When a group of investors led by The Cypress Group took WESCO International Inc. public on May 12, Charles Ames looked on with a mixture of pride and envy. As a partner at Clayton, Dubilier & Rice, Mr. Ames was at the helm of the WESCO deal from the initial discussions in 1993 to the company’s sale last year to Cypress. His first view of WESCO was of a business in a demoralized state-salespeople were defecting, profits were falling, and parent company Westinghouse Electric Corp. (now CBS Corp.) was unable to sell the division for book value.
Today, WESCO is a publicly traded Fortune 500 company with 20 consecutive quarters of earnings growth under its belt. Almost every equity analyst who covers the company rates it a “buy.”
Mr. Ames says the recent IPO is a sign that WESCO was a company with momentum when it left Clayton Dubilier’s hands. He even wonders if exiting the company when his firm did was the best move. “I still wish there was some way I could have gone along for the ride,” he says.
That WESCO has thus far been a positive experience for two successive buyout groups warrants a closer look at the deal structures and operational strategies that brought the company to its current admirable state of affairs, especially with LBOs of LBOs becoming increasingly popular-for example, Behrman Capital last month sold Condor Systems to DLJ Merchant Banking Partners and Global Technology Partners (BUYOUTS May 3, p. 12). This month, BT Capital Partners sold U.K.-based Punch Taverns to Texas Pacific Group.
A True Corporate Orphan
The WESCO buyout saga began in 1993, when the Pittsburgh-based company was showing signs of being unloved by employees and parent alike.
WESCO started as a distribution arm for Westinghouse, with its main duty to sell tons of Westinghouse electrical wholesale products through hundreds of branches around the world. But by 1993, its business model was not in line with market demand. That year, WESCO lost $11 million in operating income on sales of $1.5 billion. Profits had been declining for several years. The company had instituted budget cutbacks, hiring freezes and travel constraints, which did not help the bottom line or company moral. “WESCO had lost its way,” says Steve Burleson, the company’s chief financial officer.
“We started with a fairly dispirited group of people, with a declining sales trend, and that was transformed into a very energetic company.”
It was during this miasma of decay that Clayton Dubilier first approached Westinghouse about the possibility of a buyout. The notion of a manufacturer having its own distribution business was seductive, Mr. Ames told them, but not practical. The partners at Clayton Dubilier persuaded Westinghouse that WESCO’s focus should not be on moving Westinghouse product, but on moving whatever product the market demanded. This could more easily be achieved outside of the confines of the parent corporation.
Westinghouse agreed, but balked when the New York firm offered $340 million-$60 million less than the division’s book value. “We told them that we could not pay more than that because of the condition the company was in,” Mr. Ames says.
Westinghouse, then advised by Lazard Freres & Co. and Goldman, Sachs & Co., decided to shop its division around, and what followed was a year of further demoralization. The industrial giant gradually discovered that no one was willing to pay full price for WESCO, Mr. Ames says. In the meantime, nearly 100 salespeople left for greener pastures.
Westinghouse eventually returned to Clayton Dubilier in February 1994 and signed a deal-the company agreed to the $340 million price tag for WESCO. Clayton Dubilier contributed $83.3 million in equity from its fourth fund. Bank debt was provided by Barclay’s Capital Corp.
Under the terms of the agreement, Westinghouse retained a 10% stake in WESCO, with options to acquire an additional 10%, which the company eventually exercised. Management of WESCO received a 16.8% stake in the company, partly in options. Clayton Dubilier set aside a 5% pool for high-performing branch managers, an incentive structure which Mr. Ames describes as being key to WESCO’s subsequent success.
The Road to Wellville
As the time approached to select a chief executive officer for the company it was soon to own, opportunity knocked at Clayton Dubilier’s door in a very literal way. Roy Haley walked unannounced into the New York offices “looking for something to do,” Mr. Ames says. The firm was impressed with Mr. Haley’s credentials and his ideas for WESCO. He previously had been CEO of Reliance Electric, which sold to Exxon Corp. in the late 70s. Mr. Haley was hired to run WESCO.
The biggest structural change that Mr. Haley and Clayton Dubilier made at the new company was to incentivize the branch managers. These incentives included a share purchase scheme for management by which one share bought would give a manager the options to two additional shares, the exercise of which were tied to the manager’s performance.
Clayton Dubilier also got rid of arbitrary and cumbersome accounting procedures, including a practice whereby every time a branch had an increase in sales, it would be allocated an increase in overhead expense by the home office.
Mr. Ames would personally visit branches and make presentations on the new incentive structure. “The numbers almost immediately saw a turnaround,” Mr. Burleson says.
A rise in managerial entrepreneurialism correlated with a boom in sales at WESCO that still is reverberating. By 1996, sales had increased to $2.3 billion from $1.5 billion. In 1998, WESCO reported sales of $3.1 billion.
“We started with a fairly dispirited group of people, with a declining sales trend, and that was transformed into a very energetic company,” Mr. Ames says. “[Salespeople] now were thinking that this was the best company they could work for. They felt the sky’s the limit.”
Mr. Ames says one WESCO salesperson earned more than $1 million in a single year, based mostly on snaring a contract in 1996 to provide electrical parts to the peacekeeping forces in Bosnia.
Not all of the sales growth came from lifted spirits, however. Since 1995, WESCO has acquired 18 smaller electrical companies whose combined sales added $1.1 billion to the balance sheet.
“I still wish there was some way I could have gone along for the ride,” Clayton Dubilier’s Charles Ames says.
By 1998, Clayton Dubilier had toyed with a number of exit strategies, including an IPO, which Mr. Ames favored. “I was reluctant to sell it,” he says. “I felt it had growth potential.”
WESCO’s book was circulated to a number of strategic buyers, and at one point General Electric Co. expressed interest, but ultimately it was The Cypress Group which won out, in part because it offered to increase management’s stake in the company to 30%.
In April 1998, The Cypress Group agreed to acquire WESCO for $1.1 billion, which represented a 10-times EBITDA multiple based on the company’s 1997 figures (BUYOUTS May 4, 1998, p. 1). Cypress committed $210 million in equity. The firm also brought in Chase Capital Partners and Lexington Partners to invest $50 million each in the deal-fund restrictions prevented Cypress from investing more than 20% of its equity in any one deal.
Clayton Dubilier had paid down much of WESCO’s debt, and this allowed Cypress Group to add a healthy supply of leverage to the transaction. In May 1998 Chase Manhattan led an offering of $300 million worth of high-yield bonds with a rate of 9.125%. The bank syndicate also provided $50 million of discount debt.
Goldman Sachs & Co. advised WESCO on the sale.
The deal was a windfall for Clayton Dubilier and for Westinghouse (by then, CBS). Clayton Dubilier’s $83.3 million equity commitment had turned into $511.3 million, and CBS’s approximately $12 million retained stake now had a realized value of $114.2 million.
The Cypress Group Takes Root
According to Mr. Burleson, Clayton Dubilier’s specialty was operational expertise, whereas Cypress Group’s forte was its strength in capital markets execution, one sign of which was WESCO’s being brought to the market seven months ahead of plans at $18 a share. At press time, the stock was trading at $19.37.
Mr. Burleson says Cypress had made it clear at the time of the acquisition that they would remain with the company until its market capitalization doubled or tripled, which Mr. Burleson says may take approximately five years.
Cypress also has forged ahead with acquisitions, the most significant of which was the September 1998 purchase of Bruckner Supply for $72 million. The Port Washington, N.Y. company provides outsourced purchasing and procurement services and expands WESCO’s business beyond its core in electrical parts, Mr. Burleson says.
It remains to be seen whether Cypress can squeeze as much juice from WESCO as Clayton Dubilier did. Profits still are increasing-for the fourth quarter of 1998, WESCO stated EBITDA growth of 48% over 1997’s numbers.
Cypress says it will use proceeds from the IPO to pay off debt resulting from the buyout. The firm can also use the stock as currency to make additional acquisitions.
If the predictions of equity analysts prove correct, WESCO’s future looks rosy. John Ford, an analyst at Bear Stearns, writes that the company is well-situated in the very fragmented $72 billion electrical wholesaling industry. He says WESCO should enjoy annual 20% earnings-per-share growth for the foreseeable future.
As more and more buyout transactions take place between buyout firms, market observers certainly will be interested to see if WESCO is capable of providing not one, but two happy exits for its private equity sponsors.
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