下载掌阅APP，畅读海量书库
立即打开
By the time Peterson and Schwarzman extricated themselves from Lehman and Shearson in 1985, the buyout business was booming and the scale of both the buyout funds and the deals themselves were escalating geometrically. Kohlberg Kravis Roberts and a handful of rivals were moving up from bit parts on the corporate stage to leading roles.
Several confluent factors were fueling the rise in buyout activity. Corporate conglomerates, the publicly traded holding companies of the 1960s that assembled vast stables of unrelated businesses under a single parent, had fallen out of favor with investors and were selling off their pieces. At the same time, the notion of a “core business” had penetrated the corporate psyche, prompting boards of directors and CEOs to ask which parts of their businesses were essential and which were not. The latter were often sold off. Together these trends ensured a steady diet of acquisition targets for the buyout firms.
But it was the advent of a new kind of financing that would have the most profound effect on the buyout business. Junk bonds, and Drexel Burnham Lambert, the upstart investment bank that single-handedly invented them and then pitched them as a means to finance takeovers, would soon provide undreamed-of amounts of new debt for buyout firms. Drexel’s ability to sell junk bonds also sustained the corporate raiders, a rowdy new cast of takeover artists whose bullying tactics shook loose subsidiaries and frequently drove whole companies into the arms of buyout firms. Over the course of five years, Drexel’s innovations revolutionized the LBO business and reshaped the American corporate establishment.
A decade earlier buyouts had been a cottage industry with just a handful of new and more established LBO boutiques. They typically cobbled together a couple of small deals a year, maybe $30 million at the biggest. Gibbons, Green, van Amerongen; E. M. Warburg Pincus, which mostly invested in start-ups; AEA Investors; Thomas H. Lee Company, started by a First National Bank of Boston loan specialist; Carl Marks and Company; Dyson-Kissner-Moran—it was a short list. But the scent of profit always draws in new capital, and soon new operators were sprouting up.
KKR, which opened its doors in 1976, was the most prominent. KKR’s doyen at the time was the sober-minded, bespectacled Jerry Kohlberg, who began dabbling in buyouts in 1964 as a sidelight to his main job as corporate finance director of Bear Stearns, a Wall Street firm better known for its stock and bond trading than for arranging corporate deals. In 1969 Kohlberg hired George Roberts, the son of a well-heeled Houston oilman, and later added a second young associate, Roberts’s cousin and friend from Tulsa, Henry Kravis. Kravis, whose father was a prosperous petroleum engineer, was a resourceful up-and-comer, small of stature, with a low golf handicap and a rambunctious streak. On his thirtieth birthday he fired up a Honda motorcycle he’d gotten as a gift and rode it around his Park Avenue apartment. In 1976, Kohlberg, then fifty, and Kravis and Roberts, thirty-two and thirty-three, respectively, quit Bear Stearns after a stormy showdown with Bear’s CEO, Salim “Cy” Lewis, a lifelong trader who considered buyouts an unrewarding diversion.
The trio’s inaugural fund in 1976 was a mere $25 million, but they quickly demonstrated their investing prowess, parlaying that sum into a more than $500 million profit over time. That success made KKR a magnet for investors, who anted up $357 million when KKR hit the fund-raising trail for the second time in 1980. A decade after KKR was launched, it had raised five funds totaling more than $2.4 billion.
While Lehman’s executive committee had balked at Peterson and Schwarzman’s suggestion that Lehman buy into companies, other banks had no qualms and by the early 1980s many were setting up their own in-house buyout operations. In 1980, two years after KKR’s landmark Houdaille deal was announced, First Boston’s LBO team topped that with a $445 million take-private of Congoleum, a vinyl-flooring producer. Soon Morgan Stanley, Salomon Brothers, and Merrill Lynch followed suit and were leading buyouts with their own capital. Goldman Sachs stuck its toe in the water as well. Goldman’s partners agonized over their first deal, a pint-sized $12 million takeover of Trinity Bag and Paper in 1982. “Every senior guy at Goldman obsessed about this deal because the firm was going to risk $2 million of its own money,” remembers Steven Klinsky, a Goldman banker at the time who now runs his own buyout shop. “They said, ‘Oh, man! We’ve got to make sure we’re right about this!’ ”
The clear number two to KKR was Forstmann Little and Company, founded in 1978. It was only half KKR’s size, but the rivalry between the firms and their founders was fierce. Ted Forstmann was the Greenwich, Connecticut–reared grandson of a textile mogul who bounced around the middle strata of finance and the legal world until, with a friend’s encouragement, he formed his firm at the age of thirty-nine. He swiftly proved himself a master of the LBO craft, racking up profits on early 1980s buyouts of soft-drink franchiser Dr Pepper and baseball card and gum marketer Topps. Though he had less money to play with, his returns outstripped even KKR’s, and like Kravis he became an illustrious and rich prince of Wall Street whose every move drew intense press scrutiny.
KKR remained the undisputed leader, though. Houdaille came to be recognized as the industry’s Big Bang—the deal that more than any other touched off the ensuing explosion of LBOs. Doggedly gathering new capital every two years or so and throttling up the scale of its deals, by the mid-1980s KKR dominated buyouts in the way that IBM lorded over the computer business in the 1960s and 1970s.
In the early days of the buyout, many of the target companies were family-owned businesses. Sometimes one generation, or a branch of a family, wanted to cash out. An LBO firm could buy control with the other family members, who remained as managers. But as the firms had greater and greater amounts of capital at their disposal, they increasingly took on bigger businesses, including public companies like Houdaille and sizable subsidiaries of conglomerates.
In their heyday in the 1960s, conglomerates had been the darlings of the stock market, assembling ever more sprawling, diversified portfolios of dissimilar businesses. They lived for growth and growth alone. One of the golden companies of the era, Ling-Temco-Vought, the brainchild of a Texas electrical contractor named Jimmy Ling, eventually amassed an empire that included the Jones & Laughlin steel mills, a fighter jet maker, Braniff International Airlines, and Wilson and Company, which made golf equipment. Ling’s counterpart at ITT Corporation, Harold Geneen, made what had been the International Telephone & Telegraph Company into a vehicle for acquisitions, snatching up everything from the Sheraton hotel chain to the bakery that made Wonder Bread; the Hartford insurance companies; Avis Rent-a-Car; and sprinkler, cigar, and racetrack businesses. At RCA Corporation, once just a radio and TV maker and the owner of the NBC broadcasting networks, CEO Robert Sarnoff added the Hertz rental car system; Banquet frozen foods; and Random House, the book publisher. Each of the great conglomerates—Litton Industries, Textron, Teledyne, and Gulf and Western Industries—had its own eclectic mix, but the modus operandi was the same: Buy, buy, buy.
Size and diversity became grail-like goals. Unlike companies that grow big by acquiring competitors or suppliers to achieve economies of scale, the rationale for conglomerates was diversification. If one business had a bad year or was in a cyclical slump, others would compensate. At bottom, however, the conglomerate was a numbers game. In the 1960s, conglomerates’ stocks sometimes traded at multiples of forty times earnings—far above the historical average for public companies. They used their overvalued stock and some merger arithmetic to inflate their earnings per share, which is a key measure for investors.
It worked like this: Suppose a conglomerate with $100 million of earnings per year traded at forty times earnings, so its outstanding stock was worth $4 billion. Smaller, less glamorous businesses usually traded at far lower multiples. The conglomerate could use its highly valued shares to buy a company with, say, $50 million of earnings that was valued at just twenty times earnings. The conglomerate would issue $1 billion of new stock ($50 million of earnings × 20) to pay the target’s shareholders. That would lift earnings by 50 percent but enlarge the conglomerate’s stock base by just 25 percent ($4 billion + $1 billion), so that its earnings per share increased by 20 percent. By contrast, if it had bought the target for forty times earnings, its own earnings per share wouldn’t have gone up.
Because stock investors search out companies with rising earnings per share, the acquisition would tend to push up the buyer’s stock. If the conglomerate maintained its forty-times-earnings multiple, it would be worth $6 billion, not $5 billion, after the merger ($150 million of earnings × 40). If the buyer borrowed part of the money to buy the target, as conglomerates typically did, it could issue less new stock and jack up earnings per share even higher.
This sleight of hand worked wonderfully in a rising market that sustained the lofty multiples. But reality caught up with the conglomerates at the end of the 1960s, when a bear market ravaged stocks, the numbers game fizzled out, and investors cooled to the conglomerate model. They came to see that the earnings of the whole were not growing any faster than the earnings of the parts, and that the surging earnings per share was ultimately an illusion. Moreover, managing such large portfolios of unrelated businesses tested even very able managers. Inevitably there were many neglected or poorly managed subsidiaries. Investors increasingly began to put more store in focus and efficiency. Under pressure, the discredited behemoths were dismantled in the 1970s and 1980s.
In many cases, buyout shops picked up the cast-off pieces. A banner year for such deals was 1981, when interest rates spiked, the economy hit the wall, and stock prices fell, putting many businesses under stress. KKR bought Lily-Tulip, a cup company, from the packaging giant Owens-Illinois and also PT Components, a power transmission components maker, from Rockwell International, which by then made everything from aircraft to TVs and printing presses. Near the end of that year Forstmann Little struck a deal to buy Beatrice Foods’ soft-drink bottling operations, and Wesray negotiated its deal to buy Gibson Greeting from RCA.
As the decade wore on and their bankrolls swelled, bigger LBO shops took aim at whole conglomerates with an eye to splitting them up, as KKR would do with Beatrice Foods in 1986. By then Beatrice had branched out from its roots as a dairy and packaged-food company to include Playtex bras and the Avis car rental chain once owned by ITT.
What turbocharged the buyout boom was a colossal surge in the amount of capital flowing into buyouts—both equity and debt.
As KKR, Forstmann Little, and other buyout firms chalked up big profits on their investments of the late 1970s and early 1980s, insurance companies and other institutions began to divert a bit of the money they had invested in public stocks and bonds to the new LBO funds. By diversifying their mix of assets to include buyouts and real estate, these investors reduced risk and could boost their overall returns over time. The money they moved into the buyout funds was used to buy the stock, or equity, of companies.
Equity was the smallest slice of the leveraged-buyout financing pie—in that era usually just 5–15 percent of the total price. The rest was debt, typically a combination of bank loans and something called mezzanine debt. The bank debt was senior, which meant it was paid off first if the company got in trouble. Because the mezzanine loans were subordinate to the bank loans and would be paid off only if something was left after the banks’ claims were satisfied, they were risky and carried very high interest rates. Until the mid-1980s, there were few lenders willing to provide junior debt to companies with high levels of debt like the typical LBO company. A handful of big insurance companies, including Prudential Insurance Company of America, Metropolitan Life Insurance Company, and Allstate Insurance Company, supplied most of the mezzanine debt, and it was far and away the hardest piece of the financing for buyout firms to round up.
The insurers’ terms were punishing. They not only exacted rates as high as 19 percent but typically demanded substantial equity stakes, as well, so they would share in the profits if the investment turned out well. When Henry Kravis demurred to Prudential’s demands on two deals in 1981 where the insurer’s terms seemed extortionate to him, a Prudential executive bluntly told him there was nowhere else for KKR to turn. At the time, he was right.
The financing landscape began to shift in 1982 and 1983 as the American economy recovered from the traumas of the previous decade—the 1973 oil embargo followed by a deep mid-decade recession, a stagnant stock market, and double-digit inflation. Inflation was finally choked off when the Federal Reserve Board ratcheted up short-term interest rates to nearly 20 percent, triggering a second recession at the beginning of the new decade. The harsh medicine worked and by late 1982 inflation had been tamed and interest rates headed down. That jump-started the economy, stoked corporate earnings, and set the stage for a potent bull market in stocks that lasted most of the 1980s. This combination of lower interest rates and rising corporate valuations put the wind at the backs of the buyout firms for much of the rest of the decade. “ It was like falling off a log to make money back then,” says Daniel O’Connell, a member of the First Boston buyout team.
On the debt side of the LBO equation, U.S. banks flush with petrodollars from oil-rich clients in the Middle East and Japanese banks eager to grab a piece of the merger business in the States began building their presence and pumping huge sums into buyout loans. At the same time, a new form of financing emerged from the Beverly Hills branch of a second-tier investment bank. The brainchild of a young banker there named Michael Milken, the new financing was politely called high-yield debt but was universally known as the junk bond, or junk for short.
Until Milken, bonds were the preserve of solid companies—the sort of companies that investors could feel confident would pay off their obligations in installments steadily for ten or twenty or fifty years. Milken’s insight was that there were lots of young or heavily indebted companies that needed to borrow but couldn’t tap the mainstream bond markets and that there were investors ready to provide them financing if the interest rate was high enough to compensate for the added risk. Renowned for his work ethic, he put in sixteen-hour days starting at 4:30 A.M. California time, an hour and a half before the markets opened in New York.
Milken built Drexel’s money machine in increments. In 1974 he assembled a small unit that traded existing bonds of so-called fallen angels, once profitable companies that had fallen on hard times. In 1977 his group began raising money for companies that finicky top-end investment banks wouldn’t touch, helping them issue new bonds. In that role, Milken’s team bankrolled many hard-charging, entrepreneurial businesses, including Ted Turner’s broadcasting and cable empire (including, later, CNN) and the start-up long-distance phone company MCI Communications.
After a breakout year in 1983, when Drexel sold $4.7 billion of junk bonds for its corporate clients, the bank saw the chance to move into the more lucrative field of advising on and financing mergers and acquisitions. Drexel would no longer just finance expansion but now threw its weight behind LBOs and other corporate takeovers. By then the Drexel organization had become a master at selling its clients’ bonds to investors, from insurance companies to savings and loans, tapping a broad and deep pool of capital, matching investors with an appetite for risk and high returns with risky companies that needed the money. Milken had such sway with Drexel’s network of bond investors that he could muster huge sums and do it faster than the banks or Prudential ever could.
KKR was one of the first clients to test Drexel at this new game, accepting Milken’s invitation to help finance a $330 million buyout of Cole National, an eyewear, toy, and giftware retailer, in 1984. Though Drexel’s debt was expensive, the terms still beat those of Prudential, and KKR soon stopped tapping insurers altogether and drew exclusively on Drexel’s seemingly bottomless well of junk capital. Kravis called Drexel’s ability to drum up big dollars in a flash “the damnedest thing I’d ever seen.” Before long, the insurance companies’ mezzanine debt mostly disappeared from large deals, replaced by cheaper junk from Drexel.
At their peak in the mid-1980s, Milken and his group underwrote $20 billion or more of junk bonds annually and commanded 60 percent of the market. The financial firepower they brought to bear in LBOs and takeover contests redefined the M&A game completely.
At the same time, a robust economy and a steadily rising stock market were yielding a bonanza for buyout investors. Investors in KKR’s first five funds saw annual returns of at least 25 percent from each and nearly 40 percent from one. They earned back six times their money on the firm’s 1984 fund and a staggering thirteen times their investment on the 1986 fund over time, after KKR’s fees and profit share. The buyout game became impossible for pension funds and other investors to resist, and when KKR passed around the hat again in 1987 it raised $6.1 billion, more than six times the size of its largest previous fund. The buying power of that capital would then be leveraged many times over with debt.
With Drexel’s backing, KKR went on from Cole National to execute five buyouts in 1986 and 1987 that would still be large by today’s standards, including Beatrice Foods ($8.7 billion), Safeway Stores ($4.8 billion), glass maker Owens-Illinois ($4.7 billion), and construction and mining company Jim Walter Corporation ($3.3 billion). The scale of the takeovers—made possible by Drexel and the mammoth new fund KKR raised in 1987—propelled the firm into the public light. With $8 or $10 of debt for every dollar of equity in its fund, KKR could now contemplate a portfolio of companies together worth $50 billion or $60 billion. The media took to calling Kravis “King” Henry, and he quickly came to personify the buyout business. (Kravis’s press-shy cousin Roberts lived and worked in faraway Menlo Park, California, off the New York media and social radar. Jerry Kohlberg resigned from KKR in 1987, after clashing with his former protégés over strategy and lines of authority.)
When KKR chased by far the biggest buyout of all time, that of RJR Nabisco in 1988, that too was largely with Drexel money. At bottom, Kravis’s power and celebrity, like the deals KKR did, were magnified by the billions put up by Drexel.
* * *
Buyout specialists weren’t the only financial players benefiting from and dependent on Milken. At the same time that LBO firms were proliferating, Drexel was also staking a new, rude, and belligerent horde that emerged on the corporate scene. The corporate establishment and a skeptical press coined a string of equally unflattering names for the new intruders: corporate raiders, buccaneers, bust-up artists, and, most famously, barbarians.
Like wolves, the raiders stalked stumbling or poorly run public companies that had fallen behind the herd, and they bought them in LBOs. Like the buyout firms, the raiders were forever on the lookout for companies whose stocks traded for less than they thought the companies were worth—because they had valuable assets that weren’t reflected in the stock price or because the companies were inefficiently managed. Both the raiders and the buyout firms sought hidden value that could be captured by splitting up companies to expose the latent value of their parts. But, despite their assertions to the contrary, the raiders generally had little interest in taking control of the firms they targeted, and—unlike buyout firms, which usually wooed the top executives of the companies they sought—the raiders dedicated themselves to taunting and eventually ousting management.
The hunted and the hunters each portrayed the other side in stark caricatures, and there was more than a grain of truth to what each side said. Many corporate bigwigs did in fact fit the raiders’ stock image. The eighties were an era of the imperial CEO, who packed his board with cronies, kept a private jet (or two or three), and spent millions on celebrity sporting events and trips that added little to the bottom line. Doing right by shareholders wasn’t high on every CEO’s agenda, so it wasn’t hard for the raiders to cast themselves as militant reformers intent on liberating businesses from the clutches of venal, high-living CEOs who cared more about their perks than about shareholders.
To the corporate world, the raiders were a ragtag band of greedy predators whose aim was to pillage companies and oust management for personal gain.
No one embodied the raider role better than Carl Icahn, a lanky, caustically witty New York speculator whose tactics were typical. After buying up shares, he would demand that the company take immediate steps to boost its share price and give him a seat on its board of directors. When his overture was rebuffed, he’d threaten a proxy fight or a takeover and rain invective on the management’s motives and competence in acidly worded letters to the board that he made public. Often these moves would cause the stock to rise, as traders hoped that a bid would surface or that the company would act on its own to sell off assets and improve its performance. Sometimes his tactics did in fact spark other companies to bid for the company he had in his sights. But either way, Icahn could cash out at a profit without having to actually run the target. Other times, the company itself paid him a premium over the market price for his shares just to get him to go away—a controversial practice known as greenmail.
Icahn’s peers were equally colorful: T. Boone Pickens, a flinty Texas oilman who launched raids on Gulf Oil, Phillips Petroleum, and Unocal; Nelson Peltz, a New York food merchant’s son known for his takeovers of the vending-machine company Triangle Industries and National Can; James Goldsmith, an Anglo-French financier who went after companies on both sides of the Atlantic, including Goodyear Tire and Rubber Company and British-American Tobacco, and whose marriages and affairs filled the gossip pages; and Ronald Perelman, a Philadelphia-bred businessman who won a heated bidding fight for the cosmetics maker Revlon, Inc., in 1985.
Milken backed them all as they pursued LBOs of companies whose shares they thought were cheap. For all their talk of overhauling badly run companies, the raiders seldom demonstrated much aptitude for improving companies. Peltz ran National Can ably enough, but Icahn ran Trans World Airlines into the ground after gaining control of it in 1986. (Icahn and Peltz were still plying their trade into the second decade of the twenty-first century.)
While buyout firms typically enlisted management in their bids, the corporate raiders’ instrument of choice was the uninvited, or hostile, tender offer, a takeover bid that went over the heads of management and appealed directly to shareholders. The device wasn’t new. In the 1960s and 1970s, Jimmy Ling of the conglomerate LTV, United Technologies CEO Harry Gray, and other acquisitive industrialists had used it now and again to seize control of unwilling corporate targets. But the raiders were a different breed, bent on shaking up the status quo, not building industrial empires. The executives of the growing companies that Milken helped finance were fiercely loyal to the banker, but his ties to the raiders earned him the enmity of most corporate CEOs. A giant of the M&A bar, Martin Lipton, inveighed against the evils of “bust-up, junk-bond takeovers.” And Lipton’s law firm took the lead in contriving legal defenses—“shark repellants” and “poison pills”—to ward off Milken’s marauders. Some banks such as First Boston attempted to straddle the fence, advising and financing corporations while also backing the raiders on particular deals, but as the raiders gained clout and cast their nets wider, Wall Street was forced to choose sides. Goldman Sachs assured its blue-chip corporate clients that it would never stoop to enabling a hostile takeover.
Even though the buyout firms used the same type of financing for their takeovers as the raiders, their aims and tactics were different. For starters, their intention was to gain control. Their investors put up money to buy companies, not to trade stocks. And unlike the raiders, buyout firms almost never pressed hostile bids against the wishes of management. In LBO circles, launching an all-out raid was all but taboo. KKR touted itself as sponsoring friendly collaborations with existing managers, which it dubbed “partnerships with management.” More than once—most famously in the case of Safeway in 1986—KKR played the “white knight,” joining forces with management in an LBO to repel a belligerent bidder. Indeed, the buyout firms were often kept in check by their own investors, for many public and corporate pension plans insisted that the firms they invested with do only friendly deals. But such opportunism hardly helped their image. They were seen as just one wing of the same disruptive, rapacious army making war on the corporate status quo. “ We came into a contested situation, so we looked like a raider,” says KKR’s longtime lawyer Dick Beattie.
In some cases, in fact, they did the nearest thing to a hostile takeover, by publicly announcing unsolicited offers for companies. Even if they didn’t bypass the board, the move usually put the target in play and put intense pressure on the company to do something to boost the share price. KKR used this tactic, known on Wall Street as a bear hug, a number of times, including with the Kroger Company, Beatrice Foods, and Owens-Illinois and eventually struck deals to buy the last two. To the lay observer, and the CEOs and directors who had to respond, the distinction between that and a genuine hostile bid made straight to shareholders was largely academic.
Moreover, the buyout firms, like an Icahn or a Perelman, did not shy from whacking excess costs at the companies they’d taken over. Both shared a view that corporate America was riddled with inefficiencies. (“ We don’t have assistants to assistants anymore,” the chairman of Owens-Illinois told Fortune magazine in 1988, the year after KKR bought the glass and packaging company. “In fact, we don’t have assistants.”) The fact that both groups had developed symbiotic relationships with Michael Milken ensured that they would be lumped together in the public’s consciousness. True or not, the image of LBO artists as a pernicious force on the corporate landscape was being permanently etched.
Egged on by the corporate establishment and labor unions, Congress explored ways to combat hostile takeovers and junk bonds. In a series of hearings from 1987 to 1989, buyout industry executives, corporate moguls, and others trooped to Capitol Hill to defend or deride the takeover wave. There was serious talk of abolishing the tax deductibility of the interest costs on junk bonds in order to kill off the alleged menace. At a meeting with Kravis and Roberts in 1988, Senator Lloyd Bentsen, who later that year ran unsuccessfully as the Democratic nominee for vice president, was said to have tossed a study prepared by KKR about the impact of LBOs in the trash. Congress in the end took no action to rein in takeovers, but some states did.
Apart from the tactics and the pursuit of companies that didn’t want to be bought, junk bonds stirred controversy for another reason: Many feared that Drexel and the LBO firms were piling too much debt on too many companies, putting them at risk in an economic downturn. Though he had made his name and fortune in LBOs, Ted Forstmann became a vocal critic of junk financing. The fiery-tempered Forstmann’s dislike of Kravis by the late 1980s had ripened into a deep-seated loathing. In op-ed pieces and in interviews, Forstmann fulminated about a culture of unbridled excess and a mounting dependency on junk bonds, arguing that it was ruining the LBO business and threatened to destabilize the broader economy. To his way of thinking, an honorable industry grounded in financial fundamentals and discipline had devolved into a quick-buck racket fueled by what he called “funny money” and “wampum.” Forstmann believed that the easy credit provided by the junk-bond market had pushed deal prices to loony levels and that target companies ended up laden with debt they couldn’t afford. Though he didn’t finger Kravis and Drexel publicly, the targets of his wrath were clear.
It was easy to see why Forstmann was upset by Drexel, because Forstmann Little didn’t rely on the junk market. Forstmann raised his own debt funds in tandem with his equity funds, in effect lending money from one hand to the other. That gave Forstmann Little great flexibility in formulating bids, but the firm couldn’t begin to marshal the masses of debt that the Drexel junk machine was feeding to its competitors. Forstmann’s firm was simply eclipsed by the scale of the Drexel operation. The competition between it and KKR had now transcended the win–loss column. Forstmann would privately rant that Kravis (“that little fart”) was leading the buyout business’s race to perdition. Kravis, for his part, was quoted snarkily telling associates that Forstmann suffered from an “an Avis complex.”