The Predators’ Ball

by Connie Bruck

  National Can would have been Good’s and Yang’s first major junk-bond deal. On February 24, two days after National Can had launched their offer, Yang met with Donald Glaser, Posner’s in-house lawyer, in the apartment in the Waldorf Towers that Posner keeps as his New York residence, to discuss his fee structure. “Then we began soliciting from various sources commitments to acquire high-yield paper,” Yang recalled.

  On March 11, however, Posner’s Evans Products—flagging under a debt load of $540 million—filed for bankruptcy. “With that, we stopped the effort,” said Yang. “The whole thing had taken about two weeks. And shortly after that, Mr. Posner sold his block of National Can [into the Triangle offer].”

  That was not done without a great deal of angst on all sides. Peltz and May, their lawyers and a cadre of investment bankers from Drexel spent the weekend of March 16–17 in negotiations with Posner’s lawyers from Paul, Weiss and with Donald Glaser. According to several of those present, the structure they arrived at by Sunday night allowed Posner’s stake to be bought out, except for about $30 million, for which he would be given preferred stock in the new company and roughly 20 percent of voting control. Peltz and May, through Triangle, would be putting in roughly $65 million, for which they would receive 80 percent of voting control. That $95 million or so from Posner and Triangle would form the equity base, upon which the remaining $365 million of debt would be layered.

  But when Glaser called Posner Sunday night, to finalize the deal, Posner vetoed it and suggested to Peltz that they be fifty-fifty partners. “I said, ‘Victor, I love you, but I’m not doing that,’ ” Peltz remembered.

  May put it more bluntly: “The twenty percent [which Posner would hold] was bad enough, but fifty percent was out of the question. I did not want to be associated with Victor Posner.”

  Peltz and May went home, convinced that they had lost the deal. But at about two o’clock the next morning Leon Black called Peltz and asked him to come back, saying that Drexel would raise the $30 million of preferred that would have been Posner’s. By mid-morning on that Monday, March 18, Posner had committed all his stock to the transaction at the $41-a-share price, and Milken and his team of salesmen were at work raising the $395 million of commitments from their buyers.

  The “commitment letter” was a crucial part of a new structure Drexel had devised. Much as banks give commitment letters for their part in these financings, so Drexel’s buyers made their commitments. And whether the deal went through or not, they would receive a “commitment fee” for their trouble. Here it was three quarters of one percent of the amount for which they subscribed.

  For its services in raising this money, Drexel was to receive one half of one percent of the $395 million in financing commitments, or about $2 million. In addition, Drexel received an advisory fee of $500,000. Upon consummation of the deal, Drexel received fees ranging from 3.25 percent to 5 percent of the varying pieces of paper totaling $395 million that it placed, less the $2 million it had received for securing the commitments. Also upon consummation, Drexel received a further fee of $2.5 million, plus warrants which if exercised would give the firm 95,000 shares of Triangle stock. All told, its fees came to roughly $25 million. Combined with the warrants Drexel had obtained from its earlier financing, the firm now had warrants for about 16 percent of Triangle stock.

  This financing was done as a private placement (with rights to register as public securities later), rather than in the public debt markets. In the last year or so, Drexel had turned increasingly to private placements, especially in the leveraged buyouts. And for the hostile deals, especially, they would now become the weapon of choice. Registering public securities with the SEC at the outset would have made the process too slow and cumbersome.

  There were, however, some disadvantages to doing these as private placements. It narrowed the market of buyers; most mutual funds, for example, buy only public securities. And it was generally more expensive for the issuer, because the buyers demanded a higher yield to compensate them for a lack of liquidity, since privately placed bonds are not supposed to be freely traded. Moreover, since these placements are private, buyers can demand individualized rewards—such as a given number of warrants to accompany a certain amount of securities. While this kind of demand and free-form allotment was not advantageous from the issuer’s standpoint, it was perfect for Milken’s system of repayment of favors, and rewards.

  This was the third time in two months that Milken’s troops in Beverly Hills had been thus mobilized—having just raised $1.5 billion in commitments for Phillips and $600 million for Coastal. “The way it works,” explained Drexel’s John Sorte, who worked on Phillips and would soon work on Unocal, “is that the salesmen call up and ask people if they’re interested, and in which kind of paper—the senior notes, or what. And if they are, the book is delivered to them the same day. Then they call back, and if they’re interested the allocations are made and the commitment letters sent out by Telecopier.

  “In Unocal, for example [in mid-April 1985, three weeks after National Can], we raised $3 billion in commitments from a Monday to a Friday. There were six Telecopier machines, and commitments from 140 institutions. The machines got all backed up, papers were lost in space. The mechanics of these things are a nightmare. It’s like running an army.

  “We use our own people, not messenger services, because we really can’t rely on anyone else,” Sorte continues. “So we put the secretaries in limousines, and send them off to get these things signed.”

  Compared to the challenges of Phillips and Unocal, National Can’s $365 million seems like child’s play. But according to Drexel’s Mary Lou Malanowski it was not an easy sell. “This was one of the first hostile deals, and it required a lot of marketing to get people interested in playing,” Malanowski said. “We had no real numbers on the company, because we weren’t inside. And usually when we raise money the buyers care a lot about the management, they want to meet them. Here there was no time. And Nelson and Peter had no track record, just this little company, which was peanuts.”

  Still, it was all done in just under thirty-six hours. The riskiest piece that Drexel had to raise was the $30 million of preferred that was to have been Posner’s. In these buyouts, the riskier pieces of paper are generally accompanied by equity kickers, so that the investors have the chance of sharing in the upside in return for their risk-taking. Coastal’s takeover of ANR had been an exception, since Oscar Wyatt had been unwilling to give any equity; Milken and his colleagues at Drexel had been so eager to bring one of these takeover bids to consummation that they had acceded to his terms.

  For Peltz, however, there were no such allowances. The $30 million of preferred was accompanied by warrants to purchase 19.9 percent of National Can. And the lenders who committed to buy it, $15 million apiece, were Carl Lindner’s American Financial and Charles Knapp’s Trafalgar Holdings Ltd.

  After Knapp was fired from the Financial Corporation of America, the once-high-flying California thrift which under his control nearly became insolvent, Milken had attempted to raise $1 billion for Knapp in his new private partnership, Trafalgar Holdings. Why anyone should have wanted to invest with Knapp, given his track record, is not clear, and apparently Milken’s would-be lenders felt that way, too, because the $1 billion did not get raised. (Knapp denies that Milken attempted to raise the money.) What Knapp ultimately did, according to one friend, was create a fund in which investors placed, say, $140,000 to reserve the right to come into the first six deals he offered them, with the proviso that if they came into none they would suffer a 50 percent penalty, of $70,000. “It was nothing—just window dressing,” said this friend. According to one investor, however, Knapp told him that he had the $1 billion on hand. In other words, it was the Air Fund come to life in its original, unadulterated form.

  Here, Knapp presumably had the $15 million he committed to invest—but he nevertheless backed out of the deal at the last minute, when it was time to fund the deal. “We couldn�
�t find anyone to replace him on such short notice,” Malanowski said, “and we couldn’t let the deal crater. So Drexel came in for the preferred, just to save the deal. It was done so fast that there wasn’t even time for it to go through the UAC [Underwriting Assistance Committee, which is supposed to approve all financings the firm does].” Drexel bought $10 million of the preferred, and the other $5 million of Knapp’s portion was bought by Atalanta/Sosnoff Capital Corporation, a money-management firm which has over $5 billion under management and is run by veteran investor Martin Sosnoff.

  According to documents filed with the SEC, Carl Lindner (through American Financial) not only bought the biggest piece of the preferred but also assumed the lead in the debt portion of the deal, committing to buy $50 million of senior notes. The next-largest commitment was made by Sallis Securities Company—which was Fred Carr, of First Executive, using a “Street name,” or pseudonym—coming in for $33 million. After that came more heavy chunks, of $20–25 million, by more disguised buyers: 338 Rodeo Corporation, which is Thomas Spiegel’s Columbia Savings and Loan; and Worldwide Trading Services, which is Atlantic Capital. By early 1985, Atlantic Capital—a private investment company just across the street from Milken’s Beverly Hills headquarters, its investment portfolio run by a former Drexel employee named Guy Dove III—had amassed about $3–4 billion of mainly municipal funds to invest. Over the next year or so, this secretive organization would probably be Milken’s single largest source in the hostile megadeals—his private pool in the woods.

  After these classic high-rollers came an assortment of corporations, insurance companies, thrifts, mutual funds, a couple of individual investors, a bank trust account. One of these buyers, experienced in the junk market, said that he bought because of what he had heard about Posner’s actions. “Victor was in no condition, half dead, but he was still bidding,” says this buyer. “He let it [National Can] go with his last gasp. He obviously thought it was a gem—and the guy’s not stupid.”

  There was Ronald Perelman (MacAndrews and Forbes), paying his dues before his mega-blind-pool offering three months hence, committing $7.5 million. And faithful Meshulam Riklis (Schenley Industries), coming in for $10 million. Riklis said, “I didn’t know anything about Peltz, anything about the company. I bought the ten million dollars of bonds because Mike was offering them.”

  Knapp was apparently not the only buyer to appear on the commitment list submitted by Drexel to the SEC who was replaced by different buyers by the time the offer was funded, several weeks later, according to a source at National Can. Investment banker Alan Brumberger of Drexel says substitution happens fairly often in the hostile deals, when speed is of the essence. “Someone will say, ‘I’ll come in for fifty [million], but I’d like to get down to twenty-five [million].’ And then they’re replaced.” They still make the commitment fee, for having signed on.

  According to one SEC attorney, it is lawful for substitution to occur as long as amendments to the original 14D document (which lists the buyers, the type of securities and the amount) are filed so as to keep disclosure current. At least in this deal, no such amendments were filed.

  Probably more serious, in terms of noncompliance with SEC rules, is the way these bonds changed hands after they were bought. Though the debt in the big hostiles was raised through private placements, the bonds were issued with registration rights and were supposed to be registered with the SEC within a timely period, generally three to six months. Then they would become public securities and could be traded freely. Until that time, the underwriter could sell the bonds only to sophisticated investors who stated that they were buying the bonds for investment purposes, not with an eye to reselling them. The purpose of this regulation is to prevent a widespread distribution of the bonds, which would effectively circumvent the registration requirement.

  Here, the securities were not registered for about fourteen months. “There was so much else going on, we just didn’t get around to it,” May said. This delay did not seem to impose any undue hardship on his bondholders who may have wanted to trade out of the bonds, however, since they did that anyway.

  By the time the securities were registered, only one of those who had originally committed to buy the senior notes was among the fifteen holders of those notes (although three of the fifteen holders were Lindner-affiliated insurance companies, holding about $38 million, which might have been part of his original $50 million). Of the seventeen senior subordinated note holders at registration time, only four were members of the original group. And of the nineteen subordinated bondholders, only three belonged to the original group.

  In sum, at least four fifths of the bonds in Triangle–National Can had changed hands at least once by the time they were registered. According to one former Drexel employee, this was no anomaly but paradigmatic, and fundamental to the smooth functioning of Milken’s machine. “The way the game works, the first people to get the deal are the friendly, docile, captive accounts,” this man says. “Then they’d move into a second tier, obviously at a higher price. So the first group got the premium, for being less shy. The docile ones served as warehouses [until Drexel was ready to move them to the next tier]. Everybody knew that Carr’s account, for example, did. They [Milken’s salesmen] would call Fred up and say, ‘We’re buying [whatever] today,’ and he’d say, ‘OK, what are you paying?’ ”

  In this deal, many of the bonds had moved out from the first-tier buyers into the portfolios of insurance companies big and small (from Prudential Insurance Company of America, with assets of about $134 billion, to Guarantee Security Life, a company with assets of about $370 million), bank trust accounts, thrifts and even a few blue-chip companies like Conoco and Atlantic Richfield.

  Seen in the larger context of Milken’s machine, this mass movement of privately placed bonds was sublimely purposeful. It meant that the first-tier high-rollers, the most crucial players, were kept happy not only with the commitment fees but with the profits upon trading. It meant that they were also quickly freed, to go on to the next megadeal. It meant that the more risk-averse, who didn’t want to go through the exposure and aggravation of being publicly identified as financing junk-bond takeovers and subpoenaed for depositions by the target’s lawyers, were still enabled to play the game—although they paid a price for their reticence. It meant that there really was liquidity, for anyone who wanted to get out before the bonds were registered. And it meant that Drexel had a virtual monopoly on the secondary trading, since no rival had enough information about the bonds or their whereabouts to compete effectively.

  Those were the advantages. The only disadvantage was that it may have been illegal—or at least pushed the outer limits of the regulations. While four fifths of the bonds changing hands as they did in Triangle–National Can is suggestive of the kind of widespread distribution the rules were designed to prohibit, as long as those investors were sophisticated and would testify that they had not bought the bonds with an eye to reselling them, but had later changed their minds, no illegality would be established. To prove illegality, the government would at least have to show by a pattern of repeated instances of such movement—as appeared to have been institutionalized at Drexel, from the first-tier to second-tier buyers—that it was deliberate and predetermined, and that the investors were indeed buying with an eye to reselling.

  This mass movement of privately placed bonds was not unlike Drexel’s 3(a)9 deals. Both were brilliant adaptations that made Milken’s machine, an engineering marvel of synchronous and complementary forces, function more efficiently, more powerfully. Both were the kind of innovation that in Drexel’s heyday its boosters might have pointed to as an example of the firm’s creativity. And both showed Drexel’s apparent willingness to treat the law as if it were a stultifying system of rules and regulations meant for the world’s less able.

  AS SPEEDY AS Milken was in raising the commitments from his obliging first-tier buyers, the Triangle offer was just under the wire. “I came in with twenty-four
hours to go [before the deadline for tendering shares into National Can’s own offer]. It would have been his company,” Peltz declares, referring to Considine. With the offer about to be announced, Peltz, hopeful that a friendly deal could be negotiated, went to Chicago to see Considine. The CEO was noncommittal. The board would consider the proposal, he said. In fact, as Peltz feared, Considine was attempting to obtain financing to top Triangle’s bid.

  Just a week later, on March 27, Peltz and May arrived at the 1985 Predators’ Ball. Peltz, too inconsequential, had not been asked to give a presentation. He wandered around, buttonholing anybody who he thought might know something. He asked Donald Drapkin, a Skadden, Arps lawyer, who had come to the conference with his friend and key client Ronald Perelman, and whose partners, led by James Freund, were representing the management of National Can. “What have you heard?” Peltz demanded. “What are they doing? Can you call someone?”

  “I was a nervous wreck,” Peltz recalled. “Everybody kept coming up and congratulating me, but I was a total basket case.”

  At Don Engel’s celebrated party in Bungalow 8, Engel introduced Peltz to Gerry Tsai, then vice-chairman of American Can; and Peltz, the wistful can magnate, made his first overtures. Also at that party was William Farley, who had recently joined the growing group of Drexel takeover entrepreneurs. (In May he would launch a successful raid on Northwest Industries, in Chicago.) “Farley told me that he knew Considine, and that Considine felt more rapport with me than Nelson because at least I’d gone to the University of Chicago,” May remembered. Later, in the Polo Lounge of the Beverly Hills Hotel, Drapkin taunted Peltz, saying, “Considine doesn’t like you, Nelson. He likes Peter.”