The Predators’ Ball (38 page)

B
Y
N
OVEMBER
1986, Milken was scouting new frontiers. “We want to finance the world with our goodies,” proclaimed Drexel chairman Robert Linton. Indeed, Milken hoped to replicate in other parts of the world the hostile contest for control that his chosen had waged so successfully in this country. Japan, where the hostile takeover was still nascent, was his first target. On November 10, Drexel held a mini-Predators' Ball in Tokyo.

Milken presided over this lavish affair. It featured two days of presentations (with simultaneous translation) by a familiar cast—a dozen of Drexel's star junk issuers, including Revlon Group, Wickes Companies, Occidental Petroleum Corporation, MCI Communications, Texas Air Corporation and Triangle Industries. The U.S. ambassador to Japan, Mike Mansfield, was a luncheon speaker. The event was organized by Harry Horowitz, Milken's Washington lobbyist and the chief organizer of the Beverly Hills bond conference in 1985. Even Don Engel, of Bungalow 8 fame, was on hand to play his accustomed part, ushering some of the Drexel clients to “baths” (Japanese massage parlors) outside Tokyo each night after dinner.

Drexel executives deemed the conference a huge success. They believed that the Japanese, while still cautious (they traditionally were buyers of triple-A credits with household names), were now ready to wade into the junk market. The Japanese seemed receptive to the gospel Milken preached: that the rating agencies were wrong and that they, the Japanese investors, should reap the benefit of those prevailing misconceptions, as so many thousands of their
American counterparts had done over the past decade, by investing in the high-yield companies of the future.

While Milken did not make it explicit to this audience, they were participating in the first phase of the process he had authored in the United States. First he would build a client base of buyers. Then he would raise capital for small-time entrepreneurs. And finally he would transform those entrepreneurs into mighty challengers, financing their raids on the giants of Japanese industry. The process would be replicated, but the time would be compressed: what had taken seven or eight years to evolve in the U.S. would probably occur within two. And even if the Japanese culture proved too inimical to the hostile takeover in Japan, Milken still wanted to tap the reservoir of Japanese capital to mount raids in this country that were far larger than any he had ever backed—ten- and fifteen- and twenty-billion-dollar bids.

It seemed only natural by the fall of 1986 that Milken should be expanding his scope to cover the world. The home territory, where he was using junk bonds to revolutionize and restructure the American corporate landscape, was in some sense already appropriated. While there were certainly many more battles to be fought, many more giant corporations to be won, Milken's gospel had gained such currency that it was no longer the heresy of an outcast but the liturgy of Wall Street. If everyone had decided to come to his first party, mustn't it be time to start another?

Milken may have been restless, but many of his colleagues would have been content to pause and savor the moment. That Milken, and Drexel with him, could have scaled the heights they had made some of them lightheaded. Who would have imagined that such a rarefied atmosphere would ever be theirs to enjoy? The payout from Milken's singular idea had been so bountiful—in terms of money, and power, and even a growing social acceptance—that the prevailing mood at Drexel in the fall of 1986 was close to euphoria.

It was captured in a framed quote, in large, bold print, which Drexel investment banker Stephen Weinroth had displayed in his office. Referring to the junk-bond market and takeovers, it read: “Drexel is like a god in that end of the business and a god can do anything it wants. . . . They are awesome. You hate to do business against them.”

The quote was from Michael Boylan, the president of Macfadden
Holdings, excerpted from an article in the June 1986 issue of
Barron's.
It had been sent to Weinroth and other colleagues by Arthur Bilger, of Drexel's Beverly Hills corporate-finance department.

Many of Drexel's wish lists drawn up in early Cavas Gobhai sessions—wish lists which had been wistful, grandiose, almost delusional at the time—had become reality. Among them was the goal articulated by Leon Black in 1979 when he recorded the corporate-finance team's resolution to find and help create “the robber barons of the future.” Now, in 1986, Black expounded happily on his fully realized goal.

“What I like about Drexel is that our clients are the growth companies of this country, and the heads of these companies are often real principals. They are the modern version of robber barons,” Black declared expansively. “These are the guys shaking up management, these are the guys who are building empires.”

He ticked off his favorites: his friend and client Carl Icahn; Henry Kravis of Kohlberg Kravis, with whom he had worked on that firm's $6.2 billion buyout of the Beatrice Companies; Samuel Heyman, the chairman of GAF whose $6 billion bid for Union Carbide had been financed by Drexel; Rupert Murdoch, whose purchase of television stations from Metromedia had been financed by Drexel; and Ronald Perelman.

“I look at them as the Rockefellers of one hundred years ago,” Black continued eagerly. “They're very, very bright. They keep you awake. They've got lots of guts.”

But Black reserved his most exuberant praise for the man who made all this possible. “I'm not much given to hero worship, but I have to tell you I never thought there would be a Michael Milken. He's someone who sees the big picture all the time—and also the small picture, down to the details. He knows so many industries in such depth. He knows the balance sheets of companies better than many of our clients do. And he is so aggressive. He has an absolutely voracious appetite. He wants one hundred percent market share.”

To be creating empire-builders—choosing them, molding them, sitting on their boards, owning pieces of their growing companies—was heady business, especially for investment bankers who, before 1985, had been the lesser-knowns of Wall Street. Black was not alone in his breathlessness. One of his colleagues in corporate finance, G. Christian Andersen, who had lived through what he refers
to as the “Bataan death march” on Wall Street in the early seventies, when he bounced from one failing firm to another, declared that he once had thought of getting his doctorate and teaching history; but now, in 1986, he said he felt he was
making
history.

“We are the gentlemen who finance and create change,” Andersen declared. “When I read [Alvin] Toffler's
Future Shock,
and he described this vortex of change that whirls around us, and it happens very fast in New York City, and slower in Des Moines, and even slower in the outback of Australia, the thing that was amazing to me was, when I looked at the funnel of that maelstrom, the vortex of that sits right in the middle of my desk. I am the fella who determines what the change will be. If I don't finance it, it ain't gonna happen. I get to decide who's going to get capital, to make the future. Now, I ask you—what's more romantic than that?”

As overblown as Andersen's image of himself had become, there was a germ of truth in what he said. For the most highly leveraged mega-acquisitions—the nouveaux entrepreneurs who were changing the face of corporate America—Drexel was indeed the only conduit.

What Drexel had done was to securitize the low-grade corporate loan, much as Salomon Brothers had securitized mortgages in its creation of the mortgage-backed security. In its securitizing of the corporate loan, Drexel had to some degree displaced the banks and the insurance companies, which had formerly had the acquisition-financing role to themselves—just as their clients, America's major corporations, had had the acquisitor role to
them
selves. Now those banks' clients were as likely to be prey as predator. And those clients were being felled, one after another, in acquisitions more highly leveraged than the banks would ever have financed.

The banks were lenders in many of Drexel's deals, but their loans were generally short-term and secured. Without Drexel to place the unsecured, subordinated debt, these deals would never have happened. And while other investment banking firms now were eager to play Drexel's part, the megadeals spawned securities—junk bonds—in amounts that no investment-banking firm but Drexel could sell.

Drexel's monopoly of this market, following the earlier years of monopoly of the nontakeover junk market, had resulted in a trajectory of growth that was unprecedented on Wall Street. At the end of 1977, Drexel's revenues were about $150 million; the firm had
about $75 million in capital, of which less than $40 million was equity. The book value of its stock (as of August 1977) was $4.47 per share. By the end of 1985, the firm's revenues were $2.5 billion; it had about $1 billion of capital, of which over 75 percent was equity. The book value of its stock was $58.66 per share. Its profits were thought to be about $600 million pretax and $304.2 million after taxes—which would place it not far behind the mammoth Salomon Brothers, which had nearly double Drexel's capital.

And by the end of 1986, Drexel's revenues would soar to a record $4 billion and its after-tax earnings to an estimated $545.5 million—making it the most profitable investment-banking firm in America. Salomon was second in earnings, with $516 million. Goldman, Sachs is a closely held partnership which, like Drexel, does not publicly report earnings, but its earnings were estimated by Perrin Long, an analyst at Lipper Analytical Services, Inc., to have been between $475 million and $500 million.

The engine of this growth, of course, was Milken's group. In 1978 it had been contributing 100 percent of the firm's profits. With the growth of corporate finance, which Milken fueled—first with the original issuance of junk bonds and then with the LBOs and the takeovers—the share of Milken's group in the firm's profits declined to roughly 43 percent by the end of 1985. But corporate finance, his adjunct, had been increasing its profits at a rate of roughly 50 percent a year. In 1977 the corporate-finance department had $4.2 million in revenues; in 1985, it had made about $700 million.

In this entrepreneurial firm, where salaries were moderate and all the heavy compensation came in bonuses, those payouts were staggering. In 1985 Drexel is said to have devoted roughly $400–500 million of its $2.5 billion in revenues to bonuses. Milken—Drexel's highest-paid member—is said to have received about $40 million as his bonus (this did not include, of course, profits from all his trading partnerships and other investments, which associates estimated brought him closer to $100 million for the year). And even the top bankers in corporate finance—who had always felt like the poor cousins compared to Milken and his group—had little to complain about. Leon Black, for example, is said by one friend to have received about $8 million (in a bonus payment that included warrants). And in 1986 Drexel would pay out as much as $600 million in bonuses, with Milken and his high-yield department reportedly receiving over $250 million and corporate finance receiving $140
million. One corporate-finance executive, who estimated by the fall of 1986 that his bonus for that year would be roughly $9 million, commented, “This is Disneyland for adults.”

As spectacular as Drexel's profits were, they were no anomaly on Wall Street in the early and middle eighties. The M&A frenzy had thrown off enormous fees to the other major investment-banking firms even before Drexel had a toehold in the business. Also, the period from 1981 to 1986 had seen one of the most powerful, sustained surges in stock and bond history. Firms were awash in trading profits. A number of Wall Street investment houses had taken advantage of this prosperity, too, to sell shares to the public and transform themselves from private partnerships into giant worldwide corporations. Salomon Brothers, which merged with the publicly owned Phibro Corporation in 1981, had increased its capital from only $200 million in 1980 to about $3 billion by mid-1986.

But no other investment-banking firm had vaulted into the financial stratosphere at Drexel's velocity. And no other firm had redefined the M&A business on its own unique terms (with the ability to raise billions of dollars almost overnight, from Milken's junk-bond network), terms which could not be matched by anyone else on the Street. Other firms sought to imitate Drexel. They attempted to break into the junk-bond market. They embarked on merchant banking. They initiated bridge financing, at great risk to themselves, in a desperate attempt to compete with the “highly confident” weapon. What had happened by the fall of 1986, quite simply, was that Milken had cast not only Drexel but to a large degree the Street in his image.

The most powerful firms, with the most cachet, had made their entrances into the heretofore disdained junk market in 1983 and 1984. By the end of 1985, Salomon; Morgan Stanley; Goldman, Sachs; and First Boston (in that order) were each making small incursions into Milken's preserve. Trailing close behind them came many other notable investment banks. Drexel's market share slipped to about 56 percent from the sovereign 60–70 percent it had held in earlier years. But even now, with its market share lowered, there was no close second, just a crowd of would-be competitors at the lower end of the chart. In 1985 Drexel had done seventy-three deals, for a total of $6.7 billion, and Salomon, its closest competitor, had done nine deals for $1.4 billion.

Some of Milken's colleagues at Drexel took undisguised pleasure
in their rivals' flounderings. Morgan Stanley, for example, having first suffered the Oxoco debacle, where the company had defaulted within six months of the underwriting, had embarrassed itself further in its underwriting of $540 million of People Express bonds, some of which had plunged to as little as 35 percent of their issue price by July 1986. As Chris Andersen commented to
The Wall Street Journal,
“They [Morgan Stanley] announced with great fanfare that they were coming in to ‘gentrify' the high-yield market.” (Andersen was referring to a trade-publication headline that had trumpeted Morgan's entrance.) “I wonder how they feel about it today. Maybe it's a tough business. Maybe it isn't any more genteel than the steel business or the auto business or the banking business.”