The Wall Street Journal Interactive Edition -- July 16, 1998
KKR's Big Drive Into Golf
Hasn't Been A Good One
By MITCHELL PACELLE
Staff Reporter of THE WALL STREET JOURNAL
Leveraged-buyout chieftains and avid golfers Henry Kravis and George
Roberts boast handicaps of just 10 and 5, respectively, but their firm's tee shot
into the golf-equipment business has disappeared into a bunker.
Evenflo & Spalding Holdings Corp., which Kohlberg Kravis Roberts took
control of in 1996 with a $370 million investment, derives one-quarter of its
revenue from its TopFlite golf balls. It also sells Ben Hogan clubs, all kinds of
other Spalding sporting equipment -- as well as, in an unlikely pairing, infant
and juvenile products under the Evenflo name.
Despite these strong brand names, however, cash
flow has fallen due to problems in Spalding's
international markets and the high cost of entering
the premium, or higher-priced, golf-equipment
market. The company is staggering under more than
$725 million of bank and bond debt. Its 10.375%
bonds have plunged to less than 70% of face value,
and the bank debt is trading at a discount. Because
$18 million of debt payments are due in September,
KKR is widely expected to take action soon.
The betting on Wall Street is that KKR can't afford
the black eye it would get from a write-off of the
$416 million its funds have poured into the company
so far, given the failure of two other KKR
investments in the past few years. KKR's $250
million investment in Bruno's, a Birmingham, Ala.,
grocery chain it bought in 1995 for about $1 billion, was effectively lost when
the grocer sought bankruptcy-law protection from creditors in February. And
it lost its $300 million investment in Flagstar Cos., which operates Denny's
and other restaurants, when a restructuring last year gave 96% of the equity
to creditors.
"It is highly improbable in our mind that KKR would risk losing its
investment in [Evenflo & Spalding] and further damaging the return potential
of this fund (and its future fund-raising capability) without a major effort to
maintain the company's financial viability," junk-bond analyst Robertson
Stephens wrote in a recent report. Mr. Alaimo says he expects a
recapitalization to be announced soon, and rates the bonds a "speculative buy."
But other investors remain uneasy.
Imperial Capital, a Los Angeles
investor and broker of distressed
securities, sold its bonds earlier this
year. Although Imperial Capital's Dale
Leshaw says he expects a KKR bailout,
he figures the bonds will fall further
to "the low 60s, and the vultures will
start to circle. There could be another
fight between KKR and bondholders."
In fact, hedge funds that specialize in
distressed securities have already
circled and pounced, says Marc Lasry
of New York-based Amroc
Investments, which trades distressed
securities. Some such funds are buying Evenflo & Spalding debt, betting it
will rise in value on a KKR bailout of the company. Evenflo & Spalding still
enjoy strong brand names, and the company isn't nearly as sick as the two
others that KKR declined to bail out, these investors believe.
On July 2, the company met in New York with its lenders, led by
BankAmerica. (Mr. Alaimo, the junk-bond analyst at the bank's securities
unit, says he doesn't have anything to do with the loans, which were made by
a separate unit.) It's unclear exactly what solutions were proposed at the
meeting, but rumors have been circling that a separate KKR buyout fund will
buy a majority state in Evenflo, the baby-products division, and that KKR will
also inject more money into Spalding. A KKR spokeswoman declined to
comment on any aspect of the company.
In its financial report for the quarter ended March 31, Evenflo & Spalding
said it is "examining several transaction structures for the disposition of
Evenflo to an affiliate. The proceeds for any such sale would be applied to
reduce indebtedness under the company's senior debt agreement." The
company said it expected to complete such a sale by the end of its fiscal year
ending Sept. 30. The sale of a controlling stake in Evenflo by one KKR fund
to a second KKR fund is likely to "raise all kinds of interesting questions"
about whose interests will be served, says one investor in distressed
companies.
KKR won a bidding war for Evenflo & Spading nearly two years ago, paying
what is believed to have been between $950 million and $1 billion, including
about $370 million in assumed debt. KKR's initial investment of $370 million,
from the same fund that bought into Bruno's, gave it an 88% ownership stake.
Last year, Evenflo & Spalding added Gerry Baby Products Co., acquired
from Huffy Corp., using $46 million from a second KKR fund.
Spalding's venture into premium golf products required a substantial
investment in advertising, promotion, and endorsement deals. Last November,
it bought Ben Hogan Co., another equipment maker. At the same time,
international markets worsened, in part due to economic problems overseas.
In the quarter ended March 31, Spalding's international sales declined 23%
from the same quarter of 1997, due to weakness in Asia, Europe and Mexico.
The same report showed company-wide selling, general and administrative
expenses rose 20.3%.
"The operating performance has deteriorated under KKR, and it was very
highly leveraged when they bought it," says BancAmerica's Mr. Alaimo. "The
company has had negative free cash flow since they bought it."
The foray into premium golf equipment made matters worse. Spalding
introduced Top-Flite clubs into an increasingly competitive premium market
in 1995, before the KKR buyout. Callaway Golf, maker of high-tech clubs
like Big Bertha, has watched its share price plunge due to discounting by
rivals and upstart new competitors.
"It's a very tough market to break into," says Mr. Alaimo. "They did have
some modest success. But it required a huge investment for advertising and
promotion, and now the market has turned against them." Although Evenflo
doesn't break out financial results for high-end golf products, says Mr.
Alaimo, "I doubt they make money in premium golf."
In danger of violating covenants with its lenders related to interest coverage
and leverage, Evenflo cut a deal in March under which the loan terms were
modified, through Sept. 30, in exchange for a higher interest rate and more
collateral. That same month, Moody's downgraded the $200 million of
10.375% bonds, due 2006, to Caa2. "The entire liquidity of the company
became an issue," explains Moody's analyst Kevin Kusnierek.
The bonds, then trading at nearly 90 cents on the dollar, began declining in
value. After disappointing results were announced for the quarter ended
March 31, and Evenflo & Spalding said it was exploring the possible sale of
Evenflo, the bonds plunged to a low of about 63% of face value, before
recovering to near 70% on talk of the bailout.
To bolster cash flow, Evenflo & Spalding has begun restructuring its
international operations by streamlining in Japan and Europe.
Nonetheless, at least one of the 20 or so banks that participated in the bank
loan has sold its stake at about 95% of face value, according to Mr. Lasry. He
contends that if the rumors of an impending KKR bailout are correct, "you'll
see the bonds move up by five to 10 percentage points."
SATISFIED BEARS: As the stock market struggled to slight gains in the
second quarter, the professional naysayers known as short-sellers profited.
The shorts, who make money when stocks go down, registered a 6.9% gain in
the quarter, based on the 20 short-sellers included in the Rockbridge Short
Sellers Index. Michael R. Long, of Rockbridge Research, Charlotte, N.C.,
says the gain doesn't quite make up for the 7.6% loss the shorts suffered in the
first quarter.
But individual successes on once-robust stocks were many. Big winners for
the shorts, as the stocks fell, included Samsonite, SmarTalk Teleservices,
Caribiner International, Sunbeam, Zenith Electronics, Danka Business
Systems, Callaway Golf and Fila Holdings, according to Rockbridge Research.
Rockbridge says big losers for the shorts -- or stocks that defied the shorts'
pessimism -- included Computer Learning Centers, America Online, Ascend
Communications, Dell Computer, Yahoo! and Amazon.com.
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