Sunday, November 9, 2014

Background on Wesray, the leveraged buyout pioneer

Wesray was a prominent private equity firm during the 1980s. It took its name from its two founders, William E. Simon and Ray Chambers. Prior to founding Wesray, Simon had a long career on Wall Street and in the federal government, culminating in his service as Treasury Secretary for several years under Richard Nixon and Gerald Ford. Chambers was fifteen years younger than Simon and had a more modest career: he was originally a tax accountant but became an early practitioner of the leveraged buyout during the 1970s, buying and selling several small companies.

Simon and Chambers met in 1980 through a mutual acquaintance, and Simon instantly recognized the potential of leveraged buyouts. He and Chambers became ad-hoc partners, teaming up to acquire a small business that supplied oysters to restaurants and another small business that rented musical instruments. A year later they became business partners on a more permanent basis, founding Wesray in September 1981.

Wesray's first major deal was its 1982 acquisition of Gibson Greetings, a greeting card printer, from RCA. The deal had an element of luck: Simon and Chambers had originally intended to buy a mobile communications company that RCA owned called Tactec Systems, and they ended up buying both Tactec and Gibson.

The Gibson acquisition was a phenomenal success. Wesray paid $81 million for the company even though its book value was $87 million, and most of that book value was tangible assets that Wesray could borrow against, which meant that it had to put up only $1mm of the purchase price as equity, with the other $80mm being borrowed money.

The acquisition coincided with the beginning of an enormous bull market, and Wesray was able to take Gibson Greetings public less than 18 months later at a $290mm valuation. Simon and Chambers each contributed a third of the equity investment, which meant that they each made $70mm on a $330k investment.

While Gibson made their reputation, it was far from being their only profitable deal. Wesray purchased Avis Car Rental in 1986 and, as with Gibson, flipped it less than two years later for a huge profit.


Why was Wesray successful?

Simon's fame undeniably contributed to Wesray's success. His reputation as a political and financial leader gave him and Chambers access to deals they probably wouldn't have received otherwise.

Leverage and timing also played a role. Wesray borrowed 99% of the purchase price of Gibson Greetings, and it used similarly high leverage for its other leveraged buyouts. One article estimates that Wesray borrowed 98% of the money it used on its average deal. In the bull market of the 1980s, this gave Simon and Chambers a powerful tailwind.

But it would unfair to claim that their success was merely a result of luck, leverage, and fame. They also had a thoughtful strategy that allowed them to make investments with favorable risk/reward ratios. With Gibson Greetings, and again with many of their later deals, Simon and Chambers invested in companies that had both the potential for growth and valuable assets that they could use to secure loans. Essentially, the asset value allowed them to borrow money at lower rates and with less risk than they would otherwise have to take.

They also demonstrated a sense of perspective. Simon wanted to pull back in the mid-1980s as valuations rose and the competition for leveraged buyouts increased. He recognized, either explicitly or intuitively, that Wesray's investment strategy worked best when companies traded near their asset value and became less viable as prices rose. He also cared about his fiduciary duty and worried about Wesray's other investors losing money. In this regard he was the opposite of Henry Kravis, who was always eager to do more and bigger deals irrespective of valuation.


Sources

Pubic information about Wesray is scant, but I was able to dig up a few things. A 1986 article from Fortune describes the firm's history and investment strategy. Another article, from Cincinnati Magazine, profiles Simon. (Gibson Greetings had its headquarters in Cincinnati.) Simon's autobiography, A Time for Reflection, also discusses Wesray, although it emphasizes his conservative political philosophy more than his career as a buyout pioneer.

On Quora, someone asked "Why was the 1981 Gibson Greeting Cards LBO such a home run?" and "Ray Chambers" responded. I can't guarantee that this is really Chambers, but it has the ring of truth:

There were a number of factors that attracted us to purchase Gibson.  We had the opportunity to acquire the company at a discount from book value.  The management of Gibson, led by Tom Cooney and LR Jalenak, were inspired to turn in record performances because for the first time in their careers they had the chance to own a meaningful part of the equity of their company.  Because of the purchase price being a discount from book value, the lenders were willing to look to the liquidating value of the assets more than the historic cash flow as security for their loans.

When the Gibson transaction was completed in January, 1982, the prime lending rate of interest was 21 percent and economists were predicting it would go to 30 percent.  Thankfully, during 1982 it went the other way and Gibson's management performed splendidly.  The net profit for the year 1982 after interest on the significant amount of debt was the same as the previous year when the company had no debt.  In early 1983, the IPO window opened for a short time and Gibson was able to capitalize on that opportunity in the market.

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