The Loewen Group

3^[a]) Some might describe Loewen as “financially distressed”. Is this a fair description of its problem? (a) What are the manifestations and apparent costs of this so-called financial distress? (b)

1. The definition of financial distress is a situation in which a firm has difficulty meeting its debt obligations. Thus, the situation of the firm in 1999 is similar to the one of the definition. During that year the maturing debt was 875$ million, which represented around the 38% of the total debt outstanding, which was 2.3$ billion at the beginning of the year. The amount of cash that the company owned was 30$ million, which was able to cover only 3.43% of the payments due. Also, it is important to underline that the debt of Loewen had very strict covenants which enabled to declare bankruptcy on all its debt if only a single payment of interest or capital had been missed. In 1999 the company was not in compliance with some covenants, requiring the approval of the creditors in order to not declare bankruptcy. Also, the company owned very illiquid assets used for its death care activity, so they will have difficulties in raising cash in a short term. Also, issuing new debt to repay the old debt seemed a very difficult possibility, considering the low rating of the company (B-) and its high leverage. The market value of equity was around 143 million (74 million shares at the beginning of 1999 and a price per share of 1.93$ in February 1999). If we consider the market value of debt equal to the book value (the cash is so little that we can assume it to be zero), the current market debt-to-equity is 16.08. This ratio is much higher considered the average of the sector. Using financial data from the beginning of 1999, the market debt-to-equity of SCI was around 0.39, for Stewart Enterprises 0.40 and for Carriage Services 0.50, while the one of Loewen was around 3.74. Another strong indicator of the distressed situation of the company is given by its interest coverage ratio, given by the operating profit divided by the interest expenses. This indicator represents how easily the company is able to repay the interest on its debt using only the profits from its core activity. In 1998 it was 3.7 for SCI, 4.1 for Stewart Enterprises and 2.6 for Carriage Services. In the same year it was 0.4 for Loewen, indicating that the operating profits could not cover the interest expenses. Finally, the last indicator to consider is that in the year before February 1999 the price of the Loewen bonds outstanding decreased 30%. This means that investors were quoting these bonds taking into consideration the recovery rate that they were able to get (if we assume the quotation at par it would be around 70%), considering the firm virtually bankrupted. To sum up, all of its indicators conveys the idea that the firm was in a very bad financial situation and so, it could be considered in distress. In other words describing Loewen as “financial distressed” seems to be a fair description of its problems.

1.  The manifestations of this difficult situation are primarily noticeable in the financial markets. As previously said, the decrease of 30% of the price of the outstanding bonds means that investors did not confidence in the stability of the company. Also, the 92% decrease in one year of the stock price means that there was a fire sale of the stock on the equity market, underlining the concern of investors for a long-term prosecution of the business. Third manifestation is recognizable in October 1998 where the founder and CEO of Loewen resigned and was substituted by John Lacey, who had the reputation of a successful turnaround specialist. This was an attempt from the shareholders (and in particular the biggest one, the Canadian Imperial Bank of Commerce) to restore the situation of the firm. The last clear manifestation of this financial distress is related to the pace of acquisitions. In 1997 Loewen spent around 546$ million to acquire funeral homes and cemetery properties, while in 1998 they cut it more than 50% to 278$ million. It is worth to notice that all the other three competitors increased the amount spent on acquisitions from 1997 to 1998.
   As for the costs, we can divide them in direct and indirect costs. For the formers, the costs associated with the investment bankers that the company hired in 1998 in order to restructure its financial situation. Also, the negotiations with the bank to restructure the debt will require the hiring of lawyers and professionals, who will have a cost for the firm. Finally, in case of bankruptcy, the trial will represent a huge cost for the company (normally around 3-4% of the enterprise value). As what concerns the indirect costs, the decrease in the price of the bonds and the shares represents a cost respectively for bondholders and shareholders. Furthermore, the change in CEO will surely change the company’s strategy. Related to this and considering that the acquisitions of the main competitors increased steadily till 1999, it is also probable a reduction in market share for Loewen in the death care business, which could have repercussions on its image and reputation. Finally, considering the high debt-to-equity ratio and its bad credit rating, Loewen is facing costs from a funding perspectives, because investors are no more willing to lend money to the company or, in case they are still willing, they would require high returns on their investment.

4) What are Loewen’s alternatives? (a) What would you recommend to John Lacey? (b)

1. Loewen has basically six alternatives. The first one, which is the most difficult to implement, is to raise new debt in order to pay for the old debt. This option is not easily viable, because investors will not lend money to a company which is on the edge of the bankruptcy. Similar to this option there is the injection of cash inside the company through an equity issuance. Considering the past life of the company it is noticeable that every year the number of shares increased. This is a sign that the firm used this tool in order to grow. However at the moment, shareholders would not willing to put further cash in a company that does not assure a continuation of the business in the future months. The third one is to file for bankruptcy. In this situation, Loewen will probably have to consider both the American and Canadian legislation and this will exacerbate the trial costs, since some conflicts between the two courts could arise. The fourth option is to find a company willing to buy the entire business. In this situation, the new company would pay for the debt of Loewen of the coming months. However, two factors affect the viability of this alternative: the first is related to the low price of the stock, which makes a takeover easier; the second is that the bad performance, from a profitability point of view, together with the unhealthy financial situation makes the company a unfavourable target. The fifth alternative is the fire sale of assets. This is a viable possibility, although it involves some difficulties. In fact, the death care business deals with illiquid assets as cemeteries and funeral homes, which cannot be normally sold quickly and without huge discounts on the market value. However, if the least profitable businesses are sold, the total situation of the company will have a benefit, in particular for a cost reduction point of view. The last option is the restructuring of the debt. In this situation Loewen has to privately negotiate with the debtholders a reduction of the interests (or even the capital) or to extend the maturity of the debt^[b]. Considering that a court solution will involve costs both for the company and for the debtholders (normally recovery rates with in-the-court procedures are lower and more extended in time) this solution is the easiest to reach.