The Predators’ Ball (15 page)

In the sixties and seventies, the LBO market consisted mainly of buying private companies or divisions of public companies. LBOs that involved taking sizable public companies private did not start until about 1980.

And it was not until William E. Simon, former U.S. Treasury Secretary, pulled off the Gibson Greetings deal that the LBO became the craze of Wall Street. Wesray, the private investment group that Simon headed, acquired Gibson Greetings from RCA in 1982. In 1983, when Gibson Greetings went public again, Simon's group emerged with a remaining holding of about 50 percent in Gibson—and a profit of $70 million. By 1984, the dollar amount of completed LBOs would increase fourfold within the year, to reach $18.6 billion.

Though Drexel had not pioneered the LBO, it was a match made in heaven. It was a philosophical fit: the LBO represented a shift of control from a bureaucratic organization into entrepreneurial hands. And it was an extension of what Milken had been doing since 1977, when he started to help his clients to leverage their balance sheets with high levels of debt, through the issuance of junk bonds. Indeed, that realignment of the balance sheet—in which debt, with its tax-deductible interest payments, was so favored—had been explored by Milken in the paper he wrote in 1973 (after leaving Wharton) with one of his professors, James Walter. Entitled “Managing the Corporate Financial Structure,” the paper examined ways of optimizing investor returns by modifying a company's capital structure, and compared that to the management of an investment portfolio.

“Notwithstanding the focus of most corporate executives upon
the operating side of the business, opportunities for profit enhancement also exist in the financial end of the business,” Walter and Milken wrote. “The liability and net worth segments of the balance sheet represent portfolio positions that are subject to modification as conditions warrant. Neglect of such matters is patently inconsistent with rational behavior.”

In raising the financing for LBOs, Drexel would be doing what it did best—for the mezzanine level of unsecured debt in these highly leveraged deals was by definition junk. Before Drexel, that financing had generally been raised from private placements with a handful of insurance companies. But Milken had his legions of ready buyers, raised on a diet of just such high-yielding debt from companies with highly leveraged balance sheets. In 1982 Drexel placed the mezzanine financing for two deals, and in 1983 it did two more. Investment banker Leon Black, the only one in corporate finance besides Fred Joseph who seemed to have Milken's respect, headed the LBO group.

From there, it was a natural progression. If Milken could place the most difficult portion of debt in an LBO, which is a friendly, negotiated takeover, why couldn't he do the same thing in an “unfriendly LBO”—which is a hostile takeover using debt?

In November 1983, Joseph, Milken and members of their respective teams met with Cavas Gobhai in a suite at the Beverly Wilshire Hotel, next door to Drexel's new Beverly Hills office, to engineer the quantum leap. As Joseph recalled that meeting, “We started by asking, ‘Where does our financing muscle really come into play?' One thing that's hard to finance is unfriendly acquisitions. You can't finance them, because you can't tell people you're going to do the deal, and you don't know if you're going to need the money, and you don't know how much money you're going to need, because you may have to raise the price, and you don't have access to the inside information, and a lot of people don't like to get involved in unfriendly deals.”

Those were the problems. By the end of that two-day session, Milken, Joseph and the rest had decided to find a candidate so that they could start experimenting with solutions to them in the real world. Within a few weeks, T. Boone Pickens, targeting the Gulf Oil Company with his pygmy-sized Mesa, became their first test case.

But the germ of this new wildly egalitarian system—in which, before long,
anyone
(with Milken behind him) could take over any
company, no matter how large—had begun to grow about a year earlier, at yet another Gobhai session.

“We wanted to position ourselves so that Drexel had an awesome M&A capability,” Joseph recalled, “because we had the access to the money and the power.” They wanted to become so strong that companies doing deals would clamor to hire them—even if only to neutralize them. At the time, it was the stuff of fantasy, the daydream of omnipotence of every have-not.

At that 1982 session, Joseph and the others drew up a list of the people who were the stars of the M&A world. It included Martin Siegel of Kidder, Peabody; Eric Gleacher of Lehman Brothers; Bruce Wasserstein of First Boston; Felix Rohatyn of Lazard Frères; Ira Harris of Salomon Brothers—and lawyers too, like Martin Lipton of Wachtell, Lipton, Rosen and Katz, and Joe Flom of Skadden, Arps, Meagher, Slate and Flom.

At a Gobhai session, of course, all ideas are entertained, no matter how outrageous. This list, therefore, was not a literal recruitment list; Flom, for example, was not seen as a potential candidate, although his ties to the firm would grow as Drexel became one of his firm's five biggest clients over the next few years. But Joseph would later say that there were four on that list whom they did want—and Martin Siegel was at the top. “I took Marty on then, as my assignment to recruit,” Joseph would say four years later, in an interview in mid-1986 shortly after Siegel had left Kidder to join Drexel.

When that list was drawn up, the idea of persuading any of those individuals to join Drexel was, as David Kay put it, “chasing rainbows.” Before it could have even the faintest hope of luring one of those stars, Drexel had to bust its way into the M&A preserve, through sheer financial force. And one way to do that—which would be implemented not literally but in spirit—emerged at this session.

Drexel's problem was that it had no Fortune 500 client with a billion-dollar bank line to wage a takeover. But what if
Drexel
had the billion dollars, at the ready? Or what if they said they did (and got it later)? And what if, by their staking the word of the firm on this claim, the world believed it and acted accordingly? In the new lexicon—and universe—that Drexel would soon create, this concept would become known as the “highly confident” letter. But for now it was christened (for its emptiness) the Air Fund.

“We would announce to the world that we had raised one billion dollars for hostile takeovers,” one Drexel executive recalled. “There would be no money in this fund—it was just a threat. The Air Fund stood for our not having a client with deep pockets who could be in a takeover. It was a substitute for that client we didn't have.

“That concept led to our making Carl Icahn real instead of nettlesome. Carl ended up being our Air Fund. Boone ended up being our Air Fund. We manufactured out of thin air—almost thin air—a credible takeover guy.”

O
N
A
PRIL
2, 1985, the conference room on the eighth floor of the no-frills National Can headquarters in southwest Chicago was packed with the usual armies of deal advisers—M&A lawyers from Skadden, Arps, Slate, Meagher and Flom as well as from Paul, Weiss, Rifkind, Wharton and Garrison, and investment bankers from Salomon Brothers. There were some new investment-banking faces too, troops who were still a little green but who had launched a juggernaut that was now commanding the attention, and fear, of corporate chieftains across the country, as well as the one in this room.

Drexel—in the spirit of the GI Joe poster hanging behind the desk of one of Drexel's senior executives, a poster which had been designed as a mock ad for the firm and featured the hero leading his platoon, their guns spitting fire—had arrived.

Two weeks earlier, Triangle Industries, controlled by Nelson Peltz and Peter May, had made a Drexel-financed, unsolicited $41 all-cash tender offer for all outstanding shares of National Can. Now, with other options for the company having failed to materialize, it looked as though a friendly deal might be struck. Frank Considine, the silver-haired, patrician CEO of National Can, threaded his way through the crowd and asked Peltz to come into his office. May was Peltz's one-third partner, but Peltz was the lead player and deal-maker. Alone with Peltz, Considine told him that he might be willing to do the deal, but the shareholders would have to get a better price. The two men talked for about ten minutes, and then Peltz raised his offer to $42 a share.

“Nelson did that dollar totally on his own,” said Fred McCarthy
of Drexel, who was advising Peltz. The additional dollar raised the price of the deal by $9 million. “Leon [Black] and I thought it was outrageous, but once he'd done it, what were we going to do? At that point we could have said, ‘We won't play anymore.' Instead we said, ‘Don't do it again.' ”

The negotiations continued. James Freund of Skadden, who was representing National Can, continued to pound away at Peltz, trying to get him to go up another dollar—which would have raised the price of the deal by another $9 million—but Peltz, now chastened, resisted. “I
wanted
to give another dollar,” Peltz said. “A dollar in this deal meant nothing. What was a dollar? But I had to get the OK from Mike Milken, and he was in Hawaii.”

According to one long-standing acquaintance of Milken, his wife, Lori, had made him promise that on his vacation he would not work from 9
A.M
. on; so Milken took his family to Hawaii, where he slept for a few hours in the late evening, rose at 1 or 2
A.M
. and worked until 9
A.M.
—by which time it was 2
P.M
. in New York and most of the business day was over.

“Mike was unreachable,” Peltz said. “They [his Drexel advisers] were blocking my calls. They thought I was being too gracious.”

Freund said, “I knew he wanted to go up a buck—assuming he could get the money. But I finally realized I was working over the wrong guy. All the discipline was being imposed by Milken and company.”

Peltz was indeed—as his Drexel advisers, McCarthy and Black, had so heavily reminded him—not the true principal here, only Milken's chosen agent. He had come into the breach when Victor Posner, one of Milken's longest-standing clients and a member of the high-rollers' coterie, had been cornered. Posner had owned 38 percent of National Can. In February 1985, National Can, along with an employee stock-ownership plan, had launched an offer for 51 percent of the company's shares which would have left Posner—who was in desperate need of cash to make interest payments on debt for at least two of his companies—with a sharply devalued minority position. If Posner was to be rescued from this worst-of-all-worlds situation, a competing bidder would have to be brought in.

By this time, in early 1985, Milken was moving his players across the M&A field as though it were a chessboard. The Air Fund had matured into the “highly confident” letter, in which Drexel would announce that it was “highly confident” it could raise a
given sum, necessary for its client to take over his desired company. It then would obtain from its buyers “commitment letters,” in which each promised to buy a certain amount of junk bonds. These bonds would be issued by the shell corporation formed to acquire the target, and secured by the assets of the target.

It was an evolving strategy, changing slightly each time it was implemented. Thus far Milken had launched the junk-bond-financed hostile takeover on behalf of T. Boone Pickens, in Mesa's run at Gulf; Saul Steinberg, in Reliance's bid for Disney; Carl Icahn, in his bid for Phillips Petroleum; and Oscar Wyatt, in Coastal Corporation's bid for American Natural Resources (ANR). Only one of these targets, ANR, had actually been acquired—less than a month before Triangle made its offer for National Can.

Even for Drexel—home of the underdog and the proverbial outsider—Peltz and May were small-time. All they had to their names was a controlling interest in a tired old vending-machine, wire and cable company, Triangle Industries—its 1984 revenues were $291 million, compared to National Can's $1.9 billion—plus about $130 million of cash that first L. F. Rothschild and then Drexel had raised for Triangle from the sale of junk bonds. But none of the bigger players to whom Drexel had shopped the National Can deal had been interested. None considered the deal a bargain. And as one longtime associate of Peltz said, “The others all had more at risk—only Nelson had so little to lose.”

So Peltz and May were brought to the fore. And on April 4, 1985, they reached an agreement with National Can to acquire the company at $42—not needing to go up the extra dollar after all.

For a while, Peltz recalled, everyone held his breath, waiting to see whether this paper miracle would collapse. The only other Drexel-backed takeover to achieve consummation, ANR by Coastal, was a sturdier construct. “There is no comparison between Coastal and this,” Peltz asserted, visibly offended at the suggestion that Triangle was not the first of Milken's minnows to actually swallow a whale. “Coastal was a big company, with significant assets. It wasn't so leveraged. Triangle was a company with a fifty-million-dollar net worth. This was the first of the superleveraged buyouts to go through.”

The acquisition of National Can cost $465 million. Triangle contributed $70 million as equity, to which another $30 million was added through its sale (underwritten by Drexel) of preferred stock;
the debt portion layered above that consisted of $365 million raised with junk bonds by Drexel. And after the deal closed, Drexel raised another $200 million from junk bonds, in order to pay down National Can's preexisting bank debt. So the total debt of National Can, once the $200 million was added to the preceding $365 million, was $565 million.