A Bush in the White House. Thin neckties. A looming
recession. If there’s any doubt the 80’s are back, how about this: the return
of Michael Milken.
Or, at least, the legacy of Michael Milken. The convicted
junk-bond swindler is being watched like a hawk by the Securities and Exchange
Commission and confines most of his public activities to charitable events.
Lacking the luck of Marc Rich, the pardonless Mr. Milken has to stay away from
anything reeking of securities or debt, according to an S.E.C. decree he signed
in 1991.
But some of Mr. Milken’s minions are back in the picture-big
time, as Dick Cheney might say-doing the work they’d been trained to do at the
now-defunct Drexel Burham Lambert Inc. under his supervision. Just as Drexel
controlled the modern junk bond, so it controlled the modern junk-bond
work-out, in which distressed bonds were swapped for stocks, usually to placate
Mr. Milken’s famous bond-holding friends.
When the firm collapsed in 1991, some Drexelites had made
enough money to retire. Some left the business, but most dispersed across Wall
Street. The work-out specialists-the foot soldiers who greased the treads of
Mr. Milken’s junk-bond armored division and cleaned up his messes-moved to a
handful of firms, including Donaldson, Lufkin & Jenrette (which took over the reins of the junk-bond market), Smith
Barney, Jefferies & Co. and Alex. Brown.
Even in a booming
economy, there are always distressed companies, and so the ex-Drexelites kept
busy. But now junk bonds are trading at 1991 levels, default rates are rising
and the unheralded mechanics of Mr. Milken’s old money machine are back in
demand, plying the trade they learned under him and for him, and even competing
against one another for business.
Of the eight or so New York-based investment banks with
sizable work-out businesses, five of them are headed up by former Drexelites.
Bound by an odd kind of omertà and
grounded in a deep reverence for-if not fear of-Mr. Milken, they are out there
bringing companies back to life, and seeing some put out of their misery.
Barry Ridings is a large,
affable man with an orderly mop of gray hair and an uncommonly full mustache
who seems like the sort who would love PowerPoint presentations-which he does.
Mr. Ridings, 48, was at Drexel from 1986 until 1991, though never at the center
of power.
“Drexel was the New York
Yankees, and I was on the team,” Mr. Ridings said. “But I wasn’t the guy at
bat. I was the guy who came out in the seventh inning and raked the base path.”
Now, however, Mr. Ridings
runs the largest work-out advisory group of any of the Drexel alumnae, at
Lazard Frères & Co. In the last year, he has handled a $7.7 billion job for
the Korean conglomerate Daewoo Group and deals in the hundreds of millions for
Boston Chicken and underwear empire Fruit of the Loom.
Mr. Ridings, who arrives
at his Rockefeller Center office by 7 a.m. and stays until 8 p.m., said he’s “always marketing.” He has a PowerPoint
presentation at the ready for companies seeking his help.
He presents the numbers: The market for junk bonds is valued
at about $646 billion in 1999 (compared with $173 billion in 1990), and the
market for low-credit-rating syndicated bank loans is at $320 billion, with an
estimated 7 percent default rate. “You’ve got an almost $1 trillion problem,”
Mr. Ridings concluded.
Even if that is an exaggeration, it means business is
booming. “BAD NEWS IS GOOD NEWS,” reads the first bullet point on Page 1 of Mr.
Ridings’ PowerPoint presentation. And so it is.
Page 18 shows the
industries in which new junk bonds were issued in 1999: any you can imagine.
Surprisingly, only 2 percent was in technology; 13 percent was in media and
cable, and fully 32 percent was in telecom-the next big work-out field, Mr.
Ridings believes.
Around Page 28 of the
presentation, the troubled company’s board of directors begins to see what a
work-out will mean, should they choose to pay Mr. Ridings’ group its $125,000
to $250,000 a month in fees, as well as its average 1 percent stake in the
restructured debt to avoid bankruptcy (not a guarantee).
A work-out could mean Mr.
Ridings’ group probes their company’s management-incompetent or fraudulent, too
fat or too lean. A work-out is an examination of the employees: size of staff,
contracts, salaries. It means a look at anything that could be affecting the
company’s ability to repay its debt. And fixing it will likely mean some
combination of swaps, rights offerings, interest moratoriums, debt buybacks and
bankruptcy filings, as well as cutting divisions, lowering pay and even cutting
jobs.
The company’s managers might seek their own representation,
and that brings in lawyers. Lawyers swarm around troubled companies: The firm’s
board has lawyers, Mr. Ridings’ team employs lawyers and there are also
independent bankruptcy lawyers marketing their services.
Also circling are
“vulture investors”: firms who can smell an undervalued securities a mile away.
Battling them are the leveraged-buyout firms.
Lastly and most
importantly, there are the bond-holders themselves. Back in the Drexel days,
they were poorly organized and often subject to Mr. Milken’s will, Mr. Ridings
said. Now they form committees and hire their own lawyers and consultants. For
this reason, most work-outs now involve filing Chapter 11, which requires a
two-thirds majority of bond-holders. That’s a lower bar than the 80 to 90
percent of bond-holders Drexel alumni say they used to need to perform their
out-of-court work-outs back in the old days.
And the sheer size of
debt these days necessarily makes things litigious. “You cannot make $1 billion
in debt go away outside of court,” Mr. Ridings said.
Add to all of that the
accountants, the government, other bankers and the press, and there’s a good
reason that work-out specialists like Mr. Ridings put in those 12-hour days.
Because of the
complicated scope of their work, many of the top work-out specialists have law
degrees and experience in an assortment of investment-banking departments.
“It requires a wider skill
set,” said Joseph Radecki, who was at Drexel from 1983 to 1991 (“to turn out
the lights,” as he likes to put it) and who now runs the group at CIBC World
Markets.
“Restructurings are like
M.&A. assignments,” said Richard Nevins, who was at Drexel from 1985 to
1991 and now runs the group at Jefferies & Company Inc. “You have to get
into the guts of the business, and you have to work with whatever you got.”
These days, there’s
enough business to go around for the entire ex-Drexel crew. “There was some
very sloppy underwriting done in the late 90’s,” said Mr. Nevins, another
large, affable man with a mustache. “As the high-yield market gets strong,
people start to stretch; people start papering over mistakes.”
Are things as good as Mr.
Ridings suggest? “Yes, we’re all running around congratulating ourselves on how
terrible life is,” Mr. Nevins said, only half-joking.
Like Mr. Ridings, Mr.
Nevins’ work-outs at Jefferies have run the gamut. He recently handled a $1
billion deal for satellite company ICO Global Communications, which Mr. Nevins
said was the largest bankruptcy of 2000, and a $1 billion deal for AmeriServe,
a food distribution company.
Mr. Radecki, meanwhile,
has followed a Drexel game plan of the 80’s, taking advantage of the sharp
decline in oil prices that occurred in the late 90’s.
“Nineteen ninety-eight to
2000 saw a lot of distressed debt in oil and gas companies,” he said. “When oil
dropped to $11 a barrel, most of those companies lost their liquidity. We saw a
lot of small bankruptcies.” Mr. Radecki’s group at CIBC recently restructured
$300 million in debt for the National Energy Group.
But shifts in industries
and the economy are not the only things auguring bankruptcy these days. Because
of changes in regulations, Mr. Ridings said, almost every major nursing-home
company in the country is bankrupt, and the health-care industry is generally
in a shambles. His group recently helped restructure one of the largest, Sun
Healthcare Group Inc., in a $2 billion deal.
At principal investor
Joseph, Littlejohn & Levy, meanwhile, Paul Levy, a onetime co-head of
Drexel’s work-out group who appears in Connie Bruck’s The Predators’ Ball , has just acquired, with a partner, the
health-care company AdvancePCS, for about $1 billion. They have also acquired New
World Pasta, maker of the Ronzoni brand, for $140 million.
But of course, as long as
there is debt, there will be work-outs.
“Capital markets are
stupid,” said Mr. Ridings. “We make a living because of the herd mentality on
Wall Street. Because of the excesses of the capital markets. Because they do
things they shouldn’t do.”
Predators No More
At Drexel, the people in
the work-out group were not the ones pulling up to the Predators’ Ball at the
Beverly Hilton in white limos. They weren’t the ones drinking champagne with
Diana Ross in Don Engel’s notorious Bungalow 8. They were behind the scenes,
plugging leaks, “paying debt (by) issuing more debt,” as Mr. Nevins put it.
“We put the grease on the
wheels,” said David Ying, Mr. Levy’s partner at J.L.L. and once a co-head of
the Drexel group as well.
The most common form of
grease was the exchange offer-an out-of-court settlement that involved swapping
distressed bonds for stock. Drexel started the practice as a service to their
clients and bond-holders. It later became a profitable business unto itself,
drawing, like M.&A., large fees for advisory work and percentages. Exchange
offers were far quicker than bankruptcy proceedings (Drexel managed to snatch
business from and deeply annoy the legal community, among its many enemies) and
more lucrative. They were also ephemeral.
“We didn’t fix the
companies,” Mr. Ridings said. “We just put Band-Aids on them. All the parties,
particularly the creditors, didn’t want to deal with the problem.”
Mr. Ridings said that
Drexel often “put too much debt” on companies, particularly when it was funding
leveraged buyouts. “We didn’t have a margin of safety. So as soon as they had a
hiccup, they ran into problems.”
Richard Nevins and Joseph
Radecki agreed. Debt was often issued “knowing there would be problems,” Mr.
Radecki said. Drexel’s restructuring department was often just “kicking [the
problem] down the road,” said Mr. Nevins. Issuers were “paying debt by issuing
more debt.”
Paul Levy conceded that, by urging such solutions as
exchange offers, Drexel did not always properly mend its clients. “It is a fair
generalization that a company is more completely fixed in a bankruptcy than out
of a bankruptcy.” But he added that bankruptcies are “long, slow and tedious,”
and that Drexel’s exchange offers happened quickly enough to keep a company’s
business from languishing as it went through bankruptcy proceedings.
However myopic or
greed-driven its practices were, Drexel’s influence laid the groundwork for
today’s restructuring market, which is much larger but also more stable than
that of the 1980’s.
After Drexel and the junk-bond market collapsed in 1991, a
certain sobriety descended on the business. Mr. Milken’s absence left a vacuum
at the center of the leveraged-debt market. The sharks couldn’t hold their
highly leveraged empires together without him. And a collective realization
that leveraged debt could not be plied as flagrantly as it had been by the
Henry Kravises and Ron Perelmans seemed to affect Wall Street. Buy-outs and M.&A.
deals began relying much more on equity.
At the same time, the
exchange offer was transformed into the “pre-arranged bankruptcy,” essentially
the same procedure with the addition of a Chapter 11 filing. That draws the
process out, work-out specialists say, but it also gives the debtor breathing
room.
And everyone seems to
agree that today’s market is healthier for everyone involved. “Now, we’re
fixing them,” Mr. Ridings said.
“The pre-arranged
bankruptcies are the zenith of perfection,” said James Schneider, head of
Drexel’s restructuring group from 1981 to 1991. “They have the least damage on
the company and are best for the shareholders.”
Like many of Mr. Milken’s
original minions, Mr. Schneider made enough money through Drexel to retire at
the age of 44. But it cannot be for that reason alone that he clings to his
affection for his old boss. Mr. Schneider, like Mr. Milken himself, speaks of
the “revolution” that Mr. Milken and his junk-bond empire wrought, and believes
that Mr. Milken got a raw deal.
Most of those who were
part of the former Drexel work-out crew feel the same way, even if they were
left broke, as Mr. Ridings said he was. They spoke of Mr. Milken’s
“brilliance,” and of his unfair treatment at the hands of Wall Street and the
government. Mr. Milken did not return calls for comment.
Only David Ying spoke
differently. At the top of Drexel, he said, “there were a few greedy and
unethical people, and one of them went to jail.” Mr. Milken went nameless.
Meanwhile, his minions are out there, still making the world safe for companies
with debt.
