Return Of The Buyout Kings

By Daniel Kadlec

Michael Milken may have lost his bid for a presidential pardon, but some familiar wheeler-dealers that he either funded or fought in his heyday as Wall Street's junk-bond king have resurfaced, let back in the game by a receding stock market. And they aim to play. The names include Carl Icahn, Henry Silverman, Ted Forstmann, Irwin Jacobs and Henry Kravis--an '80s reprise that almost makes you want to cue the Ramones and slam dance.

We're not on the verge of a greedfest like the reckless '80s, a period that youngsters may be surprised to learn was far more rapacious than anything served up during the Internet bubble. But change is in the air, and the wolves have their noses up. Last week Federal Reserve Chairman Alan Greenspan cut interest rates for the second time in less than a month. The rate cuts make it cheaper to borrow, a must in almost all buyouts that aren't stock swaps.

Just as important, the stock market has fallen and can't get up, making takeovers more affordable. For the same reason, companies that use only stock for acquisitions have had that currency devalued. This leaves the raiders to rule, and they're suddenly finding they have renewed access to a crucial financing source--junk bonds. That well went dry as investors funneled their money into stocks in recent years. Junk-bond mutual funds suffered net outflows of $10 billion last year. But since Jan. 1, junk funds have had net inflows of $3 billion, according to AMG Data, bringing them to an aggregate total of $87 billion.

Odyssey Investment Partners and First Reserve Corp., a pair of buyout firms, were among the earliest to tap this replenished reservoir to finance a takeover. Last week they agreed to buy Dresser Equipment from oil-services giant Halliburton for $1.6 billion. More of that can't be far behind.

Already, unsolicited bids--the preferred '80s raider weapon--are on the rise. The value of these bids more than doubled last year, to $5 billion, reports Thomson Financial. Meanwhile, Kohlberg Kravis Roberts, which became a household name with its $25 billion takeover of RJR Nabisco in 1989, is in the process of raising $6 billion, its largest pool ever for deals.

Of course, a few key '80s players never went away. Bottom fisher Sanford Weill, for one, amassed an impressive array of financial companies on the cheap while others were getting tech-obsessed. He is now the head of Citigroup, one of the world's largest banks. Icahn, the '80s raider who shook Texaco and took TWA, has asserted influence in small doses throughout the '90s by buying large amounts of distressed corporate debt, as has former Milken colleague Leon Black at Apollo Advisors.

Icahn, though, has clearly stepped up his pace, pushing Nabisco Holdings into the arms of Philip Morris and briefly rattling mighty GM's cage with a large stock purchase last year. Now he's thrusting himself into the middle of American Airlines' plans to buy TWA--long after he sold his controlling interest in the latter.

The '90s have punished some raiders, who proved to be better bomb throwers than managers. Saul Steinberg once stalked high-powered execs at Disney and Chemical Bank. Now, with his company Reliance Group imploding, he is in such straits that he has liquidated his art-filled 34-room Park Avenue apartment. Even his mother is suing him. Ronald Perelman, another once formidable raider, is trying to clear up his own disaster at Revlon, which he controls. That company's stock has declined 90% in the past three years.

"Those of us who have survived are going back to acquiring companies because valuations have come down to reasonable levels," asserts Silverman, CEO of Cendant, which operates franchises in the real estate (Century 21) and travel (Ramada, Travelodge) industries. Silverman was a seller in recent years, shedding 18 businesses for $4.5 billion in 1999 alone. Since the stock market tanked last year, he has been buying again--at prices, he says, that are a third of what he would have had to pay just two years ago. So far he has bagged Merrill Lynch Real Estate, Fairfield Communities and the 82% of Avis he didn't already own.

Forstmann, controlling partner at the LBO firm Forstmann Little, is perhaps best known for his stand against the use of junk bonds to finance takeovers during the Milken era. In fact, LBO pros like Forstmann are a different breed, focusing on buying broken companies, fixing them and selling at a profit five or so years later. Classic raiders hope for a fast turnaround. Often they merely take a stake in a company and push for asset sales that produce immediate value to stockholders. Then they sell.

Still, Forstmann is another re-energized buy guy. On Jan. 16, he announced the $1 billion takeover of Citadel Communications, which owns more than 200 radio stations. The deal is his first big U.S. acquisition in five years.

Forstmann and others hope to acquire more companies now that values have tumbled. "It's still not easy," cautions Joe Rice, managing partner at LBO firm Clayton Dubilier & Rice. "In some cases you can offer double what a stock is trading at, but that's still half where it was a year ago--and the company says no thanks." After spending $1 billion on three overseas companies in the past 18 months, Rice says he's eager to hunt in the U.S. again.

The biggest values are in what are known as deep cyclicals--paper, chemical and metals companies. Those don't usually make good takeover candidates for anyone but a strategic buyer looking to get bigger or fill out a business need. lbo firms and other "financial buyers" prefer recession-resistant businesses whose stable incomes securely cover the large interest expense incurred in a buyout. Such buyers now say they see values in the food, energy and utilities industries.

So where will the sharks strike? Struggling whales such as Xerox, Polaroid and AT&T are vulnerable; so are Perelman's Revlon, and Chiquita Brands (40% owned by onetime raider Carl Lindner)--all in vicious down cycles.

Irwin Jacobs, whose '80s buyout/bust-up raids on AMF, Kaiser Steel and Enron, among others, helped win him the nickname "Irv the Liquidator," has changed his style and gone back to work in this new climate. Last year he bought nearly 5% of the all-but-dead insurer Conseco--some 16 million shares, at about $7 each. Jacobs helped install former GE star Gary Wendt as CEO, and with Conseco now trading at $16, he has a paper profit of $144 million.

The buyout game is more complicated today. The typical LBO has three layers of financing--equity (put up by the buyer), senior debt (borrowed from a bank), and junior debt, or junk bonds (most often provided by junk-bond mutual funds). Banks are reluctant to lend for speculative buyouts with the economy slowing, though the Fed's rate cuts are easing that condition.

The mathematics of obtaining capital has been the single biggest obstacle to the raiders' staging a full-fledged return, says Howard Marks, chairman of Oaktree Capital Management. "Buyout firms were able to purchase venerable U.S. icons in the '80s because they could borrow 20 times their money," he notes. (Remember those "highly confident" letters, as in, "I'm highly confident I can borrow the money to take over your company, bub," that Milken and pals used so effectively to terrorize CEOs?) "If you wanted to buy a company for $10 billion, you could probably do it on $400 million in equity. You can't do that anymore. Today you get maybe 3 1/2 times your equity investment--not 20 times."

Leverage--popularized in the '80s as OPM (other people's money)--is what makes LBOs work. Think of it like this: You buy a house for $200,000 with 20% down, or $40,000. Say you later sell the house for $400,000. Your profit is $200,000 on a $40,000 investment. That's a fivefold return on a property that merely doubled in value. Now imagine the math if you put down only 5%, which is how raiders did it in the '80s.

There have been other impediments to raider activity. Better management, for instance. Gone is the widespread corporate fat that marked the '80s. Two decades of shareholder activism and a hotly competitive global economy in the '90s have led CEOs to trim fat without prodding.

Besides, today "most LBO funds won't engage in hostile activity," says Greg Polle, who co-heads the mergers-and-acquisitions department at Salomon Smith Barney. "They spend more time trying to have good relations with boards so they will be viewed as a warm and friendly place."

Warm and friendly dealmakers. These are indeed very different times. But with capital getting easier to find and plenty of stocks still down, buyout kings may find that even the Ramones can still make sweet music.

--With reporting by Bill Dowell/New York

With reporting by Bill Dowell/New York