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Revco Drug Store, hampered by the increasingly reluctant suppliers and unable to restructure its heavy debt load filed for protection under Chapter 11 of the Federal Bankruptcy Code on 29thJuly 1988.The bankruptcy filing came just 19 months after the Revco Drug chain was taken private in a $1.3 billion leveraged buyout.(Holusha, 1988) It was about 3 months since it had stopped making the interest payments on the high – yield debt used for the financing of the buyout. The bankruptcy filing makes Revco the largest leveraged buyout to fail financially.
 
Leveraged buyout refers to the process in which the management of the company borrows heavily to buy back the shares of the company, thereby placing the burden of extra debt on the company. This buyout technique had been used very aggressively in years before the filing as large number of leveraged buyout funds had been formed to provide financing for the deals. In most of the buyout cases, management of the company and the buyout – fund investors can take over the company by putting up only 10 % or so of the purchase price as the permanent equity capital.
 
Revco bankruptcy filing had been anticipated by the analysts on Wall Street ever since the news of a breakdown in the company’s negotiations with the holders of its junk bonds spread like a fire.Revco’s bankruptcy produced jitters among other holders of high risk bonds from buyouts in which the companies have heavy debt loads and weak or non-existent earnings.
 
Revco’s chairman, Boake Sells, said that the filling was essential to keep the stores operating. As per him, the best solution to save Revco was to continue to operate rather than selling the stores or other assets.He also revealed that the negotiations with stockholders and bondholders had collapsed over the terms of a proposed debt for equity swap which would have been sufficient in producing partial payments for the bondholders. During a news conference at the company’s headquarters, he said that “This is a fight about who owns Revco, and not about how Revco operates”.
 
Meredith Adler, an analyst with L. F. Rothschild & Company, said the failure at Revco was a result of the high price paid by the managers who took the company private in December 1986 and the financing terms that left the company pressed for cash.”They paid too much for the buyout and it was structured badly, with all interest currently payable,” she said. ”Basically, they were not given time to fix the problems.”
 
In some buyouts, she said, managers are given an interest-free grace period to improve a company’s operations before additional demands are made on its cash flow. Mr. Sells said Revco had to pay $150 million in interest payments during the fiscal year ending May 31, 1988, but annual cash flow was estimated at only $125 million.
 
There were management problems as well. The buyout anticipated rapidly rising sales and profits. But competition in the $34 billion drugstore industry stiffened as supermarkets expanded their pharmacy departments and discount stores fought for non-pharmacy sales. Revco responded by cutting prices, but that squeezed already-thin margins.The company ran a huge promotion to clean out inventory but neglected to replenish shelves for the all-important Christmas season. To broaden margins, the emphasis was switched from pharmaceuticals to higher-priced, but slow-selling items, like appliances.
 
Sales stagnated. The buyout plan projected that sales would reach $3.37 billion in the year ending May 31, 1988.(Harris, 1992) In fact, through early February 1988, sales were only $1.66 billion.Profits had disappeared as well at Revco, which was once the nation’s largest drugstore chain. In the last year before it went private, Revco earned $39 million, according to the company. For the fiscal year 1988 through early February, it had posted a net loss of $51 million. The projections called for Revco to earn $103.6 million in the full year ending May 31.
 
Revco was also hampered by the reluctance of banks to finance inventory build-ups for holiday sales. ”They did not even have enough to meet seasonal working capital needs,” Ms. Adler said. ”In the previous year, they needed $90 million in bank financing for the Christmas season, but banks only gave them $60 million.”The buyout added $1.1 billion in debt to a company whose previous debt had been less than $300 million. Although some debt had been repaid through asset sales, the company remains $1.16 billion in debt.
 
Revco announced in April that it would miss a $46 million interest payment on its junk bond debt, causing concern among some merchandise suppliers. Mr. Sells said some suppliers had refused to ship orders until they had been paid for previous orders.The leveraged buyout was led by Revco’s founder, Sidney Dworkin, who built the chain, starting in 1956, from a single drugstore in Detroit. While the buyout was being arranged, the price was increased by 10 percent to fend off a competing bid by the Dart Group.

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