The Soldering Of Weak Links

At least three companies owned by buyout firms made Standard & Poor’s monthly “weakest-link” list released today (Feb. 15)—Duane Reade Inc., Sunny Delight Beverages Co., and Ziff Davis Media Inc. It’s an ignominious distinction to be sure. But each company has been posting better results, and don’t expect their owners to give up without a fist fight.

Altogether one hundred and thirteen companies made the S&P weakest-link list this month, up from 27 companies in January. No, there hasn’t been a big jump in the number of distressed companies. S&P simply expanded its definition of weakest links to include companies and organizations that are rated B- or lower, and that are also at risk for being downgraded. Previously the cut-off was CCC or lower. Research shows that more than one in 10 companies rated B-, and more than a quarter of all CCC+ or lower rated companies default on their obligations within a year. One victim from last August’s list was Amtrol Inc., a maker of water storage equipment owned by Cypress Group Inc. The company filed for Chapter 11 in December.

In a ratings report issued in December, S&P found that the operating performance of drug store chain Duane Reade has been deteriorating since the fourth quarter of 2001. The company, which has an estimated $405 million in S&P-rated debt, posted a lofty debt-to-EBITDA ratio of 13.6x for the 12 months ended Sept. 30, 2006, S&P said. Among the challenges: higher labor costs and gloves-off competition from rival drugstore chains.

But owner Oak Hill Capital Management, New York, is satisfied with Duane Reade’s recent performance. It feels that the company simply took a little longer than anticipated to hit its stride, according to a source following the transaction. The company, subject of a 2004 take-private, boasts a 70 percent market share in Manhattan, where barriers to entry for rivals are high. EBITDA grew by 45 percent from 2005 to 2006, after the company introduced a more rigorous system to support better decisions about what snacks and other merchandise to stock, my source said.

A management team brought aboard in November 2005 has also executed on a strategy of opening fewer stores—10 to 15 per year, down from 30 to 40—to boost return on capital. Creditors have taken notice. According to my source, the company’s senior notes trade above par. Its subordinated debt securities have traded up from the low 60s 12 months ago to the high 90s of late. In fact, don’t be surprised to see a revived Duane Reade taken public again later this year, sources told me.

Sunny Delight Beverages, a fruit juice company owned by Boston-based J.W. Childs Associates LP, also appears to be on the ascent. In a report issued in late September, S&P keyed in on the heavy debt load: Adjusted debt-to-EBITDA stood at more than 8x for the 12 months ending June 30, 2006, up from 7x for the year-ago period. Among the company’s challenges, S&P said, is keeping costs under control in the face of higher bottle prices.

But a source tracking Sunny Delight’s progress said that the company, a 2004 carve-out from Procter & Gamble, has rebounded strongly from a weak finish to 2005. The company eventually succeeded in passing higher costs on to customers last year, helping EBITDA to double from 2005 to 2006. The company has just about retired a $30 million revolver. That leaves it with a little more than $100 million in debt, a virtually untapped credit line, and “dramatically improved liquidity,” according to my source. Adjusted debt-to-EBITDA has plummeted to about 3.5x since S&P issued its last report. Now comfortable that the business has stabilized, J.W. Childs has shifted its attention to growth, my source said.

That takes us to Ziff Davis Media. The publisher of PC Magazine got hammered, along with the rest of the technology publishing market, in the early 2000s. EBITDA shot higher in the first nine months of last year, to $12.8 million, after the company placed greater emphasis on generating revenue from Internet publishing. But Ziff Davis, with an estimated $303 million in S&P-rated debt, faces sharply higher cash payments beginning this month on $151 million of 12 percent compounding notes. “Maintaining liquidity beyond the near term will require immediate and significant improvement in Ziff Davis’s EBITDA and discretionary cash flow,” an August S&P report concluded. Owner Willis Stein & Partners LLC, Chicago, has been trying since at least last summer to find a buyer for some or all of the company’s three main divisions.

“We are continuing the sale process on all three assets, we have interested parties for all three, and we are continuing to work through those processes,” said Avy Stein, managing partner at Willis Stein.

Look for this and other stories in the Feb. 19 edition of Buyouts Magazine. Subscription required.