The Predators’ Ball (25 page)

Was the greenmail game dead? Had Icahn decided that no
amount of fast-earned dollars was worth being called a racketeer? Was the scourge of corporate America going respectable?

What now seems clear is that Icahn had decided it was time to move to the next plateau. He had been saying for a couple of years that what he really wanted to do was gain control of these companies and sell off some pieces. He no doubt meant this. In a stock market where companies were as undervalued as many were in the early eighties, it was feasible—if one chose the right companies—to gain control, sell off parts in order to pay for the cost of the acquisition, and be left with the best part of the company almost for free. Over the long term, it would be far more profitable than grabbing a quick greenmail.

It would also be less aggravation. Icahn had accumulated a fortune of over $100 million. Even with his rare hunger for dollars, he could now afford to be a little more choosy. Greenmail had become the
bête noire
of corporate America. From now on, taking greenmail openly was going to mean incessant suits from enraged shareholders and incessant beatings in the press.

Moreover, Congress was up in arms about greenmail and it seemed as though legislators might figure out a way to outlaw it. In March 1984 Icahn had testified before a congressional subcommittee and had said—somewhat surprisingly—that he agreed that they should “end buybacks.” But if they were going to end buybacks, he had argued, they should also make illegal all the defensive maneuvers open to managements—“Do not let them print up stock, do not let them issue themselves golden parachutes, do not let them sell the crown jewels.”

Whether or not Congress outlawed greenmail was almost not the point. The point was, once an activity was so popularized that it was front-page news, what was Carl Icahn doing in it? He had made his fortune by entering a relatively undeveloped field, taking it farther than anyone else, and then—when it got too crowded and visible—moving a small step forward, in a natural progression. He had first gone into puts and calls. As that became more popular, he had mixed it with classic arbitrage. When options exploded, he had gone into risk arbitrage. Then he had decided to better control the arbitrage, by becoming the principal himself. Now it was time to become—at least often enough to give him the credibility he would need to continue his progression—the acquirer.

And this, interestingly enough, was when Leon Black came to
call to offer Icahn a Drexel war chest. For in the summer of '84, at a Gobhai seminar, Black, Fred Joseph and others had been discussing their need to find those players whom no one else could or would finance, who therefore would be desperate enough to pay the price (in interest rates to the junk-bond investors, and fees and equity stakes to Drexel) of Drexel's dollars. Icahn was one obvious candidate. While David Kay, head of Drexel's fledgling M&A group, objected to their representing the notorious greenmailer, that objection was overruled. Icahn was, after all, a singularly able greenmailer; he had amassed over $100 million in about five years, and his annualized return for that period was over 80 percent. It would hardly be like Drexel to place a higher value on respectability than on performance.

Moreover, Icahn fit nicely into a plan that Black, then head of Drexel's LBO group, was advancing—to get cash into players' hands by refinancing LBOs they had already done, replacing bank debt with junk bonds, and adding in a surplus for a war chest. How much surplus was right would vary in each case, depending upon the appetite of the player. For example, Drexel did a refinancing for William Farley, a small-time Chicago entrepreneur, who had acquired a company which he renamed Farley Metals. Drexel raised $80 million for the refinancing and $60 million for a war chest; about one year later, in the spring of 1985, Farley put that war chest (and more) to use when he made a $1 billion acquisition of Northwest Industries.

Icahn's appetite dwarfed Farley's, but he was far less compliant. Farley gave Drexel 5 percent of equity in Farley Metals and accepted a Drexel-designated director, Leon Black, on the board; Icahn refused to give any equity, and he took no Drexel-designated director. In late 1984, Drexel raised $225 million for the refinancing of ACF, and the bulk of the remainder, roughly $155 million, went into a war chest. According to Black, however, Milken would have raised another $200–300 million for Icahn had he been willing to give up equity. Said Icahn, “I don't like giving up equity. I've learned over the years, a dollar bill is a better partner than a partner.”

When Icahn found his next target, in any event, he was not hampered by a lack of cash. Drexel was there, ready and willing to back him—in his $8.1 billion tender offer for Phillips Petroleum.

In late December 1984, just weeks after the ACF junk bonds
were sold, T. Boone Pickens, the most sanctimonious of the raiders, who had vowed often that he would never accept greenmail, was greenmailed out of his Phillips stock. Drexel had backed two hostile bids, both unconsummated—Pickens' Mesa Petroleum bid for Gulf Oil, and Saul Steinberg's Reliance bid for Walt Disney. It was eager now for one of its players to pick up the Phillips ball that Pickens had dropped.

Phillips had announced a recapitalization plan in which all shareholders could participate, except that Pickens got cash in exchange for his stock while the rest of the shareholders were offered a package of cash and securities. The buzz on the Street was that the Phillips recapitalization plan was much too low, and that the situation was therefore ripe for another bidder.

“We decided that since a lot of our clients—Ivan Boesky, Irwin Jacobs, Carl Icahn—were rumored to be holding big positions in Phillips stock, we should try to interest someone in doing the transaction,” Drexel investment banker John Sorte recalled. “But it had to be someone not wanting greenmail. We'd now used the high-yield weapon twice—in Gulf and then in Disney, where Steinberg took greenmail. And we decided we shouldn't be using this weapon for greenmail. Too much criticism.”

Drexel tried to interest companies they thought might be bona fide acquirers of Phillips. Pennzoil (which had recently lost Getty Oil to Texaco) was one. “David Kay thought Pennzoil was a natural,” said Sorte, “but I'm not sure they ever returned his phone call. David Kay and others in M&A did lots of cold calls.”

In the end, the only interest that Drexel was able to stir was Icahn's. Flush with his ACF war chest, Icahn had begun buying Phillips stock in late December, two days after the company's announcement of its recapitalization plan and its buyout of Pickens. In February 1985 he decided to wage a proxy fight to defeat Phillips' recapitalization plan, which was to be voted on at an annual shareholders' meeting on February 22. He hired another Wall Street firm, Donaldson, Lufkin and Jenrette, Inc., for the proxy solicitation.

The open question was whether Icahn would accompany his proxy fight with a tender offer. In the past he had preferred to combine the two, because used in concert they put far more pressure on the target. But a tender for Phillips would be exponentially greater than any that he—or, for that matter, Drexel—had done before. The junk-bond-financed hostile takeover was so nascent that there was no blueprint.

In Mesa's run at Gulf, before there was any public announcement of an offer, Milken and his troops had obtained commitments for about $2.2 billion from their network of bond buyers. Drexel had circulated not the commitment letters that later became boilerplate, but thick securities-purchase agreements, which were haggled over endlessly by Drexel and the prospective purchasers' lawyers.

Those who were thus solicited became insiders and were prohibited from either trading in Gulf stock or divulging the information. But word did leak out (or some of those solicited bought stock) and the stock price traded up so rapidly that the deal became too expensive for Pickens to make the tender offer. Instead, Drexel had negotiated a $300 million private placement for Mesa with Penn Central, controlled by Carl Lindner, and Pickens had used that to make a far smaller offer—which ultimately sent Gulf into the arms of a white knight, Standard Oil of California.

Now it was clear that, with Phillips, Drexel could not attempt to obtain oral commitments before an announcement and take the risk of a run-up in stock price. Icahn came up with an alternative: to borrow methodology from the establishment. When major corporations launched their hostile takeovers, they did so on the basis of commitment letters for the financing from commercial banks. Drexel, Icahn suggested, should act like those banks and give him a commitment letter.

Sorte and Black thought that Icahn's demand was outrageous. Drexel, they argued, was acting merely as agent for the lenders to Icahn, and if it gave him a commitment letter, the amount would be charged against the firm's capital. In two years, however, this strange notion would be known as “bridge financing” and would be the rage on Wall Street. Investment banks would commit their own capital to a deal, in a “bridge” between the time of the offer and the time it actually had to be funded. By funding time, the investment bank would have placed much if not all of the debt with bond buyers.

Trying to respond to Icahn's demand for a letter of commitment, Black finally ventured, “Why don't we say we're ‘highly confident' that we can raise it? It's really different. It hasn't been done before.”

“Carl looked at me,” Black recalled. “He turned to his lawyer and said, ‘What do you think?' His lawyer said, ‘Leon's full of shit. It's not legally binding, what good is it?' ” Sometime in the early
hours of the morning the meeting broke up, with Icahn saying he was no longer interested in doing the tender offer. But the next morning he called Black and said, “You know that ‘highly confident' letter you were talking about? . . .”

That was the beginning of Drexel's famed “highly confident”—the pronouncement that would seem, for a time, almost talismanic in its power. One after another, multibillion-dollar tender offers were launched on the power of those two words, uttered by Drexel. It became an article of faith for Milken that once he had said he was “highly confident” that he could raise a given amount of financing for a bid, he would never renege or cut back on the terms, because then, of course, the words would be just words.

(It took some time before Black and his colleagues recognized fully the magic of the “highly confident” letter. In Phillips, they charged Icahn $1 million for it. By the time they launched the Mesa-Unocal raid for Pickens, two months later, they were charging $3.5 million for it—although they changed the words to “firmly believe” because “highly confident” had become too charged a phrase in Congress.)

I
CAHN
'
S BID
for Phillips was the first tender offer ever launched without its financing in place, and the first in which no banks were to participate. Icahn was proposing that he acquire Phillips in an $8.1 billion deal that was part cash and part securities. The cash portion, which Drexel had said it was “highly confident” it could raise, was $4.05 billion. And this $4 billion was to be raised from an amalgam of senior notes, senior subordinated notes, and preferred stock—
all placed with Milken's army of buyers.
Thus, Phillips was to be, essentially, a hostile leveraged buyout. Icahn would pay the debt with Phillips' own cash flow.

Icahn formed a dummy partnership, for which Milken would sell junk bonds, ultimately secured by the assets of Phillips. If the transaction went through, Icahn would pay down his mountain of debt—$11 billion, set atop an equity sliver of $800 million—by selling off some assets and utilizing the company's cash flow.

Unlike the friendly leveraged buyouts that Black had structured, in which commercial banks, typically, were the lenders for the senior level of debt and Drexel placed the subordinated debt, with Phillips even the senior level was to be lent by Milken's network. For some time, Milken had been asking his fellows, “Why do
we need the commercial banks?” With Phillips, Drexel announced to the world that they did not.

The world, however, was disbelieving. Phillips and its advisers charged in the ensuing litigation that Milken's “highly confident” assertion was nothing but sleight-of-hand. The company ran full-page newspaper ads demanding, “Is Icahn For Real?”

Icahn, meanwhile, had been holding Drexel back from the next step, which was obtaining written commitments from the bond buyers. It was going to cost him, which is why he had been postponing it, but after the taunting ads he gave Drexel the go-ahead. He would have to pay a commitment fee to the subscribers of three eighths of one percent, or $37,500 for each $10 million pledged. In the abortive Mesa-Gulf deal, those who had committed orally to buy the bonds received nothing for their trouble—while Mesa walked away with a net gain of $214 million after taxes. Milken had realized then that his customers would have to be paid to play, in the future.

If Drexel raised these commitments and the deal did not go through, Icahn would have to pay Drexel one eighth of one percent of all the commitments obtained. Drexel had fought hard with Icahn to be paid one percent of the commitments raised, as they had been in Disney. But Disney, Icahn had argued, was a $700 million deal, and this was $4 billion. Instead, he got the one eighth of one percent in return for agreeing to pay Drexel 20 percent of his profits if he sold his stock. This profit-sharing would become boilerplate in future Drexel-backed raids.

With all these hefty surcharges, therefore, Icahn did not want to raise the entire $4 billion—and with the vote on management's recapitalization plan just a week away, it was unlikely, anyhow, that Milken could raise the $4 billion in time. According to Black, Milken was pressing Icahn to let him raise $2 billion, but Icahn drew the line at $1.5 billion. In forty-eight hours, it was done.

Sorte commented, “Lots of the buyers now were the same ones that we'd lined up one year before in Mesa-Gulf [when they obtained $2.2 billion in oral commitments]. And we kept a lot of our powder dry. For example, we didn't put in the S&Ls, even though we had lots of them. We realized that if we started having lots of S&Ls in hostile deals, we would jeopardize their ability to be in any [because of the growing concern in Congress about junk bonds and thrifts' investments in them]. And a lot of our big buyers weren't there. Executive Life wasn't there. Columbia S&L wasn't there. Carl
Lindner wasn't there. We wanted people to think we were not stretched.”