Within the past 7 or 8 months (give or take), I’ve done several posts about the Chapter 11 Bankruptcy case of Florida Reprographics (Tampa) and two posts about the Chapter 11 Bankruptcy case of United Reprographics (Seattle).
Both of those companies declared “Chapter 11” Bankruptcy. Under Chapter 11, companies continue to operate, eventually file a “plan of reorganization”, pursue the plan (once it’s confirmed by the BK court), continue operations, and, hopefully – someday – emerge from (leave) bankruptcy. Our Chapter 11 BK laws are designed to give debtors “a fresh start.” Some make it through and survive, some don’t.
Once one of the largest reprographics companies in the Eastern Region of the U.S., The Louis Frey Co. (based in New York City) went bankrupt in 2003; the case was first filed as a “Chapter 11” Bankruptcy but, shortly thereafter, was converted to a “Chapter 7” Bankruptcy. Chapter 7 is a liquidation process; a Trustee is appointed by the BK Court to oversee the liquidation (and, sometimes, the collection) of assets and to conduct an orderly distribution of the assets to the company’s creditors (and, if money is left over, which is seldom the case, distribution of remaining assets to the company’s shareholders.)
So, Chapter 11 – the business continues to operate, and, Chapter 7 – the business discontinues operations, winds-down, goes “kaput.”
The Louis Frey Company Chapter 7 Bankruptcy case was very, very interesting, for sure. For, prior to declaring bankruptcy, the principal shareholder of the Louis Frey Co, Mr. Seymour Weiner, hired ARC to “manage” Frey’s business. Why anyone would hire a competitor to manage his business is, well, “beyond me, beyond my imagination.” And, I’ll not comment any further on that point.
I’m a student of the reprographics business and industry, and I guess that’s why I found the Louis Frey BK case so interesting. I remember reading every filing, every document. I even spoke and corresponded with one of the lawyers representing the Frey Co’s largest creditor. It was not just the Frey BK case that was so interesting to me, it was a collateral suit, brought by the Trustee and Frey’s largest creditor (Merrill Lynch Business Financial Services) that was the most intriguing, interesting part of the Louis Frey Co matter.
What provoked today’s post about the Louis Frey Co BK case – which was over and done with several years ago – was that, while I was doing some BK research, I came across “the decision” (document), rendered by the BK Court Judge; this decision enabled the Trustee to recover substantial funds, and, as I understand it, allowed Merrill Lynch Financial Services to recover the full amount it was owed by the Louis Frey Co.
At the end of this post, I’m going to post a link to the complete document I mentioned in the preceding paragraph. If you like to learn new things, this document should be on your list of “stuff to read.” The document author was the Chief Judge of the Bankruptcy Court. It is a very interesting read. There’s a lot of information in the document about the reprographics business and industry. And, about “valuations”.
In particular, the judge found in favor of the plaintiffs (The Trustee and Merrill Lynch) and against the defendant (American Reprographics – ARC – and BPI, and ARC owned division).
For those of you who are not in the “FM” business, but are thinking about it, and even for those of you who are in the “FM” business, there’s some interesting food for thought brought to light in the document I’ve mentioned – in the court case, there were three different experts hired to furnish opinions as to “the worth/value of Louis Frey’s business.” Three different experts = three different “opinions” and, one of them was quite funny! (I have a weird sense of humor.)
I’ve snipped just a few things from the document and placed them below, just so I can mention them.
Parties to the lawsuit:
Plaintiffs:
Trustee of the Louis Frey Chapter 7 Estate
and Merrill Lynch Business Financial Services
Defendants:
American Reprographics Co (ARC)
and BPI (an ARC0-owned division)
The “title” of the document:
POST-TRIAL FINDINGS OF FACT AND CONCLUSIONS OF LAW
The “author” of the document:
STUART M. BERNSTEIN
Chief United States Bankruptcy Judge
Dated: New York, New York, July 28, 2006 (date the decision was rendered)
From the introductory paragraph:
Yann Geron, the plaintiff and chapter 7 trustee (the “Trustee”) of Louis Frey Company, Inc. (the “Debtor”) and Merrill Lynch Business Financial Services, Inc. (“Merrill”), the Debtor’s secured lender, commenced these adversary proceedings to recover damages from the affiliated defendants American Reprographics Company, LLC (“ARC”) and BP Independent Reprographics (“BPI”).
The defendants formerly managed the Debtor’s business, and the plaintiffs charge, in substance, that the defendants destroyed the Debtor and then stole a substantial part of its business. The parties consented to the core jurisdiction of this Court. (Joint Pre-Trial Order, dated Dec. 13, 2005, at § B, at 3) (“JPTO”) (ECF Doc. # 58.)
The Court conducted a six-day bench trial in April 2006.
Near the end of the document, there’s a large section devoted to the calculation of damages (basically, the calculation of the value of the business), and, as I mentioned, there were three different experts, each with their own opinion.
Two of the experts broke the “total” into two parts; 1) the “primary component” of the business – which was Louis Frey’s “FM” business – and, 2) the “remainder component” of the business – which was Louis Frey’s non-FM reprographics business.
From the section that talks about expert Aronow’s calculations (you really need to read the complete document, because this is just bit of what was said)…
The damages for the Primary Component were calculated by measuring the benefit to ARC derived from the customers taken from the Debtor. The benefit to ARC was measured by the increase to ARC’s enterprise value, or EV, attributable to the incremental earnings on sales to the Debtor’s former customers. This was a multi-step process. Aronow started with the net sales attributed to the Debtor’s former customers during the year beginning November 1, 2003. The parties stipulated that 15 customers defected to BPI, and that the net sales invoiced to these customers totaled $5,768,000. Aronow ignored the sales to the six former customers that left ARC during the year, and reduced the net sales to $5,405,000.
These net sales did not translate into an equal amount of profit; ARC (or BPI) incurred incremental costs to service the additional business. The former customers taken by the defendants were FM customers, and Aronow calculated ARC’s historic FM profit margin at 28.7%. Aronow then estimated the variable selling, general and administrative costs (“SG&A”) attributable to the additional business (9.8%), subtracted that number from the profit margin (28.7%), and computed the incremental EBIT percentage as 18.9%. In other words, the $5,405,000 in net sales yielded an incremental EBIT of $1,022,000.
The incremental EBIT signified that every dollar of sales attributable to the Remainder Component translated into additional EBIT of $.049. Aronow multiplied the net sales of $6,102,000 by the estimated incremental EBIT multiple (4.9%), and arrived at incremental EBIT in the amount of $299,000.
So, reprographers, there you kind of have it; this particular expert, Mr. Aronow, estimated that:
a) - - - Frey’s “FM” business, at $5.4 mil in (net) Sales, yielded incremental EBIT of approximately $1.022 million.
b) - - - Frey’s non-FM (regular reprographics) business, at $6.1 mil in (net) Sales, yielded incremental EBIT of approximately $299,000.
Do any of you still wonder why I believe its essential that you be in the “FM” (MPS) business?
One of the experts rendered an opinion that I found very amusing!!!: (Remember the stuff below was pulled from the document authored by the Judge):
The defendants presented expert testimony from Howard Brod Brownstein.
Brownstein’s opinion was unencumbered by any analysis. In simplest terms, he opined that an existing customer has little or no value, and the Debtor’s (meaning, the Louis Frey Co’s) customer relations, in particular, had no value, primarily because they were at-will customers:
According to Brownstein: To the extent BPI acquired anything, what they acquired was a hatful of possibilities. There was no guarantee that they would maintain these customers. There was no guarantee that these customers wouldn’t, for the reasons that had nothing to do with the quality of ARC service, go elsewhere. They were free to do so. And so, to impute some long-term cash flow and then discount it back or apply capitalization factors is what we used to call garbage in garbage out when we did financial analysis at the Wharton School.
After criticizing the income approach, Brownstein leveled his attack on the use of EBIT multiples as a valuation tool:
Implicit in each of these multiple cap rates, discount rates, is risk and return. You ask yourself, if this were traded on the New York stock exchange, would I buy it given what they’re selling it for? And if you analogize it to a business with this much risk, would you accept this amount of return? And the answer is absolutely not. A group – a small group of customers with no long-term contracts, what risk is there in that? Enormous risk. So to even talk about anything long-term and start with multiples which apply to a whole huge enterprise of hundreds of millions of dollars, it’s just ridiculous.
Brownstein’s demeanor was that of an advocate rather than an expert, and his opinion ignored actual practice. People change their doctors, lawyers and accountants just as architects and engineers change their reprographic service providers.
Yet professional practices are often bought and sold. Brownstein attempted to explain the contradiction, opining that an accountant’s client is “very wedded” to his accountant, and “I think those kind of clients would tend not to be as likely to move.” He ignored the fact that the Debtor (meaning, the Louis Frey Co) had been servicing some of its customers for more than 30 years. In any event, a professional’s clients, like reprographics customers, do move. While their reluctance to do so may increase the multiple of revenues used for valuation purposes, it undercuts Brownstein’s core theory that “at- will” customers have no value.
More important, Brownstein’s theory ignored the reality of ARC’s own business practices. During the past eight years, ARC has acquired approximately 90 reprographics companies. It typically pays approximately four times EBIT. In short, the value of a reprographic business is derived from its EBIT, and EBIT is determined by sales to customers. Moreover, the defendants were already managing the Debtor, had locked up Wiener with an employment agreement, had taken possession of the Debtor’s personal property, were in contact with the Debtor’s customers, and were armed with the Debtor’s confidential information relating to those customers. Suffice it to say, the defendants were in place to effect a smooth transition, and reduced the risk to them that a prospective buyer might otherwise face. Accordingly, I reject Brownstein’s opinion.
Here’s a link to the complete document (caution it’s over 50 pages and will take some time to load, so be patient.) To me, it’s just as good as a chapter in a Tom Clancy novel – full of intrigue.
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