BUSINESS/SPECIAL REPORT

ANATOMY OF A SHAKAN EMPIRE

INVESTORS ARE QUESTIONING EDPER’S ABILITY TO THRIVE IN A NEW ECONOMIC ORDER

DEIRDRE McMURDY November 23 1992
BUSINESS/SPECIAL REPORT

ANATOMY OF A SHAKAN EMPIRE

INVESTORS ARE QUESTIONING EDPER’S ABILITY TO THRIVE IN A NEW ECONOMIC ORDER

DEIRDRE McMURDY November 23 1992

ANATOMY OF A SHAKAN EMPIRE

INVESTORS ARE QUESTIONING EDPER’S ABILITY TO THRIVE IN A NEW ECONOMIC ORDER

BUSINESS

SPECIAL REPORT

For many Canadians, the euphoria that accompanied the Toronto Blue Jays’ World Series victory was one of the few bright spots in an otherwise grim season of economic and political discontent. Indeed, the Jays managed to accomplish a feat that defied the country’s most seasoned leaders: the baseball team briefly displaced the mounting anxiety over Canada’s fading economic fortunes and a divisive debate over the Constitution. But for the Blue Jays’ owners, the reflected glory was especially sweet. For the past two years, the embattled Edper empire, which owns 90 per cent of the baseball club through John Labatt Ltd., has endured the grind of increasingly intense speculation about the firm’s future performance. In the past month, as dismal financial results for the third quarter were reported by other key Edper-controlled companies such as Royal Trustco Ltd., long-simmering rumors created a sense of panic in the investment community. And in an eerie echo of the Reichmann family’s financial spiral, the fragile faith of investors collapsed and Edper group stocks plummeted.

In part, the stock-market assault on the recession-ravaged corporate empire of brothers Peter and Edward Bronfman represents a backlash against the group’s complex corporate structure and the controversial style of the senior Edper managers (page 46). But it also reflects a critical turning point in the collective consciousness of Canadians. As the once-exalted icons of North American capitalism like the Reichmanns’ Olympia & York Developments Ltd. (O&Y), Stelco, General Motors Corp., IBM Corp. and the airlines have fallen from grace, shareholder and public insecurity and disillusionment about the future have heightened. As

well, the dislocation caused by the current severe recession has been exacerbated by a coincident restructuring of the Canadian economy under new global pressures. Now, because so many of the familiar points of reference have eroded, rumors about the next major financial collapse—often fuelled by short-sellers who profit from market panics—quickly gain credibility and can easily become selffulfilling.

In recent weeks, the downward slide of the Canadian dollar on international currency mar-

kets, and the concurrent increase in interest rates and unemployment levels, have greatly contributed to an acute sense of anxiety. What started as a jittery dance by currency speculators around the outcome of the constitutional referendum failed to end with the vote. In the weeks following Oct. 26, the dollar has fallen about two cents to trade below 80 cents (U.S.), reflecting widespread international pessimism about Canada’s economy. In response, the Bank of Canada raised interest rates again last week from 6.18 per cent to 6.97 per cent.

ŒN EMPIRE

“People are threatened and fearful,” says Lawrence Lunn, chairman of Vancouver-based investment counsellor Connor, Clark & Lunn Ltd. “There’s a real meanness in the air—a great readiness to believe the worst about everyone and everything.”

For companies within the Edper universe, public mistrust and meanness could not have converged at a worse time. In the past, Edper executives have relied heavily on trust, rather than on detailed financial disclosure, to convince investors that Edper was capable of sustaining a superior annual rate of growth for its myriad companies. Along with a strong

record of performance through the 1980s, the Edper partners inspired trust by cultivating an image as austere corporate monks who despised luxurious trappings. They flaunted their "shared values,” a corporate code of ethics, in annual reports and public statements, and emphasized the point that they ate modest lunches together, using that valuable time to discuss Edper-related business.

Herd: With that approach, and the promise of annual 15-per-cent returns through their innovative program of “managed earnings,” the partners tapped into the public’s strong desire to believe in them and in their success. A kind of herd mentality, known to cause banks and investors to trip over themselves to offer credit and capital, stampeded towards Edper. “It was just like with O&Y—you felt like a jerk if you didn’t own their paper because everyone else did,” recalls one major investment-fund manager. Another expert compared the former fascination with Edper with the current thrall over the acquisition spree by media magnate Conrad Black, who last week acquired a 22.6-per-cent stake in Southam Inc. of Toronto, from Torstar Corp., for $259 million. “There’s always a new god ascending,” he says. “That’s the nature of the market.”

It is also the nature of the market, however, to abandon fallen idols. Until mid-1990, when the cold fingers of the e recession first gripped Edper compati nies, the Bronfman brothers and their I hired guns were the toast of Bay $ Street. Although the brothers and z their chief corporate architect, Jack x Cockwell, deliberately dodged the glare of publicity, they succeeded only in whetting the public appetite for information. Furthermore, the soft-spoken brothers, who came from a wealthy and sheltered background, were a delicious counterpoint to the scrappy, blunt South African to whom they had entrusted their inheritance from the family’s Seagram distilleries in Montreal.

In financial circles, Cockwell, who is a compact and intense man with penetrating blue eyes, was held in awe as much for his innovative financial vision as for the unswerving loyalty he commanded from the troops of young accountants he recruited. While widely

acknowledged as a genius for his transformation of the Bronfmans’ fortune into an empire, at the same time he was also feared for his impatient wilfulness and his brutal boardroom tactics. In fact, few people in the financial community are willing to speak for attribution about the Edper group, because of its past record of heavy-handed threats of retaliation for public criticism.

The dual legacies of trust and toughness have contributed, at least indirectly, to the current woes of the Edper partners. Those who trusted them now feel disappointed, while those who feared them gleefully anticipate their demise.“People feel somehow abused by the Edper group,” noted one Montreal-based pension fund manager, who spoke on condition of anonymity. “There is a great thirst for blood and revenge and blame, however unfair or dangerous that could be to all of us.”

The most obvious threat, if the sprawling empire falters, lies in its sheer size. Edpercontrolled companies employ 110,000 Canadians in industries from brewing to forestry, and its holdings represent about she per cent of the Toronto Stock Exchange. Included in Edper’s interlocked corporate structure are a string of well-known names such as Noranda Inc., MacMillan Bloedel Ltd., London Life Insurance Co., Royal LePage Real Estate, Bramalea Ltd., Trizec Inc., Norcen Energy Resources Ltd. and North Canadian Oils Ltd.

Outside Canada, the association between Edper and the Canadian economy is so strong that when the most recent wave of speculation hit Edper, the Canadian dollar fell almost one cent. Said the Edper observer: “The notion of being too big to fail was shot down along with the Reichmanns. But the Bronfmans are so pervasive in our economy that no matter how much we resent it, we have to help them land this thing rationally and gradually.”

Assets: The issue of Edper’s financial health has been the focus of discussion, especially since the collapse of the Reichmann family empire. But however grave the reality, even the group’s harshest critics concede that there is an extremely solid base of assets that could be sold. To date in 1992, Labatt has already sold its flour-milling operation and its 60-percent stake in Maple Leaf Foods Inc. In early September, the company, which has frequently been reported for sale, announced its intention to shed another $2 billion worth of holdings to focus more narrowly on its entertainment and brewery divisions. Meanwhile at Noranda, a diversified natural resources company, a partial interest in Hemlo Gold Mines Inc. and

Canada Wire and Cable Ltd. have recently been sold.

A greater concern, however, is the future of the Edper companies even if they do manage to avoid a major corporate overhaul. According to some economists, Canada is now in the throes of a fundamental economic transformation that will ultimately reduce the significance of the traditional natural resources and manufacturing sectors where Edper has concentrated its presence. Instead, more technology-intensive and knowledge-based companies will gradually emerge. “It’s a huge mistake to think the world is going to return to the way it was, and it’s a loser’s game to wait for that to happen,” says economic consultant Nuala Beck of Nuala Beck

& Associates Inc. in Toronto. In the stock market, investors interested in reaping the benefits of strong corporate growth have already started to favor smaller, more flexible companies that dominate specific niche markets in burgeoning industries.

A lack of exposure to the new economy is not the only area where the Edper empire has fallen behind. One of the most pronounced trends in the investment industry over the past five years has been the move away from conglomerates towards companies that specialize in one, clearly understood, business segment. Despite the frequent criticism of their convoluted structure, Edper executives have responded slowly to the repeated requests from outside investors that they consider streamlining their operations. “People are fed up with complicated paper games. They want to go back to basics,” says Michael Ryan, a vicepresident at Leith Wheeler Investment Counsel Ltd. in Vancouver. But Robert Harding, chief operating officer at Hees, insists that

Edper companies are making steady progress towards the simplification of their maze-like corporate structure.

While critics claim that Edper companies move too slowly in some areas, they also complain about frequent and abrupt changes in direction and strategy. According to Ryan, pension funds and other large institutional investors, whose portfolio performance is reviewed quarterly, are increasingly averse to “surprise write-offs and unpredictable accounting changes.”

Troubled: One of those abrupt changes, according to critics, took place in the late 1980s, when Hees first moved into the corporate workout business, with a vague mandate to apply its know-how to troubled operating companies. The Hees partners soon became preoccupied with fraudbattered National Business Systems Ltd. of Mississauga, Ont. Then, they won a Pyrrhic victory over industrial conglomerate Enfield Corp. of Toronto, which left them with problematic investments in dying sectors such as glass packaging and a staggering load of unresolved lawsuits.

But perhaps the most damaging—and damning—surprise emerged in September. After months of publicly insisting that its exposure to the problems at O&Y were limited to a joint investment § in a real estate company, Triä zee Corp Ltd., Edper eventu| ally revealed a secret partii nership agreement through I which it held a $ 138-million stake in the Reichmann family’s World Financial Center in New York City. For some frustrated investment analysts, the revelation finally convinced them to stop following the companies.

The Edper partners concede that Hees’s failure to disclose exposure to O&Y was a mistake, especially as they struggle to turn over a new leaf with their investors. They insist, however, that they were constrained by a confidentiality agreement with thensecretive clients, the Reichmanns, from making any public statements related to the deal. “We’ve learned from O&Y that in future, we have to make sure that the boundaries of client confidentiality don’t impinge on our own integrity,” notes Harding. He and the other Edper executives may gradually be able to regain the confidence of skeptical investors and nervous creditors. But what is clear is that, as was the case with the Reichmanns, the market will precipitate sweeping changes if they are not soon initiated from within.

DEIRDRE McMURDY