It’s much the same with businesses. When they’re thriving, their income statements all look alike – tidy family portraits of profits and tranquility. It’s when companies fail that all their neuroses and idiosyncrasies come into view. That’s when you discover dysfunctional capital structures, crazy expenses in the attic, crackpot expansion theories. By then, though, it’s often too late. It takes a special leader – a combination of analyst, mother hen and disciplinarian – to save a failing company. It also takes the right team, rigorous planning and a measure of luck. Here’s a look at three Top 250 companies that (maybe) made it through the turnaround, and the perspectives of the men who led them there.
No. 19 on the Top 250
“You can’t pretend something’s not broken if it’s broken,” says Eric Yeaman, CEO of Hawaiian Telcom.
Under Yeaman’s leadership, the company successfully emerged from Chapter 11 bankruptcy last November, but, when he arrived in 2008, it was clearly broken. “When I came on board,” he says, “company morale was pretty low. We were in the papers; we were losing customers; and the company was losing $150 million a year.” For a company with as many problems as Hawaiian Telcom had, bankruptcy is often the only answer. But bankruptcy comes with its own set of problems.
Some of the company’s difficulties were technical, related to the change of ownership from Verizon to a local hui partnered with The Carlyle Group, the private equity firm that orchestrated the buyout. For example, many of the company’s back-office functions, like customer-service, billing and product development – all systems that Verizon had handled on the Mainland – had to be recreated here from scratch. That process didn’t go well. Other problems had to do with Hawaiian Telcom’s management and corporate structure. All these problems affected the bottom line.
The first step was to quantify the problems. “There are some real basic things you’ve got to look at,” Yeaman says. “Revenue, cost structure, profitability or lack thereof, and cash flow – where is the money coming from and where is it going? What is the productivity of your business? What can you do to increase revenue, decrease costs and better allocate your capital? And how do you compare to your peers?” That last point is critical for a company in a capital-intensive industry like telecommunications. “After all,” Yeaman says, “to attract capital, you need investors, and investors are going to compare you to your peers.”
But the heart of Hawaiian Telcom’s problems was that the company was simply over-leveraged. It couldn’t generate enough revenue to cover the enormous debt racked up by The Carlyle Group when it bought the company. “We needed to restructure the balance sheet,” Yeaman says. “There was no way this company was going to survive with its current debt structure. We needed to do something to stabilize the company, which was losing $10 million a quarter in revenue. You can only cut costs so much before you run out of levers to pull.”
Of course, Chapter 11 is largely a process to figure out what a company is actually worth. Working backward from that figure, you can calculate how much debt the company can really afford. “That’s the cornerstone of the restructuring process,” Yeaman says. “You have to come up with what you believe the value of the company is, based on a plan that you think makes the most sense for your business. Once you come up with a plan, you have to defend that plan during the restructuring process. There are going to be people on both sides. Some try to drive the value down; some try to drive the value up. Our responsibility is to come up with a fair valuation.”
That backward calculation is a powerful tool. Indeed, for companies in bankruptcy, it’s often the main ingredient of the turnaround. “Do it once, and do it right,” Yeaman says. “Otherwise you end up in Chapter 22.” Hawaiian Telcom seems to have done it right. Entering bankruptcy, the company had about $1.2 billion in debt, including both secured and unsecured creditors. When it emerged from bankruptcy two years later, the calculated value of the company was just $460 million – $300 million in debt and $160 million in equity for the secured creditors. The rest of the company’s liabilities – and all the existing shareholder equity – were wiped out.
“We drew a line in the sand,” Yeaman says. “We felt our debt level needed to be at $300 million because that was the right capital structure.” In other words, he says, given the revenue the company expected to generate, that was the most debt the company could afford to service. Ultimately, the company’s creditors and the court agreed. The effect on expenses was dramatic. “It reduced our interest costs by over $60 million a year,” Yeaman says. In addition, he points out, the company stabilized revenues. “We were losing $10 million a quarter – $40 million a year, approximately – in revenues. For the last seven quarters, though, we’ve stabilized revenue at about $100 million a quarter, give or take a million or a million and a half.”
Hawaiian Telcom’s plan also looked forward. “The other thing we wanted to do was position the company for growth,” Yeaman says. To that end, the company invested millions of scarce dollars to develop new products and services: VOIP for business; an Ethernet-based product; several new managed-services options; and IP VPN, or virtual private networks that can run over the Internet. Moreover, in June, the company finally received permission from the state Department of Commerce and Consumer Affairs to launch its long-awaited digital cable TV service. “Those were all products we wanted to launch while we were in reorganization,” Yeaman says. “That way, when we did emerge, we would be well-positioned to grow.”
For now, Yeaman’s tenure with the company looks like a success. In the first quarter of 2011, Hawaiian Telcom actually turned a modest profit. Just as important, the market has smiled on the company since it emerged from bankruptcy in November 2010. “Since the stocks first began trading again,” Yeaman points out, “the value of the shares went from $16 to today’s value of about $28 a share. That’s about a 75 percent increase. In the same time, the S&P didn’t go up that much, and our peers actually went down 9 percent in that period.”
Almost at the same time Yeaman was leading the turnaround at Hawaiian Telcom, Mark Storfer, COO of Hilo Hattie, was chaperoning that company through its own Chapter 11 saga. Storfer, a well-known business consultant in Hawaii, already had a reputation for dealing with troubled companies. “I was at Liberty House as COO in 1998 when we filed for Chapter 11,” he says. “That company was in reorganization for three years, then we successfully emerged and sold the company to the Macy’s division of Federated Department Stores.” Storfer clearly knows something about unhappy families.
So, when California businessman Ted Nelson was considering buying troubled Hilo Hattie from founder Jim Romig, he hired Storfer to help with the due diligence. That began Hilo Hattie’s whirlwind path to Chapter 11. “I quickly realized,” Storfer says, “that, in order to survive, we would need to seek protection from federal Bankruptcy Court, which we did in October 2008.” That turned out to be just one small step in the company’s turnaround.
Hilo Hattie, which has gone through three owners in as many years, is an excellent example of plans gone awry. First, the company negotiated a favorable payment arrangement with its creditors, only to have that deal quashed by the plummeting economy and filing for bankruptcy. One of the advantages of Chapter 11 is that it’s sometimes easier to get financing, because bankruptcy lenders move to the front of the creditor line. Storfer says Nelson had bankruptcy financing arranged in advance to help get the company out of Chapter 11. “Unfortunately, when we filed in the fall of 2008, that was the economic meltdown. Ted’s financing dried up very quickly.”
In the end, Donald Kong, whose company, Royal Hawaiian Creations, was one of Hilo Hattie’s largest creditors, acquired the stock from Nelson and brought the company out of bankruptcy. As with Hawaiian Telcom, Chapter 11 erased most of the rest of the company’s liabilities. “The court only required Hilo Hattie to pay 5 percent of its debt,” Storfer says. (He notes, though, that the court doesn’t always wipe the slate clean this way. “In the case of Liberty House, we repaid most of our debt. That’s because Liberty House was better capitalized and was able to demonstrate in court that it could generate sufficient future profit.”)
While it’s helpful to start with a clean slate, to really turn around a troubled company, you’ve got to know what went wrong to begin with. In Hilo Hattie’s case, that part was clear. “It was a textbook mistake,” Storfer says. “Expansion – aggressive, fast, poorly thought out store expansion to the Mainland. We had stores in Florida, Tennessee, California, Nevada and Arizona, and I can say, with hindsight, what happened: poor site selection, poor planning, poor demographics and huge capital investments over a short period of time. Most of the stores were only opened about a year and we had to close them all. Jim Romig, the founder, is a friend of mine, but I’m sure if he had it to do over again, he wouldn’t do all that expansion – at least not the way he did.”
So, while the cure for Hawaiian Telcom might have been bringing new services to market, for Hilo Hattie, it was getting back to basics. That included painful cost cuts – layoffs, rent reductions and store closures – but it was mainly a renewed focus on the company’s Nimitz flagship store rather than a planned move to Waikiki.
“The Nimitz location was fine,” Storfer says, “but we needed a reason for visitors to come here. It had to be more than just the product.” Now, Hilo Hattie has a hula studio, a kumu hula and hula dancers. Visitors can see a hula show or take lessons or visit the company’s aloha shirt museum. There’s also a “Hawaiian-style” Internet café where guests can enjoy Hawaiian food and beverages. “I think we’re the only place in town selling Dole Whips,” Storfer says. It’s all part of a new strategy to create a destination shopping experience.
Is the plan working? “The numbers are all pointing in the right direction,” Storfer says. “We submitted a five-year sales and profitability plan to the court and, one-and-a-half years in, we’re right on target. We’re showing increases of 30-plus percent in sales, which is above our competitors, we understand.
“Of course,” he adds, “the figures of the last couple of years were easy to beat; not like the heyday numbers of 2005 and 2006.”
* Did not supply information for Top 250.
Central Pacific Financial
No. 31 on the Top 250
John Dean, who became CEO of Central Pacific Bank in March of 2010, points out that not all turnarounds are bankruptcies. Nor do they always have the same causes. Troubled banks, for example, may have different symptoms than failing utilities or retailers. Dean estimates that “of all the banks that have failed over the last 100 years, something like 97.5 percent of these failures were driven by poor asset quality.” That’s certainly the case for CPB and its parent, Central Pacific Financial Corp., which were buffeted by bad real estate investments on the Mainland.
The cure? Like Storfer, Dean talks about controlling costs and improving efficiencies. Like Yeaman, he believes strongly in building teams and fostering the right corporate culture. But, for a bank, much of the process is simply about attracting capital. In fact, Central Pacific only recently emerged from a consent decree with the federal government that required the bank to improve its balance sheet by adding hundreds of millions of dollars to its reserves. Dean, like Storfer, is a turnaround veteran – this is his fourth troubled bank – so he understands that he was hired, in part, because of his ability to attract this kind of capital. That’s a role he’ll likely play as long as he’s at Central Pacific.
But, as Dean points out, sometimes the success or failure of a turnaround is based largely on forces outside the company’s control. Hilo Hattie, for example, may have arranged financing in advance of bankruptcy, but those plans crumbled with the rest of the economy. Dean notes that banks are just as subject to these market forces. “In banking, the market is critical,” he says. “Are the markets in your favor or are they going against you? If the real estate prices in the market you’re serving are headed south, it’s a much more difficult problem, because, in effect, every quarter you’ve got to mark your book to market. You reevaluate it, and guess what? It drops another 5 percent.” That means you need still more capital. It’s a death spiral.
“Fortunately,” Dean says, “by the time I got here, that market was starting to level off. It was still bad, but that’s much better than a falling market. That was in our favor.”
The other market that was critical for Central Pacific’s turnaround was the market for banks themselves. “We needed to raise private equity to refinance and recapitalize the bank,” Dean says. “A lot of private equity money had already been raised in the market, originally to acquire and refinance banks that were failing or that regulators had seized. By the time I arrived here, though, the markets were shifting and there was a growing interest in recapitalizing banks.”
So, while Dean will probably get the credit for Central Pacific’s turnaround, he’s a little more circumspect: “You need a little bit of luck,” he says. “And, to be honest with you, we had things going in our favor.”