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Inside an empire


Published in "Canadian Business"newsmagazine May 24-June 6, 2004

An exclusive interview by Canadian Business

For the Phelan women, privatizing Cara was a new beginning--both for the business and their family.

On a sunny afternoon in late April, the heiress to one of Canada's biggest business empires is just waking up. She yawns. Drools on her chin. Then dozes off again. Not the kind of behaviour you expect at a business meeting to chart the future of a 121-year-old corporation. But then again, Mia Phelan-Johnson is only seven months old.

Yet, in a way, it is precisely because of her that everyone has gathered in the living room of this red-brick mansion in Toronto's tony Rosedale neighbourhood. Mia's mother, Holiday Phelan-Johnson, is there, having flown in with her from their home in Sausalito, Calif. So, too, are her aunts, Gail Regan and Rosemary Phelan. Together, the three women reign over Cara Operations, the $1.1-billion-per-year restaurant conglomerate that they took private at the end of February.

As the third and youngest generation in the room, it will probably one day be up to Mia (and her dozen or so cousins) to carry the Cara legacy forward. She will inherit much as she grows older. There is the wealth - the family is worth somewhere in the order of $380 million - the houses and the yachts, and the social status that comes with belonging to one of the richest clans in Canada. There is the company and its several chains, with 1,200 restaurants and 39,000 workers. And with all that, there is the baggage - the squabbling and infighting of a sort that has stained so many family businesses.

Witness the Bronfmans, the Cuddys, the Batas, the Eatons. Billions have been lost, families torn apart, lives ruined. Often, those stories are told from the outside. But in a series of interviews, Canadian Business was given exclusive access to Cara, one of Canada's oldest family-owned businesses, as it closes out an important chapter in its history. And whatever its similarities to other well-known Canadian dynasties, the Phelan clan's tale is unlike any other - a saga marked by it own jealousies and ambitions, and by a family commitment to morality in business that has at times led Cara to leave millions on the table.

The company that returned to family control is hardly the same one the Phelans took public 35 years ago, when sales amounted to just $33 million. Cara has morphed from an airline caterer to an operator of major restaurant chains, like Swiss Chalet, Harvey's, Second Cup, Kelsey's and Milestone's. Despite remarkable growth and the prevalence of its brands, however, as a public company it was never able to inspire investors, and was a perpetual underperformer: in the period between late summer of 1993 and the day before Cara announced its intention to go private last August, the value of its shares appreciated by a measly 26%. With SARS, mad cow, avian flu and the worsening ailments plaguing the airline industry (which remained a significant revenue source), Cara's share price went from bad to worse in recent years. For the Phelans, who had long threatened to take the company private again, that presented an opportunity. Though they ran into opposition from institutional investors who criticized the initial offer as too low, the Phelans won out after slightly sweetening the bid.

But the Cara tale is far from over. The same calamities that befell the hospitality industry when Cara was public are still threats, for the short term anyway. Over time, however, the challenges are different. To pull off the privatization, Cara assumed mounds of debt - flying in the face of its conservative culture. At the same time, several of its marquee brands are looking tired. But above all is the issue of succession. In a bitter and public dispute that continued through much of the '90s, the Phelan women wrestled control of the company from patriarch Paul James (P.J.) Phelan and his son, Paul Phelan Jr. As the battle wore on, alcoholism and dementia incapacitated P.J., a one-time Second World War air force squadron leader and entrepreneur, who died in September 2002. Meanwhile, Paul Jr. has barely any contact with the family.

As Mia spits her soother onto the floor, is it any wonder that so much effort is being made to ensure that the next generation doesn't fall victim to the mistakes of the past? Because it is doubtful Cara could survive another family feud.

They were an arduous seven months for Gail Regan. Starting last August, she, along with sister Rosemary and niece Holiday, had battled with large fund managers and Paul Jr. for control of Cara. Shareholder meetings were scheduled, cancelled, and scheduled again. Then, in November, Air Canada "repudiated" its contracts with the caterer, raising questions about the division, which accounts for 15% of Cara's revenue. So when Gail's daughter Honor, the youngest of four children, walked down the aisle for her wedding, in Kelowna, in late February - just after shareholders finally approved the privatization - Gail was ecstatic. It was then, in a telephone call the weekend of the ceremony, that the 59-year-old Cara matriarch offered to sit down and share her views on the company. (That decision was an about-face. "I don't think this is the right time for me to be seeking the spotlight," she had said repeatedly. "I think the focus should be on the company.")

For anyone familiar with Cara's history, the challenge is to separate the family from the business. The two share DNA. In fact, the term "family business" says as much about Cara's values and image as it does about its ownership - a business ethic that has fuelled its success while at times hindering its growth.

When the women of Cara decided to talk, it was a family affair, too, as Gail, Rosemary and Holiday gathered in late April in a boardroom in Cara's old headquarters, tucked away in Toronto's chi-chi Yorkville district. (Its corporate head office is across the street from Terminal 3 at Pearson International Airport.) Though the wallpaper was peeling in places, the chandeliers, family portraits painted in oil, solid oak doors and sculpted fountain out front gave it a majestic air. For lunch, Regan ordered Swiss Chalet - quarter-chicken dinners all around, except for Holiday, who requested a chicken salad.

Between bites of white meat, Gail, 59, said that while the privatization has garnered a lot of attention, she takes more pride in the company's early accomplishments. "In the 19th and early 20th centuries, millions of people came and they went to the Prairies and we fed them," she says. "We fed a nation." She is dressed, as she almost always is, in a dark blazer with a silk scarf tied in a bow around her neck. (It's her trademark look. Even in a documentary about family businesses she once helped make, she donned the same outfit to sail into the sunset in a Laser.)

Aside from her nautical training, which came from her father, who was a champion sailor, Gail's formal education took place in the classrooms of the University of Toronto. One degree followed the other - her four degrees have more letters than her name - and the experience peppers her speech. For instance, in recalling Cara's hostile takeovers in recent years, she alludes to research on a U.S. rescue mission in Albania. She comfortably switches from abstract business concepts to classic literature to theology. "She is a very inquisitive person," says James Gillies, professor emeritus at Schulich School of Business at York University, who has known the Phelan women since they were teens. "I think of Gailey as a wee bit eccentric, imaginative and creative." He suspects she brings those traits to Cara and the numerous non-profit boards she's sat on, including the Friends of Women's College Hospital and Energy Probe.

Perhaps because of her education, or maybe because of her age (she's 12 years older than her sister), Gail presents herself as leader of the pack. Certainly, she is the keeper of the histories, citing important dates - like when her great-great-grandfather Daniel Donegan patented a "crematory" in Los Angeles, in 1893. More than once she interrupts her co-owners to say, "I'll answer this one - I do have an MBA."

Holiday, at 34, is the youngest of the trio, and appears eager to absorb the family folklore. She assumed a position on Cara Holdings' board after her mother, Sharon, died 10 years ago. "You grow up really quick," she says over her salad. "I was 24. Even though it's shocking to be thrown into an adult world, I felt really supported by my family." Board duties aside, Holiday's passion is directing environmental documentaries. She has completed one on California's ancient redwood forest - produced with her husband Christopher Johnson - and the couple are talking to National Geographic about a documentary on sharks in New Zealand's reef system. She travels from her home in California to Toronto four times a year, and is looking for an apartment in the city for when she's here on company business.

For now, she is staying with her Aunt Rosemary, 47, who bought a house in Rosedale with her second husband, Sam Blyth - who was once married to shoe-empire heiress Rosemarie Bata - just seven months ago. (Similar homes in the neighbourhood have recently sold for $5 million.) At 17, Rosemary was even younger than her niece when she took a seat on the board of the holding company that in turn owned Cara Operations. She says she still isn't sure why her father involved her. "Did he just want a body to fill the chair?" she wonders. "Or did he want to educate me in the systems and way the business works?"

Rosemary, dressed in an open-collared blouse with a charcoal pinstripe suit, is the most enigmatic of the three. When her sister speaks, Rosemary often gazes out the window, cutting in occasionally to ground Gail's comments. (At one point, the elder sister mentions a documentary that compares P.J.'s succession woes to the story of Job in the Old Testament. Rosemary says simply: "No, Gail. No.") She joined the operating company board last year. To that end, Rosemary plans to enrol in a corporate governance course at University of Toronto's Rotman School of Management this September.

Gail Regan is the clear voice of the group. She says the opportunity to speak publicly about the privatization is similar to a company throwing a party to close a deal. "People have to emotionally process a change so it's true," she says. "We don't want publicity, we just want to live our lives. But we felt that there has to be a process of expression on change."

Some companies have archives. Some put out a book to commemorate a milestone. Cara and the Phelans, with two books, two movies and archivists, make a full-scale production of it.

Cara got its start as the Canada Railway News Co. in 1883, building on the business of a few entrepreneurial Phelans who were selling apples and newspapers on trains leaving Toronto. As people found new ways to travel, the company kept pace. But by the time P. J. Phelan came along, in the mid-'50s, Cara's ownership structure was a mess, as were its business divisions. As the company's history books like to boast, P.J. "awoke the sleeping giant" when he consolidated ownership and shifted Cara's focus from transportation to restaurants. The corporate chronicles, however, don't quite tell the whole story.

While P.J. had a clear vision for the company, he never laid out in writing how the next generation should assume control. True, he involved them at an early age by giving them seats on the board of the holding company, but it met just once a year, around Christmas, and was partly an excuse to enjoy a meal at Toronto's Royal York hotel. P.J. never definitively chose which of his children would replace him. "I think the succession issue was incredibly painful for P.J.," says Gail.

It is unclear when family ties started to unravel, but in the early '90s Paul Jr. quit the board. Lawsuits over share structures flew back and forth. By 1998, tensions peaked. Paul Jr. sold his Cara shares to his sisters and niece. "I felt good about it at the time because Cara collapsed and I got into the tech boom market and that took off," he recalls. (Paul Jr. apparently had an eye for technology. He claims to be "the first individual in the whole entire world" to own a personal computer: "I've been saying that for five or 10 years and my kids keep saying, 'Don't say that - people will think you're crazy.' ") ,p>When the tech bubble burst, Paul Jr. wanted back into the family business. He began buying up non-voting shares. When Cara once again raised the spectre of going private - investors had been hearing that for years - he and his nine million shares came out fighting, alongside institutional investor Jarislowsky Fraser. "If SARS hadn't been there, if mad cow hadn't been there and if Air Canada was not in bankruptcy [protection], Cara would have been making a lot more money," says Len Racioppo, the Toronto-based president of Jarislowsky Fraser. "We don't buy a company based on the earnings over the next 12 months." Though the fund company objected to the initial transaction price, it sold after the Phelans upped their offer by 35¢ to $8 per share.

Investors like Paul Jr. had no choice but to liquidate. The Phelan women, meanwhile, came out of the process determined never to let the succession nightmare happen again. And as for Cara, it ended up with a nine-digit bank loan.

Three hundred and sixty-five million dollars - that's the cost of freedom, at least if you're running Cara. That means no more shareholders griping about quarterly earnings. The freedom to grow - or not to grow - as you please. And the freedom to speak. During a late-April interview, Gabe Tsampalieros, CEO of Cara and a longtime ally of the Phelan women, lists the names of the company's new board, days before a formal announcement. "If we were a public company, I couldn't have told you that," he laughs. The way Tsampalieros sees it, the privatization was "win, win, win all around. We have more freedom, [the family] has the peace they want, shareholders have the money they always wanted."

Watching Tsampalieros interact with the three Phelans and play with baby Mia, it's clear he fits in the family better than their own brother does. (There's no love lost between the two men - Tsampalieros doesn't mention Paul Phelan Jr. by name, while the brother says the executive is "a little doggie on my sisters' chain.") Not only is he the CEO, Tsampalieros is also Cara's largest franchisee, with 32 Harvey's and Swiss Chalet restaurants. Even the naturally forthright Gail Regan sits back to listen to the CEO speak. What's more, this outsider - a one-time commercial lawyer - was allowed to retain a slightly more than 1% position in the family business, which is more than Paul Jr. can say.

In keeping with the corporate structure laid out by P.J., the owners largely leave company business to non-family management. They may help draft corporate direction at the broadest level, but it has been Tsampalieros's job to get there, through divestments, expansion and acquisition. Gail says she occasionally runs ideas past the CEO for his consideration. "Sometimes, he will follow through, sometimes not," she says. "It's like a bouncing board for ideas."

When he was hired, in 1995, Tsampalieros's orders were to shake up Cara's ailing business units. P.J.'s health had started to fail. The burger wars had bitten into Harvey's and many Cara restaurants desperately needed a fresh coat of paint. According to analysts, Tsampalieros did much of what he set out to achieve. But there's still more work to be done. For one thing, revenues at chains like Harvey's and Second Cup have declined as competitors flood the key market of southern Ontario, the company's heartland. Two years ago, Cara bought Vancouver-based restaurant chain Milestone's, but has been slow to roll the concept out across Canada. Meanwhile, the western expansion of Swiss Chalet is only now picking up after a disappointing start.

While such examples reinforce Cara's slow and steady reputation, it will strike fast when opportunity arises. Michael Bregman says that was the case when Cara launched a takeover bid of Second Cup, in 2001. Bregman, who was chairman and a major shareholder, says he had just completed an extension of a five-year shareholder agreement with Cara executives to prevent the food giant, which already owned 39% of the coffee chain, from gulping it down whole. Then Bregman's father passed away. A few weeks later, he says, Tsampalieros came by his office and announced Cara planned to acquire control. Recalls Bregman: "I asked him, 'Gabe are you here to inquire if this is acceptable to me...or are you telling me this is a courtesy before announcing it?' " The two sides fought a protracted battle for control, which Cara won. "Business can be tough, and I can be a tough guy," says Bregman. "But this crossed every line that I would draw in terms of business conduct. And I could never get over that, to be honest with you."

Other companies are safe from Cara for the time being. "I see us paying off the bank debt," Gail says. "That looms large, and we won't be doing any acquisitions for the next two years." Just the sound of the word "debt" seems to knock the wind out of Holiday, who sighs loudly and sinks in her chair. "This is our modus operandi right now," she says. Tsampalieros admits the debt load is heavy. "We are more leveraged than we have been in the last 15 years," he says. But, he adds, "we weren't reckless" during the privatization.

For the time being, the company will focus on cutting costs. While observers have speculated that the Cara privatization was merely a preamble to its going public again - perhaps as a trust, but certainly at a premium to the price the Phelans paid - privacy is something that Tsampalieros says gives him more room to manoeuvre than in the past. In 1998, for instance, Cara announced it would shutter 71 outdated Harvey's locations and took a $15-million writedown. In a matter of days, investors lopped $225 million off Cara's market cap - almost equal to the burger chain's annual revenue. "That would suggest what was left was worth nothing," Tsampalieros says.

One person who can relate to Tsampalieros's relief is Ron Joyce, the co-founder of Tim Hortons, of which he was sole owner. (He was eventually bought out by U.S. fast-food giant Wendy's International.) "In many ways, private companies are a lot more efficient," says Joyce. "What I loved with the Tim Hortons chain was I would quite often have my board meetings when I was shaving in the mornings." Joyce's connection with Cara isn't just casual: he held several meetings with Cara executives while looking for a Canadian buyer of his doughnut chain. Paul Jr., meanwhile, alleges Holiday vetoed any deal - because she "didn't like doughnuts." Joyce says he's never heard that, and he got the impression Cara was "very interested" in acquiring his growing chain. In the end, he sold to Wendy's because he wanted the chain to expand into the U.S. To the end, though, he held "quite a few shares" in Cara. "The shares didn't do that great, but the takeout made it worthwhile," Joyce says.

Now that Cara is private, far fewer people need worry about what could go wrong. For the moment, the biggest threat is Air Canada - the airline-catering division's biggest customer. Cara got a scare last November when the airline repudiated its contract. The two sides signed another contract a month later, but Cara was forced into a substantially reduced deal. Now, since going private, a new problem has emerged: Cara has reportedly asked the union representing airline catering workers for up to $20 million in concessions. That comes at a time when competitors argue they can replace Cara's airport-based facilities with offsite operations. Tsampalieros has some innovative ideas to spice up the airline division - and maybe even turn airplane food into food again. Among them, he plans to allow travellers to pre-order meals from Cara's most popular restaurant brands.

In any event, industry watchers worry Cara's debt will leave its hands tied in the event of another storm. "They got struck by lightning three times last year," says portfolio manager Racioppo. "Who the heck knows what's coming for them? Have no doubt about it, Gail, her sister and her niece have taken on a pretty big risk here." For the Phelans, however, sentiment can trump trepidation, at least when it comes to the airline business. "Anything that comes through the door, I get very attached to," says Gail. "It is not something we would let go easily."

That emotional connection will likely play a greater role from now on. The women say they now can implement projects that might have drawn the ire of shareholders before. Holiday would like to see some Cara restaurants go green in their packaging. Gail, on the other hand, is allergic to wheat and says many Canadians are, too. "I don't know if it's cost effective," she says, "but I would like to see non-wheat bread products available."

Perhaps the most stark example of the women's involvement in decision-making occurred in the mid-'90s. Cara's management was approached by a wildly successful U.S. chain, growing at a rate of 30 outlets per year and looking to expand north of the border. Revenue was already in the hundreds of millions, and it had carved out a new and profitable niche. All in all, it would be a sexy buy. The problem was, it was Hooters - and the Phelan women put their collective foot down. "As soon as it hit us, it certainly wasn't seriously entertained," says Holiday. "I'm sure the business has a good income, but it wasn't going to fit under the umbrella of the companies we felt proud about." In short, she says, "we didn't want to sell porn."

Hooters - porn or no - didn't fit. (Then again, neither did Grand & Toy, but Cara still bought the officer supplier in 1990 and ran it for six years.) There's no telling what investors would have thought had they heard of Cara's fleeting interest in the cheeky bar, or that it had been turned down on the principles of the principals. Hooters, which eventually penetrated the Canadian market with 13 locations, now grosses US$750 million a year.

Paul Phelan Jr. looks upset, but it's hard to tell whether that's because he's talking about the family's strife, or because of his near-death experience the day before in the Old Forest Hill stone mansion the Phelan family grew up in. He and his daughter Jennen had been in the elevator in the two-storey home when it stalled between floors - and then caught fire. Paul Jr. grabbed the emergency phone to call his wife, who promptly dialled 911. Within minutes, the fire department was on the scene to rescue them. Safely seated now in his office at the back of the house, Paul Jr. recalls how, as a child, he would invite his friends to take "scary elevator rides. I've taken my last scary elevator ride," he adds firmly.

As you enter the house through the iron gate and heavy oak front doors, it's like walking into a castle. Portraits of past Phelans adorn the walls. A tarnished suit of armour, complete with sword, guards the foot of the stairs. The regal imagery clashes with the mound of computer parts strewn across Paul Jr.'s desk and the half-empty bottle of Scope on the mantle, beneath an ink sketch of T. P. Phelan - whose ventures included buying 1,600 barrels of apples and shipping them off for sale in England in 1873.

The home is in a state of disrepair, and in that reflects P.J.'s troubled legacy. The visionary behind the modern Cara was always one to get his hands dirty when it came to business. He went to Ryerson in Toronto to learn to cook, calling himself the first Phelan restaurateur. He never thought small. "I want to be friends with the world," P.J. said during a 1996 interview. "But I want to make a dollar, too."

While he had a strong idea of where Cara should go, P.J. never figured out how his family would fit into the picture. With age, he grew more stubborn about relinquishing control. Since the early '80s, the family had been meeting regularly with David Bork, a consultant with the Aspen Family Business Group, who tried repeatedly to design a succession plan for the family. P.J. never bought in. The problem became acute when he fell ill in the mid-'90s without setting out a clear succession plan. "He didn't see the girls as not having a place in the company," says Gail. "He just didn't see them having a vote."

In essence, a power vacuum formed. The fights became more vicious, spilling into the courts. In 1998, the family made a last-ditch effort to salvage relations. P.J.'s shares were put under control of trustees who along with the four children drafted a shareholders agreement. Almost immediately, Paul Jr. sold his shares to his sisters and niece. "You've got a lot of fractious behaviour," says Bork now. "For a company to survive and prevail, they have got to reduce the amount of distractions."

Today the two sides dispute some of the details of what happened, but seem to agree P.J. would have liked to see his son to take over. "I always thought he really wanted Paul Jr. to succeed him," says James Gillies. "It was a male macho thing." Today, though he sold his stake to his siblings, Paul Jr. is the most bitter of the lot. "I thought my father was catering to his daughters," he says. "But I see now that they were controlling bullies." He says he believes Cara went private to push him out of the scene -and that it was a shock to be shut out of the family business. "It's been part of my whole life," he says. "You don't realize how much that works on your psyche, and then one day you wake up and you're not you anymore, and you're not the person you've always been."

That tension is what Mia was born into. She is part of the reason for renewed efforts to craft a peaceful transition to future generations. Once again, Bork is helping guide the family. And with only the Phelan women left in the picture, they are more willing to consider his advice.

The ideal structure, as Bork sees it, is a new entity superseding Cara Holdings. The added layer of governance will require a new shareholders' agreement, giving each woman's family a single vote. How each share is voted will be determined in individual family councils. Each family, in turn, will have to develop its own succession plan and determine who is qualified to vote.

Hammering out the details is a daunting challenge. The Phelans must contend with staggered generations. While Mia is perhaps 18 years away from her first vote, Gail's son Sean is 40 and doing advisory work for the company. It doesn't help that the clan is scattered across North America. "This family has its own share of challenges," says Bork. But Cara's three owners think they have an edge. "We're women," they say in unison. "We are much more consensus-oriented and less driven," says Rosemary. "Not less driven," adds Holiday. "Less driven by ego."

In Anna Karenina, Leo Tolstoy famously wrote: "Happy families are all alike; every unhappy family is unhappy in its own way." Despite all the talk about democracy and planned succession, the fact remains: families are illogical, emotional entities, some more so than others. No matter how many rules you devise, you can't choose your family. Can the Phelans put history behind them and bring peace to their clan? Clearly, going private is part of that effort. Cara is now largely back where it was 35 years ago. If the three women are successful, in 35 years Cara will still be a thriving company that Mia, like her great-grandfather, will be proud to call her own.

Given the state of the airline industry, it is not surprising that Cara's catering division is hurting. What is astonishing is that that division is down only 6% from 2001. With the recent news the airline signed a deal with its union, is the worst over? Even if Air Canada survives, there's talk of new competition. To cut costs, Cara has asked its unionized staff at its flight kitchens to take a pay cut.

Milestone's

The casual eatery is the newest addition to the Cara menu. Milestone's - with it's trademark Bellinis - is a real growth opportunity. It has expanded to more than 25 locations since the first restaurant opened on Vancouver's Denman Street, in 1989. It attracts some of the beautiful people; pop-idol Justin Timberlake was recently spotted at one with actress Cameron Diaz.

Second Cup

There's only one way to describe the performance of this coffee shop: decaffeinated. Sales for the café chain fell last year for the first time in years. If Second Cup doesn't sweeten its sales soon, it could lose its illustrious title as the "leading specialty coffee retailer in Canada" to Starbucks, which is growing faster than you can order a grande latte.

Kelsey's

The neighbourhood bar and grill is growing at more than 10% a year. If Kelsey's can keep that pace up, its sales should surpass Cara's airline catering division sometime this year. Last month, the chain announced it will switch over to 100% Canadian beef. Welcome news for Alberta's cattle farmers, who are still suffering from last year's mad cow outbreak.

Other brands include Montana's Cookhouse, Outback Steakhouse, Air Terminal restaurants, summit food service.

Written by Mark Brown

With files from Jason Kirby




  
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