Dade Behring's Recap Plans

For more than a year, Dade Behring has been wading through a financial morass that is likely to lead to bankruptcy, a sale of assets, or a reorganization of capital structure. As concerns mount about its long-term prospects, Dade Behring and its lenders are seeking to restructure the company's burdensome long-term debt. While stubborn lenders have been unwilling to accept less than a near-to-full return on their investment, several events this spring seem to be motivating them to be more flexible.

For more than a year, Dade Behring Inc. has been wading through a financial morass that is likely to lead to bankruptcy, a sale of assets, or a reorganization of its capital structure.

The nation's sixth largest diagnostics company, with revenues of $1.18 billion in 2000, is staggering under nearly $1.6 billion of debt. Angry bondholders have watched the value of their investments plummet to less than 90% discount to par. The company sought and received waivers of its bank covenants through July. Last fall, it also hired Goldman Sachs to look for strategic alternatives.

Several events this spring, however, brought the situation to a head, and stubborn lenders previously unwilling to accept less than a near-to-full return on their investment now appear to be more flexible.

First, finding a buyer for the company doesn't seem to have worked, at least so far. The company denies it's up for sale, but outsiders say that Dade's owners, encouraged by several recent high-valuation deals in diagnostics, put a $2 billion price tag on the company and that no one bit at it. And Dade hasn't, to date, found buyers for parts of its businesses, either, all of which are in mature sectors of the industry and, in most cases, need an infusion of R&D funding to bring them up to date. The company's crown jewel, its best-selling clinical chemistry product line, Dimension, is highly attractive to mid-sized and large hospital labs and accounts for 40% of its total revenues. But the technology behind it isn't compatible with other chemistry lines, and would be hard to integrate with them, according to Henry Weinert, president of Boston Biomedical Consultants.

For R&D funding Dade probably can't look to Aventis SA , which owns 57% of the company (but significantly less of its voting shares) and hasn't put more money into it.

In April, the debtors made an attempt to reshuffle their loans, which gave the company some relief in the form of lower interest rates, but didn't reduce the amount owed. At the same time, Bain Capital, the investment firm that founded Dade seven years ago [See Deal], bought some bonds on the assumption that at such low prices they would be a good investment. This maneuver consolidated the number of senior subordinated bondholders to less than 300, meaning that the company no longer has to file financial reports with the SEC. Thus, outsiders are likely to have more difficulty obtaining information about the company's finances, but Dade and its lenders, at the same time, will get a chance to work out their differences away from public scrutiny. Dade executives say that although it isn't making public disclosures, it continues to communicate extensively with financial stakeholders and others.

The greatest impetus to negotiation, however, came when the company's banks wouldn't let it make a $19.5 million interest payment to senior subordinated (unsecured) bondholders, due in early May. The banks were playing hardball with the bondholders, who in turn, saw no reason to compromise. The banks themselves had started talking with the company about financing alternatives in late December. The move apparently worked: the bondholders agreed that a refinancing, in which they were likely to lose even a portion of their investment, would be better than a bankruptcy, in which, as unsecured creditors, they stood to lose everything. They also may get equity in exchange for debt forgiveness, as would the banks.

Dade executives, for their part, are confident that all parties can work out a financial recapitalization. "No one, including financial shareholders, wants to put the underlying operating business at risk," says CFO Jeff Naylor, who joined the company last fall as part of a major senior management shake-up. "Our ability to recapitalize the debt is driven by our underlying business, which is very strong."

Indeed, the company had revenues of $334 million for the first quarter of 2001, 14% higher than the same period a year ago and bolstered primarily by the strong performance of its chemistry instrument product line (which was up 19%), as well as a change in accounting rules that added 5 percentage points to the increase. While revenues for the full year 2000 were down 10% from 1999 to $1.184 billion, about half of the decline was due to the impact of foreign exchange. The other half came from events that aren't going to recur. These included the sale of several marginal businesses, as well as a decision to sever ties with the distributor of the company's coagulation products, Allegiance Healthcare Corp. , and bring distribution of those products in-house. The move, which became official July 1, should ultimately boost margins and add about $10 million a year to Dade's coffers starting immediately, says Naylor. But, in the short-term, it hurt Dade as Allegiance sold off inventory to complete the shift.

Moreover, Dade has undertaken a series of internal moves to bolster margins and revenues. In the past year, it has implemented programs that cut expenses by more than $50 million a year, with a one-time restructuring cost of $65 million. The workforce was reduced by about 10% (a 20% reduction in head count at the US headquarters in Deerfield, IL), without impacting service. The layoffs affected all functional groups and all ranks, starting with high-level executives, says Mark Wolsey-Paige, the company's SVP, business development and strategy. The company has a new senior management team; gone is CEO and chairman Steve Barnes, a Bain Capital executive who was in charge of Dade and was at the helm when it entered into a disastrous refinancing deal with Bain and Goldman two years ago. Former COO and president Jim Reid-Anderson now holds the top spot.

These recovery measures, while not enough to solve the problem, give the company credibility with banks. The cost-cutting programs are substantially completed and the financial savings have exceeded expectations, says Naylor. Through these initiatives, the company has increased cash flow by $120 million a year. First quarter results attest to their success, he says, noting that EBITDA grew 21% in the first quarter from the same period a year ago.

The cuts are in sync with the company's shift in strategic direction away from being a broad-based supplier to one that focuses on select areas. Dade Behring plans to devote resources to its strongest product lines, namely the Dimensionand a few immunochemistry businesses, which compete in what Wolsey-Paige claims is a combined $10 billion market. The company continues to operate its mature businesses, like microbiology and hemostasis, where it says its leading market share allows it to have strong gross margins. But it isn't investing in new technologies for them and isn't funding any efforts in cutting-edge, high-growth areas of diagnostics like molecular testing or diabetes testing.

The scenario wasn't supposed to play out this way when Bain Capital formed Dade International Inc. nearly seven years ago by buying the diagnostics business of BaxterInternational Inc.. Bain bet that its financial expertise would benefit a company in a very mature, consolidating industry and insisted it could bring discipline to an inefficient, overly technical organization. It set out to do this with a series of acquisitions culminating in the 1997 merger of Dade International Inc. and Behring Diagnostics Inc. [See Deal], then owned by Hoechst AG, (now part of Aventis SA ). The resulting diagnostics company was highly diversified, with leading positions in chemistry, microbiology, serum proteins, cardiac markers, and drugs of abuse, as well as a global infrastructure that could push products to all parts of the world. Because of its broad reach and exclusive focus on diagnostics, the new company was expected to have a tremendous advantage over competitors, notably through its economies of scale and market clout.

But with margins comparatively low for health care, sluggish growth and lots of debt, its backers weren't able to take it public. Seeds of the current crisis were sewn two years ago, when the company undertook a financial restructuring that allowed major shareholders Bain and Goldman Sachs to sell part of their equity back to the company at a cost of more than $400 million to Dade. The company financed most of the deal by issuing new debt; Aventis also put in nearly $80 million. The debt-to-EBITDA ratio, which for healthy companies in this industry is normally four or less, went up to six and was as high as 8.3 last fall, says Moody's Investor Service analyst Russell Pomerantz; it is now closer to 6.5. Bondholders were furious, but lacking voting shares, they couldn't act.

Everyone's hope is to give the company breathing room to rebuild. The business is stable and capable of producing an operating profit; Weinert predicts it has the potential to grow at "market rates." The Dimensionand the company's two-year-old point-of-care cardiac testing module, the Stratus CS, are hits. Moreover, he says, the financial woes, so far, don't seem to be scaring customers away.

But even if negotiations succeed, Dade faces some long-term challenges. Its debt load will continue to be cumbersome. It has little to no presence in the high-margin, fastest-growing areas of diagnostics, and it doesn't have enough money to fund new endeavors—nor is it clear that the recapitalization plan will give it sufficient funds to do so. Growth at market rates may be better than the alternative, which is no growth at all, but it isn't enough to help investors get a satisfactory return on their money. Still, investors hope that for all of their effort, they might eventually make a profit.