Over the last two decades Loewen Group, a death care provider, had been growing by acquiring small independent funeral homes and cemeteries in densely populated areas but in recent years the company had also acquired several large established funeral chains. Over the last five years alone, Loewen had embarked on an aggressive growth strategy which accounted for consolidated revenues’ growth of nearly 30% a year on average from $303 billion to over $1.1 billion. This growth through acquisitions was funded primarily through debt which was evident as long term debt increased $922.8 million from 1994 to 1998; this was a 195.88% increase. One benefit of debt financing was that it provided a tax benefit. From 1994 to 1998 Loewen had paid $488.6 million in interest. Loewen’s tax rate was 45% therefore; debt financing resulted in a tax savings of $219.87 million. Another advantage of debt financing was that it did not afford the lender ownership. Therefore, the lender had no say in how one’s business was conducted. In order for one to reap the benefits of debt financing though one must be able to comply with all aspects of the debt agreement. When unable to do so the consequences can be devastating to a business.
Unfortunately, aggressive growth through debt financing did not bode well with the Loewen Group. With the 30% average revenue growth one would expect to see their earnings grow too, but this was not the case. Loewen lost $599 million for 1998 compared to earning $43 million the previous year, an approximate 149% decline in one year. Within 5 years of the start of their “acquisition frenzy” of larger established funeral chains they were facing what one in the financial world would call “financial distress”. Financial distress is defined by Investopedia as “A condition where a company cannot meet or has difficulty paying off its financial obligations to its creditors. The chance of financial distress increases when a firm has high fixed costs, illiquid assets, or revenues that are sensitive to economic downturns.” Loewen Group unfortunately had a few of the above issues and then some. Fixed costs for funeral homes were approximately 65%; this was due in part to the fact that a funeral home may only have one to two funerals a week but still had to be maintained. Their competitor, SCI, would “cluster” the funeral homes together which reduced fixed costs to an average of 54%. 54% is still high but better than 65%. Such a plan also afforded SCI the ability to sell off assets, eliminating redundant cost and reducing the total cost of the acquisition. Funeral home assets were not in great demand at this time as the death rate had declined; therefore funeral home assets were very illiquid. Though the above financial distress pre-cursors were in place, internal issues also played a large role in creating Loewen’s financial distress.
Loewen’s aggressive acquisition strategy seemed only to focus on the acquisition with little to no thought to the next step of the process. Loewen’s competitor, SCI, acquired full ownership of all acquisitions whereas Loewen took a majority ownership and made payments for the rest to help ease taxes. These acquisitions were funded largely with debt in which the terms of such debt were very complicated and not in favor of Loewen. An example of this was the purchase of Prime Succession with Blackstone Group. If Loewen bought out Blackstone by exercising their option it would effectively pay an amount that would give Blackstone a 24% return on its investment. Loewens’ ROA (using actual assets as avg assets were not given) in 1996 was only 1.83%. This was an extremely high return to negotiate. Blackstone also had a put in which they could sell their stock to Loewen using a calculation based on EBITDA. This definitely did not favor Loewen due to most acquisitions were purchased largely through debt. Loewen did not market the acquisitions instead decided the...
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