Milken

"“Notwithstanding the focus of most corporate executives upon the operating side of the business, opportunities for profit enhancement also exist in the financial end of the business,” Walter and Milken wrote. “The liability and net worth segments of the balance sheet represent portfolio positions that are subject to modification as conditions warrant. Neglect of such matters is patently inconsistent with rational behavior.”"

"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."

"An Israeli emigrant, Riklis had started out with a stake of just $ 25,000, buying and combining small companies in the 1950s. By the time he met Milken in about 1970, Riklis controlled a conglomerate, Rapid-American, which had sales of close to $ 2 billion. It included such companies as International Playtex, Schenley Industries, Lerner Shops and RKO–Stanley Warner Theatres. What Riklis had done was acquire one company and then use its assets to acquire the next, and that company’s to acquire the next, in ever larger circles. He acquired these companies by issuing mainly bonds, or debt, in exchange for the company’s stock. As Riklis liked to say, Rapid-American owed its success to “the effective nonuse of cash.”"

"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."

"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.”"

"Carl Lindner through American Financial, Saul Steinberg through Reliance Insurance, Meshulam Riklis through Rapid-American, Victor Posner through several of his companies, the Belzbergs through a number of their companies, and others—who issued their own paper and bought one another’s and traded, with Milken the nexus for it all."

"Milken found his métier researching and trading these bonds. First he learned everything he could about the companies whose bonds he would be trading, preparing for his hours on the trading desk as though it were orals. Then he was ready to make his bet."

"Milken would in effect create his own firm within the firm of Drexel Burnham, one which its members would refer to simply as “the Department.” He laid the groundwork for that autonomy in 1973. From the very beginning, Milken made it mandatory that a certain portion of his people’s profits were reinvested in trading accounts which he ran. It was a system of forced savings, in which these salesmen and traders were able to watch—from a distance—their wealth accumulate. With the kind of return Milken got, no one really had much to complain about. On the other hand, if one decided to leave him on less than amicable terms, as one trader would, there might be difficulty in getting one’s money out. It was a powerful disincentive to taking any secrets from Milken’s operation to a rival firm."

"The major difference between Riklis’ debt-laden acquisitions and those of Milken’s later acquirers was that Milken’s chosen would issue the bonds for cash and then give the cash to the shareholders, while Riklis would issue the bonds directly to the shareholders. Both Riklis and his successors a generation later, however, would be using to their advantage the same debt-favoring provision of the U.S. tax laws: interest (on bonds) is deductible, but dividends (on stock) are not. Therefore, assuming roughly a 50 percent corporate-income-tax rate, a company that can pay shareholders a rate of return of 7 percent on dividends can just as easily pay 14 percent interest on subordinated debt, because it can deduct the interest."

"By 1980, soaring interest rates were already causing bondholders to suffer. So, in order to keep luring bond buyers into the market, Milken and Joseph came up with newfangled pieces of paper over the next several years. High-coupon, high-premium convertible bonds (if the related common stock declined, the high yield would offer significant downside protection). Bonds with warrants. Commodity-related bonds: four were exchangeable into silver, one into gold, two had returns related to the price of oil, and one had a coupon which would increase based on the volume of trading on the New York Stock Exchange."

"Milken was offering these low-rated companies a new financial instrument that blended the best of equity and debt: long-term, dilutionless, less restrictive capital. The average life of these bonds was fifteen years, with no principal payments due for ten years. This was subordinated debt too, which meant it was subordinated to the claims of any senior-debt holders. If they wished, the companies could continue to acquire senior debt at a lower interest rate from banks—which would draw comfort from the level of subordinated-debt capital beneath them. Like a mountaintop-real-estate developer who builds one row of homes with spectacular views, sells them and then builds another in front, repeating the process until the latest row has reached the very cliff, the companies could continue to acquire senior debt, without interference from the subordinated-debt holders, who would be relegated to increasingly junior positions."

"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."

"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 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 does not run with the herd. He is, said Joseph, “one of the greatest natural contra-thinkers I’ve ever seen. If you say, ‘It’s a nice day,’ he thinks about the fact that people think it’s a nice day, maybe it’s not nice somewhere else, maybe it’s not gonna be nice, compared to what, what do you mean, nice day? He really thinks that way. That is perfect for an investor, or a trader, to be a contra-thinker. It turns out it is perfect for a finance business, trying to figure out what’s going to happen in the future.”"

"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.”"

"As though to underline this desire for structural egalitarianism, Milken had no office. On the infrequent occasions when he was away from his desk in the center of the trading floor, he urged others to use it. Meetings were generally open to all who were interested. People were encouraged to perform numerous functions. In a later SEC deposition, given in 1982, Milken described some people in his group as “quasi-trader salesmen,” explaining that “on a given day he could be primarily selling, and another day he could be trading. Another day he could be doing something else.”"

"“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."

"Now McCaw told Milken that McCaw Communications wanted help to buy more cellular licenses. But Milken saw a new threat to Craig McCaw. "You're exposed," Milken said. McCaw was trying to grow two capital-intensive businesses at once while facing deeper-pocketed competitors on both fronts. He couldn't grow in both cable and cellular for long. Milken warned McCaw that his company was too deeply in debt. There was an irony—the foremost apostle of debt telling Craig McCaw that his financial strategy was too risky. According to Perry, McCaw didn't show much reaction. He just took it in thoughtfully and said merely, "Hmm. Okay." But Milken was right. The Southwestern buyout of Metromedia's cellular business showed how the bigger boys were prepared to snatch licenses that McCaw needed. Previously, McCaw had been annoyed by industry talk that his company was spread thin. To his face, the chair- man of PacTel had called his company a "house of cards." "I was tired of hearing about how much leverage we should take," McCaw says. Hearing the same message from Milken gave it a new urgency; it "hit McCaw right between the eyes," Stanton said later. McCaw had to focus his company on one business or the other."

"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."

"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."

"I called Milken, who said, “John wants a billion seven fifty. But he thinks he could sell the Boston station to Hearst for six hundred million. So it’s a billion one for the other stations.” I called Murdoch and reported all that. Rupert wasn’t fazed and just asked how much the whole effort would cost. I called my friend Marty Pompadur, a very senior media executive who had been a key ABC executive and knew everything about broadcasting. An hour later Marty was in my office, and we began chewing over how to build a fourth network."

"Milken was made the poster boy for Wall Street excesses after the Crash of 1987. In a plea bargain deal in 1990, he pleaded guilty to six felony counts, including securities fraud, mail fraud, and tax evasion, and served twenty-two months of a ten-year sentence after cooperating with authorities and getting time off for good behavior. He was fined $200 million and ordered to pay $400 million in restitution to investors."

"Milken found his métier researching and trading these bonds. First he learned everything he could about the companies whose bonds he would be trading, preparing for his hours on the trading desk as though it were orals. Then he was ready to make his bet."

"Milken would in effect create his own firm within the firm of Drexel Burnham, one which its members would refer to simply as “the Department.” He laid the groundwork for that autonomy in 1973. From the very beginning, Milken made it mandatory that a certain portion of his people’s profits were reinvested in trading accounts which he ran. It was a system of forced savings, in which these salesmen and traders were able to watch—from a distance—their wealth accumulate. With the kind of return Milken got, no one really had much to complain about. On the other hand, if one decided to leave him on less than amicable terms, as one trader would, there might be difficulty in getting one’s money out. It was a powerful disincentive to taking any secrets from Milken’s operation to a rival firm."

"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."

"Milken was offering these low-rated companies a new financial instrument that blended the best of equity and debt: long-term, dilutionless, less restrictive capital. The average life of these bonds was fifteen years, with no principal payments due for ten years. This was subordinated debt too, which meant it was subordinated to the claims of any senior-debt holders. If they wished, the companies could continue to acquire senior debt at a lower interest rate from banks—which would draw comfort from the level of subordinated-debt capital beneath them. Like a mountaintop-real-estate developer who builds one row of homes with spectacular views, sells them and then builds another in front, repeating the process until the latest row has reached the very cliff, the companies could continue to acquire senior debt, without interference from the subordinated-debt holders, who would be relegated to increasingly junior positions."

"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.”"

"An Israeli emigrant, Riklis had started out with a stake of just $25,000, buying and combining small companies in the 1950s. By the time he met Milken in about 1970, Riklis controlled a conglomerate, Rapid-American, which had sales of close to $2 billion. It included such companies as International Playtex, Schenley Industries, Lerner Shops and RKO–Stanley Warner Theatres. What Riklis had done was acquire one company and then use its assets to acquire the next, and that company’s to acquire the next, in ever larger circles. He acquired these companies by issuing mainly bonds, or debt, in exchange for the company’s stock. As Riklis liked to say, Rapid-American owed its success to “the effective nonuse of cash.”"

"Milken meant to inspire so that his people would feel like cathedral-builders, not bricklayers, and he did so. “If he was walking over a cliff,” declared one former disciple, “everyone in that group would have followed him.”"

"“Notwithstanding the focus of most corporate executives upon the operating side of the business, opportunities for profit enhancement also exist in the financial end of the business,” Walter and Milken wrote. “The liability and net worth segments of the balance sheet represent portfolio positions that are subject to modification as conditions warrant. Neglect of such matters is patently inconsistent with rational behavior.”"

"The major difference between Riklis’ debt-laden acquisitions and those of Milken’s later acquirers was that Milken’s chosen would issue the bonds for cash and then give the cash to the shareholders, while Riklis would issue the bonds directly to the shareholders. Both Riklis and his successors a generation later, however, would be using to their advantage the same debt-favoring provision of the U.S. tax laws: interest (on bonds) is deductible, but dividends (on stock) are not. Therefore, assuming roughly a 50 percent corporate-income-tax rate, a company that can pay shareholders a rate of return of 7 percent on dividends can just as easily pay 14 percent interest on subordinated debt, because it can deduct the interest."

"According to one long-standing acquaintance of Milken, his wife, Lori, had made him promise that on his vacation he would not work from 9 A.M. on; so Milken took his family to Hawaii, where he slept for a few hours in the late evening, rose at 1 or 2 A.M. and worked until 9 A.M.—by which time it was 2 P.M. in New York and most of the business day was over."

"Carl Lindner through American Financial, Saul Steinberg through Reliance Insurance, Meshulam Riklis through Rapid-American, Victor Posner through several of his companies, the Belzbergs through a number of their companies, and others—who issued their own paper and bought one another’s and traded, with Milken the nexus for it all."

"Weinroth lapsed into the familiar refrain (articulated by Milken, Icahn and others of their persuasion) about the decline of corporate America in the hands of its managers, and its rescue by the new breed of manager-owners. “Old companies were started by true entrepreneurs, who had children some of whom were affected by the ills of the rich,” he continued. “They brought in professional managers, who ran the companies in a conservative fashion . . . but those professional managers didn’t have an ownership stake. Their risk-reward ratio was skewed to being a conservator, not an initiator. Then the second-generation [managers] grew to the top. And even if they were high quality as managers, they were certainly not entrepreneurial. And then that group promoted people who couldn’t threaten them, and they in turn hired people inferior to them, who lived for their perks and compensation and ran their companies conservatively because they had no upside interest. And by the time you go through several generations of these managers, you have a company run by dull-normals!"

"Earnings might be unimpressive (and therefore the stock price low) but if there is a great deal of depreciation, for example, then cash flow can be high. And it is cash flow, in its ability to service debt by making interest payments, that makes a highly leveraged acquisition viable. In his original issuance of junk bonds, Milken had recognized the importance of cash flow, more than earnings, in assessing whether the leveraged companies he was underwriting would be able to meet their debt payments. Now that he had moved from $25 million offerings to multibillion-dollar deals, the calculation was not so different—just bigger."

"Milken does not run with the herd. He is, said Joseph, “one of the greatest natural contra-thinkers I’ve ever seen. If you say, ‘It’s a nice day,’ he thinks about the fact that people think it’s a nice day, maybe it’s not nice somewhere else, maybe it’s not gonna be nice, compared to what, what do you mean, nice day? He really thinks that way. That is perfect for an investor, or a trader, to be a contra-thinker. It turns out it is perfect for a finance business, trying to figure out what’s going to happen in the future.”"

"Peltz understood that if he was to have a vehicle for acquisitions, that vehicle would have to have cash flow sufficient to make the interest payments on its debt. Trafalgar had almost no cash flow. And no one—including the hungry Milken—would raise any junk-bond financing for him until he had a company with some kind of cash flow."

"Milken struck a different note. He told this reporter in an interview in 1987, “I welcome competition. Other people might see things we don’t see. We might see things they don’t see. The negatives are—and I’m trying to state this in a positive way—that some deals may get done that shouldn’t get done, and then that may hurt the perception of the high-yield market. People have a tendency to remember only the ones that didn’t work out. “Financing is an art form,” Milken added. “One of the challenges is how to correctly finance a company. In certain periods of time, more covenants need to be put into deals. You have to be sure the company has the right covenant—to allow it the freedom to grow, but also to insure the integrity of the credit. Sometimes a company should issue convertible bonds instead of straight bonds. Sometimes it should issue preferred stock. Each company and each financing is different, and the process can’t be imitative.”"

"“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."

"One of the most thoughtful was James Grant, editor of Grant’s Interest Rate Observer, who had carved out his anti-junk position back in September 1984. Grant explained that he had reached this point of view, first, because the world even at that time was long on debt and short on equity, and he followed the old investment adage that one should own the thing in short supply and shun the thing in surplus. What an illiquid world needs is cash, he reasoned, and so the debt security to own (if one chooses to own debt at all) is the one with the highest ratio of cash flow to interest expense—not, in other words, the junk securities of companies which typically have little financial leeway. Second, Grant reasoned that the holdings of junk bonds were so concentrated in a handful of institutions (Milken’s inner circle)—which issued bonds and bought each other’s paper—as to invalidate the argument of safety through diversification in one’s portfolio. And, third, he declared that the junk idea had been carried too far, and that a faddishness had grown around its progenitor and prose-lytizer, Milken. Thus, Grant declared in September 1984, “. . . our hunch is . . . that, in some basic way, junk has had its day.”"

"As though to underline this desire for structural egalitarianism, Milken had no office. On the infrequent occasions when he was away from his desk in the center of the trading floor, he urged others to use it. Meetings were generally open to all who were interested. People were encouraged to perform numerous functions. In a later SEC deposition, given in 1982, Milken described some people in his group as “quasi-trader salesmen,” explaining that “on a given day he could be primarily selling, and another day he could be trading. Another day he could be doing something else.”"

"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."

"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 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."

"Now Black returned to the scene, telling Icahn that Milken not only would raise the $750 million with PARS out of the company, but would raise another $500 million war chest, or “blind pool,” in the company in which PARS would be placed. Bond buyers who liked the airline could buy its debt; those who were enamored of PARS could buy that company’s debt; others could mix the two. The company that would be formed to receive PARS—and the $500 million—would be called Mandrake (as in the magician)."

"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."

"By 1980, soaring interest rates were already causing bondholders to suffer. So, in order to keep luring bond buyers into the market, Milken and Joseph came up with newfangled pieces of paper over the next several years. High-coupon, high-premium convertible bonds (if the related common stock declined, the high yield would offer significant downside protection). Bonds with warrants. Commodity-related bonds: four were exchangeable into silver, one into gold, two had returns related to the price of oil, and one had a coupon which would increase based on the volume of trading on the New York Stock Exchange."

"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."

"The deal closed in mid-November, and within two weeks there were reports that Revlon was going to sell its Norcliff Thayer health products and Reheis special chemical businesses to the Beecham Group of Britain for about $400 million, and its ethical-drug division to Rorer for over $600 million. Both deals were announced by the first week of December. Some onlookers were puzzled by the speed with which the Rorer deal, particularly, was done, and by the absence of an auction. Howard Gittis, however, explained, “They had an exclusive. Well, almost an exclusive. We said, ‘If we get the company, and you commit to us now, then we won’t shop the deal.’ ” This agreement should arguably have been disclosed in SEC filings if it was indeed made during the course of the deal. When later asked to comment, Gittis denied that anyone had been given an exclusive. “At that point [in December], the money was just sitting there in the bank, but they couldn’t call [buy back] the bonds for six months,” this buyer said. “So it was completely safe now, good for the S&Ls, and Milken wanted the bonds back.” That suited him, he added, because he wanted to get his money out. And he was eager to be a team player so that Milken would come back to him in the next deal. This is the same kind of movement of the bonds—out of the hands of a high-rolling buyer into those of the more reticent thrifts, insurance companies and pension funds—that took place in Triangle-National Can. Here the high-risk, private buyers were freed to go on to the next megadeal, which in December was GAF-Union Carbide; while the more risk-averse but still hungry players could be fed."

"Milken struck a different note. He told this reporter in an interview in 1987, “I welcome competition. Other people might see things we don’t see. We might see things they don’t see. The negatives are—and I’m trying to state this in a positive way—that some deals may get done that shouldn’t get done, and then that may hurt the perception of the high-yield market. People have a tendency to remember only the ones that didn’t work out. “Financing is an art form,” Milken added. “One of the challenges is how to correctly finance a company. In certain periods of time, more covenants need to be put into deals. You have to be sure the company has the right covenant—to allow it the freedom to grow, but also to insure the integrity of the credit. Sometimes a company should issue convertible bonds instead of straight bonds. Sometimes it should issue preferred stock. Each company and each financing is different, and the process can’t be imitative.”"

"The common perception is that capital is scarce, Milken declared in his timeworn message, but in fact capital is abundant; it is vision that is scarce."

"One of the most thoughtful was James Grant, editor of Grant’s Interest Rate Observer, who had carved out his anti-junk position back in September 1984. Grant explained that he had reached this point of view, first, because the world even at that time was long on debt and short on equity, and he followed the old investment adage that one should own the thing in short supply and shun the thing in surplus. What an illiquid world needs is cash, he reasoned, and so the debt security to own (if one chooses to own debt at all) is the one with the highest ratio of cash flow to interest expense—not, in other words, the junk securities of companies which typically have little financial leeway. Second, Grant reasoned that the holdings of junk bonds were so concentrated in a handful of institutions (Milken’s inner circle)—which issued bonds and bought each other’s paper—as to invalidate the argument of safety through diversification in one’s portfolio. And, third, he declared that the junk idea had been carried too far, and that a faddishness had grown around its progenitor and prose-lytizer, Milken. Thus, Grant declared in September 1984, “. . . our hunch is . . . that, in some basic way, junk has had its day.”"

"Milken meant to inspire so that his people would feel like cathedral-builders, not bricklayers, and he did so. “If he was walking over a cliff,” declared one former disciple, “everyone in that group would have followed him.”"

"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."

"Weinroth lapsed into the familiar refrain (articulated by Milken, Icahn and others of their persuasion) about the decline of corporate America in the hands of its managers, and its rescue by the new breed of manager-owners. “Old companies were started by true entrepreneurs, who had children some of whom were affected by the ills of the rich,” he continued. “They brought in professional managers, who ran the companies in a conservative fashion . . . but those professional managers didn’t have an ownership stake. Their risk-reward ratio was skewed to being a conservator, not an initiator. Then the second-generation [managers] grew to the top. And even if they were high quality as managers, they were certainly not entrepreneurial. And then that group promoted people who couldn’t threaten them, and they in turn hired people inferior to them, who lived for their perks and compensation and ran their companies conservatively because they had no upside interest. And by the time you go through several generations of these managers, you have a company run by dull-normals!"

"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."

"Now Black returned to the scene, telling Icahn that Milken not only would raise the $ 750 million with PARS out of the company, but would raise another $ 500 million war chest, or “blind pool,” in the company in which PARS would be placed. Bond buyers who liked the airline could buy its debt; those who were enamored of PARS could buy that company’s debt; others could mix the two. The company that would be formed to receive PARS—and the $ 500 million—would be called Mandrake (as in the magician)."

"The deal closed in mid-November, and within two weeks there were reports that Revlon was going to sell its Norcliff Thayer health products and Reheis special chemical businesses to the Beecham Group of Britain for about $ 400 million, and its ethical-drug division to Rorer for over $ 600 million. Both deals were announced by the first week of December. Some onlookers were puzzled by the speed with which the Rorer deal, particularly, was done, and by the absence of an auction. Howard Gittis, however, explained, “They had an exclusive. Well, almost an exclusive. We said, ‘If we get the company, and you commit to us now, then we won’t shop the deal.’ ” This agreement should arguably have been disclosed in SEC filings if it was indeed made during the course of the deal. When later asked to comment, Gittis denied that anyone had been given an exclusive. “At that point [in December], the money was just sitting there in the bank, but they couldn’t call [buy back] the bonds for six months,” this buyer said. “So it was completely safe now, good for the S& Ls, and Milken wanted the bonds back.” That suited him, he added, because he wanted to get his money out. And he was eager to be a team player so that Milken would come back to him in the next deal. This is the same kind of movement of the bonds—out of the hands of a high-rolling buyer into those of the more reticent thrifts, insurance companies and pension funds—that took place in Triangle-National Can. Here the high-risk, private buyers were freed to go on to the next megadeal, which in December was GAF-Union Carbide; while the more risk-averse but still hungry players could be fed."

"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."

"Earnings might be unimpressive (and therefore the stock price low) but if there is a great deal of depreciation, for example, then cash flow can be high. And it is cash flow, in its ability to service debt by making interest payments, that makes a highly leveraged acquisition viable. In his original issuance of junk bonds, Milken had recognized the importance of cash flow, more than earnings, in assessing whether the leveraged companies he was underwriting would be able to meet their debt payments. Now that he had moved from $ 25 million offerings to multibillion-dollar deals, the calculation was not so different—just bigger."

"According to one long-standing acquaintance of Milken, his wife, Lori, had made him promise that on his vacation he would not work from 9 A.M. on; so Milken took his family to Hawaii, where he slept for a few hours in the late evening, rose at 1 or 2 A.M. and worked until 9 A.M.—by which time it was 2 P.M. in New York and most of the business day was over."

"Peltz understood that if he was to have a vehicle for acquisitions, that vehicle would have to have cash flow sufficient to make the interest payments on its debt. Trafalgar had almost no cash flow. And no one—including the hungry Milken—would raise any junk-bond financing for him until he had a company with some kind of cash flow."