The Predators’ Ball (45 page)

One of his clients going somewhere else—not just on a deal, but even on a trade—Milken took as a personal affront. And he was so vigilant that he missed little that occurred in his market. One client recounted getting a call from Milken in 1986, when Milken was steeped in multibillion-dollar transactions. “ ‘You people just bought five million dollars' worth of bonds through Oppenheimer,' Mike said. ‘I could have gotten you those bonds for half a point better.' I said, ‘How do you know, and more important, why do you care?' And he said, ‘We want every piece of business.' ”

One rival trader said Milken's omnivorousness goes even further. “Mike wants not one hundred percent but one hundred and one percent—because not only does he want to do
all
your business, but he also is not happy unless you actively trade, churn the account.”

When Milken had 60–70 percent of the market, no one who
intended to stay in it could afford to alienate him. Knowing they were being gouged by Milken but thriving on his merchandise, many of his clients had what one Drexel employee described as a “love-hate relationship” with Milken. Even some of those clients closest to him—Fred Carr, for example—actively (though privately) encouraged competitor investment-banking firms to enter the junk market. But while those firms did enter, they were not committed to that market the way Milken was. And how could they be? He had created it, he viewed himself as not only its progenitor but its guardian. They had come along, late in the day, for the ride.

Morgan Stanley, which by 1985 was emphatic about its determination to be a serious participant in this market, underwrote $540 million of junk bonds for People Express from December 1983 to April 1986. But in the summer of 1986, when People was on the verge of bankruptcy and some of its bonds plunged to as low as 35 percent of their issue price, Morgan Stanley made itself scarce. No bids were forthcoming. James Caywood, who first started buying bonds from Milken as a money manager in the late seventies, said, “Where was Morgan? Nowhere! Who's the only one who can tell you what's going on? Mike. So you go crawling on your knees. I was only in it for five million, but still. He took me out of it. I thanked him. He said, ‘You don't have to thank me, Jim—it's my obligation.' ”

As Milken was approaching the zenith of his power, in 1985, there were some clients who so suited his larger purpose that he was willing to grant them more autonomy than most, or even take a beating from them in a negotiation. Carl Icahn was one, and Samuel Heyman was another. Heyman is a Harvard-educated lawyer and successful real-estate developer, who had taken over GAF in 1983. By the spring of 1985 he had substantially improved GAF's earnings. Heyman was smart, studious, polished (a different breed from Peltz and Perelman), and he was gearing up for a major acquisition. That spring, he was talking to a premier investment bank about its underwriting $150 million of junk for GAF.

Heyman had been a close friend of Eli Black, the former United Brands chairman, and had known Leon Black, Eli's son, as he was growing up, so Leon Black became Drexel's emissary, along with Fred Joseph. Heyman ultimately agreed to give the deal to Drexel, but he drove a hard bargain. Underwriters generally will not commit to exact terms until the night before the offering, when the deal
is priced—and then issuers are at their mercy because they already have too much invested in the deal's consummation to walk away.

So Heyman insisted that Drexel agree to a fixed formula, with no leeway for negotiating at the end. He argued that the rating agencies were wrong in their assessment of GAF as a below-investment-grade credit, because they were so biased in favor of “companies with little debt, whose managers buy Treasuries and have no ideas.” This, of course, was an argument close to Milken's heart. He told Heyman that in his next life he was going to set up his own rating agency. And he agreed that the issue should be priced as though GAF were an investment-grade credit.

The formula Heyman bargained for was 115 basis points over Treasuries. The other firm which had been talking to Heyman about the issue was not willing to commit to a fixed formula. Milken, however, accepted Heyman's terms. “Then Treasuries went down two hundred basis points, and the spread between the Treasury rate and the junk-bond rate widened dramatically,” Heyman recalled. This meant that Milken was committed to sell these bonds at a rate that was well below the lowest end (strongest credits) of the junk market. The GAF bonds were issued at eleven and three-eighths. “In the end, most firms would have said, ‘We just can't do it,' ” said Heyman. “But Drexel gave some customers a big discount, they did swaps, they put their commission money into it. Mike told me later, his blood was spilling.”

From Milken's standpoint, however, it was all for the usual good cause. Less than six months later, he was raising $3.5 billion for GAF's bid for Union Carbide, and by that time Milken had achieved his accustomed bargaining position: on top. For this amount of money, in a hostile bid, Heyman had nowhere else to turn. And though Heyman fought hard with Milken's assistant, Peter Ackerman (Milken remained characteristically above the fray), in the end Heyman had to agree that in the event GAF did acquire Union Carbide, not only would the refinancings and some of the divestitures have flowed in a golden flux through Drexel, but Drexel would also receive (ostensibly to distribute to the bond buyers, but maybe to keep for Drexel) 15 percent of the equity in the newly constituted company.

By 1986, when “merchant banking” arrived as the new craze on Wall Street, Drexel had already amassed equity stakes in more than 150 companies. Milken had had the principal mentality from
his earliest days as a trader, and the firm had followed his lead. It had become partners with many of its clients. This approach suited Milken especially, because not only did it mean sharing in the upside of the companies he was backing, but it augmented his control. With Milken and his group owning a sizable chunk of a company's stock—and being just a few phone calls away from amassing a much larger block—the chairman of that company would tend to be pliant.

Drexel had started demanding its pound of flesh in equity back in the late seventies, when the firm sought warrants as well as fees in its junk-bond underwritings. But its amassing of equity took a quantum leap as Drexel moved into financing leveraged buyouts in 1983–84, and then the hostile LBOs, or takeovers. The equity in these deals is, of course, where the massive upside potential lies. And Drexel typically demanded warrants (to purchase the stock cheap) as equity kickers to help sell the bonds. It seems, however, that much of that equity never reached the bond buyers.

Richard Cashin, of Citicorp Ventures, who has worked with Drexel on a number of LBOs, said, “Drexel was developing a clientele in these deals that was rate-oriented, like mutual funds. So Drexel would sell them the bond, maybe at a discount—and Drexel would keep the equity. They would say, ‘The buyers
need
the equity.' Well,
Drexel
needs the equity.

“A lot of the bonds are done on swaps—Drexel will give someone a Levitz bond for a Safeway. It's so Byzantine, you never know how much the trade was, where the equity has really gone. They register the equity in Street names out in L.A.

“In Levitz,” Cashin continued, “they said, ‘The bond buyers
need
the equity.' Then we find out, who has the equity? It's Drexel. It's a movie, you've seen it a hundred times before, you could cut it short but you don't. Look, we're Citibank—it's crazy for us to go on bended knee to L.A. But we do. Because we find they're very smart and they benefit fifteen ways to Sunday, but they do what they say they're going to do and they get the deal to close.”

One former Drexel employee confirmed Cashin's view. “In a buyout, Mike's guys might say, ‘OK, we need twenty-five percent of the equity in order to sell the debt.' But then it never goes to the bond buyers. Mike's salesmen know their accounts, they can say, ‘Buy this,' and they will. And the buyers don't even know that the warrants are available.”

As the competition with rival firms intensified and the options of clients grew—especially prospective clients, not already wedded to Milken—he encountered some resistance. In one instance in early 1985, Merrill Lynch offered to do an offering of about $200 million of preferred stock at 14.5–14.75 percent (depending on the market at the time of pricing) for Home Insurance. Hearing about the deal, Drexel quickly offered to do $250 million at 14 percent. “We had the order and were writing the prospectus, but George Schaffenberger [then chairman of Home Insurance] said, ‘I have to give Drexel a chance,' ” recalled a Merrill investment banker. “They came back with American Financial [owned by Carl Lindner] as the buyer for the whole thing—and they were demanding warrants for twenty to twenty-five percent of the company. George told them to stick it.” Merrill did the offering, raising $285 million, at 14.75 percent.

“It was their old bait-and-switch, what they do all the time,” this banker continued. “Do you know what ‘highly confident' means? It means that Mike is highly confident that he's
got
you, one way or the other, and he's going to change it fourteen different ways at the last minute, and the deal's fine but you're not.”

Some prospective clients too just wanted to do a debt issue, and did not want to become dues-paying members of Milken's club. Not everyone for whom Milken raised money also bought others' junk bonds—but those who did not were the exception rather than the rule. One of the driving forces of Milken's machine, after all, was overfunding: he would raise more than a company needed (or had filed for), and then the company would invest the surplus (or, in some cases, the entirety) in junk. Fred Joseph once told
Business Week
that 70 percent of their deals were overfunded (by which he meant they raised more than their initial filing). One chairman of a company recalled that he wanted to raise about $100 million of junk bonds, with which he planned to refinance his bank debt. “Drexel said, ‘We'll raise a hundred twenty-five million for you. You'll have twenty-five million extra. You'll be paying fifteen percent [interest], so you'll want to invest in an issue we have coming up, which will pay fifteen percent.' ” This prospective client went to a rival of Drexel's for the underwriting.

Lawrence Coss, chairman of Green Tree Acceptance, a Minneapolis company that services sales contracts for mobile homes and recreational vehicles, is one Drexel client who did not want to play
the game—and believes he paid the price. In early 1985, Green Tree hired Drexel to underwrite a unit offering of bonds and stock. Midwest Federal Savings and Loan Association, its then 71 percent shareholder, wanted to sell most of its stock, so the offering would include over 50 percent of Green Tree's shares. Since it was such a sizable block, Green Tree officials expressed their concern that it be widely distributed, and Drexel, they said, assured them that it would be.

Shortly after the offering, however, Coss said, James Dahl, who was Milken's most aggressive salesman by early 1985, called Coss and gave him a list of purchasers of his stock who would be filing 13Ds: Columbia Savings, Strong Capital Management, Martin Sosnoff and Reliance Insurance Company. It was Saul Steinberg at Reliance who, with his block of 9.3 percent, set Coss most on edge, since Coss thought immediately of Steinberg's greenmail of Disney, in 1984. However, Coss received assurances from his investment banker at Drexel, Gerald Koerner, that the stock was just “parked” with these longtime Drexel customers to prevent there being a surplus in the market, and that when the stock price went up, the shares would be distributed out.

According to one source, Coss then began receiving calls from Milken or one of his salesmen, offering him junk bonds to buy or acquisitions to consider. Coss didn't want to buy the bonds, this source added, and none of the suggested acquisitions was just right. So he declined everything. Over the course of the next five months, Steinberg raised his stake to 10.3 percent, then 11.8 percent, then 14.9 percent, and then indicated he was going to raise his stake to 20 percent and eventually 25 percent. Coss, said this source, was convinced that because he had refused to play the game he was paying the penalty—by being the target of either a real takeover threat or at least tactics of terror.

In October 1985, Green Tree sued Drexel and Reliance, charging violations of trust and fiduciary duty, breaches of contract, and fraud, among other things. In March 1986—while he was at the Predators' Ball—Steinberg sold his Green Tree stock back to Green Tree, reaping a profit of about $26 million. The suit against Reliance was dropped, but in the fall of 1986 the Green Tree litigation against Drexel was still pending—one of the few clouds in that fair-weather season.

C
OSS
'
S ANXIETY
would have been shared by most chief executives if they were not members of Milken's inner circle. Some did business with Drexel but still tried to protect themselves. One deal that Milken is particularly proud of is the financing he did for the toy-makers Mattel, Inc., when that company was on the verge of bankruptcy in 1984. After a $231 million cash infusion, the company went through a dramatic turnaround. Milken and many in his group, through their investment partnerships, were among the investors. Drexel, however, was not the lone money-raiser. It was accompanied by E. M. Warburg Pincus and Company and Reardon and Joseph.

As Mattel's then chairman, Arthur Spear, explained, “Drexel wanted to do it alone—but we said they couldn't. It was going to be more than bonds [also stock], and, knowing their stable, we were concerned about who the shareholders would be. I told Michael [Milken] that.”

Milken accepted the compromise in Mattel. And despite his craving for every last piece of business, after Green Tree filed suit he may have realized that there were some clients who—either because they didn't want to play the game or because they were unnerved by having their bonds and, especially, their stock held by his coterie of high-rollers—were better off elsewhere. But there were some clients who were potentially so integral to Milken's vision that he would not tolerate either losing or sharing them.