The Loewen Group, Inc. Corporate Financial Management

CORPORATE FINANCIAL MANAGEMENT

Case Study: The Loewen Group, Inc.

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Group 2

Chien Chia LIN                                 B00738274

Theodoros KALLINTERIS              B00715593

Xiangning XU                                    B00740876

Chenchen LU                                     B00701021

Oscar Joel LEON SANDOVAL       B00746392

Jiaxuan XU                                         B00542687

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Executive Summary

Loewen is a funeral service company which has experienced a fast growth in the previous years, thanks to its policy of aggressive acquisitions of funeral homes, cemeteries, insurance companies, etc. Those acquisitions were mainly financed with debt, which is cheaper compared with equity financing. Additionally, Loewen had significant amount of tangible assets and stable cash flows, which enabled Loewen to borrow extensively.

However, the growth model was not able to sustain. Many of these acquisitions were not efficient enough to generate expected synergy. The high leverage restricted the company to sell its properties or issue new equities due to debt covenants.

Although Loewen has not yet missed any payments on its debt, revenues and profits of Loewen are not enough to pay off its financial obligations to its creditors. It is fair to describe Loewen as in financial distress.

To be relieved from this situation, Loewen has the following alternatives: reduce cost and increase profitability; negotiate with creditors to postpone the payment terms and relieve some covenants; sell some of the assets right away before their value drop even further; reorganize under Chapter 11; merge into another firm or file for bankruptcy.

To conclude, we recommend Jon Lacey first to seek internal solutions to raise profitability and cost reduction, then to negotiate with creditors to solve illiquid problem. If none works, we would suggest selling Loewen to an investment firm (potential buyer Blackstone) that specializing in managing distressed companies.

1. Loewen Group growth: first half of the 1990s

1. The growth of Loewen in 1990s

The stable increase of number of deaths in the U.S. (0.8% annually compounded), together with the lack of price competition, provided a favorable condition of growth in the death care industry in the U.S. During the 1990s, pre-need sales became more important in the share of the death care business as the former Baby Boomers turned into their 50s and 60s.

From a corporate point of view, Loewen Group grew by a sequence of acquisitions. The Acquisition Expenditures had grown from 1991 to 1995, the sales and net income also correspondingly grew in this period [Exhibit 1]. By buying up funeral property in concentrated geographic areas and introducing cluster management, acquisitions not only helped the company to expand the geographical scope but also reduced some variable and fixed costs.

1.  Costs of debt financing

Compared with using equity, using debt to raise fund is cheaper. Especially for this industry, their possession in lands and stable cash flows give them advantages to find loans in lower interest rates. Furthermore, financing by debt can create tax shields. Concurrently, in debt financing, the earnings generated from the operation, after the debt cost deduction, can directly become shareholders’ benefit as more earnings are being spread among the same number of shareholders. This measure also can allow shareholders to maintain their control and the ownership of the company without the interference from the outside. [Exhibit 2]

1. Loewen's condition in 1999

The company was highly profitable for the period 1989-1995, with steady growing sales (CAGR: 46%) and operating profit (CAGR: 40%). However, in 1997, Loewen underperformed unexpectedly, which was regarded as the turning point for the company’s financial position. Since then, Loewen had gradually approaching the financial distress which appeared in 1999. Both the external and internal factors contributed to illustrate its position.

1. Aggressive development strategy

From 1996 to 1998, Loewen acquired 386 funeral homes and 372 cemeteries, valuing $1.3 billion. Meanwhile, Loewen even tried to diversify its operation by acquiring insurance companies. However, the acquisitions weren’t effective enough with regard to the expected synergies. The company failed to generate money from its newly acquired assets, with a 51% reduction in ROA in 1997 [Exhibit 3].

Furthermore, another proof for Loewen’s ineffective decisions in acquisitions was the acquisition revenue multiple. Loewen paid a higher acquisition revenue multiple compared to its competitors in 3 consecutive years since 1996, particularly for the year of 1998. However, the acquisitions were not cost effective in terms of the total revenue of the new assets.  [Table 1]

1.  Inefficient management style

Different from other competitors, Loewen retained the same management team to ensure the acquiree’s business autonomy. Instead of benefitting from the synergies of acquisitions, Loewen proposed financial aids and merchandising supports during the companies’ operations, which not only increased the administration cost but also affected management efficiency. Due to accelerating acquisitions, the high SG&A cost (SG&A/Sales), increasing from 8.5% to 11%, negatively affected the profitability margin of the company.

1. Excessive debt financing

Besides, the position of Loewen in 1999 was also related to excessive debt financing. The company’s long-term debt remained high [Exhibit 5], being the primary source to finance company takeovers. Meanwhile, the reducing profitability of the company because of the demising death rates resulted in confronting financial problems since 1997. Loewen’s decreased profitability margins [Exhibit 4] and the augmented interest expenses corollary of high level of debt, deteriorated its ability to service its debt payment [Exhibit 6].