Path: bloom-picayune.mit.edu!snorkelwacker.mit.edu!americast.com!americast.com!americast-post Newsgroups: americast.forbes From: americast-post@AmeriCast.Com Organization: American Cybercasting Approved: americast-post@AmeriCast.com Subject: Fishing in foul water Date: Fri, 6 Nov 92 11:08:08 EST Message-ID: "Copyright 1992 Forbes, Inc. Any further reproduction or redistribution without the express written permission of Forbes and ACC is prohibited." Fishing in foul water Samuel Zell and David Schulte went fishing for bargains. They caught Carter Hawley Hale. Maybe they should have let it get away. By John H. Taylor NEVER MIND the nationwide retail re- cession, never mind the special prob- lems of department stores. Chicago investor Samuel Zell, 51, and his part- ner David Schulte, 45, last year won control of Carter Hawley Hale Stores, the once prestigious, then bankrupt Los Angeles-based department store. They spent $267 million to buy some of its defaulted bonds and trade claims, which they ultimately swapped for 75% of the reorganized company's common stock. Most of the investment money came from a $1 billion vulture fund they put together two years ago called Zell/Chilmark; another $25 million came from a limited partner. What did Zell, Schulte and compa- ny get for their money? A $2 billion (sales) chain that has lost more than $500 million since 1987. But Zell, one of the smartest real estate men in the country, also knew he was getting control of prime locations in Califor- nia, where the chain does 90% of its business under the Broadway, Empo- rium and Weinstocks names. The chain has stores in Santa Monica Place, Century City, Beverly Center and Sherman Oaks Fashion Square in Los Angeles, Market Street in down- town San Francisco and Horton Plaza in San Diego. Although Zell and Schulte knew the stores were aging and top man- agement weak, they figured that with a lower interest burden, a total face- lift, cost-cutting and a pickup in the California economy, the stores would turn around. They worked out a reor- ganization that cut debt from $1.7 billion to $1 billion, slashing annual interest outlay from $145 million to $92 million--only $73 million of which is cash. Once the California economy picked up--it always did--they would be sitting pretty. Only the California economy, groaning under high taxes, massive defense layoffs, outrageous environmental constraints and a gen- erally sluggish national economy, doesn't seem to be recovering. As Carter Hawley emerged from bankruptcy in early October, Califor- nia was mired in its worst economic downturn since the Great Depres- sion, with no recovery in sight. The state has already lost 760,000 jobs in the last two years, and the state unem- ployment rate is nearly 10%. ''The state is caught in a vicious cycle, with job losses in key sectors causing con- straints in spending, cutbacks in pro- duction and more layoffs,'' says UCLA economist David Hensley. ''There's no end in sight.'' Schulte, a financial man who head- ed Salomon Brothers' workout de- partment in the early 1980s, says the store upgrades--$453 million in im- provements between now and 1997--can still be funded from cash flow. During the tough haggling over the bankruptcy reorganization, Zell and Schulte squeezed more than $20 million in rent reductions and contri- butions from landlords for store im- provements. They are also negotiat- ing to sell other stores or assign the leases to other retailers. The disclo- sure statement Carter Hawley filed as part of its reorganization says the company expects to generate about $96 million in cash flow (earnings before taxes and depreciation) next year, more than enough to pay for $75 million in capital improvements. Maybe, but those estimates are probably too rosy, given the current state of the California economy. Car- ter Hawley's cash flow projections assume California will begin a sus- tained economic recovery early next year--and that Carter Hawley's same- store sales will pick up between 5.6% and 6.6% every year from 1993 through 1997. Those predictions are at odds with virtually every expert's assessment. Same-store sales fell 10% last year and were off 3% last quarter. And Carter Hawley has proved itself a notoriously wretched forecaster. In May 1991, for instance, the company projected it would lose $5 million that fiscal year. Final loss turned out to be $217 million. If cash flow doesn't meet projec- tions, Zell and Schulte concede they will have to either raise more money or curtail the improvement program. Meanwhile, they must quickly find a top retailer to run the show. On Oct. 9, the day after the company emerged from bankruptcy, Philip M. Hawley, the longtime chief executive, an- nounced plans to retire by Jan. 31. They'll almost certainly have to go outside: There's no heir apparent, and the company has always been regard- ed as light on management. Carter Hawley Hale shares were trading recently for 6 1/2. At that price, Zell/Chilmark is now showing an $88 million paper loss--which may not sit too well with their outside investors, who are paying Zell and Schulte annual fees of about $17.5 million to manage the $1 billion fund. Zell and Schulte told investors when they were raising the fund that they aimed for a compound annual pretax return of 40%. Patience, Schulte says, adding: ''I do think the only thing that will lead me to regret this [deal] is if California died.'' One who doesn't regret the deal is Jeffrey Werbalowsky, financial adviser to Carter Hawley's old creditors, many of whom tendered their bonds to Zell and Schulte for 47 cents on the dollar. Says Werbalowsky: ''When we sold those bonds, we knew that if the economy and department store in- dustry recovered, Zell/Chilmark would make a lot of money, but we also knew if the economy and the company continued to go down, we'd be very happy we sold.'' Werba- lowsky adds (pause), ''And we're very happy we sold.''  "This information is the property of Forbes, Inc., ACC takes no responsibility for its content, or the actions of any individual or institution, predicated on the information herin. Forbes Subscriptions are available to students and faculty members at the student/educator rate of $33 for one year, 27 issues. Regularly priced $52. Information about print subscriptions may be had by calling 1-800-888-9896. For further information about the electronic version of Forbes, contact usa@AmeriCast.COM"