At first glance, poultry producer and processor Pilgrim’s Pride and shopping center REIT General Growth Properties would seem to have little in common. But while they may be in different business sectors they share a remarkable number of common woes.
Both are laboring under crushing debt obligations associated with recent acquisitions, and both face potentially insurmountable problems servicing or restructuring their debt. The problems facing both companies are further exacerbated by the economic downturn. In each case, the founding families may lose control of the companies, or perhaps even their entire investment. Both companies have also seen their share prices plummet.
And now, both companies have been hit with securities class action lawsuits.
While these two new lawsuits at one level are the result of these two companies’ particular challenges, the underlying debt issues and complications arising from the current credit crisis could affect legions of other companies, and possible spark even further securities litigation.
Pilgrim’s Pride: As detailed in a front-page October 17, 2008 Wall Street Journal article entitled "Debt Woes, Feed Costs Come Home to Roost at Pilgrim’s" (here), Pilgrim’s Pride is struggling under the burden of debt associated with its 2007 acquisition of rival Gold Kist, making Pilgrim’s Pride the "world’s largest chicken company."
As noted in a subsequent Journal article (here), in addition to an "increasingly untenable debt load," the company has been "hammered by rising prices for feed, bad bets in the grain market, [and] falling prices for chicken." The October 17 Journal article details an ill-timed hedge the company had entered, fixing its grain feed costs when prices had peaked, locking the company into a costly contract just before prices began to decline.
Pilgrim Pride’s financial challenges have been "exacerbated" by the economic downturn, as a result of which fewer consumers are dining out, reducing demand for chicken.
Due to these circumstances, Pilgrim Pride’s share price has declined 97 percent this year. On October 30, 2008, press reports (here) speculated that the company, which faces pending interest payments it may not be able to fulfill, is a "likely" candidate for bankruptcy.
In addition, and also on October 30, 2008, plaintiffs’ lawyers issued a press release (here), announcing that they have filed a securities lawsuit in the Eastern District of Texas against Pilgrim’s Pride and certain of its directors and officers. A copy of the complaint can be found here.
According to the press release, the complaint alleges that the defendants "misrepresented the Company’s financial condition and concealed the impact of the Company’s capital problems on its business and prospects." The Complaint specifically references the company’s September 24, 2008 press release (here), in which it announced that it had "notified its lenders that it expected to report a significant loss" in its fiscal period ending September 27, "due to high feed-ingredient costs, continued weak pricing and demand for breast meat, and the significant impact of hedged grain positions during the quarter."
According to the press release, the complaint alleges that the defendants failed to disclose that:
(a) the Company’s hedges to protect it from adverse changes in costs were not working and in fact were harming the Company’s results more than helping; (b) the Company’s inability to continue to use illegal workers would adversely affect its margins; (c) the Company’s financial results were continuing to deteriorate rather than improve, such that the Company’s capital structure was threatened; (d) the Company was in a much worse position than its competitors due to its inability to raise prices for customers sufficient to offset cost increases, whereas its competitors were able to raise prices to offset higher costs affecting the industry; and (e) the Company had not made sufficient changes to its business model to succeed in the more difficult industry conditions.
General Growth Properties: As detailed in Wall Street Journal articles dated October 20, 2008 (here), and October 28, 2008 (here), the "aggressive mortgage financed acquisition strategy" of General Growth Properties, the second-largest U.S. mall owner, "has left the company with little ability to pay debt coming due amid the credit crisis."
As detailed in an October 27, 2008 Bloomberg article (here), General Growth’s shares have declined over 95 percent this year "on concern that the company won’t be able to refinance about $1.2 billion of debt this year." The debt stems in part form the company’s 2004 $11.3 billion acquisition of Rouse companies.
Compounding the company’s difficulties are the departures of three of the company’s senior executives (refer here), on reports that the executives had obtained loans from a trust associated with the company’s founding family, in order to pay of margin debt the executives had incurred to acquire stock in the company.
The company had earlier sought to raise capital through the sale of preferred stock, but these efforts "fizzled", as reported in the October 28 Journal article. The company is now seeking to sell three massive Las Vegas luxury malls, to try to address the company’s "most pressing problem," which is $900 million in mortgage acquisition costs coming due on November 28. The October 28 Journal article reports that "without an extension or new funding, General Growth doesn’t have cash on hand to pay the debt."
General Growth is burdened not only with the heavy load of debt that financed its acquisition strategy and difficulty in obtaining credit or additional capital, but it is also challenged by falling real estate values and increasing vacancy rates, driven by the declining economy.
On October 31, 2008, plaintiffs’ counsel issued a press release (here) announcing that they had initiated a securities class action lawsuit in the Northern District of Illinois against General Growth and certain of its directors and officers. A copy of the complaint can be found here.
According to the press release, the Complaint alleges that the defendants "made false and misleading statements about General Growth’s access to financing," in particular that the company "had the ability to refinance billions of dollars of debt that was coming due in the fall of 2008 and the spring of 2009, on acceptable terms." The complaint further alleges that the company failed to disclose that "the Company’s President/Chief Operating Officer had received loans from the Chief Executive Officer’s family trust in violation of the Company’s own Code of Business Conduct and Ethics."
Discussion: Pilgrim’s Pride and General Growth are far from the only companies burdened with debt incurred as a result of acquisitions fueled by the easy credit during an earlier era. Nor are they the only companies laden with debt they may not be able to refinance or repay while also facing the adverse effects of the general economic downturn.
Just this past week, the U.S.’s second largest ethanol producer, VeraSun, filed for bankruptcy; VeriSun also fell victim of wrong way hedges on corn supplies (refer here). Well-known retailers Mervyn’s, Linens ‘N Things, and Shoe Pavilion are already in liquidation (refer here). The financial difficulties have also spread to some unexpected places, as described, for example in the October 29, 2008 Wall Street Journal article entitled " Cash-Poor Biotech Firms Cut Research, Seek Aid" (here).
One particular area of concern involves the numerous companies acquired as part of debt-financed leverage buyout. As detailed in a November 2, 2008 New York Times article entitled "Debt Linked to Buyout Tighten the Economic Vise" (here), "many of the loans used to finance the deal are coming due at the worst possible time." The article quotes a Harvard Business School professor as saying that "The big question is how apocalyptic it will be."
In the weeks and months ahead, there will be other companies – perhaps many other companies – faced with precisely the same dismal circumstances as these two companies. In the current economic downturn, all companies will suffer, and weaker companies will struggle. Highly leveraged companies may not survive.
As other companies toil with these challenges amid the difficult financial conditions, many of them may also become the target of securities litigation. Indeed, as I noted in recent posts (here and here), the "bad economic vibe" could result in further securities litigation.
While the arrival of additional securities lawsuits seems likely, it remains to be seen how many of these cases succeed. As I noted in a recent post discussing the subprime-related securities litigation (here), courts increasingly appear skeptical of allegations that a company’s collapse in the current challenging economic circumstances, even if the result of aggressive or even sloppy business practices, is the result of fraud.
An additional question these cases present is whether they are sufficiently credit-crisis related to be included in my running tally of subprime and credit crisis-related securities litigation (which can be accessed here). While I could certainly come up with arguments for including these cases, in the end I don’t think they belong on the list. These cases are more the result of generalized business conditions rather than the specific phenomenon I have been trying to capture in my lawsuit tracking. But regardless of how they are categorized, these cases certainly do suggest we are and will remain in a period of heightened litigation activity.
One final note about these cases is that they involved companies outside of the residential real estate and financial services industries. Whether or not these cases are credit crisis related for purposes of categorization and tracking, they are definitely indicative of the way in which deteriorating financial and economic conditions — that originated in the subprime arena but quickly spread more broadly — threaten to extend the current litigation wave beyond the financial sector to the general marketplace.
The subprime and credit crisis litigation wave may well have been contained to a relatively narrow segment of industries, but as economic conditions continue to deteriorate, the litigation thread will become more generalized and widespread.
Another Failed Bank: After the close of business on Friday October 31, 2008, state banking regulators closed Freedom Bank of Bradenton, Florida, and the FDIC was named as a received. An FDIC press release describing the closure can be found here. According to the FDIC’s Failed Bank List (here), the closure of Freedom Bank is the 17th U.S. bank seized by regulators so far in 2008.
As reflected in a November 1, 2008 Bloomberg article (here) reporting about Freedom Bank, the number of bank closures in 2008 year-to-date represents the highest number of bank failures since 1993, which was of course at the tail and of the last significant era of failed banks.
The Bloomberg article also reports that Freedom Bank had lost $258 million in the last two quarters from rising losses on real estate loans. Freedom is the second bank failure in Bradenton this year; in August, regulators closed First Priority Bank of Bradenton (about which refer here).
Contagion: The November 1, 2008 New York Times article entitled "From Midwest to M.T.A., Pain from Global Gamble" (here) describes how market place participants as diverse as Wisconsin school systems and New York’s Metropolitan Transit Authority were ensnared in the financial difficulties of formerly high-flying Irish bank Depfa, which in October 2007 merged into German bank Hypo Real Estate. The consequences for Hypo have proved to be dire, as the company recently required a massive bailout from the German government.
The consequences for the Wisconsin schools have also been calamitous, as detailed in the article. The article does not mention that the Wisconsin schools have already launched a lawsuit against the broker/dealer and investment bank responsible for the schools’ CDO investment. My prior post discussing the Wisconsin schools’ lawsuit can be found here.
PLUS Week: This upcoming week, I will be in San Francisco attending the PLUS International Conference. As a result, The D&O Diary will likely not maintain its usual publication schedule. If you see me at the conference, I hope you will take a moment to introduce yourself, particularly if we have not previously met. See you in San Francisco.