Wall Street West—Employee Stock Plans See Rebirth as Market Stumbles

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ESOPs are back.

The employee stock ownership plan was something of a hit a generation ago. And even today there are certain giants, such as rental car giant Avis, that employees own under an ESOP.

The plans have some interesting attributes, the basics being that an ESOP provides an exit strategy for sellers, while incentivizing and providing a modicum of job security for employees.

But with the high market valuations on Wall Street and elsewhere for the past decade, ESOPs had fallen out of favor.

“It’s tough to do an ESOP if an owner can go public, or sell to a public company willing to pay 25 times earnings,” said Larry Hurwitz, chairman of the downtown Los Angeles-based national business valuation firm Marshall & Stevens Inc. But now, the IPO market is dead, and public company currency stock is getting cheaper. Moreover, banks are chintzy today when lending to leveraged buyout firms, so the LBO market is a snail, too.

“But banks are more than willing to lend to an ESOP,” said Hurwitz. “We expect to do about 25 to 30 ESOPs in the greater Los Angeles market in the next year. We are doing one right now.”

(On such deals, Marshall & Stevens does the valuation work, while Hurwitz hustles up bank financing through his Lawrence Financial subsidiary, he said.)

ESOP deal sizes start at $7.5 million, said Hurwitz, although the brokerages especially UBS Warburg-PaineWebber tend to move in when values get much above $50 million.

Banks will lend to finance an ESOP buyout and not an LBO due to the unique structure of the employee plan. First, the ESOP deal is tax-free, so owners can sell for about 30 percent less, noted Hurwitz. In general, an ESOP will buy a company for about seven times earnings, or 10 times EBITDA (earnings before interest, taxes, depreciation and amortization). And banks like financing cheaper deals, with less leverage.

Second, the proceeds of the ESOP sale are typically invested in government securities and doled out by the bank at a measured pace to the seller, if the company performs. That gives the owner a reason to not sell a dog-in-the-making. If the business craps out, the banks seize the seller’s collateral the government bonds.

Third, some academic studies have shown that ESOPs do well, probably because employees do realize their stake in the outcome. There are some advantages for owners as well.

“They can sell only a minority, such as one-third of the company, if they want to,” said Hurwitz. “They can keep control, but monetize some of their wealth.”

ESOPs tend to work better when employees are routinely kept informed about their ownership and the value of their stake in the company.

“It’s not enough to just give them (employees) a paycheck,” Hurwitz said. “A monthly statement, showing their shares and values, is important.”

An annual independent evaluation of the value of the company and thus the value of employee shares also helps workers feel their stake is meaningful, not esoteric.

In general, employees “cash out” either when they retire or leave the firm, if they have been vested.

Phone Chatter

John Marrone, branch manager with brokerage-investment banking shop Roth Capital Partners in West Los Angeles, has sent out his own yuletide e-mail. It contains some investment tips for clients “who think the three largest phone companies in America aren’t going to go out of business.”

The phone giants have been flattened by a steamroller on Wall Street this year, with AT & T; Corp. trading recently at about $19 a share, down from a 52-week high of $61. Meanwhile, MCI WorldCom Inc. was down to $14 from a 52-week high of $55, and Sprint Corp. was trading at $23 a share, down from $72.

“I guess the market is saying the whole telephone infrastructure is going to melt down,” says Marrone.

The nemesis of the big phone companies and their long-distance traffic is the Internet, concedes Marrone. It’s possible that in the future, many ordinary long-distance telephone calls will be carried by the Internet. But for now, long-distance chat via the Web is balky, and requires special equipment. In short, the Web’s takeover of the long-distance market may be a while yet coming, according to Marrone.

“I remember 10 years ago, they said we would have ‘on demand’ movies at home. I live in West Los Angeles today, and I still rent movies, or watch them when they are shown (by broadcast or cable stations),” said Marrone. “It may be a while before we talk on the Internet.”

Tougher and Tougher

H. Wayne Snavely, former U.S. Marine and current chairman and chief executive of Torrance-based business lender Imperial Credit Industries Inc., is toughing it out, judging by his comments last week.

Imperial Credit stock traded down to 60 cents a share last week, a new all-time low, and down from the $1 level it maintained for a couple months. Imperial Credit stock is but a shadow of the $23 a share it hit in the good ol’ days of 1997. (The company’s bonds now trade at 30 cents on the dollar.)

Imperial Credit ran into trouble when it got into consumer lending in the late 1990s, from which it has since retreated. But Snavely himself is not quitting, not running and not dodging phone calls.

“You look at the stock, you look at the bonds, and there is no question that the market is treating us as a candidate for bankruptcy,” said Snavely. “But we are not going to go bankrupt.”

Snavely said calendar 2001 will be profitable.

Some investors have wondered how Imperial Credit might make money during a downturn, if it managed to lose money in a boom. But Snavely says Imperial Credit is ready for a business slowdown.

“We have already written down, taken reserves against losses. We have probably already done the things that other lenders will have to do next year,” he said. “We have already taken our medicine.”

With little institutional support for Imperial Credit on Wall Street, the stock is an orphan, and as year-end approaches, it is a holding that can be sold for a tax loss, said Snavely. That hurts the stock, too.

But Snavely said the game is not over, and that he wants full reporting on later innings. “I talked to you now, when times are bad. You better call me back when times are good, next year,” said Snavely. “Or I will call you.”

Contributing columnist Benjamin Mark Cole writes about the local investment community for the Los Angeles Business Journal. He can be reached at [email protected].

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