Drexel

"Drexel’s problem was that it had no Fortune 500 client with a billion-dollar bank line to wage a takeover. But what if Drexel had the billion dollars, at the ready? Or what if they said they did (and got it later)? And what if, by their staking the word of the firm on this claim, the world believed it and acted accordingly? In the new lexicon—and universe—that Drexel would soon create, this concept would become known as the “highly confident” letter. But for now it was christened (for its emptiness) the Air Fund. “We would announce to the world that we had raised one billion dollars for hostile takeovers,” one Drexel executive recalled. “There would be no money in this fund—it was just a threat. The Air Fund stood for our not having a client with deep pockets who could be in a takeover. It was a substitute for that client we didn’t have. “That concept led to our making Carl Icahn real instead of nettlesome. Carl ended up being our Air Fund. Boone ended up being our Air Fund. We manufactured out of thin air—almost thin air—a credible takeover guy.”"

"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."

"Drexel clients—in addition to Triangle Industries—would make bids for companies, all backed by Milken’s junk bonds. Mesa Petroleum, with a net worth of $ 500 million, would go for Unocal. Lorimar, with a net worth of $ 105 million, would offer $ 1 billion for Multimedia. Sir James Goldsmith would make a bid for Crown Zellerbach Corporation for $ 1.1 billion. Golden Nugget, with a net worth of $ 230 million, would go for Hilton Hotels for about $ 1.8 billion. 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."

"Milken’s theory was that many companies don’t go broke on the operating-profit line; rather, it is often financial charges that kill them. If there were a way of reducing or removing those charges, these companies might survive and ultimately return to health. Drexel investment banker Paul Levy, who would come to specialize in this area, stated that its key is the concept of the “flexible balance sheet,” or adapting to a company’s changing needs. If a company is being choked by its interest-payment obligations, why not make those payments in common stock? Or why not just exchange the old debt paper for common stock, and eliminate the charges entirely? In this new-age finance, nothing is written in stone. “People used to issue bonds, and after twenty years they would repay them,” Levy said. “That’s hogwash!” The bondholders would tend to accept these offers, no matter how displeasing, because they would find themselves between the proverbial rock and a hard place. As Levy explained, these exchange offers are essentially an arbitrage. If a buyer purchased at par a bond which then came to trade at sixty cents on the dollar, he would probably be willing to exchange it for a piece of paper trading at sixty-five cents—especially if he thought his alternative was to be stuck holding the bonds of a bankrupt company."

"Working from a Los Angeles office, Milken had created a $125 billion pool of capital that had helped tiny companies swallow giants and permitted obscure executives to gain control of world-famous busi- nesses. So effective was his operation that a mere statement that Milken believed he could raise a financial war chest in pursuit of a particular corporate quarry—a so-called "highly confident" letter—could cause panic at the company targeted for takeover. Secretive, feared by competitors, and closely monitored by securities regulators, Milken already played an enormous role in the communications industry. During his time at Drexel, he channeled some $26 billion into MCI, McCaw, Metromedia, Viacom, TCI, Time Warner, Turner, Cablevision Systems, News Corporation, and other cable, telecom, wireless, publish- ing, and entertainment companies."

"In the wake of Drexel’s success, the entire financial industry tried to come up with ways to provide increased credit for clients. New instruments were invented. The short-term “bridge loan,” for example, became common. This was an interim arrangement that allowed a company to complete a transaction without the permanent financing that would ultimately be required. The problem with bridge loans, however, was that sometimes the bridge was not long enough: if there was a downturn, the company might wind up in bankruptcy before the lenders of this interim financing would be reimbursed. It was a time of unprecedented competition among the lenders and investment bankers, and a time when greater financial risks were taken."

"Ted Forstmann opposed junk bonds with an almost religious fervor. His financing apparatuses involved straight subordinated debt, and this resulted in a more conservative structure for his management and his investors. Nevertheless, Forstmann Little’s returns to its investors were remarkable, the equal of the KKR deals financed by Drexel and Milken’s junk bonds."

"The high-yield bond was indeed, as a Drexel publication put out by Milken’s department would say some years later, “a financial instrument whose time has come.” Historically, low-rated companies had borrowed money short term on a senior, secured basis from banks, and longer term from insurance companies in private placements (although some companies were too low-rated to qualify for the private placements). But those loans had been laden with restrictive covenants. The other source of capital, of course, was equity offerings—but those diluted the value of the stock already outstanding. Furthermore, the equity markets had been so depressed through the seventies that for many companies—particularly the contingent Drexel was attempting to serve—an equity offering was not even an option."

"Wynn concurred. “We symbolized, in terms of timing and our essential posture, the archtruth of Drexel’s philosophy. There we were, wanting more money than anyone could argue we had a right to. It was venture capital, masquerading as debt finance,” he concluded, capturing the essence of Milken’s operation."

"Weinroth was drawn to Drexel because he saw a “happy constellation” in place. The medium-sized companies Drexel was targeting were indeed an underserved market, the high-yield bond was its perfect product, and Milken was already dominant in trading those bonds. Moreover, Weinroth—avuncular, rotund, hardly an investment banker in the white-shoe mold—felt temperamentally suited to these clients and the role he would play. “With medium-sized companies, you can really get to know the managements, and you can really help them. I figured I could make a difference. I wasn’t dealing with an Exxon.”"

"Perelman’s plan, at least at the start, was to do here what he had done on a much smaller scale in his earlier acquisitions, with Technicolor perhaps the best example: acquire the company with virtually all debt and then sell off the pieces he didn’t want, using the proceeds from their sales to pay down the debt and getting the remaining business virtually for free. Perelman made this plan explicit in his tender-offer document, stating that Pantry Pride believed it might be able to realize up to $1.9 billion—the total of his offer, at the starting $47.50 per-share price—from the sale of substantially all the assets of Revlon, excepting the beauty business. And it was, obviously, necessary to firm up these divestiture prices as much as possible, for Perelman—and, more to the point, Drexel—to know just how much they could afford to bid."

"Drexel became a pioneer in what Wall Street would by the mideighties loftily call merchant banking (a term borrowed from the British), which simply meant that a firm was using its own capital to finance deals (as a debt and/or equity participant)."

"In theory, the Underwriting Assistance Committee (UAC), formed in 1982, had to approve every underwriting the firm did. On the committee were about eight or ten (it varied slightly over the years) corporate-finance professionals. The investment banker for every proposed underwriting wrote a memo to the UAC, outlining its substance and the pluses and minuses of Drexel’s doing the deal. Also, in 1984 or so, Leon Black introduced into his memos (which then became the form) a first-page paragraph stating what Drexel’s compensation would be. “That marked a subtle shift here,” claimed one investment banker. “The fees don’t belong there. The deal should be judged on its merits, not the fee. It was going public with our venality.”"

"The Drexel culture encouraged entrepreneurism at every turn. Compliance, capital allocation, exposure and accounting were centralized, but all other decisions were left to the head of each group, so that the firm was run as a loosely connected association of free enterprises."

"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."

"The difference in the attitudes of those who were owners and those who only felt like employees was clear to him. “If you get a guy with some of his money in a company, he’s going to do better than people who are getting a salary and bonus based on the size of the company,” declared Joseph, delivering the Drexel exegesis. “. . . We wanted to finance companies of the future by picking guys who were going to be successful entrepreneurs, and our main discipline was getting them to have their money in the company. And we insisted on it.”"

"“two-tiered, bust-up junk-bond takeover.” “Two-tiered” referred to the fact that bids had featured a front end which paid cash to tendering shareholders and a back end which paid debt securities, thus pressuring shareholders to tender speedily so as not to be left in the second group. But now that Milken appeared able to raise almost any sum of money through the sale of junk bonds, Drexel had moved to the all-cash bid—which would be much harder to defeat in court. “Bust-up” referred to the plan, in most of these deals, to pay down the debt by selling off pieces—if not the entirety—of the company."

"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."

"Asked when he conceived of the megaleap he made with Revlon, Perelman replied that it was “a process of bites.” No, he did not have this trajectory in mind when he started out in 1978 to buy the jewelry company, Cohen-Hatfield. “Go back to 1978: even if we’d defined it, we couldn’t have funded it,” said Perelman, who refers to himself in the first person plural. “This could not have been done without Drexel.”"

"Gobhai, who encourages the use of metaphor and animal imagery in his groups, recalled that someone in the room put forth the idea that most investment-banking firms functioned as a pride of lions, in which the male lions (the investment bankers) ate their fill first, and then the remains of the kill came down the line (to the traders, the salesmen and the research people). What they ought to do at Drexel, someone else ventured, was function as a wolf pack, with all of them bringing down the kill and all eating together. Put more directly, Milken and his group should not have the lion’s share. There could be no question of these investment bankers having the lion’s share in the traditional mode, since Milken was the engine that empowered them. He needed the product they brought him, it was true; but he could replace them in a moment. They could not replace him. But should they be more like him, should they (to adopt the metaphor) run with his pack? Traders typically had a principal mentality (often using the firm’s capital to take positions), whereas investment bankers tended to have an agent mentality (facilitating transactions on behalf of a client, who was in turn the principal). Milken had a principal mentality with a vengeance. He invested not only the firm’s capital but his own and his people’s profits. At this point, he was buying the bonds of bankrupt or near-bankrupt companies, at enormous discounts, and investing in some venture-capital deals. While his partners in corporate finance did not know just how much money Milken and his associates were making in these trading and investment partnerships, they rightly surmised that it was a king’s ransom next to their own incomes (which in 1978 were under $100,000 a year)."

"In March 1984 Perelman took the company private, with Drexel raising the $95 million that the deal required. Then, the next fall, he became enamored of the huge tax-loss carryforward, or net operating loss, in Pantry Pride. He reasoned that this NOL not only could be put to good use in sheltering the income of any company he might acquire, but would give him a substantial advantage in a bidding war."

"In November 1983, Joseph, Milken and members of their respective teams met with Cavas Gobhai in a suite at the Beverly Wilshire Hotel, next door to Drexel’s new Beverly Hills office, to engineer the quantum leap. As Joseph recalled that meeting, “We started by asking, ‘Where does our financing muscle really come into play?’ One thing that’s hard to finance is unfriendly acquisitions. You can’t finance them, because you can’t tell people you’re going to do the deal, and you don’t know if you’re going to need the money, and you don’t know how much money you’re going to need, because you may have to raise the price, and you don’t have access to the inside information, and a lot of people don’t like to get involved in unfriendly deals.”"

"Milken’s theory was that many companies don’t go broke on the operating-profit line; rather, it is often financial charges that kill them. If there were a way of reducing or removing those charges, these companies might survive and ultimately return to health. Drexel investment banker Paul Levy, who would come to specialize in this area, stated that its key is the concept of the “flexible balance sheet,” or adapting to a company’s changing needs. If a company is being choked by its interest-payment obligations, why not make those payments in common stock? Or why not just exchange the old debt paper for common stock, and eliminate the charges entirely? In this new-age finance, nothing is written in stone. “People used to issue bonds, and after twenty years they would repay them,” Levy said. “That’s hogwash!” The bondholders would tend to accept these offers, no matter how displeasing, because they would find themselves between the proverbial rock and a hard place. As Levy explained, these exchange offers are essentially an arbitrage. If a buyer purchased at par a bond which then came to trade at sixty cents on the dollar, he would probably be willing to exchange it for a piece of paper trading at sixty-five cents—especially if he thought his alternative was to be stuck holding the bonds of a bankrupt company."

"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."

"While Milken apparently chose to not spend his money, however, he certainly had been driven to accumulate it from the very start. And, after all these years, he was still trying to shave every trade, still trying to milk his best clients (“If we don’t make money from our friends, who will we make money from?”), still demanding everything but the firstborn son in deals where he could get it. And still, in the view of one Drexel employee, shortchanging his partners."

"Milken believed that people were at their most productive when they felt they were part of a collective enterprise. There could, therefore, be no stars, and that included him. That was why he refused to have his picture in Drexel’s annual report—it would detract from the team spirit. He had no office, only his desk on the trading floor, for the same reason. He had no meaningful title in the firm, and there were no meaningful titles in his group; no one was to be ranked over someone else. (As Milken had mentioned, his group’s Christmas card, in the form of a bond, was an undifferentiated printing of the names of all its members—a graphic illustration of this principle.) He would not, of course, have allowed the members of his group to speak to the press, because of his insistence upon secrecy and control; but he also mentioned that he did not want his people to start thinking of themselves as stars. It would be harder to motivate them, come four-thirty Monday morning."

"“Coastal was a big company, with significant assets. It wasn’t so leveraged. Triangle was a company with a fifty-million-dollar net worth. This was the first of the superleveraged buyouts to go through.” The acquisition of National Can cost $465 million. Triangle contributed $70 million as equity, to which another $30 million was added through its sale (underwritten by Drexel) of preferred stock; the debt portion layered above that consisted of $365 million raised with junk bonds by Drexel. And after the deal closed, Drexel raised another $200 million from junk bonds, in order to pay down National Can’s preexisting bank debt. So the total debt of National Can, once the $200 million was added to the preceding $365 million, was $565 million. Five hundred sixty-five million dollars was a towering debt load for $100 million of equity to carry. And Peltz pointed out that even the $70 million from Triangle, at the equity base, came from its earlier offering of junk. “We put the hundred million in the sub [the subsidiary, Triangle Acquisition Corporation, formed for the buyout]. But it was all debt! We called it equity here [at Triangle Acquisition Corporation], but it was debt over here [at Triangle]. Do you understand the leverage in this deal? It was eleven to one!"

"At most investment-banking firms, if they had filed to do a junk underwriting for $100 million but found they could sell only $50 million, they typically would cut the deal back to whatever they could sell. But Milken had for years now made it a point of honor that he would not cut back a deal. As he would testify with apparent pride in a deposition in mid-1986, “I would say also that in my entire career on Wall Street I have never backed out of a transaction once I’ve agreed to stand up to it, no matter how onerous it turned out to be.” This policy presumably sprang not only from Milken’s sense of probity, but from his knowing it was good for business. It was meant to—and generally did—incur a sense of deep indebtedness in the client. Marshall Cogen of General Felt Industries, for example, recalls that in the hard times of 1980 Drexel filed to raise $60 million for General Felt but found they could sell less than half of that; the firm took the rest. As Cogen said in an interview in 1986, “I have never seen that done by another investment banking firm—never. Today everyone wants to bank us—Goldman, Lazard. But no one else would have raised that money back in 1980. And without it I never could have developed the base I have.”"

"When major corporations launched their hostile takeovers, they did so on the basis of commitment letters for the financing from commercial banks. Drexel, Icahn suggested, should act like those banks and give him a commitment letter. Sorte and Black thought that Icahn’s demand was outrageous. Drexel, they argued, was acting merely as agent for the lenders to Icahn, and if it gave him a commitment letter, the amount would be charged against the firm’s capital. In two years, however, this strange notion would be known as “bridge financing” and would be the rage on Wall Street. Investment banks would commit their own capital to a deal, in a “bridge” between the time of the offer and the time it actually had to be funded. By funding time, the investment bank would have placed much if not all of the debt with bond buyers. Trying to respond to Icahn’s demand for a letter of commitment, Black finally ventured, “Why don’t we say we’re ‘highly confident’ that we can raise it? It’s really different. It hasn’t been done before.” “Carl looked at me,” Black recalled. “He turned to his lawyer and said, ‘What do you think?’ His lawyer said, ‘Leon’s full of shit. It’s not legally binding, what good is it?’ ” Sometime in the early hours of the morning the meeting broke up, with Icahn saying he was no longer interested in doing the tender offer. But the next morning he called Black and said, “You know that ‘highly confident’ letter you were talking about? . . .” That was the beginning of Drexel’s famed “highly confident”—the pronouncement that would seem, for a time, almost talismanic in its power. One after another, multibillion-dollar tender offers were launched on the power of those two words, uttered by Drexel. It became an article of faith for Milken that once he had said he was “highly confident” that he could raise a given amount of financing for a bid, he would never renege or cut back on the terms, because then, of course, the words would be just words."

"Drexel’s problem was that it had no Fortune 500 client with a billion-dollar bank line to wage a takeover. But what if Drexel had the billion dollars, at the ready? Or what if they said they did (and got it later)? And what if, by their staking the word of the firm on this claim, the world believed it and acted accordingly? In the new lexicon—and universe—that Drexel would soon create, this concept would become known as the “highly confident” letter. But for now it was christened (for its emptiness) the Air Fund. “We would announce to the world that we had raised one billion dollars for hostile takeovers,” one Drexel executive recalled. “There would be no money in this fund—it was just a threat. The Air Fund stood for our not having a client with deep pockets who could be in a takeover. It was a substitute for that client we didn’t have. “That concept led to our making Carl Icahn real instead of nettlesome. Carl ended up being our Air Fund. Boone ended up being our Air Fund. We manufactured out of thin air—almost thin air—a credible takeover guy.”"

"Then, in 1978, at age thirty-five, he decided to venture out. He borrowed $1.9 million to buy 34 percent of Cohen-Hatfield Industries, a jewelry distributor and retailer with $49 million in revenues that year. In 1980, Cohen-Hatfield spent about $45 million to buy MacAndrews and Forbes, a maker of chocolates and licorice extracts, and the Cohen-Hatfield name was dropped in favor of MacAndrews. In the fall of 1980, MacAndrews issued its first batch of junk bonds, a modest $33 million, underwritten by Drexel with Bear, Stearns. Over the next four and a half years, Perelman set out on a wholly leveraged, though relatively small-time, acquisition trail. He tried and failed to acquire the Richardson Company and the Milton Bradley toy and game company, but he made money in both transactions. He succeeded in buying, for a total of about $360 million, Technicolor, Inc., the film processor; Video Corporation of America, a major manufacturer of home videocassettes; the film-processing assets of Movie Labs; Consolidated Cigar; and a controlling interest in Pantry Pride. Roughly $140 million of this money came from Drexel junk-bond offerings, the rest from banks—and all built on that original (borrowed) $1.9 million, back in 1978."

"Peltz appeared to share little of his bankers’ anxiety. In mid-1985 he purchased through Triangle a $2 million apartment in Paris. “Mike made him put it on the market,” commented one Drexel investment banker, “which was the right thing to do. We have a responsibility to our bondholders. What’s he going out and spending the company’s money like that for, when he’s got this mountain of debt?” By the beginning of 1986, however, the first good news was in (and Peltz took the apartment, still unsold, off the market). National Can had had a record year in 1985; its earnings (for April 17 through December) were $162 million, up from $68,775 the year before; Triangle’s stock had quadrupled, making it the third-best performer on the New York Stock Exchange. With interest rates down, Peltz and May were refinancing the company’s acquisition debt, meaning they were paying down that debt and replacing it with newer debt at lower interest rates. And their combined personal stakes in the company had gone from a market value of roughly $8–9 million when they purchased the controlling block of Triangle stock, in 1983, to about $34 million. Adding in a premium for control, which would have been present if they were to sell their block, it was now worth more than $40 million."

"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."

"The Drexel culture encouraged entrepreneurism at every turn. Compliance, capital allocation, exposure and accounting were centralized, but all other decisions were left to the head of each group, so that the firm was run as a loosely connected association of free enterprises."

"Asked when he conceived of the megaleap he made with Revlon, Perelman replied that it was “a process of bites.” No, he did not have this trajectory in mind when he started out in 1978 to buy the jewelry company, Cohen-Hatfield. “Go back to 1978: even if we’d defined it, we couldn’t have funded it,” said Perelman, who refers to himself in the first person plural. “This could not have been done without Drexel.”"

"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."

"While Milken apparently chose to not spend his money, however, he certainly had been driven to accumulate it from the very start. And, after all these years, he was still trying to shave every trade, still trying to milk his best clients (“ If we don’t make money from our friends, who will we make money from?”), still demanding everything but the firstborn son in deals where he could get it. And still, in the view of one Drexel employee, shortchanging his partners."

"Milken believed that people were at their most productive when they felt they were part of a collective enterprise. There could, therefore, be no stars, and that included him. That was why he refused to have his picture in Drexel’s annual report—it would detract from the team spirit. He had no office, only his desk on the trading floor, for the same reason. He had no meaningful title in the firm, and there were no meaningful titles in his group; no one was to be ranked over someone else. (As Milken had mentioned, his group’s Christmas card, in the form of a bond, was an undifferentiated printing of the names of all its members—a graphic illustration of this principle.) He would not, of course, have allowed the members of his group to speak to the press, because of his insistence upon secrecy and control; but he also mentioned that he did not want his people to start thinking of themselves as stars. It would be harder to motivate them, come four-thirty Monday morning."

"In March 1984 Perelman took the company private, with Drexel raising the $ 95 million that the deal required. Then, the next fall, he became enamored of the huge tax-loss carryforward, or net operating loss, in Pantry Pride. He reasoned that this NOL not only could be put to good use in sheltering the income of any company he might acquire, but would give him a substantial advantage in a bidding war."

"Perelman’s plan, at least at the start, was to do here what he had done on a much smaller scale in his earlier acquisitions, with Technicolor perhaps the best example: acquire the company with virtually all debt and then sell off the pieces he didn’t want, using the proceeds from their sales to pay down the debt and getting the remaining business virtually for free. Perelman made this plan explicit in his tender-offer document, stating that Pantry Pride believed it might be able to realize up to $ 1.9 billion—the total of his offer, at the starting $ 47.50 per-share price—from the sale of substantially all the assets of Revlon, excepting the beauty business. And it was, obviously, necessary to firm up these divestiture prices as much as possible, for Perelman—and, more to the point, Drexel—to know just how much they could afford to bid."

"In theory, the Underwriting Assistance Committee (UAC), formed in 1982, had to approve every underwriting the firm did. On the committee were about eight or ten (it varied slightly over the years) corporate-finance professionals. The investment banker for every proposed underwriting wrote a memo to the UAC, outlining its substance and the pluses and minuses of Drexel’s doing the deal. Also, in 1984 or so, Leon Black introduced into his memos (which then became the form) a first-page paragraph stating what Drexel’s compensation would be. “That marked a subtle shift here,” claimed one investment banker. “The fees don’t belong there. The deal should be judged on its merits, not the fee. It was going public with our venality.”"

"When major corporations launched their hostile takeovers, they did so on the basis of commitment letters for the financing from commercial banks. Drexel, Icahn suggested, should act like those banks and give him a commitment letter. Sorte and Black thought that Icahn’s demand was outrageous. Drexel, they argued, was acting merely as agent for the lenders to Icahn, and if it gave him a commitment letter, the amount would be charged against the firm’s capital. In two years, however, this strange notion would be known as “bridge financing” and would be the rage on Wall Street. Investment banks would commit their own capital to a deal, in a “bridge” between the time of the offer and the time it actually had to be funded. By funding time, the investment bank would have placed much if not all of the debt with bond buyers. Trying to respond to Icahn’s demand for a letter of commitment, Black finally ventured, “Why don’t we say we’re ‘highly confident’ that we can raise it? It’s really different. It hasn’t been done before.” “Carl looked at me,” Black recalled. “He turned to his lawyer and said, ‘What do you think?’ His lawyer said, ‘Leon’s full of shit. It’s not legally binding, what good is it?’ ” Sometime in the early hours of the morning the meeting broke up, with Icahn saying he was no longer interested in doing the tender offer. But the next morning he called Black and said, “You know that ‘highly confident’ letter you were talking about? . . .” That was the beginning of Drexel’s famed “highly confident”—the pronouncement that would seem, for a time, almost talismanic in its power. One after another, multibillion-dollar tender offers were launched on the power of those two words, uttered by Drexel. It became an article of faith for Milken that once he had said he was “highly confident” that he could raise a given amount of financing for a bid, he would never renege or cut back on the terms, because then, of course, the words would be just words."

"Then, in 1978, at age thirty-five, he decided to venture out. He borrowed $ 1.9 million to buy 34 percent of Cohen-Hatfield Industries, a jewelry distributor and retailer with $ 49 million in revenues that year. In 1980, Cohen-Hatfield spent about $ 45 million to buy MacAndrews and Forbes, a maker of chocolates and licorice extracts, and the Cohen-Hatfield name was dropped in favor of MacAndrews. In the fall of 1980, MacAndrews issued its first batch of junk bonds, a modest $ 33 million, underwritten by Drexel with Bear, Stearns. Over the next four and a half years, Perelman set out on a wholly leveraged, though relatively small-time, acquisition trail. He tried and failed to acquire the Richardson Company and the Milton Bradley toy and game company, but he made money in both transactions. He succeeded in buying, for a total of about $ 360 million, Technicolor, Inc., the film processor; Video Corporation of America, a major manufacturer of home videocassettes; the film-processing assets of Movie Labs; Consolidated Cigar; and a controlling interest in Pantry Pride. Roughly $ 140 million of this money came from Drexel junk-bond offerings, the rest from banks—and all built on that original (borrowed) $ 1.9 million, back in 1978."

"“two-tiered, bust-up junk-bond takeover.” “Two-tiered” referred to the fact that bids had featured a front end which paid cash to tendering shareholders and a back end which paid debt securities, thus pressuring shareholders to tender speedily so as not to be left in the second group. But now that Milken appeared able to raise almost any sum of money through the sale of junk bonds, Drexel had moved to the all-cash bid—which would be much harder to defeat in court. “Bust-up” referred to the plan, in most of these deals, to pay down the debt by selling off pieces—if not the entirety—of the company."

"“Coastal was a big company, with significant assets. It wasn’t so leveraged. Triangle was a company with a fifty-million-dollar net worth. This was the first of the superleveraged buyouts to go through.” The acquisition of National Can cost $ 465 million. Triangle contributed $ 70 million as equity, to which another $ 30 million was added through its sale (underwritten by Drexel) of preferred stock; the debt portion layered above that consisted of $ 365 million raised with junk bonds by Drexel. And after the deal closed, Drexel raised another $ 200 million from junk bonds, in order to pay down National Can’s preexisting bank debt. So the total debt of National Can, once the $ 200 million was added to the preceding $ 365 million, was $ 565 million. Five hundred sixty-five million dollars was a towering debt load for $ 100 million of equity to carry. And Peltz pointed out that even the $ 70 million from Triangle, at the equity base, came from its earlier offering of junk. “We put the hundred million in the sub [the subsidiary, Triangle Acquisition Corporation, formed for the buyout]. But it was all debt! We called it equity here [at Triangle Acquisition Corporation], but it was debt over here [at Triangle]. Do you understand the leverage in this deal? It was eleven to one!"

"At most investment-banking firms, if they had filed to do a junk underwriting for $ 100 million but found they could sell only $ 50 million, they typically would cut the deal back to whatever they could sell. But Milken had for years now made it a point of honor that he would not cut back a deal. As he would testify with apparent pride in a deposition in mid-1986, “I would say also that in my entire career on Wall Street I have never backed out of a transaction once I’ve agreed to stand up to it, no matter how onerous it turned out to be.” This policy presumably sprang not only from Milken’s sense of probity, but from his knowing it was good for business. It was meant to—and generally did—incur a sense of deep indebtedness in the client. Marshall Cogen of General Felt Industries, for example, recalls that in the hard times of 1980 Drexel filed to raise $ 60 million for General Felt but found they could sell less than half of that; the firm took the rest. As Cogen said in an interview in 1986, “I have never seen that done by another investment banking firm—never. Today everyone wants to bank us—Goldman, Lazard. But no one else would have raised that money back in 1980. And without it I never could have developed the base I have.”"

"In November 1983, Joseph, Milken and members of their respective teams met with Cavas Gobhai in a suite at the Beverly Wilshire Hotel, next door to Drexel’s new Beverly Hills office, to engineer the quantum leap. As Joseph recalled that meeting, “We started by asking, ‘Where does our financing muscle really come into play?’ One thing that’s hard to finance is unfriendly acquisitions. You can’t finance them, because you can’t tell people you’re going to do the deal, and you don’t know if you’re going to need the money, and you don’t know how much money you’re going to need, because you may have to raise the price, and you don’t have access to the inside information, and a lot of people don’t like to get involved in unfriendly deals.”"

"Gobhai, who encourages the use of metaphor and animal imagery in his groups, recalled that someone in the room put forth the idea that most investment-banking firms functioned as a pride of lions, in which the male lions (the investment bankers) ate their fill first, and then the remains of the kill came down the line (to the traders, the salesmen and the research people). What they ought to do at Drexel, someone else ventured, was function as a wolf pack, with all of them bringing down the kill and all eating together. Put more directly, Milken and his group should not have the lion’s share. There could be no question of these investment bankers having the lion’s share in the traditional mode, since Milken was the engine that empowered them. He needed the product they brought him, it was true; but he could replace them in a moment. They could not replace him. But should they be more like him, should they (to adopt the metaphor) run with his pack? Traders typically had a principal mentality (often using the firm’s capital to take positions), whereas investment bankers tended to have an agent mentality (facilitating transactions on behalf of a client, who was in turn the principal). Milken had a principal mentality with a vengeance. He invested not only the firm’s capital but his own and his people’s profits. At this point, he was buying the bonds of bankrupt or near-bankrupt companies, at enormous discounts, and investing in some venture-capital deals. While his partners in corporate finance did not know just how much money Milken and his associates were making in these trading and investment partnerships, they rightly surmised that it was a king’s ransom next to their own incomes (which in 1978 were under $ 100,000 a year)."

"Wynn concurred. “We symbolized, in terms of timing and our essential posture, the archtruth of Drexel’s philosophy. There we were, wanting more money than anyone could argue we had a right to. It was venture capital, masquerading as debt finance,” he concluded, capturing the essence of Milken’s operation."

"The high-yield bond was indeed, as a Drexel publication put out by Milken’s department would say some years later, “a financial instrument whose time has come.” Historically, low-rated companies had borrowed money short term on a senior, secured basis from banks, and longer term from insurance companies in private placements (although some companies were too low-rated to qualify for the private placements). But those loans had been laden with restrictive covenants. The other source of capital, of course, was equity offerings—but those diluted the value of the stock already outstanding. Furthermore, the equity markets had been so depressed through the seventies that for many companies—particularly the contingent Drexel was attempting to serve—an equity offering was not even an option."

"The difference in the attitudes of those who were owners and those who only felt like employees was clear to him. “If you get a guy with some of his money in a company, he’s going to do better than people who are getting a salary and bonus based on the size of the company,” declared Joseph, delivering the Drexel exegesis. “. . . We wanted to finance companies of the future by picking guys who were going to be successful entrepreneurs, and our main discipline was getting them to have their money in the company. And we insisted on it.”"

"Weinroth was drawn to Drexel because he saw a “happy constellation” in place. The medium-sized companies Drexel was targeting were indeed an underserved market, the high-yield bond was its perfect product, and Milken was already dominant in trading those bonds. Moreover, Weinroth—avuncular, rotund, hardly an investment banker in the white-shoe mold—felt temperamentally suited to these clients and the role he would play. “With medium-sized companies, you can really get to know the managements, and you can really help them. I figured I could make a difference. I wasn’t dealing with an Exxon.”"

"Peltz appeared to share little of his bankers’ anxiety. In mid-1985 he purchased through Triangle a $ 2 million apartment in Paris. “Mike made him put it on the market,” commented one Drexel investment banker, “which was the right thing to do. We have a responsibility to our bondholders. What’s he going out and spending the company’s money like that for, when he’s got this mountain of debt?” By the beginning of 1986, however, the first good news was in (and Peltz took the apartment, still unsold, off the market). National Can had had a record year in 1985; its earnings (for April 17 through December) were $ 162 million, up from $ 68,775 the year before; Triangle’s stock had quadrupled, making it the third-best performer on the New York Stock Exchange. With interest rates down, Peltz and May were refinancing the company’s acquisition debt, meaning they were paying down that debt and replacing it with newer debt at lower interest rates. And their combined personal stakes in the company had gone from a market value of roughly $ 8–9 million when they purchased the controlling block of Triangle stock, in 1983, to about $ 34 million. Adding in a premium for control, which would have been present if they were to sell their block, it was now worth more than $ 40 million."

"Drexel became a pioneer in what Wall Street would by the mideighties loftily call merchant banking (a term borrowed from the British), which simply meant that a firm was using its own capital to finance deals (as a debt and/ or equity participant)."