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REV: MARCH 4, 2002

The Loewen Group, Inc. (Abridged)
In March 1999, John Lacey and the management team at the Loewen Group, Inc., had to decide what course of action to take in light of the company's imminent financial difñculties. On January 22,1999, Lacey, a renowned turnaround specialist, was appointed chairman of Loewen, the

second largest death care company in North America. Headquartered in Burnaby, British Columbia,
Loewen owned over 1,100 funeral homes and more than 400 cemeteries in the U.S. and Canadá; it

also owned 32 funeral homes in the United Kingdom. The company had come a long way since its modest beginnings in Canadá, where Ray Loewen, the founder (and, until recently, chairman and CEO), started out helpinghis father run the family funeral business in the late 1950s. During the last two decades, Loewen Group had grown explosively, mainly by acquiring small independent funeral homes and cemeteries in densely populated urban markets; in recent years the company had also acquired several large established funeral chains. Over the last five years alone, Consolidated revenues had grown by nearly 30 percent a year, on average, from $303 million to over $1.1 billion.

Despite its impressive growth, the company faced a major financial crisis. It lost $599 million for 1998, compared to earning $43 million the previous year. Loewen's on-going acquisitions program had been aggressively ñnanced with debt. At year-end 1998, total debt stood at more than $2.3 billion—more than seven times the amount outstanding five years earlier. Loewen's common stock,

which was simultaneously traded on the New York, Toronto, and Montreal stock exchanges, had ended the year at around $8 in New York, down from roughly $40at the end of 1996.
Confronted with the company's mounting difficulties, in October 1998 the Board of Directors

replaced Ray Loewen as CEO; soon thereafter, with the appointment of John Lacey, he was also replaced as chairman. The company also took some steps to raise profitability and cash flows. It Consolidated various administrative functions at corporate headquarters and cut management overhead. It reviewed its pricing policies. Finally, it hired investment bankers to explore various financing options, includingasset sales, strategic partnerships, and outside capital investments in the company. However, the company's situation continued to worsen, and in mid-February 1999 Standard & Poor's downgraded Loewen's public bonds from B+ to B-, its fourth downgrade in less than a year. Loewen's stock price dropped 38% that day. In addition, Loewen would almost surely viólate certain covenants in its bank debt as a result of the company's 1998 financial performance, making it necessary to restructure the debt. Overall, in the twelve months prior to February 1999, Loewen's stock price fell by about92%, to $1.93, and its bond prices fell by 30%.
This is an abridged versión of an earlier case, The Loewen Group, Inc., HBS No. 201-062, which Professor Sruart Gilson prepared with the assistance of Research Associate José Camacho asthe basis for class discussion rather than to¡Ilústrate either effective orineffective handling of an administrative situation. Material inthis case and inthe original comes from published sources (public company documents and the general business press) and draws onresearch by David Gallo, Ian Reynolds, and Collin Roche (all HBS Class of2000), as reported intheir paper, "The
Loewen Group: An AutopsyofaChapter 11 Death Care Company."

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The Loewen Group, Inc. (Abridged)
201-082

on hand However, this would not be sufficient to meet several large interest and principal payments

Loewen had not yet missed any payments on its debt, and had approximately $30 miliorof-cash

that were due over the coming months. Apayment default would only make negotiations with creditors more difficult, and increase the likelihood of bankruptcy. This possibility would no doubt company's debts.

weigh heavily on the managers' minds as they turned to the important task of restructur.ng the

The Death Care Business

Services; and related producís like cemetery plots, caskets, urns, and gravesite markers Funeral services and cemetery plots can be sold either on an "at-need" basis (i e., at the time of death) or on a "prearranged" or "pre-need" basis. In the latter case, payment for afuneral service or cemetery pío is made in advance, and the proceeds are either held in trust or invested in an insurance policy (that ñames the death care firm as beneficiary).

The primary activities of death care firms include the provisión of funeral, burial, and cremation

In 1999 the death care industry was highly fragmented, with approximately 22,000 funeral homes and 9,600 commercial cemeteries in the U.S. Most of these were small family-owned concerne that served their local communities, where reputation and personal relationships were cr.tically

important in generating future business. The largest firms in the industry were like Loewen, publiclv traded, and had achieved this scale by acquiring hundreds of independent funeral homes and cemeteries. At the end of 1998, the four largest firms (Service Corporation, Loewen, Stewart Enterprises and Carriage Services) collectively owned 2,986 funeral homes and 1,083 cemetery properties in the U.S., but this represented only 13.5% and 11.3%, respectively, of the US market. (They also owned businesses outside the US.) Exhibit 1provides financial data for the major firms in the industry and Exhibit 2shows their stock price performance.

A-regate revenues in the death care industry were relatively predictable. One reason was that death°rates were largely driven by demographic factors that did not vary significantly from year to year Since 1960, the number of deaths in the U.S. had increased at an annually compounded rate of 08% ayear. Occasional large deviations from this rate were possible, however.1 Another stabihzing

influence on revenues was the historical lack of price competition in the industry. New entry into the funeral home business was extremely difficult, given how much weight most people placed on family members were rarely in a trame of mind to haggle over pnce.

tradition and reputation when selecting a funeral home. New entry into the cemetery business was often limited by regulation, or by scarcity of land. Further, in the case of at-need sales, bereaved

This industry stability produced an exceedingly low business failure rate among funeral homes_ According to Dun &Bradstreet, the average annual failure rate for funeral homes and crematona-b out of every 10,000—was less than one-tenth the rate for all U.S. businesses.
Pre-need Business

increasing share of the death care business. The segment of the population that was most hkely to

During the 1990s, pre-need sales of funeral services and cemetery plots had come to represent an

1For example, the number of deaths in the U.S. actually declined in 1981 and 1982-by 0.6% and 0.2% respectively-but then increased by 2.3% in 1983 due to the sudden onset of HlV-related illnesses. Source: F. B. Bernstein and \. C. Nainzadeh, Post
Life Services, Merrill Lynch, April 26,1999.

The Loewen Group, Inc. (Abridged)

201-082

sales, particularly of cemetery plots; by 1998 $258 million (41%) of its funeral services revenues was respectively in 1995).

buy on a pre-need basis—former Baby Boomers who were now in their 50s and 60s—was rapidly expanding. From the companies' perspective, pre-need sales provided away to lock in sales growth and market share. Alarge and increasing fraction of Loewen's revenues was derived from pre-need

from pre-need sales, as was $306 million (75%) of its cemetery revenues (up from 22% and 61%

Stewart Enterprises, and $225 million for Carriage Services.2 (The backiog represented the total valué of msurance policies outstanding that have been taken out to cover the costs of providing future services and producís under pre-need sales contracts.) It was estimated that the total pre-need market in the U.S. was between $20 billion to $50 billion in size, measured by current backiog.3
Pre-need sales gave rise to cash flows in advance of rendering services. These funds were either invested insecurities or in an insurance contract. Companies earned an investment return on monies

SCI was especially aggressive in marketing its pre-need business. At the end of 1998, SCI had a pre-need funeral backiog of $3.7 billion, compared to $410 million for Loewen, $819 million for

Standard industry practice was to defer recognition of revenues until services were delivered, but for

that were paid to them in advance. The accounting for pre-need services was quite complicated.

additional customer payments and expenses would not be received ñor incurred until well after that recognition. pre-need sales of cemetery plots, the profit on the sale was usually as current income, aíthough

Growth Through Consolidation

Loewen Group and the other large public death care companies employed adramatically different business model than traditional family-owned funeral homes. Traditional businesses had historically had to contend with high fixed operating costs, which limited profit margins. Fixed costs were hieh because afuneral home might typically perform only one or two services aweek, yet have to employ an office receptionist and various back office staff full time. Similarly, essential assets like hearses and embalming equipment would sit around most of the time unused, tying up capital. geographic áreas, and eliminating redundant assets and overhead expenses. A cluster of funeral

reahze enormous cost savings in the industry by buying up funeral properties in concentrated

In the 1960s, Robert Waltrip, founder of Service Corporation (SCI), recognized the potential to

continued to opérate acquired properties under the original ñame; no "SCI" sien or lo^o'was displayed. ° °

within a 30- to 60-mile radius. It was estimated that in an SCI-owned funeral home fixéd costs represented 54% of revenues on average, compared to 65% for the rest of the industry (althouch SCI homes were typically somewhat larger than average)." To avoid alienating local communities SCI

share hearses and other fixed assets. Atypical cluster might include ten to twenty properties located

homes formed this way would only have to employ a single receptionist, for example, and could

SCI's consolidation strategy had two other potential benefits. First, through increased buvins power, the company might be able to obtain price concessions from suppliers (e.g for caskets and embalming chemicals). In addition, managers of the acquired businesses would gain access to SCI's
2 Ibid.

- Data from the National Funeral Directors Association.

4See C. Schreiber and B. Esty, Service Corporation International, HBS Case No. 296-080()uly 24,1996).

The LoewenGroup, Inc. (Abridged)
201-082

versus 23% for the average U.S. funeral home.and charged excessive pnces.6

recurring

Ray Loewen's Way

them relative autonomy:

You can't have agroup of MBAs in ahead office telling funeral director* how to work They with the firm that carries the family ñame.8

funeral home and cemetery owners who were potential acquirees.

demand for capital increased, and «^^^^^J*^ August 1987, Loewen paid S1.8

As Loewen oroup tumi

As Loewen Group continued to & through acquisitions duringToronto Stock Exchange. grow the 1970s and 1980s te o

5 /Wd.

7Kenneth Bagnell, "A Frofitable Undertaking," The Ghbcand Mail, October 21,1988, p.128.
8 /b/rf. 9 JWd.

The Loewen Group, Inc. (Abridged)

201-082

thereafter, Loewen acquired a small local chain of funeral homes in Fresno, California. Having achieved a foothold in the giant U.S. market, Loewen Group's growth escalated. Dozens, later hundreds, of new properties were added every year. Exhibit 3 shows acquisition premia paid by Loewen and its competitors and Exhibit 4 presents summarized financial data over a ten-year period.

By 1998, the company had propertiesin 48 U.S. states and eight Canadian provinces.

SCI's Hostile Takeover Offer Described in the news media as "fierce competitors" and "arch rivals," Loewen Group and SCI

increasingly found themselves competing for properties in the same markets. In 1994, the two companies collided in the United Kingdom, where each sought to acquire the large British funeral

company, Great Southern. SCI ultimately prevailed, paying almost S20Ü million.10
During 1996 SCI had made several informal acquisition proposals to Loewen, but all were declined. On September 17,1996—the very day that Loewen's stock began trading on the New York Stock Exchange—SCI announced a formal offer to acquire all Loewen common stock for US$43 a share, which would valué Loewen at about $2.5 billion. The offer was addressed to Ray Loewen personally, in a letter from SCI's president (Exhibit 5). At the cióse of the day of this announcement, Loewen stock traded at about US$40, below the proposed acquisition price, but significantly higher than the S33.75 closing price the day before.

Loewen's board of directors promptly rejected the offer. Ray Loewen believed the company's stock, which only two weeks earlier had traded around $30 a share, was significantly undervalued. He portrayed SCI's action as an attempt to elimínate an important, and more successful, competitor. One sympathetic expert described the situation as "This is an example of someone taking advantage of a company that is struggling."11 Although within two weeks of its initial offer SCI increased its bid to $45 a share—and redirected its offer to Loewen's shareholders directly—Ray Loewen said the company's stock was worth at least $52 a share. The stock price was depressed, he argued, because of a recent unfavorable jury verdict against the company in Mississippi. A funeral home operator had accused Loewen Group of reneging on an agreement to purchase two of his homes, plus certain insurance services. Although the properties were worth only a few million dollars, in November 1995 the jury found the company Hable for damages of $500 million, including $400 million in punitive damages. Loewen's stock price fell by 15% on the day the verdict was announced, and its bonds were soon downgraded to speculative, or "junk," status.12 To appeal the verdict, under Mississippi law the company would have had to post a bond equal to 125% of the award, or $625 million. For the year, the company reported an expense of
$165 million to settle this and other lawsuits.

Loewen responded vigorously to SCI's informal approaches as well as to its formal offer. It filed an antitrust lawsuit in U.S. Federal court against SCI. (Soon thereafter a number of states, as well as

the Canadian government, started their own antitrust investigations of the proposed acquisition.)

10 Rachel Bridge, "SCI Set to Tie Up Southern Deal," The Evening Standard, August 8,1994, p. 1.
Mark S.Poert, "Smaller firms would gainfrom 'death-care' spiral," Mcrgcr and Acquisitions Reporl, September 23,1996.

Junk bonds, also known as high-i/icld or belmv inveslmenl grade bonds, are bonds that receive ratings lower than a BBB- by
Standard & Poor's,or a Baa3 rating by Moody's.

201-082

The LoewenGroup, Inc. (Abridged)

T.

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Loewen also adopted lucrative severance packages, or "golden parachutes," for more than 70 of its sénior executives> And, perhaps most significantly, it accelerated its acquisition program.

was determined by aEBITDA-multiple calculation of Blackstone's equity in the investment. During all of 1996, Loewen acquired 159 funeral homes, 136 cemeteries, and two insurance companies, for total consideration of $620 million. By the beginning of 1997, it had entered into agreements to purchase $222 million of additional properties. 6 eea mt0 Arelatively high percentage of the financing for these acquisitions carne from issuing debt The equity issues. At the end of 1996 Loewen's debt/equity ratio was 1.4.1.

exercised its option, Loewen would be obligated to pay Blackstone an amount of cash (or shares) that

debt. A few months later, in a similar transaction, Loewen and Blackstone acquired Rose Hills cemetery, the largest cemetery in North America, for $285 million, of which $155 million was fínanced with debt These transactions were complicated. After four years Loewen would have the option to buy Blackstone's equity stake (a "cali"); but after six years, Blackstone would have the option to sell its stake to Loewen (a "put"). If Loewen bought out Blackstone, it would effectivelv pay an amount that would give Blackstone a24% return per annum on its investment. If Blackstone

The total purchase price was $320 million, fínanced with $190 million of bank and public high-yield

its plans to acquire the then-fourth-largest funeral service provider in the U.S., Prime Succession Inc

In June 1996, Loewen, in partnership with the investment fírm, The Blackstone Group, announced

ra0nTnn?T^PTf^ ^ ?? *?**« would move towards the top debt target range when it range of 1to 1.5." It expected that this ratioWaS * maimain ítS lm**m of thet0 equityratio in the made more acquisitions, but it would endeavor to bring the ratio back down eventually through tnrougn Succession and Rose Hills transactions.

In the first week of 1997, SCI suddenly dropped its bid for Loewen. In addition to concerns over the antitrust suit and Loewen's various takeover defenses, SCI cited Loewen's high debt financing costs as a major deterrent to proceeding with the offer. Special mention was made of the Prime

Distress

an "2?!*aní,roleup from $93 million in 1996. for the full year, interest expense on long-term debt in fínancing this Srowth- ^d was $132 million, F 8 ebt

company sentry into the United Kingdom, where it acquired 32 funeral homes DebTa^Xri

Loewen continued its aggressive growth strategy in 1997, acquiring 138 funeral homes 171 cemeteries, and one insurance company, paying a total of $546 million. The year also marked the

Loewen scemetery business also declined in 1997, from 31% to 28.2%. The company safd thTs decline occurredinpartbecause it reversed $3.7 million of sales (and $1.2 million of retotJcosís)to^it had
13 Loewen already had a"poison píll" shareholder rights plan in place before SCI made its offer.

homes (Le., those not acquired during the year) performed 3.2% fewer services thanin 1996 anTthe rrnl™r8m TT by theSe Pr°Pertiesreserves for doubtful to 38.7%. The company attributed most of the margín decline to an mcrease in declined fr°m 40.8% accounts. The gross margin earned bv

Aic in part to a decline this in L°7fn'sb"si^in death rates, which negatively impacted all The companycompaña death care attributed Although Loewen's total funeral revenues increased by 9.5% during the year, its estíbllheTfuneS*

14 The Loewen Group Inc., Fcrm 10-K, December 31,1996. The ratio was calculated on the basis ofbook valúes.

TheLoewen Group, Inc. (Abridged)

201-082

services and cemetery businesses continued to fall. In early October, itannounced that earnings for the third quarter would likely be more than 30% below what analysts' had forecasted—causing

reported in 1996 for transactions that were supposed to have taken place in 1997, but were never consummated. In addition, ittook a $2.1 million write down for cemetery accounts receivable. These trends worsened in 1998. Revenues and profits for the company's established funeral

Loewen's stock price to fall 15% in a single day. Management blamed the shortfall on declining death rates, difficulties in integrating newly acquired assets, and problems in the cemetery business. By the end of 1998 Loewen's stock price had fallen to $8.44, from $25.75 at the start of the year.

New Management

recording an accountinggain of about $5 million.

In the second half of 1998, Loewen took anumber of steps to address its problems. It severely cut back the pace of acquisitions. During all of 1998, it acquired only 89 funeral homes and 65 cemeteries, paying $278 million. It hired investment bankers to explore different options for raising cash and improving profitability. In July 1998, it sold its First Capital Life insurance subsidiary for $24 million,

more than 18% of the company's common stock, but he had been forced to surrender almost his entire stake to the Canadian Imperial Bank of Commerce to settle a personal loan. Now the company's largest shareholder, the bank nominated John Lacey as Loewen Group's new chairman.

In October, following the company's third-quarter profit warning, Ray Loewen resigned as chief executive officer, and three months later he was replaced as chairman. Loewen had recently owned

maximizing shareholder valué ... I think what I do is look for opportunities to deliver valué to the shareholders."15 abihty to raise large amounts of cash through asset sales. For example, while at Oshawa Group a Canadian grocery store chain, he negotiated the sale of the entire company for $1.5 billion Following his appointment to Loewen, Lacey said: "My role over the last five or six years has been one of

A gradúate of Harvard Business School, John Lacey had built a reputation as a successful turnaround specialist. On the day that his appointment was announced, Loewen's stock price increased by 20% on the Toronto Stock Exchange. In previous assignments, Lacey had shown an

Company Debt

. .nBy ^ ?nc? 0f the year' Loewen GrouP's long-term debt was the highest it had ever been, at $2 3 billion (including debt due within ayear). The debt structure was complicated. For example it owed approximately $540 million to a consortium of 25 Canadian and U.S. banks, led by the'Bank of Montreal. It also had over $1.5 billion of publicly issued, sénior guaranteed notes outstanding in nine different tranches.16 About $875 million of the total long-term debt would mature in 1999.

Almost all of the debt was secured, or collateralized, by various assets of the company. If Loewen assets that secured their debt. In 1996, the banks and the note holders had agreed to share most of were liquidated, secured creditors would be entitled to receive the cash generated from the sale of the
Drew Hasselback, "Lacey Joins Loewen For Another Selloff," The Financial Post, January 25,1999, p. C02.
1 ft

cUfferSTÍahTri^6 d3SS °L* TÍ^355 Security or asset ""» classe* Senerally differ by risk profiles that are determined by andSoZ Pn0n* °" Underiyin6 assel- In thís «•* the tranches of debt had differing maturities

201-082

The Loewen Group, Inc. (Abridged)

due in against each of the nextthtwoife'oftheF^K^^^S^^**^ Loewenduring el years. In return hev h»H T Wa 8ewraI yeare' with SM million £™«^ Among other tHngs, ,he

For tax reasons, the sellers had chosen to be oafd inl^f V'0156"'68 that Loewen h*d acquired

™'«~ *£n^

™. «t included SS7,

ownership of the company's stock changed sgnifícantlv LoZ would have tob°ndsto repurchase the bonds for 101% of their face valué. s,Sm,lcantly' Loewen '" S** offer stated «« ,f

¿L^^^^it;Sdathtrrsrr °hr prinr•p™reSent their interes^ ¡n thecfse Such

TsZ£*• 8KUred Cred¡,°- ^K^eTi ,h?e^alT'A8cP'? r*""' ¡"terf—fírom was that firms were worth more as goine concern» 'X ? t°' ^ Central Pres"mption of the Code aU P"**rS' fÍrmS benefited in oth