Threshold Resistance (6 page)

When we completed our initial appraisal in late September, it was clear to us that Mobil was trying to buy the company on the cheap. Now, it may have seemed the height of folly for a guy from Detroit to start a bidding war against a huge multinational oil company. But I sensed that our team had an advantage. By nature and temperament, we could look at this asset—and its potential—in a fundamentally different light. Where we saw it as a real estate deal, Mobil, an industrial company, was going to operate the ranch as an industrial business. I also was sure they were assessing the value of the company using their conventional corporate earnings-per-share basis. After all, they had acquired other companies based on this type of analysis.

Here's how Mobil probably saw it. The Irvine Company had
earned approximately $10.9 million after taxes in fiscal 1974–75; it was not out of line to offer nineteen to twenty times earnings, or about $218 million for the 8.4 million shares outstanding. Their offer on the table when we got interested was $24 per share, or $192 million. The Irvine Company's earnings had been growing at about 10–12 percent annually, which gave Mobil confidence that the deal would contribute to their own financial results. Clearly, they had room to go higher.

But how high were we willing to go? We looked beyond earnings per share and appraised the value of the opportunity on the basis of land value and real estate development upside, which led to a significantly higher present-day valuation: at least $400 million. If we played our cards right, we could outbid Mobil and still get the ranch at a huge discount to its value. We opened our bidding at $27 per share, $3 more than Mobil's offer. The courts recognized our offer and opened the bidding.

This deal got started because of prior relationships, and it moved forward because of them, too. Wells Fargo had been our lead bank on the West Coast for nineteen years, and we had developed an excellent relationship. I thought they would be the perfect catalyst to bring together a consortium of banks to finance what would be one of the largest real estate transactions in history. In October, Wells Fargo committed to be our lead bank. In November, I added my good friend Ben Lambert of Eastdil Realty to the team to assist with the structuring of a preliminary business plan and land absorption projections to present to the banks. I also brought on Kenneth Leventhal to handle accounting matters after Ken and his associate, Stan Ross, came all the way from Los Angeles to my office in Detroit and made an impressive presentation and an impassioned plea for the business. In concluding his pitch, Ken remarked, “Mr. Taubman, if we don't get the assignment to work with you on the Irvine Ranch, I intend to slit my wrists!” That's dedication.

In the meantime, the bidding intensified when the Canadian real estate firm, Cadillac Fairview Corporation, offered $265 million in the form of cash and notes—notes guaranteed by the pledging of Irvine Ranch ground leases.

Determining that the Irvine Company on a present-value basis was worth at least $50 per share, we upped our offer to $31.81 per share. Charles Allen and I also felt it would be wise to bring in additional partners.

The first person I called was Max Fisher, my dear friend from Detroit whose financial resources were matched by his extraordinary business judgment. My next calls were to other close friends: Henry Ford II, chairman of the Ford Motor Company, and Howard Marguleas, a nationally known agriculturist with many years of farming experience throughout California. I had developed a close personal relationship with Henry in Detroit, and Max and I had worked with Howard as fellow members of the United Brands board of directors. We also included Milton Petrie and were joined by Joan Irvine Smith. To round out the group, we included Donald Bren, one of the leading land developers in California. Don had constructed thousands of housing units in the state, many of which were developed on the Irvine Ranch. Each of these partners brought much-needed expertise as well as financial resources to our team. We also liked and trusted one another.

While Cadillac Fairview and our new Taubman-Allen-Irvine team continued the bidding process, we conducted personal meetings with the eight additional banks selected to round out our consortium. In addition to Wells Fargo, we were joined by Chase Manhattan Bank of New York, First National Bank of Boston, the Bank of New York, Security Pacific, Seattle First National, Citibank of New York, Bank of America, and Manufacturers National Bank of Detroit. (I was now a board member of the bank that had provided my $5,000 loan in 1950 to start the Taubman Company.)

Cadillac Fairview dropped out of the bidding in April 1977, which allowed us to focus exclusively on Mobil. Under court supervision, the bidding continued on a day-to-day basis. Each party was allowed just twenty-four hours to outbid the opposition. All bids were to be cash or its equivalent only. On May 2, Mobil opened with a bid of $36.50 per share.

My partners had granted me the authority to bid up to $400 million on behalf of the shareholders, who had agreed to capitalize Taubman-Allen-Irvine personally for not less than $100 million. We would borrow the remaining $300 million.

It is important to note that our analysis of a present-value purchase of $400 million was based on future-value assets in excess of $600 million. Unlike bureaucratic Mobil Oil, we evaluated the Irvine Company as a real estate investment, based on real estate assets. We also recognized the value of the more than $100 million in road and utility infrastructure already in the ground, waiting for development.

In addition, the hundreds of residential ground leases held by such millionaire homeowners as advertising guru David Ogilvy represented a large asset. The ability to raise these lease payments substantially over time would boost revenue, and we predicted that most residents would opt to purchase the land under their homes rather than pay the escalating rents. My good friends Claude Ballard of Goldman Sachs and Shire Rothbart of the Taubman Company were heavily involved in assessing and ultimately following through on this extraordinary refinancing opportunity.

In negotiating anything, it is essential that you clearly establish your own objectives and point of view. It also helps to understand just where the other party is coming from. The Irvine Company's reported corporate earnings were incidental to our basic evaluation model. But they were critical to Mobil. We predicted, based on Irvine Company 1976 year-end earnings of $17.9 million, that the
maximum bidding authority granted by Mobil's board would be approximately nineteen times earnings, or $340 million. We were betting Mobil would quit before reaching that ceiling.

On May 9 we outbid Mobil by $0.25, bringing our offer to $309.25 million.

Mobil countered on May 10 at $37.60 per share, or $316.4 million.

The next day we returned the compliment at $37.75, or $317.66 million.

They countered on May 12 at $38.25, or $321.87 million.

We came back with $38.35 per share on the thirteenth for $322.7 million.

I will always remember fondly the daily phone calls with my sons, Bobby and Billy, during this manic, high-stakes bidding war. They would always want me to counter Mobil's offer, and would encourage me with a spirited mix of well-thought-out rationale and youthful optimism (Bobby was twenty-four, Billy just nineteen). Their competitive juices were flowing, and so were mine.

After a tense weekend, Mobil bid $38.75 per share, or $326.1 million.

We came right back the next day at $39 per share, or $328.185 million.

Mobil's president, who was handling the bidding personally, gave us his full and last shot on May 18 at $40 per share, or $336.6 million.

My small bump of $0.10 to $40.10, or $337.44, ended the bidding on May 19. We were notified the next day that Mobil had withdrawn—just $3 million below the ceiling I predicted.

By the aggressive terms of our offering agreement, we had only two months to complete this massive deal. So after a full-court press by all our banks and associates, we met in the Los Angeles offices of Wells Fargo for the closing on July 22, 1977. I had never seen so many lawyers, bankers, and boxes of documents in one room in my life. Unfortunately, the champagne would have to wait.

Charlie Johnson of Wells Fargo pulled me into a small private room and informed me that there was an unexpected snag. Some years earlier, Don Bren had sold his company to International Paper, which had wanted a presence in the Southern California real estate industry. Things didn't go as anticipated, so Don bought back his company, granting International Paper certain warrants to buy back in if they wished.

Don was a partner in Taubman-Allen-Irvine as an individual. But the clever folks at IP wanted Bren's company, in which they still had the right to 50 percent ownership, to hold the interest in the ranch, thus setting up the opportunity for IP to get into the deal. They were holding up the assets Bren had pledged for our deal without their blessing.

While we waited in that crowded board room in Los Angeles, Wells Fargo representatives in New York were frantically trying to work something out with International Paper and Bren's lender, Bank of America, to no avail. Sensing that we were at an impasse, Charlie proposed plan B. Wells Fargo would extend me the credit for Don Bren's portion of the equity. That would allow us to close on schedule. It would be up to me to collect from Don and let him back into the deal or hang onto the larger ownership stake myself. I agreed to plan B. At the very last minute, Bren worked out a $5 million payment to IP, and we began the hours-long process of signing documents and shaking hands. The closing then went forward without a hitch.

Despite these annoyances, things worked out very well for us. Without selling any assets, we paid off the banks in fifty-one weeks! I served as the chairman of the Irvine Company, which we incorporated as a Michigan company, for six years. The company's performance exceeded our most ambitious expectations, paying out 20 percent dividends to the shareholders annually.

Delighted with our returns and recognizing that intense local
management was required to sustain this success, my partners and I (not including the Irvine family members) decided to sell our interests in the company in 1983 to Don Bren. The transaction was based on a valuation of $1 billion. Don continues to ably run the company to this day.

A billion dollars was a lot of money in 1983. And who wouldn't be happy with a tenfold profit in six years, on top of the 20 percent annual dividends we paid out? I certainly can't complain, but I have to be honest. I really didn't want to sell the ranch.

In 1983, I was still in my fifties and running my businesses with more focus and energy than ever. I also saw continued upside potential for the Irvine Company. On the other hand, my close friends and partners Henry Ford II, Max Fisher, and Milton Petrie were in their late sixties and seventies, and for the most part had retired from active business lives. From their point of view, cashing out made all the sense in the world. One very important aspect of being a good partner is respecting the wishes of your fellow partners, even if they are not perfectly aligned with yours.

So we sold the ranch and almost never looked back. And as I continued to build centers and develop projects, I also pursued other investment opportunities.

I
f you are younger than forty, you probably can't remember a time in America before interstate highways. So you surely never experienced the joy of crowding into your family's unreliable, unair-conditioned car to bump along secondary roads to a vacation destination or relative's home. There was one aspect of these long-forgotten journeys that I always looked forward to. Often, in the most unpredictable places, you came upon a family-owned diner that offered classic American culinary delights: delicious hash browns, hamburgers, hot dogs, homemade pies, and milk shakes. The food was so good, you didn't even notice the filthy washrooms, surly waitresses, sticky counters, and busted jukeboxes. Then again, you could be equally disappointed with a restaurant chosen entirely by the persuasiveness of faded billboards or the cycles of grandma's bladder. And those unfortunate stops kept on disappointing for miles and miles, often requiring a number of urgent unplanned visits to the nasty restrooms of gas stations down the road.

Pardon the pun, but dining along the highways of America in the 1940s and 1950s was a crapshoot. That is, until the orange-roofed outposts of Howard Johnson's popped up all over the country along two-lane highways. A meal at HoJo's never delighted anybody,
although those fried clams were something special. But a family making the trek from Grand Rapids to Cleveland or from Pittsburgh to Miami, could pull into any Howard Johnson's parking lot with confidence that the restrooms would be reasonably clean and the food would be less than life threatening. Everything was consistent and controlled, from the waitresses' uniforms to the taste of the HoJo Cola (no Coke or Pepsi sold here).

America's first franchise motel company, Holiday Inn, was founded in the early 1950s by Memphis home builder Kemmons Wilson with much the same promise. You never wrote home about the accommodations, but every Holiday Inn met certain standards of cleanliness and service, regardless of its location. Pull in with your weary family after a day of dusty driving, and you knew just what to expect.

I call this type of consumer promise
consistent mediocrity.
Don't underestimate its power, especially at lower price points. Howard Johnson restaurants and Holiday Inn motels had the same underlying appeal that food giants such as McDonald's, Burger King, and Wendy's have. Are you passionately drawn to the sandwich you order at Wendy's, or are you more interested in its competitive price, consistency, and convenience? McDonald's rarely comes out on top in newspaper surveys of the best burgers in town. America's quick-serve burger franchises, now doing successful business around the world, are really in the frozen food distribution business. They specialize in serving customers a protein fix in environments of little excitement or delight. But a Quarter Pounder with cheese tastes the same in Baltimore or Beijing. And McDonald's bathrooms are clean all over the planet—no small feat!

Consistent mediocrity is the quick-serve franchise's most important brand promise. And that's where I saw an opportunity.

In the 1970s, Max Fisher, the Milstein brothers, Carl Lindner (chairman of Great American Insurance in Cincinnati), and I owned
52 percent of United Brands, the produce giant known for such international food brands as Chiquita Bananas and John Morell Meats. (It was a great investment for us—we bought in at $4.25 per share and sold at $26.) One of our companies was A&W Restaurants, the first franchise food operation in the world. In 1922, two California entrepreneurs named Roy Allen and Frank Wright created a “healthy herb drink” they called root beer. From their first barrel-shaped root beer stand, Allen and Wright introduced distinctive drive-in restaurants and stands along America's highways. Unlike Howard Johnson's or McDonald's, however, the environment of a typical A&W—complete with waitresses on roller skates—was exciting. The company's frosted mugs of fresh root beer were special.

United Brands research found that consumers familiar with A&W had far deeper, and more positive, emotional ties to the brand than they did to McDonald's or any other fast-food franchise. People equated A&W with first dates, graduation celebrations, and memorable family outings. And they loved the taste of the root beer and root beer floats, especially when served in a heavy glass mug right out of the freezer. (Always put the ice cream in the mug first, and then pour in the root beer to avoid overflowing.)

Unfortunately, A&W had grown out of control. No two of the company's 2,000 units looked alike. Operators had negotiated their own deals, closing down for the winter months and buying few, if any, supplies through the company's Santa Monica, California, headquarters. With consumers losing confidence and the brand losing its distinctiveness, United Brands decided in the early 1980s to divest the A&W Restaurants business along with the rights to all on-premises serving of A&W Root Beer. (The bottling and canning rights to the beverage were sold separately.)

Convinced that the franchise still had plenty of magic, I bought A&W Restaurants from United Brands in 1982 for a relative pittance: $4 million. It was no Irvine Ranch, but the challenge and opportunity
really interested me. In the year or so before my acquisition, A&W had begun to test new-concept A&W Great Food Restaurant units, which featured broader menus including salad bars, homemade ice cream, fresh hamburgers (never frozen), and all-beef hot dogs. Several of the prototypes had set up shop in our malls and were flourishing.

A shopping center's food offerings are very important. Attractive sit-down or “tablecloth” restaurants hold the customer longer in the mall and increase the number of monthly visits. With such popular national chains as P. F. Chang's China Bistro, California Pizza Kitchen, Brio Tuscan Grille, and the Cheesecake Factory well represented in today's better mall properties, it's hard to believe there was a time when it was nearly impossible to convince good restaurant operators to locate in regional shopping centers. But that certainly was the case. The earliest malls in America stayed open only two evenings a week, following the traditional schedules of their anchor department stores. No restaurant could make it on lunches and afternoon walk-in traffic alone.

Once again, we went against the grain. From the opening of our very first projects (after overcoming intense community and union opposition), Taubman centers featured extended business hours—10 a.m. to 9 or 10 p.m. Monday through Saturday, and noon to 5 p.m. on Sundays. With great traffic and longer hours, restaurant operators began to take a look. But strict labor laws and union regulations made it difficult for establishments employing more than a few people to make ends meet.

Largely to overcome these challenges, we developed the very first food court at Southland Mall in Hayward, California, in 1964. World's Fare, as we called it, featured eight to ten kitchens offering a variety of food choices from Chinese and Italian to burgers and pizza. Tables for all the restaurants were located in a common court policed by mall personnel. Everything was served on china, which was cleaned in a
central dishwashing facility. The World's Fare establishments—smaller operations than typical full-service restaurants—were owned by individual families, thus solving the labor problems and allowing for very economical delivery of good food. Mom and dad, brothers and sisters, aunts and uncles could work morning, noon, and night, without violating any regulations, to keep their businesses prospering. These were some of the most dedicated, hardworking people I have ever met. And the customers loved the opportunity for each member of their family to select a favorite cuisine. Service was fast, the setting was comfortable, and shoppers could resume their shopping relaxed and refreshed.

The new A&W Great Food Restaurant concept was demonstrating just how appealing an antidote to consistent mediocrity could be. Sales were terrific in our mall-based stores. To help deliver on our fresh food promise, we had a full-time dietitian on staff. With her help we introduced whole wheat buns for our hamburgers (our meat was never frozen in the Great Food restaurant), posted the calorie count for all items on our colorful menu boards, and tested a variety of new offerings, ranging from chili burgers to salads with low-fat dressings.

In short order we closed about 1,500 of the 2,000 A&W units (that many were underperforming or just doing their own thing) and began building franchise-owned Great Food and traditional restaurants. We reworked the remaining franchise agreements and designed affordable renovation packages to assure more quality and consistency throughout the chain. In a few years, the number of stores climbed back up to around seven hundred. Special attention was paid to our very successful restaurants in the Asia Pacific markets, especially the Philippines and Indonesia. Interestingly, root beer is a taste enjoyed in most parts of the world except Great Britain. There, it seems, the most popular toothpaste brand tastes just like root beer. (That's a level of threshold resistance not even the most clever marketer could overcome.)

I took a personal interest in the quality of our hot dogs. I consider myself a connoisseur when it comes to sausage, and hot dogs are in the sausage family of foods. The best sausage in the world, at least in my opinion, is produced in Hungary. So, shortly after acquiring A&W, I visited several
Wurstmackers
(sausage makers) in Budapest to see what I could learn. After they realized I was a good customer, a few of the more friendly wurstmackers shared their secrets. One tip kept coming up in all my conversations: garlic was the critical ingredient. They also agreed that the best all-beef sausage should be made of chuck or shoulder meat, a more flavorful cut that gave the hot dog more texture and bite.

Armed with the knowledge of the masters, I returned to the United States—Queens, New York, to be specific—to find a manufacturer willing and able to produce the best all-beef hot dog in the world. After much trial and error, we came up with the perfect recipe, full of taste, lower in fat, with just a hint of garlic. Our A&W quarter-pound hot dogs—always steamed first, then rolled on a grill—were a big hit. I would send dozens of them to my friends all over the world. We also sold these delicious hot dogs to country clubs, where they were included on the menu as “steak dogs.”

You might be wondering if flying off to Budapest to meet with sausage gurus is the best use of an entrepreneur's time. You bet it is. Your product is all-important. Why should your customer be excited about your business and its offerings if you're not? Ralph Waldo Emerson famously observed that “there is no strong performance without a little fanaticism in the performer.” Right on. Nothing pleases me more than to learn that a customer and his or her family have had a great experience in one of our malls. It doesn't matter if you are selling a $40,000 automobile or a $2 hot dog. Customers know if they are receiving value, and they will reward you with their loyalty whenever they do so. And once we got the hot dog perfected, I knew people would find special value and enjoyment in a visit to A&W Restaurants.

Of course, not all my creative efforts to redefine and reenergize A&W were successful. In fact, one experience in particular still leaves a very bad taste in my mouth. We were aggressively marketing a one-third-pound hamburger for the same price as a McDonald's Quarter Pounder. But despite our best efforts, including first-rate TV and radio promotional spots, they just weren't selling. Perplexed, we called in the renowned market research firm Yankelovich, Skelly, and White to conduct focus groups and competitive taste tests.

Well, it turned out that customers preferred the taste of our fresh beef over traditional fast-food hockey pucks. Hands down, we had a better product. But there was a serious problem. More than half of the participants in the Yankelovich focus groups questioned the price of our burger. “Why,” they asked, “should we pay the same amount for a third of a pound of meat as we do for a quarter-pound of meat at McDonald's? You're overcharging us.” Honestly. People thought a third of a pound was less than a quarter of a pound. After all, three is less than four!

We tried a half-pound burger (two patties to the pound) for just ten cents more than a Quarter Pounder. That wasn't a big hit either.

Needless to say, I was depressed by this experience, enough so, that I started to get more involved in K–12 education, teacher training, and public school reform. There is an important lesson to be learned from all this. Sometimes the messages we send to our customers through marketing and sales information are not as clear and compelling as we think they are. A product benefit you value may not be high on the list of the consumer's needs. Research is worth the cost, especially if you are investing millions of dollars in an advertising campaign that could confuse more than convince. The customer is always right, even if he or she never mastered fractions!

We also came to another important conclusion. While working hard to differentiate A&W Restaurants from the frozen-food emporiums like McDonald's, it didn't help to focus our marketing on a
direct comparison with these competitors. That just reinforced the notion that we were one of them. By naming our product a “third-pounder,” we framed our offering within the context of the powerful McDonald's Quarter Pounder. That diminished the more important messages of fresh beef, healthy menu choices, and frosted mugs of the best root beer in the world.

When we found the right buyer, in 1994, we sold A&W Restaurants for nearly $20 million. We had righted the ship, rekindled the magic, developed a terrific food tenant for our centers, and created a franchise organization equipped to nurture a venerable brand. The only thing I regret is that I didn't buy the bottling and canning rights to A&W Root Beer. United Brands offered them to me for around $35 million at the time I acquired the restaurants. A few years later they were sold to a Texas venture capital company for $135 million. Of course, at the time, I didn't see how the root beer would help my shopping center business. The restaurants could and did.