Loewen Group, Inc. Case Study

EXECUTIVE SUMMARY

In 1999, the Loewen Group, Inc., was the second largest death care company in North America. Based in British Columbia, Loewen owned more than 1,100 funeral homes and 400 cemeteries in the U.S. and Canada and 32 funeral homes in the U.K. The company was founded by Ray Loewen who inherited a small funeral home from his parents in the late 1960’s. At the time, the whole sector was starting to grow by acquisition and consolidation. The idea was to achieve considerable cost savings by acquiring geographically concentrated funeral properties and cutting redundant assets as well as overhead expenses. Therefore, in early half of 1990’s, Loewen grew explosively by an aggressive implementation of this method. Moreover, Loewen heavily used debt financing to raise capital for these acquisitions to be able to keep up growing their market share and to save taxes thanks to increasing interest payments. Indeed, in 1996, Loewen acquired one of the largest funeral service providers in the U.S. for $320 million and the largest cemetery in North America for $285 million. The following year, i.e. 1997, Loewen acquired 170 funeral homes, 171 cemeteries and an insurance company. All these operations were principally financed through debt (banks and bonds).

But, in 1997 and 1998, the management started to issue several profit warnings due to – decline in death rates, inefficient integration of acquired properties and issues of the cemetery business. By the end of year 1998, the group had $2.3 billion debt obligations in which $882 million were long-term debt maturing in 1999 out of the total $1.4 billion of long-term debt. Furthermore, the group’s interest coverage ratio declined by 17% to less than 1 in 1998, which can be interpreted as the group’s earnings were insufficient to manage the required interest payments. In 1999, the group breached some covenants of debt contracts due to a missing debt payment. Finally, after reaching a peak at $39 in 1996, the current stock price of Loewen is trading at $1.93, a decline of more than 95%. Given the financial state that The Loewen Group finds itself in 1999, going forward they have two options to restructure their debt either through out-of-court procedures or through filling for a bankruptcy. Both these options involve restructuring their debt to get more favourable terms. The out of court procedures additionally involve selling land to fulfil short term obligations and reducing expenses through downsizing and consolidation. On the other hand, filing for bankruptcy involves long term plans such selling underperforming assets, shifting focus to the pre-care business, reviewing pricing, forming funeral clusters and requesting for a debt-to-equity swap. Although an out-of-court settlement would be more desirable because of the flexibility and lower costs involved but due to the time crunch, the illiquid nature of the assets involved and the heterogeneity of the debt coming up with a plan that suits everyone will be difficult. The practical option would be to file for bankruptcy which gives more time for reorganization and coming up with a plan that suits most of the creditors.

Explosive Growth and Aggressive Acquisitions (Loewen Group in early 1990s)

The company grew explosively in early half of 1990s by aggressive acquisition of small and independent funeral houses, cemeteries and related companies. They acquired a majority share in the companies, but continued with their old management, giving them autonomy of the funeral homes. This created a positive sentiment from the acquired firm’s perspective as it could carry the “family name”. This sentiment might have helped the group in some of their acquisitions.  They were able to raise capital for their acquisitions by 2 means:

1. Debt financing: Loewen Group heavily used debt financing to raise capital for their acquisitions. Between 1989 and 1995, the total debt on the firm grew from $84.8 Million to $934.5 million. The company’s policy was to have a high debt to equity ratio (1 to 1.5) to finance their capital needs to continue with their aggressive expansion plans.
2. Public Equity: As the demand for Capital constantly kept increasing into the late 1980s, Loewen Group listed its stock in the Toronto Stock Exchange in 1987 to raise capital. 3 years later (1990) the Group listed their stock in NASDAQ as well after entering the US market.

Their strategy of debt financing led to the following advantages for the firm:

1. Growth in market share: Debt financing was the reason that Loewen Group managed to acquire the 2nd biggest market share after SCI. The growth led to significant positive trends in revenues and consequently profits.[pic 1]
2. Tax Benefits: The firm enjoyed tax shield because of their debt financing as can be seen in the graph. The increase in interest payments enabled them to save on taxes. By 1995, Loewen Group was saving close to $25M in tax benefits.
3. A positive track record of meeting interest commitments created a positive image in the market of the firm’s financial strength. This could have potentially led to a positive impact on their share price. The trends in share prices were upward till 1996, but a direct causal relationship cannot be established with the limited data.

The road to Financial Distress (The Loewen Group in 1999)

The Loewen Group started its consolidation of funeral homes in 1969. The group accelerated its inorganic strategy in the sector from 1990s onwards, which is evident by the high CAGR (51%) of acquisition expenditure between 1991 and 1996. In 1996, Lowen Group acquired Prime Succession Inc. and Rose Hills with support from the Blackstone Group. More than 50% of the amount spent on these acquisitions was financed through debt (banks and bonds). The following year, i.e. 1997, Lowen group acquired 138 funeral homes, 171 cemeteries, an insurance company and 32 funeral homes in U.K. Since these transactions were majorly financed through debts, the interest expenses in increased at a CAGR of 41% between 1989 and 1998.

The group’s stock price peaked in 1996 at USD 39, however, in the next two years the stock price decreased by ~78%. The management cited three reasons for the decrease in earnings – decline in death rates, inefficient integration of acquired properties and issues of the cemetery business. By the end of year 1998, the group had USD 2.3 billion debt obligations (USD 1.4 billion long term and USD 0.94 billion short term). Of the total long-term debt ~63% was maturing in 1999. Furthermore, the group’s interest coverage ratio declined by ~17% to less than 1 in 1998, which can be interpreted as the group’s earnings were insufficient to manage the required interest payments. Lastly, the group’s debt contracts had several covenants. An event of default was defined as a breach of any covenant or non-payment of the scheduled interest and principal amount. Further, an event of default in one contract led to the default of other debt contracts. In 1999, the group breached some covenants, which worsened the group’s financial health condition.