Doo-Doo Diligence and Buccaneer Businessmen

Numbers matter, as do people

March 2008 By Denny Hatch

singlepage

Last week I did a column on the simultaneous bankruptcies of two famous catalogs—Lillian Vernon and The Sharper Image—and received a long comment from Michael Muoio, president and CEO of Lillian Vernon. (See the image below.)

His comment ran beyond 1,500 characters, and I quickly e-mailed him with effusive thanks for taking the time to write and to ask him to either cut it or finish it so I could run it as two entries with “continued” on the first one.

Muoio e-mailed me back and said, “Wanna do a phone call?”

I e-mailed him back and said sure, and that I would write the thing and let him see it before it ran.

No response. And no phone number to call him.

Finally, Muoio and I connected by phone this week.

My sadness after talking to him was acute.

The Sale
From 2001 to 2003, sales at Lillian Vernon progressively declined and losses increased. In 2003, the $250-million-a-year company lost $18.6 million. That year—50+ years after founding and running the company, and with no planned line of succession—the iconic Lillian Vernon sold her business for $60.8 million to private equity investors and it came under the umbrella of Ripplewood Holdings.

According to Michael Muoio, Lillian Vernon was essentially bankrupt in 2000. It was saddled with a very expensive “legacy IT system with multiple platforms and IBM-based.”

Lillian Vernon Under Ripplewood
Ripplewood paid $60.8 million, then sold off the building for $40 million, so the net cost was $20.8 million—less than one-tenth annual revenue. Not a bad deal.

Honestly believing they could overcome the hurdles, the new owners planned to combine Lillian Vernon with a Time-Life catalog and expand the corporate gift business. “The strategy was sound,” Muoio said, “but it was a matter of execution.” For example, $7 million was spent trying to bring the IT system into the 21st century. Ripplewood could not make it work and lost $25 million a year over the next three years. This meant negative cash flow after three years was more than $100 million with no positive results.

Lillian Vernon on Sun’s Watch
In 2006, Sun Capital Partners bought the company at a distress price of $10 million and installed Muoio as president and CEO. He honestly believed he could overcome the IT problem, but could not. On top of that, he was hit with postal and delivery increases—15% and 18% respectively. The price of paper also increased, adding an additional $15 million in costs.

“We trimmed overhead where we could,” Muoio told me. “We took a good whack at it, but it was too much for us. We improved the core business but did not take it far enough. Close, but no cigar.”

After a year and a half, Muoio and the investors threw in the towel. Just before Christmas 2007, they laid off 100 employees. And on Feb. 9, final bankruptcy was declared.

The idea that two private equity firms could spend four years giving CPR to a beached whale and lose more than $100 million boggles the mind.

“When Sun and I joined to acquire the company, we had a code name—it was: Project Las Vegas,” Muoio wrote in his e-mail to me. “I don’t think I need to explain that further.”

By calling the enterprise “Project Las Vegas,” it was clearly a crapshoot.

Isn’t another word for crap “doo-doo?”

As in doo-doo diligence?

Due Diligence
Function: noun
Date: 1903
1: The care that a reasonable person exercises under the circumstances to avoid harm to other persons or their property. 2: Research and analysis of a company or organization done in preparation for a business transaction (as a corporate merger or purchase of securities.)
—Merriam-Webster.com

Due diligence is like betting the horses.

Back in the 1960s, I got interested in horse racing. I bought “Ainslie’s Complete Guide to Thoroughbred Racing,” hit the typewriter, and reduced his 352 dense pages of information to 28 pages of rules and notes that I memorized.

Then I started buying The Daily Racing Form every Saturday to study the past performance data for the cards at Belmont, Aqueduct or Saratoga. This was not for serious betting, but rather a mental exercise to try and make sense out of myriad facts and numbers—much the same as crosswords or Sudoku are to their aficionados.

The bottom line: In one or two races a day (three at the most), the winning horse with attractive odds would pop up through the vast clutter of data and whinny rudely, “Bet me! Bet me!” Sometimes I would spring for $2 on the phone; mostly it was just fun to see how I did the next day.

If I had one takeaway point to suggest to horseplayers—and private equity firms and venture capitalists—it would be: Winning is knowing when NOT to bet.

A Personal Digression
As readers know, I had nine jobs in my first 12 years in business—three of them lasting less than a month. At one company in the 1960s, I worked nights and weekends, launched a successful new product and did a great job. Whereupon a fat little toad of a new boss was hired, and I was suddenly fired with two weeks pay. The toad subsequently brought in his chums.

It was devastating. But at least in all the times I was fired, no company ever publicly humiliated me.

It was sickening to read in The Virginian-Pilot about the surprise bloodletting four days before last Christmas. Carolyn Shapiro wrote that the terminated workers were prohibited from returning to their desks. “Supervisors brought them their belongings and escorted them out of the building immediately after they were given notice. Some of the laid-off employees had worked for the company for almost 20 years.” Axed employees were given two weeks severance if they agreed to sign a termination letter.

Merry Christmas, chumps.

Some recent examples of doo-doo diligence:

* Donald Trump Trump bought the Plaza Hotel in 1988 for $390 million and took out a full-page ad in The New York Times. “I haven’t purchased a building, I have purchased a masterpiece—the Mona Lisa,” Trump crowed. “For the first time in my life, I have knowingly made a deal that was not economic—for I can never justify the price I paid, no matter how successful the Plaza becomes.” Two years later—after letting the property run down—Trump sold it to a Saudi prince, taking a $65 million loss. Every time I see Donald Trump—in magazines, newspapers or on TV, with his comb-over do and perpetual sneer—I say to myself, “You had within your grasp the premier real estate treasure in New York, and through doo-doo diligence, buccaneer business practices and gross mismanagement, you lost the Plaza Hotel! You are a world-class schmuck!”

* The 2008 Beijing Olympics—a catastrophe waiting to happen. The International Olympic Committee committed to a Chinese city so beset with smog that tens of thousands of people will be seen on worldwide television wearing surgical masks and eating a food supply so laced with hormones and poisons that athletes who do not bring their own proteins and greens will flunk anti-doping tests. In terms of negative publicity, China and its thuggish government operatives very likely will look like utter fools, as will the International Olympic Committee.

* Hiring somebody? Due diligence is not easy. If you are called for a reference by someone who is thinking of hiring a former employee, you are limited to saying that the person did indeed work at your company and the dates. Period. Say any more, and you can be sued. A high-powered woman lawyer I know was recently called by another law firm for a reading on a former associate—a turkey—who was up for a job. “We’re thinking of hiring So-and-So,” the caller said. In a tone of voice dripping with contempt and sarcasm, my friend said, “Oh, r-e-a-l-l-y?” “Thanks very much,” said the caller and hung up. According to a 2005 ad for “Hiring the Best,” hiring the wrong person will cost you three times the annual salary. “A $50,000 employee costs you $150,000; a $150,000 employee costs you $450,000,” the copy states. “That’s for starters. There’s also lost opportunity costs ... plus lost business, potential customers and momentum!”

* The subprime debacle. Major Wall Street investment bankers and mortgage lenders worldwide—to a person—failed to do due diligence into the study of human nature. They structured tricky loans and suckered gullible consumers into mortgages that ballooned beyond their ability to pay. Meanwhile, the borrowers blithely signed these deals without hiring an accountant to do due diligence and run the numbers, so they would know precisely what to expect when the APR changed. As a result, millions of borrowers and lenders alike were greedy, stupid as hell and lazy as pigs in mud on a hot summer day.