Buyout Firms Look To Buy Minority Stakes In Mega-Deals –

In the last several weeks, Apollo Advisors, L.P. has agreed to lead two of the largest deals ever made by a buyout firm-both of which will be for minority stakes in publicly traded companies.

To add to the unusual nature of the transactions, both deals will include what some consider the risky element of acquiring convertible preferred stock in order to realize value.

An Apollo-led investor group will play a signficant role in the proposed $9.05 billion merger of trash hauler Browning-Ferris Industries with Allied Waste Industries-in which the group already holds a minority stake. In addition, Apollo and other buyers on March 1 agreed to acquire a minority stake in Patriot American Hospitality, a hotel owner and operator, for approximately $3.5 billion.

In the case of Browning-Ferris, the financial buyer consortium will commit $1 billion in equity. When that amount is combined with the $500 million the group already has invested in Allied, the trash-hauling concern may turn out to be the largest equity commitment by financial buyers to a leveraged investment since Kohlberg Kravis Roberts & Co.’s $3.2 billion equity investment in RJR Nabisco Holdings Corp. a decade ago.

Apollo will commit $440 million and The Blackstone Group roughly $350 million in new equity to the Browning-Ferris deal, giving the two buyers a 29% stake in the new company. DLJ Merchant Banking Partners and Greenwich Street Capital Partners will round out the equity component with an additional $210 million. Chase Manhattan Corp., Citibank and DLJ Capital Funding have reportedly committed to financing the merger. Howard Lipson, a Blackstone partner, said the deal is expected to close in the third quarter.

Firms Buy into Discounted Hotels

Apollo also has teamed with Thomas H. Lee Co. and, in smaller roles, Beacon Capital Partners and Rosen Consulting Group in an early March agreement to commit $700 million in equity to acquire a similar 29% stake in Patriot. “However, the sizes of the stakes being the same is just a coincidence,” said Apollo Partner David Kaplan. “We target investment size and investment return, not necessarily ownership interest.”

Chase Manhattan is the senior lender and, along with Bear, Stearns & Co., will underwrite a $1 billion high-yield offering. The deal is expected to close this summer, said Scott Sperling, a partner at Thomas H. Lee Co.

The investor group acquired the 29% stake with the belief the current common stockholders will invest an additional $300 million alongside the buyers for the convertible preferred stock, according to Patriot’s public filing. The buyout firms have committed to purchase any additional stock not acquired by the existing shareholders, which could increase their equity investment to as much as $1 billion and their stock stake to as much as 41%.

Both the investor groups in the Browning-Ferris and Patriot deals are using convertible preferred stock.

In the case of Browning-Ferris the investor group is paying $45 per share of non-cash convertible preferred stock, which will appreciate in volume by 6.5% annually on a perpetual basis; however, the company can call the notes after five years. At press time, Browning-Ferris common stock was trading at $38.31 per share.

For the Patriot stake, the buyers will pay $8.59 per share and will receive appreciation of 9.75% on their equity commitment for six years. The conversion is 70% equity and 30% cash. Patriot common stock was trading at $4.88 per share at press time.


arranging deals in this manner, the seller is able to receive a premium on its preferred stock; at the same time, financial buyers are banking that the additional stock they receive through the arrangement will pay off in the long run. This arrangement also may work to satisfy L.P.s that do not want G.P.s paying a premium to common stock, as G.P.s claim that they are paying common stock prices when one adds in the dividend they will receive over time.

However, potential difficulties abound.

First, there is no put or call agreement in either deal, thereby leaving the buyers at risk of owning stock that has depreciated or tanked completely.

Also, in these examples the financial buyers do not control a majority of board seats.

In spite of this, some buyers believe they still maintain control of their investments. “We need a shareholder vote, but we have control because we own so much of the stock, so we don’t need a contract,” said Thomas Lee, while speaking on the subject of minority stakes at a New York Capital Roundtable breakfast.

The Case for Minority Investments

Several of the biggest buyout firms, after having raised billion-dollar buyout funds, now believe the best value can be found in buying minority stakes.

One strategy is to team with a strategic partner in building a platform. “It’s hard to justify the value of buying on your own when you can buy with a corporate partner and create synergies,” Mr. Lipson said, referring to the Browning-Ferris deal.

The investor group may have felt obligated to use Allied as a platform to generate greater value for a company that has a disappointing stock price. At the time of the original 1997 investment, the company was trading at roughly $13 per share. Since then, the company’s price has stayed almost level, trading at $13.13 per share at press time. Apollo now owns 9.25% of Allied, while Blackstone maintains a 5% stake. “The trade-off you make is this is lengthening the time until liquidity, but we think it is a trade worth making,” Mr. Lipson said.

Using Assets to Create Value

In Patriot, instead of building a platform, the G.P.s are expecting to generate returns through a company that has valuable assets but is struggling to meet its short-term debt obligations. The buyers estimate that Patriot will carry about $3 billion in debt and have between $5.5 billion and $8 billion in assets after the investment, G.P. sources said.

“Patriot clearly faced some very significant problems,” Mr. Sperling said. “I think we are coming up with a solution that not only solves the near-term problems but also gives the chance to grow, which creates value for our shareholders.”

Not everyone agrees: Shareholders in Patriot have filed a suit in Delaware challenging the transaction. They claim the company’s board-which already has absorbed a poison pill, enabling it to choose its buyers-is underpricing the business.

Mr. Lee responded that this is a garden variety suit and says it has no merit.

Thomas H. Lee Co. recently has acquired minority stakes in two other underperforming public companies. The group acquired a 28.7% stake in Metris Cos., a credit card issuer, at $37.25 per share and received a 9% dividend on its convertible preferred stock (BUYOUTS Dec. 21, 1998, p. 6). Metris at press time was trading at an improved $41.69 per share.

Conversely, the firm invested in a mix of convertible preferred, with a 5% dividend annually on the conversion price, and common stock to acquire about a 30% stake in Cott Corp. (BUYOUTS June 22, 1998, p. 10). The preferred stock was acquired for $7.75 per share and the stock at press time was trading at $2.75 per share.