Employee Ownership Plans A Hard Sell in Wary Market
Wall Street West
by Benjamin Mark Cole
Who would want to be in an employee-stock ownership program, post WorldCom, post Global Crossing, post whatever-is-going-to-melt-down this week?
Proponents contend that ESOPs vehicles for employee ownership of a public or privately held company’s stock still offer a lot to both employees and business owners. The seller, under federal laws in existence since 1974, can keep capital gains tax-free if sales to an ESOP are reinvested in U.S. securities, while employees can consider payments made to acquire the company to be tax deductible.
“Congress wanted to promote employee stock ownership back in 1974, and so the tax code reflects that,” says George Ray, chairman and chief executive of LeFiell Manufacturing Inc., in Santa Fe Springs, an aerospace and aircraft sector subcontractor. Ray also is vice chairman of the National ESOP Association.
There is no arguing the tax picture for ESOPs is pretty sweet. But in these cautious times, some are counseling business owners and employees not to leap into ESOPs.
“I generally like ESOPs, but you have to consider the timing,” said Bob Rosowski, partner with Ernst & Young in downtown Los Angeles. “The valuations are going to be low now, and the Department of Labor is going to be scrutinizing ESOPs very closely.”
Generally speaking, ESOPs buy companies at a value determined by independent evaluations known as fairness opinions. Fairness opinions are paid for by the owner (seller), and their objectivity can be the subject of litigation if a company later fails, Rosowski said. If the litigation succeeds, owners may find themselves hiring expensive lawyers and owing fees to the Internal Revenue Service.
In the past, some fast-footed owners have used ESOPs as an exit strategy, selling their company to an ESOP that leveraged up to make the acquisition. In some examples, the departing owner took along prime prospects, or after a few turns of bad luck, the ESOP-owned business collapsed under the new debt load.
Still, only a tiny fraction of the nation’s 3,000 active ESOPs are ill-conceived, contends Ray, who says industry studies strongly suggest that motivated employees work harder, and that ESOP-companies perform better than like non-ESOP companies.
LeFiell Manufacturing is majority-owned by the ESOP, and most LeFiell employees participate. “Our absenteeism rate is 0.8 percent,” Ray said.
Whatever their virtues, ESOPs may be a tough sell for a while. The big bogeymen are concentrated investment portfolios, which did in many Enron employees. Ideally, investors should not keep most of their nest eggs in one basket. Yet with an ESOP, that often happens.
“Well, that is one of the risks of business ownership,” Ray explained. “Most business owners are over-concentrated. Many homeowners are over-concentrated. You get benefits, but you also get risks.”
Though it got little ink in the United States, L.A.-based vitamin powerhouse Herbalife International Inc. failed in an attempt to sell $250 million in high-yield bonds into the European market, in a deal handled by UBS Warburg. The proceeds were to help finance a $685 million buyout of Herbalife by two private equity firms: Stamford, Conn.-based Whitney & Co. and San Francisco-based Golden Gate Capital Inc. (Whitney is one of the nation’s oldest private-equity firms.)
According to some bond traders, UBS Warburg had cut back the offering to $165 million, and upped the yield to a juicy 12 percent, but still the buyers wouldn’t be tempted. In the last three years, it’s become increasingly difficult to find financing for mergers. “This is just another sign the market doesn’t like buyouts or mergers anymore,” said one analyst.
A Herbalife spokesman said last week that the going-private transaction, priced at $19.50 a share, will go ahead.
Evidently, the stock market thinks a deal will get done: Herbalife is still trading at $19 and change, well above the $15 it commanded before the April announcement of the going-private deal.
More Than Words
Armed with a Ph.D in economics from Berkeley and a stint with the Federal Reserve Board in Boston, Neil Berkman returned to his native Los Angeles 20 years ago and plunged into the business of investor relations, IR for short.
There are always companies that want IR to immediately jack up share prices. “I have to tell people every day, it’s performance plus communication that equals multiples,” said Berkman, who runs his own shop in Century City. “Some people want just the communication to do the trick.”
Lately, small-cap stocks with sensible businesses and a solid plan to enhance shareholder value are receiving a warmer welcome, said Berkman. “What investors are looking for now is transparency, a company you can understand, and honest, capable guys running it,” Berkman said.
Low profile Everest Properties LLC of Pasadena, with about $200 million under management, has been quietly buying real estate investment partnership units for the last five years, exploiting a somewhat inefficient market for equity stakes in many of the real estate syndications of the 1970s and 1980s.
“We are a mini-tender company,” said Christopher Davis, Everest general counsel and vice president, last week. “We make tender offers for real estate partnerships, mostly those organized in the 1970s and 1980s.”
Despite the advent of the Internet, there is still only a scanty, illiquid market for the trading of units in many of the aging partnerships, billions of dollars worth of which were sold on Wall Street in the real estate syndication heydays. “To my knowledge, there is still no Web site out there listing partnerships units for sale,” said Davis. Everest makes about 100 tender offers a year; only a few brokers across the country are said to specialize in real estate syndication units.
Last week, Davis was overseeing the purchase, for $30 a unit, of a Los Angeles entity named Housing Programs Ltd., which was originally sold to investors at $5,000 a unit in 1984. Some property has been sold by the partnership since 1984, and proceeds kicked back to investors, so it was not clear last week how original investors have fared over the years.
“We do not know how original investors did. We do know it is worth $30 a unit to us,” Davis said.
Contributing columnist Benjamin Mark Cole writes about the local investment community for the Los Angeles Business Journal. He can be reached at