by Connie Bruck
And Farley Industries, with earnings of $6 million, would go for Northwest Industries, for about $1.4 billion.
Other bids would take longer to germinate—but they would turn out to be the most fruitful of all.
NELSON PELTZ went through the four days of the Predators’ Ball, as he would later say, as a “nervous wreck.” Peltz, who had a track record in business that can be described as lackluster, saw National Can as the opportunity of a lifetime. He had run his family’s frozen-food business, expanding it through acquisitions and then selling it in the midseventies; it later went bankrupt. Peltz had struggled for years, been close to broke, finally managed in 1982 to acquire with Peter May a controlling block of Triangle Industries, which he intended to leverage up as his vehicle for acquisitions. Until now, nothing had worked. And he was terrified that this deal too would somehow get away from him.
What had probably gotten Peltz to this point, however—to be one of Milken’s players, on the verge of acquiring one of the largest can-manufacturing companies in the United States—was his longtime conviction that he would someday make it very, very big. This was a conviction shared by few others, and unsupported by events. But it made him persist, and continue to think in grandiose terms. Now he began to picture the vistas that would open to him if he were to acquire National Can. At Don Engel’s cocktail party at Bungalow 8, Peltz was introduced to Gerald Tsai, then the vice-chairman of American Can. “Someday,” Peltz said eagerly, “I’d like to talk to you about buying your cans.”
RONALD PERELMAN brought more to the party than Peltz did. Perelman, for whom Drexel had been doing junk-bond financings since 1980, had boot-strapped himself into a series of acquisitions—keeping the profitable core, selling off the pieces, paying down the debt and leveraging up for the next acquisition. They were small by Drexel’s new standards—who had ever heard of Ronald Perelman in 1985?—but at least they had worked.
With Drexel’s assistance, Perelman had just taken private his mini-conglomerate, MacAndrews and Forbes. And he was in the process of acquiring Pantry Pride, a supermarket chain discharged from Chapter 11 bankruptcy reorganization in 1981, which had a huge tax-loss carryforward of over $300 million that could be used to shelter income. It would be his vehicle, he hoped, for the kind of acquisition exponentially bigger than anything he had attempted before, something that would vault him forever out of the minor leagues. For the last month or so, Perelman, a crude Napoleonic type who was drawn to glamour and status, both in companies and on the social scene, had been eyeing Revlon.
At the conference, Milken and Perelman had agreed that when the Pantry Pride deal closed, Milken would raise about $350 million for that company in a “blind pool”—for the purpose of an acquisition, but with no target identified.
CARL ICAHN had been successful for years at threatening companies with a takeover only to have management buy his stock back at a premium not offered to other shareholders—a practice that came to be known as greenmail. He had started doing business with Milken just about six months earlier. Strong-willed, fiercely independent, smarter than most, he could not be controlled by Milken in the way that Peltz and Perelman could. And Milken’s was a construct—intricate, highly interdependent, requiring constant fine-tuning—where control mattered. As one former Drexel employee puts it, “Mike feels most comfortable when you owe him your life.” And most of the people Milken touched owed him.
Nonetheless, Milken and his colleagues had sought Icahn out, offering to refinance the bank debt he had used for his acquisition of ACF (only the second company he had acquired in six years, during which time he mounted a dozen major campaigns) and to provide him several hundred million dollars in surplus funds for what they called a “war chest.” Icahn had just completed his raid on Phillips—where Milken had stunned the corporate world by raising commitments for $1.5 billion in forty-eight hours—and had walked away from that ten-week escapade with a profit of $52.5 million.
Icahn gave a presentation on ACF at the conference and then wandered about, dropping in on others’. One he found especially interesting was given by Robert Peiser, the chief financial officer of TWA (Drexel had raised $100 million for the airline in the past year). He asked Peiser several questions. It made Peiser uneasy. Afterward, a few onlookers warned him that Icahn was up to no good.
THE WORLD that Milken created for his faithful would last much longer than those four days and would extend far beyond the enclave of Beverly Hills. Before his awesome machine was forcibly slowed nearly two years later, it would transform the face of corporate America.
It would introduce terror and mayhem into countless corporate boardrooms. It would cause frightened managements to focus on short-term gains and elaborate takeover defenses rather than the research and development that make for sustained growth. It would cause the loss of jobs, as companies were taken over and broken up.
But it also would help to bring the owner-manager back to American business. And it would dramatically accelerate the trend toward restructuring, as once-placid managements hastened to take measures—such as selling low-earnings assets, pruning work forces, renegotiating labor contracts, closing hundreds of older, outmoded plants—before others did it for them.
In doing all these things, the good and the bad, Milken’s machine would stir hatreds and prejudices as bitter as those in any social revolution—not surprisingly, since that in part is what this was. The denizens of corporate America would be challenged, and some would be dispossessed. In their place would come Milken’s own—a band of mainly small-time entrepreneurs, raiders, green-mailers, the have-nots of the corporate world, who had had only bit parts to play until Milken made them its stars.
Experts would long debate whether the value that Milken’s onslaught had added to American business outweighed the damage it had done. Some of the raiders’ cant, of course, had been self-serving, but some of it was true. What was not debatable was that Milken, some of his Drexel colleagues and his anointed players had made more money in a shorter period of time than any other individuals had done in the history of this country. And they may have broken lots of rules and perhaps even a few laws to do it.
PART ONE
Spreading the Gospel
1
The Miner’s Headlamp
AT 5:30 A.M. each weekday in the early 1970s, a bus pulled up to a stop in Cherry Hill, New Jersey, and a young man lugging a bag that bulged with papers mounted its steps. He was making the two-hour commute to New York City, where he worked at the investment-banking firm of Drexel Firestone. The train would have provided a more comfortable and faster ride; but, for those very reasons, it also offered more opportunity to meet other Wall Street acquaintances. They would want to engage in the kind of idle small talk that commuters share to pass the time. The thought must have been intolerable. He did not wish to be rude, but he wanted no interruption.
As soon as he had settled into his seat, being sure to take one with an empty one adjacent, he unloaded a mountain of prospectuses and 10ks (annual Securities and Exchange Commission filings) onto the seat next to him. On winter mornings the sky was still pitch black and the light on the bus was too dim for him to be able to read. He wore a leather aviation cap with the earflaps down; he had been bald for years, and although he wore a toupee his head always felt cold on these frosty mornings. Now over his aviation cap he fitted a miner’s headlamp—strapped around the back of his head, with a huge light projecting from his forehead.
Michael Milken was as anomalous at the impeccably white-shoe Wall Street firm of Drexel Firestone to which he traveled each day as were the low-rated bonds that he traded there. He came from a middle-class Jewish family. He had no aspirations to climb any social ladder. He was painfully uncomfortable, moreover, in most purely social situations. He was oblivious to appearance—not caring what kind of car he drove, or what kind of clothes he wore, or whether his aviation cap and miner’s headlamp made other passengers stare at him. Milken was occupied, at every moment, wi
th his own thoughts, and those thoughts were riveted on the bonds.
Milken had grown up in the well-to-do, largely Jewish enclave of Encino in Los Angeles’ San Fernando Valley. His father, Bernard Milken, was an accountant; from the time he was ten Michael watched at his father’s side as he prepared tax returns. A boyhood friend, Harry Horowitz, recalled that the kinetic quality so marked in Milken in later years was present when he was young. Even as a teenager he slept only three or four hours a night. He was a high-school cheerleader. And then as in adult life he eschewed all stimulants—no drugs, alcohol, cigarettes, coffee or carbonated beverages.
He graduated from Birmingham High School in neighboring Van Nuys in 1964 and then attended the University of California at Berkeley, graduating Phi Beta Kappa in 1968. While that campus was roiled with the protests of the militant left, Milken majored in business administration, managed a few portfolios for investors and was active in a fraternity, Sigma Alpha Mu.
Milken married his high-school sweetheart, Lori Anne Hackel, and headed east to the Wharton School, the University of Pennsylvania’s business school. Horowitz, visiting him during Milken’s first week at Wharton, attended an orientation dinner with him. The two were a little taken aback by Milken’s fellow students, Ivy League graduates dressed in navy blazers and smoking pipes, and they in turn were struck by the two Californians. “They were making fun of us, though in a sort of nice way,” Horowitz recalled. “And I remember Mike told me that evening that he was going to be number one in his class.” Milken did have straight A’s, but because he was short one paper he did not graduate with his class. He later co-authored a paper with one of his professors and received his M.B.A. degree.
Milken had come to the Philadelphia office of what was then called Drexel Harriman Ripley to apply for a summer job while he was at Wharton, in 1969. Anthony Buford, Jr., then a director of Drexel, recalled that a professor at Wharton, Robert Hagin, recommended Milken for the job. “Bob told me, ‘This is the most astounding young man I’ve ever taught,’ ” said Buford.
Buford was involved in a corporate-planning effort, analyzing all aspects of the firm. Like many other firms in the late sixties and early seventies, Drexel Harriman Ripley was struggling to weather the crisis of the “paper crunch,” in which back-office systems buckled and sometimes collapsed under the burden of trades, and records of stock and money delivered and received were lost. When Milken arrived, Drexel was in the throes of making the transition in its back office from the clerk with the green eyeshade to computers. Milken, who had spent the previous summer at the accounting firm of Touche Ross, was dispatched to the troubled area.
While he quickly believed he had divined the solution to the problems, his plan was not implemented. Most of the people in the back office from whom Milken tried to garner information had no more than a high-school education but many years’ worth of experience at their jobs. “Mike was like a bull in a china shop,” recalled a former Drexel executive. “He was terribly arrogant. And he didn’t have the facility to shroud his ability, couldn’t keep it from being threatening and abrasive. This army of operations people were so far beneath him in intellectual powers that he couldn’t deal with them, he could only beat on them. Soon their attitude was, Go talk to somebody else. So he never was able to unlock the system.
“Mike’s difficulty, gigantic, was that he simply didn’t have the patience to listen to another point of view,” this former executive continued. “He would assume he had conquered the problem and go forward. He was useless in a committee, in any situation that called for a group decision. He only cared about bringing the truth. If Mike hadn’t gone into the securities business, he could have led a religious revival movement.”
Whatever his interpersonal shortcomings, Milken was recognized as so high-powered intellectually that he was moved on from the back office to do other special projects, as assistant to the firm’s president, Bertram Coleman, and then his successor, James Stratton. He worked at Drexel part time throughout his two years at Wharton.
Perhaps his most significant contribution to the firm was his analysis of its securities-delivery system. Drexel, like many Wall Street firms, used to ship securities from city to city and borrow the price of the securities until they were delivered. That delivery often took as long as five days. Milken realized that delivery should be made overnight, thereby cutting the period of interest payment from five days to one. According to its vice-president of operations, Douglas Clark, that idea saved the firm an estimated $500,000 annually.
When he left Wharton in 1970, he was hired full time at Drexel, to work in the Wall Street office as head of research for fixed-income securities; from there he moved into sales and trading. While Milken’s academic record was superb, he lacked all the other requisites—Ivy League school, social standing, physical presence—for acceptance at one of the premier firms on the Street, such as Goldman, Sachs. Drexel, while it was in a state of decline, at least had a major-bracket franchise. Besides, Milken tended always to stick with what was familiar. He had already spent two years working at Drexel; he would stay there.
Drexel prided itself on its lineage. It had been founded in 1838 in Philadelphia by an established portrait painter with financial acumen, named Francis Drexel. In 1871 the firm of Drexel, Morgan and Company was opened in New York; these two firms were later consolidated into a single partnership, engaging in both commercial and investment banking, under the name of J. P. Morgan and Company in New York and Drexel and Company in Philadelphia. The two firms epitomized the elite in investment banking, though Drexel was overshadowed—as was every firm and every financier—by the legendary J. P. Morgan, so formidable that he is credited with saving the United States Treasury from collapse in 1895 and averting a Wall Street panic in 1907.
With the passage in 1934 of the Glass-Steagall Act, which mandated the separation of investment-banking activities from commercial banking, J. P. Morgan and Company and Drexel and Company became entirely separate organizations. The Morgan firm opted for commercial banking and is now known as Morgan Guaranty Trust Company. Drexel stayed in investment banking. In 1966, Drexel merged with Harriman Ripley and Company.
The Philadelphia-based Drexel was strong in money management and in research, while the New York–based Harriman Ripley and Company had blue-chip investment-banking clients. It should have been a perfect marriage. But, like so many mergers of investment-banking firms which would occur over the next two decades, this one was fractious. Some key partners of both firms left, taking clients and capital. By 1970, Drexel Harriman Ripley investment banker Stanley Trottman later recalled, “we were afraid to open the paper every day—for fear we’d see yet another deal for one of our clients filed by someone else.” That year Drexel Harriman Ripley was able temporarily to stanch the hemorrhaging by obtaining an infusion of capital—$6 million—from the Firestone Tire and Rubber Company. It changed its name to Drexel Firestone.
When Milken arrived as a full-time employee in its bond-trading department, Drexel still had some portion of its once-encyclopedic gilt-edged client list intact. Those triple-A credits, however, held no lure for him.
The universe of corporate bonds that Milken was entering consisted mainly of “straight debt”—bonds whose holders receive fixed-interest payments, typically every six months, until maturity, when the interest is repaid. A much smaller, more arcane part of the market consisted of convertible debt—bonds whose holders have the option to exchange them for other securities, usually stock. Corporate bonds are rated by rating agencies, such as Standard and Poor’s and Moody’s. Those companies with the strongest balance sheets and credit history, the elite of corporate America, are rated triple A. When they issue bonds in order to raise debt capital, the interest those bonds pay is not much higher than that of risk-free U.S. Treasury bonds. These are known as “investment-grade” companies.
A bond that is issued as investment grade and is subsequently downgraded because of a perceived deterioration in the c
ompany’s condition trades at a discount from its face, or par, value. Below-investment-grade bonds are rated Bar or lower by Moody’s, BB+ or lower by Standard and Poor’s, or are unrated. In the early seventies, these were known as “deep-discount” bonds or “fallen angels.” Also inhabiting this netherworld were those bonds known as “Chinese paper,” which were issued in the course of highly leveraged acquisitions by the conglomerateurs of the sixties.
It was these discounted bonds, both straight and convertible, some of them selling as low as ten or twenty or thirty cents on the dollar, that fascinated Milken. He had been under their sway since the sixties, when he began investing in them with money given him to manage by some of his accountant father’s clients. To persuade them to entrust him, a college student, with their money, Milken made a deal in which he would take 50 percent of all profits and 100 percent of all losses. Years later he commented (as reported in The Washington Post) that this arrangement had given him “a healthy respect for principal.”
Milken encountered the Hickman study while he was at Berkeley. W. Braddock Hickman, after studying data on corporate bond performance from 1900 to 1943, had found that a low-grade bond portfolio, if very large, well diversified and held over a long period of time, was a higher-yielding investment than a high-grade portfolio. Although the low-grade portfolio suffered more defaults than the high-grade, the high yields that were realized overall more than compensated for the losses. Hickman’s findings were updated by T. R. Atkinson in a study covering 1944–65. It was empirical fact: the reward outweighed the risk.
Milken said in an interview with this reporter that the Hickman study “was consistent with what I had been thinking about for a long time.” It also represented the kind of thoroughness that won Milken’s respect. “Hickman had studied every bond for forty-three years,” Milken remarked. “He had done very thorough, original work, without machine support and the kind of data bases that would be available today.”
