Battle for OMC: Who Really Won?

Battler for OMC: Who Really Won
28 June 1999

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Battle for OMC: Who Really Won?

Crains Chicago Business
28 June 1999
by Jeff Borden
Hundreds of Outboard Marine Corp. dealers, gathered in Chicago for the International Marine Trades Exhibit and Conference in September 1997, milled about a ballroom at the Hilton Chicago and Towers waiting to hear from their new owner.

A month earlier, they'd assumed it would be Detroit Diesel Corp. Chairman Roger Penske, a charismatic auto-racing legend and proven turnaround artist who, in less than a decade, had increased his company's marketshare in a broad array of engines to 27% from 3%.

Waukegan-based Outboard Marine Corp. (OMC) planned to fan the excitement generated by his reputation with an elaborate video introduction in which a Penske racing car symbolically morphed into a power boat as Mr. Penske appeared at the podium.

But instead of Mr. Penske, a figure unknown in the tightly knit marine industry-indeed, a man who until recently had never ridden in a pleasure boat-stood before the wary dealers.

"Okay, I guess you know I'm not Roger Penske," said Alfred D. Kingsley, a former associate of corporate raider Carl Icahn and principal in the New York investment firm Greenway Partners L.P., which took OMC, maker of Johnson and Evinrude motors, private after the purchase.

Keeping a much lower profile but playing a lead role as the buyout's ultimate skipper: international financier George Soros, who sees global applications for OMC's environmentally friendly engine technology. Funds affiliated with his New York-based Soros Management Fund LLC are the largest OMC owners with a combined 69.5% stake.

But now, two years after an 11th-hour trumping of Mr. Penske's $16-per-share bid with an offer of $18 per share, or $364 million-an accidental purchase in the view of many observers-Messrs. Kingsley and Soros find themselves strapped in for a stomach-churning voyage with no turnaround on the horizon.

OMC, which admittedly was foundering long before the bidding began, is riding even lower in the water since the buyout.

Winners and losers?

The story of OMC raises a perplexing question. Shareholders clearly were winners, pocketing $2 more per share from the Kingsley-Soros group than Mr. Penske offered. But by selling a troubled company to a financial-rather than a strategic-buyer, did the company, its employees and its loyal dealership network lose?

Consider:

• OMC's loss of marketshare in the domestic boat and motor sectors, which began years ago, continues.

Documents filed with the Securities and Exchange Commission note that the company's marketshare in motors has dropped to 33% from 49%, while its share of the boat market has dropped to 10% from 20% since 1993, though executives say the elimination of some boat brands accounts for much of the recent erosion.

Archrival Brunswick Corp. of Lake Forest and Japanese manufacturers have been the beneficiaries.

• In fiscal 1998 ended Sept. 30, OMC-which has since shifted to a calendar fiscal year-lost $150.5 million, including a $98.5-million restructuring charge. Highly leveraged with $247.0 million in long-term debt-its public debt is rated junk-bond quality-OMC lost $59.0 million in the six months ended March 31.

The company has been forced to renegotiate some of its bank covenants and has restated earnings from last year. Executives say lenders didn't object to the amendments, while the earnings restatement reflects a change in accounting methods.

• Two of OMC's largest facilities-a casting plant in Waukegan and a machining plant in Milwaukee-are being shuttered at a cost of $98 million, part of an outsourcing strategy as the company eliminates hundreds of jobs. The Waukegan site will require millions of dollars in environmental cleanup.

• Quality-control issues are bedeviling some models of OMC's highly touted Ficht Evinrude engines, which generate less pollutants, to satisfy Environmental Protection Agency regulations. Repair kits to fix the 150- and 175-horsepower Evinrude engines are being sent to dealers.

Cleaning up 'a mess'

The new OMC management team, led by well-known marine industry veteran David D. Jones Jr., argues that most of the current woes are a necessary byproduct of rebuilding a company it describes as "a mess."

"We're trying to fix all these problems, but that doesn't come free," says Chairman, President and CEO Mr. Jones, former head of Brunswick's marine products division. "These changes are absolutely essential. The strategy used by OMC for several years was flawed. The company was not in touch with where the industry is going and was very reticent to change. But we will stabilize and we will show improvement in the next 12 to 18 months."

Mr. Soros, whose firm declined repeated requests for comment about its OMC investment, can only hope that Mr. Jones is right, even as marine industry observers speculate that much of the churn at OMC would have been avoided had the company been sold to Detroit Diesel.

The Detroit company has a strong marine presence and a familiarity with fuel-injection technology, which would be useful in correcting the Ficht engine problems. And in Mr. Penske, Detroit Diesel had a rallying figure with a record of having improved the company, not only from a cost structure viewpoint but from the marketing side.

"(Detroit Diesel) was a perfect match," says Phil Keeter, president of the Chicago-based Marine Retailers Assn. of America and a former OMC engine dealer for 30 years in Tulsa, Okla.

Is highest bid best?

Don Lewis, owner of Aurora Marine Co. in Denver and an OMC dealer, is hoping for a turnaround under the new owners but notes, "I don't think they had a clue as to what they stepped into."

Indeed, many see the Kingsley-Soros deal as the unintended result of an effort to push the Detroit Diesel price higher. Mr. Kingsley strongly denies the scenario even as he notes that his Greenway Partners investment firm isn't usually a buyer. Greenway generally tends to buy a 9% or 10% stake in an underperforming company, then use proxy battles and other means to prod the company into action meant to drive the stock price up.

"You don't normally get the opportunity to do this," Mr. Kingsley says. "But when you win, as we did in this case, we're happy."

Though the investors-who formed Greenmarine Acquisition Corp. to buy OMC-won fair and square, the deal has raised the question of whether the highest bid is always the best bid.

"Of course not," says Steve Kaplan, a finance professor at the University of Chicago Graduate School of Business. "Sometimes, the highest bidder isn't the best operator, but generally, you have the fiduciary responsibility to go with the highest price, even if it breaks your heart. And, on average, that's the right thing to do."

Donald P. Jacobs, dean of Northwestern University's J. L. Kellogg Graduate School of Management, an expert on corporate governance and a veteran of numerous corporate boards, says OMC directors could have rejected the higher bid by invoking a "business judgment" argument-but likely would have faced a shareholder lawsuit.

"If it's a cash bid, it's hard to argue against a higher one," he adds.

In deep trouble

A former OMC board member, Apollo 8 astronaut and former Eastern Airlines Inc. President Frank Borman, refuses to discuss what went on as the directors debated the merits of Detroit Diesel vs. the Kingsley-Soros offer.

"It's been a long time and I don't want to comment," says Mr. Borman, who now owns a Lincoln-Mercury/Mazda/Hyundai automobile dealership in Las Cruces, N.M.

What's indisputable is that OMC was in deep trouble.

Outboard Marine Corp.Headquarters: WaukeganMajor product lines: Evinrude and Johnson engines; Chris-Craft, Four Winns, Hydra-Sports, Javelin, Lowe and Stratos boats1998 sales: $1.03 billion1998 loss: $150.5 million** Includes one-time, $98.5-million restructuring chargeSource: Outboard Marine Corp. While it boasts a gleaming array of marine brand names-Evinrude, Johnson, Four Winns and Chris-Craft among them-the company has always been defined by engineering prowess rather than marketing skills. The result was an often confusing array of barely differentiated motor and boat lines.

Meanwhile, the manufacturing process was convoluted. A strategy begun some 20 years ago to relocate plants to the South, where labor unions hold less sway than in the industrial Midwest, created what one former OMC staffer calls "a 2,000-mile assembly line" as portions of boats and motors had to be trucked from one plant to another. Margins were half the industry average. A brutal recession punished the entire marine industry in the early 1990s. OMC responded with three major restructurings in a five-year period, closing 19 plants, slashing thousands of jobs and taking hundreds of millions in charges.

Yet as recently as five years ago, OMC still did not have an overarching business philosophy or modern administrative tools such as a quality-control management system.

In 1995, the company attempted to change its ways, hiring Harry W. "Hank" Bowman as chairman, president and CEO. Mr. Bowman had no experience in the marine industry but was a well-regarded Whirlpool Corp. executive with a background in marketing and strategic planning. He was unable to substantially reposition the company.

In early 1997, OMC confronted the specter of defaulting on some of its banking agreements. That set the stage for a sale, and the company hired Salomon Bros. Inc. and Merrill Lynch & Co. to study the options. Sources familiar with the company say the advisers estimated that OMC would fetch $14 to $16 per share from a strategic buyer or $12 to $14 per share from a private equity group.

Soros group to the rescue

More than 40 potential buyers heard the OMC pitch but fewer than a half-dozen explored a purchase more deeply: Montreal-based Bombardier Inc., Sweden's Volvo AB, Muskegon, Mich.-based SPX Corp. and Detroit Diesel. Japan's Suzuki Motor Corp. considered investing $100 million in OMC, but didn't want to buy, sources add.

Detroit Diesel spent more than two months on due diligence as Mr. Penske visited OMC's far-flung operations. "The Detroit Diesel guys were absolutely first-class people. They seemed very serious about moving OMC forward," says Clark J. Vitulli, a former OMC executive who is now president of America's Power Sports in Nashville, Tenn. "Roger personally visited all the boat plants and met a lot of the employees."

Eventually, Detroit Diesel offered $16 per share and the deal moved toward a closing in the summer of 1997.

"I thought the bid we made was fair and appropriate," Detroit Diesel Vice-chairman Ludvik F. Koci says. "I figured if someone bid higher, either they knew something we didn't or they were making a mistake." Just four days before closing, the Kingsley-Soros group offered $18.

Greenway Partners owned about 2 million shares of OMC stock, purchased at an average of about $17 per share, and was looking at a painful loss if Detroit Diesel succeeded. Mr. Kingsley lined up the Soros group to help swing the deal.

"We couldn't have done it without the Soros group with us," Mr. Kingsley says.

Mr. Soros, a billionaire investor and speculator whose statements can move financial markets, also is an author, philanthropist and social activist who espouses causes ranging from the decriminalization of drugs to gun control. "He generally does very well (with his hedge funds)," says David Dreman, chairman of Dreman Value Management in Jersey City, N.J. "Soros never bets the ranch. He never gets into deep trouble. He's had bad years, but he never endangers his capital."

Locally, Mr. Soros' funds were among shareholder activists that pressed for a management shake-up at Waste Management Inc., and the ultimate sale of the Oak Brook-based trash hauler.

Careful monitoring

At OMC, Mr. Soros' managers clearly are watching closely.

"I don't believe a week doesn't go by that we don't have some level of conversation on issues we feel they should be involved in," Mr. Jones says. "We work very hard to ensure communications are very open and very candid with both the Soros and the Greenway people."

While Mr. Kingsley refutes "100%" that his group was out to simply bid up Detroit Diesel's offer for OMC, marine industry observers note that Greenmarine didn't seem prepared when it won.

It had no management team ready to put in place and had to scramble to secure $150 million in temporary financing from Carl Lindner's Cincinnati-based American Financial Group, agreeing to turn over control of the company to Mr. Lindner if the loan wasn't repaid in nine months. It has been paid back with proceeds from a junk-bond issue.

New York-based Standard & Poor's Corp. lists the company's credit rating at B+, the same rating it assigned at the time of the Greenmarine purchase. "It's indicative of a relatively high level of financial risk, but it does not indicate any liquidity concerns or any problems paying interest," says Harold Diamond, a Standard & Poor's director.

Differentiating engines

Meanwhile, Mr. Jones and Executive Vice-president and Chief Financial Officer Andrew P. Hines are moving quickly to act on their turnaround plan, consolidating 16 boat lines into eight brands and differentiating Evinrude and Johnson motors, which previously were identical except for the color of their engine covers.

Evinrude now will be the high-tech product, priced 15% to 20% higher than the low-tech Johnson motors, which continue to use standard two-stroke engine technology. Additionally, OMC has reversed its long-held policy of limiting its dealers to either Evinrude or Johnson; now, they can sell both.

"Our dealers are no longer competing amongst themselves," Mr. Jones says. And the company is willing to sacrifice overall marketshare if it can improve its position in higher-end boats and motors, he adds.

"We will base our future on high-value, high-margin and high-profile boating markets," Mr. Jones declares. "That's where we feel OMC needs to participate."

After the company lost its working-capital lender-a provision allowed First Chicago NBD Corp. to exit if OMC changed hands-Mr. Hines called on Charlotte, N.C.-based NationsBank to re-establish a credit facility, though OMC had to manage with internal cash flow for the first few months of Greenmarine's ownership.

The new management team has dismissed every senior vice-president and is hiring a new cadre of executives, but only those who "love to fight," Mr. Jones says. "This is not for the faint of heart, but you're not going to be bored here. We want people who are highly motivated."

Marine dealers are watching OMC's new direction carefully, wondering if the team installed by Messrs. Kingsley and Soros can bring the company to prominence again.

"We're concerned," says Bill Schaeffer, owner of Beaver Park Marina in Lorain, Ohio, an OMC dealer since 1980. "We've been through thick and thin with them. We're striving to take care of them and we're all hoping they do okay."

Cloudy outlook

But a quick turnaround seems unlikely. Historically, OMC has never posted an annual profit when recording a loss in the second quarter, which is a strong possibility this year. Rivals are grabbing more marketshare, particularly Japanese manufacturers, which, some OMC dealers say, have been calling on them with greater frequency.

In its current condition, OMC is not a candidate to go public again. And a sale at a higher price, or even the price for which it was acquired, would be difficult unless the new owners can work serious magic. While a return on their investment is still far away for Messrs. Kingsley and Soros, Detroit Diesel shares have surged roughly 19% this year. Nonetheless, Mr. Kingsley says he has no regrets about ending up with OMC. "We are thrilled," he says, "to own this company."

The engine behind Soros' interest in OMCTraditional two-stroke engines have been beloved by boaters because they're lightweight and powerful, but the motors are being targeted by the Environmental Protection Agency because they release an excess of unburned fuel containing hydrocarbons. Restrictions on emissions are being phased in through 2006, though California will require tough new standards by 2001.

Working with a Germany-based partner, Outboard Marine Corp. (OMC) has developed the Ficht direct-injection system, which slashes two-stroke engine emissions by 88% with no loss of horsepower by rapidly squirting tiny amounts of fuel into the engine cylinder, reducing waste.

The technology is being used in the company's Evinrude outboard motors, but the potential applications are global-which drew the attention of hedge fund master George Soros. Funds affiliated with Mr. Soros own 69.5% of OMC. "George Soros sees a worldwide picture," says Rick Eyerdam, executive editor of the Marine Business Journal, a Miami-based trade publication. "What (he was) most interested in was the Ficht technology. The world is populated by two-stroke engines, but they are terribly inefficient in the way they use fuel. The Ficht could be a very simple, very elegant solution."

Adds Mr. Eyerdam, "They've purchased some pretty significant technology for a very low price."

1999 by Crain Communications Inc.

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