominates a sale to an ESOP. The ESOP has no prior existence, so it has no individual personally or personnel capable of hard bargaining or simply walking away if the deal seems unfavorable. under federal law, a trustee must be appointed, but the trustee is not a princpal and, even in doing its fiduciary best, is not a perfect substitute for a party with its own money on the line.

Although Citizens & Southern Bank, an experienced ESOP trustee, was chosen as the trustee, Wesray and the selling shareholder seemed to roll over it with whatever terms it could get the bank to finance. Chemical Bank, the lender to the ESOP, played a much more active role in the deal, but caved in to Wesray at every opportunity. Chemical, like many other financial institutions in the late 1980s, wanted to get into the lucrative business of LBOs, and the prospect of lucrative fees and working with Wesray (though it was technically the adverse part, because it was the seller and Chemical supposedly represented the buyer) was irresistible.

In January 1989, Wesray and senior management sold Simmons to the ESOP for $241 million, including the assumption of $40 million in debt. The original LBO group, therefore, received $200 million on its original $5 million investment. It did not receive the entire amount in cash, however; $20 million came in the form of junior subordinated debt, and Wesray also gave on of the lenders, Rockefeller Group, an option to "put" its $30 million of paid-in kind equity back to Wesray. (as the terms "junior" and "subordinated" imply, this debt placed Wesray at the back of the line for any claims on assets.)

In this instance, the deal went bad before it even started. Simmons was $7 billion behind its payables at the time of the closing. Within four months, management was meeting with Chemical (which postponed the planned syndication of most of the debt as these details became known) to explain that it had a cash shortfall of $17 million, including past due payables of between $11 and $13 million, $3 million in Canadian taxes, and $2 million in letters of credit.

Notwithstanding Simmons' poor cash position from the outset, how could this business sell for $120 million in 1986, sell off all its best assets, and still be worth nearly $250 million less than three years later? The answer was contained in some fanciful projections floated to Chemical and Citizens & Southern at the time of the deal.

For the company to have any chance of surviving under this capital structure, it needed to make miraculous improvements. Simmons projected a $6 million profit for a division that lost $4 million the previous year. Three real estate properties, not especially valuable because Wesray could not or did not sell them, would have to be sold immediately.

Within months, Rockefeller Group exercised its option and returned the paid-in-kind securities to Wesray, making this the first of four give-backs the group would have to make on the deal. By the end of 1989, Simmons defaulted on Chemical's $15 million bridge loan. During 1989 and 1990, Simmons went through two debt restructurings.

Raymond Chambers, one of the investors with Wesray, broke a deadlock in negotiations to bring in Merrill Lynch Capital Markets (MLCM) as an equity investor in a restructured Simmons with the second give-back. He forwarded $5 million in cash and $5 million in Simmons securities from a trust he controlled.

In March 1991, MLCM invested $32 million in Simmons securities from a trust he controlled.

In March 1991, MLCM invested $32 million and received preferred stock, giving it 60 percent of the equity in Simmons. Westay made its third give-back by forgiving the $70 millionin Simmons debt it held.

The ESOP's ownership fell from 100 to 31 percent. The value of the ESOP stock had dropped from $48 million to only $6 million. Because part of the formation of the ESOP included eliminating the company's contributions to its 401(k) plan, the ESOP constituted the main retirement plan for most of its employees.

In November 1991, employees filed a class action against Wesray, the trustee, and a dozen managers who sold the company to the ESOP. In 1992, in connection with a settlement of the class action and after intervention by the Department of Labor, Wesray and management agreed to a fourth give-back, or $16.5 million.

It appeared that both Simmons and the ESOp were on firm financial footing with the infusions of capital. Wesray made will in excess of $100 million on the transaction. But the immediate failure of Simmons to handle the financial terms, and the four subsequent give-back, suggest Wesray took advantage of the structure of the deal and significantly overreached.

Michael Craig

3/21/07

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