Junk Bonds Are Now Out, and Ted Forstmann Is In

NEW YORK —  Occupying a prominent spot in Theodore Forstmann’s office, right next to the picture of him with George Bush, is a joke gift that the corporate buyout specialist received recently at his 50th birthday party.

It is a phony newspaper advertisement in a silver frame. Printed to look like the quarter-page “tombstone” ads that financial companies take out to trumpet completion of big deals, it says:

“We are pleased to announce the acquisition of the remaining assets of Kohlberg Kravis Roberts & Co., debtor in possession. $57,894. Forstmann, Little & Co.”

The term “debtor in possession” denotes a company in Chapter 11 bankruptcy proceedings. Kohlberg Kravis Roberts & Co., the company that Forstmann regards as his archrival, isn’t in bankruptcy, of course. Its assets are several orders of magnitude above $57,894. And it’s likely that hell will freeze over before Forstmann Little acquires KKR.

But the gag gift, and its place of honor in Forstmann’s office, hints at a new sense of optimism and vindication--if not vindictiveness--at the buyout firm that he heads, Forstmann, Little & Co.

Forstmann is the man who refused to use junk bonds. Although a pioneer of leveraged buyouts, in the late 1980s he lost out on deal after deal to KKR and other firms because he wouldn’t resort to what he scornfully called “wampum” financing.

For nearly two years, while he railed publicly against Drexel Burnham Lambert; its junk bond king, Michael Milken, and KKR--all integral parts of the junk bond mega-machine that time and again outbid him--his firm didn’t complete a single deal.

“Barbarians at the Gate,” the recent best-selling book about the battle for RJR Nabisco in 1988, portrayed Forstmann as an almost comical figure. While he fussed and fumed about the evils of junk bonds, others got the big deals done.

Now Forstmann is having the last laugh. Since the first of the year, he has completed two buyouts. Just this week, he wrapped up the acquisition of General Instrument Corp., a maker of equipment for cable television, for $1.6 billion. In February, he acquired Gulfstream Aerospace, the corporate jet manufacturer, from Chrysler Corp. for $825 million.

He is doing buyouts at a time when almost no one else is able to.

And his consternation at the junk bond wizards, it now appears, wasn’t just sour grapes. Milken awaits sentencing on felony securities fraud charges. Drexel has collapsed. Companies that were 1980s junk bond success stories have, under the weight of their debt, become 1990s disasters. Other leveraged buyout firms, such as Coniston Partners, have disbanded.

Amid the carnage, Forstmann stands unscathed. He is again taken very seriously.

“We’re in a very, very strong position relative to other financial buyers,” Forstmann says in an interview. With most of the other big players of the 1980s on the sidelines or out of business, investment bankers are turning to Forstmann Little with a long list of proposed deals.

Although his remaining war chest is only about $1.4 billion, he is expected to start raising money soon for a new fund of at least $2 billion. Constrained by Securities and Exchange Commission regulations that prohibit announcement of new investment funds before disclosure documents are filed with the government, Forstmann refuses to discuss his fund-raising plans.

But he acknowledges that Forstmann Little may soon make more acquisitions. “We’re looking at other things” to follow the General Instruments deal, he says.

Forstmann talks with a reporter in his corner office on the 44th floor of the General Motors building, overlooking much of Manhattan. As befits a leading Republican fund-raiser and head of a major financial enterprise, he is dressed conservatively in a gray suit and dark tie. But, at 50, he retains a boyish air, with hair a little longer than fashionable. His collar is unbuttoned, and he sits with one leg draped comfortably over the arm of an overstuffed upholstered chair.

Forstmann is pleased not only about the two buyouts announced this year but also about the hefty profit on the sale of assets acquired in previous buyouts. His firm last week completed the sale of Moen Group Inc., a faucet maker, to American Brands for $975 million. Forstmann Little had acquired Moen as part of Stanadyne Inc., a faucet, auto-products and instrument manufacturer it bought in 1988 for $840 million.

The sale, combined with proceeds from sales of other Stanadyne assets, brings a profit of more than 600% for the equity investors in the Forstmann Little deal. “That’s winning,” Forstmann says. “That means you were right about everything. You didn’t pay too much; you were right about the company.”

Forstmann is so pleased with the way things are going that he is giving more attention to the non-business side of his life. Long a denizen of a big apartment in Manhattan overlooking the East River, he recently bought a house at the top of Coldwater Canyon in Los Angeles. Beginning this winter, he plans to spend most of his time in Southern California, although the firm will remain in New York.

An exceptional tennis player who often beats young pros, Forstmann had a tennis court built on the property.

“The New York life is hard for me,” says Forstmann, whose net worth is estimated at several hundred million dollars. He says he prefers occupying his own house to living in an apartment. He believes that spending most of his time in Los Angeles will allow him more regularly to put in what he considers ideal working hours: “The perfect day would be to work until 3 or 4, play tennis, then have a barbecue. None of that you can do in New York.”

To be sure, the size of this year’s Forstmann Little deals is modest next to the late-1980s mega-deals--such as RJR, the biggest, which went to KKR for $25 billion. Forstmann, however, says purchasers paid absurd prices then, backed by the most suspect type of junk bonds, such as “payment-in-kind” securities that don’t even pay cash interest until maturity. Acquisitions, he contends, can now be made at more realistic prices.

Although Forstmann is in a buoyant mood these days, not quite everything is coming up roses. In March, he had to abandon plans for a new fund that would invest in and reorganize companies that had gotten into trouble from too much debt. His small stable of big investors balked, in part because they didn’t want to be associated with troubled companies, in part because they noted that Forstmann still had a considerable amount of their money sitting idly in his other funds.

Forstmann declines to make a specific prediction about how the RJR Nabisco deal will turn out for KKR. But he says that at the steep price KKR paid, the potential return didn’t seem to justify the amount of risk involved. The true test, he says, should be the size of the ultimate return--not whether an acquired company merely manages to stave off bankruptcy. Forstmann’s brother Nick, also a general partner in the firm, is more explicit. He notes that tobacco was one big part of RJR’s business, and he says tobacco assets in general have declined steeply in value since the deal. “They overpaid for the whole bundle of assets, and one major part of that bundle is becoming less valuable in the marketplace,” Nick says.

A KKR spokesman says it’s far too early to assess the ultimate success of the RJR deal.

Although Forstmann Little’s track record has been excellent, that firm is also feeling the effects of a general tightening of bank credit, sparked by high loan losses and intense pressure from regulators. Secured bank loans are an essential part of buyout financing. Although the firm got loans for its two deals this year, Forstmann’s brother Nick, a general partner in the firm and the one who deals most with the banks, acknowledges that such money is harder to get.

“In our specific situation, the banks are certainly more cautious,” Nick Forstmann says.

Ted Forstmann, the senior partner and most visible member of the firm, is renowned for his “spiel,” his repetitive condemnation of junk bonds, excessive debt and excessive fees charged by rival buyout firms and investment banks. During the interview, parts of the spiel kept popping out:

The explosion of junk bonds was “the Pandora’s Box event. . . . Credit became--and you can hardly call it credit --but this wampum became so available, anybody could raise it for any reason at all, to take over anything. . . . What happened in this euphoric period of time was a good deal was a deal that didn’t go bankrupt in a month.”

Forstmann has never wavered in the gist of this spiel. He has also lived by it, even in the lean times, giving the impression that he has nerves of steel. But he admits now that he was wracked by doubts. And, at the worst moments, at the height of the junk bond frenzy, he even thought of the unthinkable--resorting to junk bonds himself.

“I had some real internal personal battles with myself,” he says, adding that at the worst moments he wondered: “Have I gotten blindsided somehow? Am I wrong?” He adds, bitterly, “Everyone seemed to be on this bandwagon--the press included.”

With $2.7 billion in investors’ money sitting idly in his fund, and fearful that investors and even his own partners might grow restive, Forstmann summoned his brother Nick and the four other Forstmann Little general partners to a dinner meeting. He asked if they thought that he was on the wrong track, whether Forstmann Little should relent and try to do junk-financed deals.

“I took it up with these guys, and they were terrific, they were very supportive, and they said, ‘You know, we think you’re right. It’s not easy, but we think you’re right.’ ”

Forstmann Little is a small firm. It has only six general partners and a staff of fewer than 20, not counting employees of the companies it acquires. By choice, it also has a small stable of investors. They include “16 to 20 institutions,” Forstmann says, and about 20 individual investors.

Forstmann says he prefers dealing with the same loyal group rather than drumming up new sources of money. In any event, his investors have deep pockets: In addition to state pension funds, they include corporate giants such as General Electric, IBM and GTE.

John B. Carroll, president of the GTE Investment Management Corp., acknowledges that investors were beginning to lean on Forstmann to do something with the money. But, he says, it is clear now that many of the deals done then were grossly overpriced. Forstmann was right to hold back. “He didn’t buckle under the pressure,” Carroll says.

And investors are pleased. “His track record speaks for itself,” says John H. Myers, executive vice president of General Electric Investment Corp.

Since it was formed in 1978, Forstmann Little has done 16 buyouts (counting General Instruments), for a total of nearly $10 billion. During the past 12 years, the average annual return to equity investors has been a whopping 85%, while debt investors received a healthy 30%. Forstmann emphasizes that the 85% figure is after Forstmann Little’s share of the profits is subtracted.

The key difference in Forstmann Little’s financing of buyouts, compared to most other buyout specialists in the 1980s, was the way it raised “mezzanine” financing--the layer of subordinated debt sandwiched between the money put up to buy equity, and secured bank loans. KKR and others used junk bonds--high-risk, high-yield securities--to raise that middle layer of financing. But Forstmann raised his subordinated debt without bonds.

Instead he relied directly on his big investors. They invested in his Subordinated Debt and Equity Fund. In exchange for loaning money for the buyouts at a relatively modest interest rate, they got about one-third of the equity in the deals, bringing a big overall return.

Among the other large deals that the firm carried out were the acquisition, and later sale, of Dr Pepper Co., Topps Chewing Gum and Lear Siegler Inc., a diversified manufacturer. The firm owns and manages Lear Siegler and other big companies, including Safelite.

Forstmann doesn’t gloat about what happened to Milken and Drexel. But he contends that Drexel was a house of cards, and he is irate that the firm’s pre-eminence was allowed to continue so long.

The collapse of the junk bond market last year has left Forstmann virtually alone among financial companies doing buyouts.

According to Securities Data, leveraged buyouts in the first half of 1990 were off more than 95% from the same period in 1989, in terms of dollar value of deals. But Forstmann probably won’t be alone for long. With stock prices tumbling, companies may again become inviting acquisition targets. Some big financiers already have announced plans to get back into the buyout business.

William Simon, the former U.S. Treasury secretary who brought LBOs to the world’s attention in the early 1980s, when he made a stunning profit on his buyout of Gibson Greeting Cards, says he’s getting back into buyouts after sitting on the sidelines for four years.

Forstmann is famous in particular for his enmity for KKR--an attitude highlighted in the “Barbarians” book. KKR was the victor in the battle for RJR Nabisco, winning the company with a junk bond-backed bid of $25 billion, or $109 a share, a price Forstmann says was ridiculously high.

In addition to getting RJR Nabisco, LBO leader KKR’s numerous earlier buyouts included Beatrice Foods, the consumer-products company; Storer Communications, a big broadcaster, and Safeway. On the advice of a public relations consultant, Forstmann struggles now to tone down his criticism of KKR. Asked if he would care to make a prediction about what will become of that firm in the next few years, he declines.

“Would I care to? Yes. Am I going to? No.” He laughs. “I’ve learned.”

But a few minutes later, he can’t resist accusing KKR of inflating figures on returns to its investors. KKR’s published figures are “fantasy returns,” he asserts, because they don’t first subtract the cut they keep for themselves.

He contends that KKR is giving its equity investors a real return of only about 20% or 25% per year, compared to Forstmann Little’s 85%.

Through a spokesman, KKR principals Henry Kravis and George Roberts declined to be interviewed for this article. But the spokesman, Tom Daly, confirmed that the published 38% annual rate of return on the recent sale of the Motel 6 chain and 50% annual return on the sale of Beatrice assets is before KKR’s cut is taken. He declined to say how big that cut is, but industry sources say it’s 20%.

Nevertheless, Daly maintained that KKR has given investors an excellent overall return on investments. And, without being specific, he challenged the accuracy of some of Forstmann’s claimed profits. As to the health of KKR, he says, “The firm is doing fine.”

Jim Grant, editor of a Wall Street newsletter called Grant’s Interest Rate Observer and a friend of Forstmann, says, “I would love to be washed up the way Henry Kravis is washed up.” It was Grant, in fact, who gave the KKR joke ad to Forstmann.

Some of Forstmann’s own loyal investors also invest with KKR. Edward V. Regan, the New York State comptroller who is in charge of investing state pension fund money, has invested in both. In a telephone interview, Regan said he hasn’t done a detailed comparison of returns. But “our experience has been (that) with all of the partnerships we’re in . . . we’ve done very well.”

Brother Nick says the rivalry with KKR in part reflects Ted’s competitive spirit. Always a highly competitive athlete, Ted Forstmann is an avid skier, golfer and, in his school days at Yale, an ice hockey goalie.

Nick, 43, recalls his big brother playing in the 1961 Harvard-Yale hockey game:

“Yale didn’t have all that great a hockey team. Harvard did. He rose to the occasion, made 50 or 60 saves in the game, and they tied it. He rises to the occasion.”

There is also a musical side to Forstmann. He is an accomplished piano player and at his birthday party got to accompany one of his favorite groups, the Nitty Gritty Dirt Band.

He is a strong supporter of Jack Kemp, the U.S. Secretary for Housing and Urban Development. When Kemp failed to show enough strength to win the 1988 Republican presidential nomination, Forstmann helped bankroll the Bush-Quayle ticket.

He has also been involved in charitable activities, including a center for children with learning disabilities and education programs run by the Catholic Archdiocese of New York. He was a Big Brother for 13 years.

Among his more exotic charitable activities was the financing a group of Afghan rebels in the 1980s. He says the idea was first brought up by a tablemate at a White House luncheon, and he soon received a visit from an Afghan rebel general.

It seemed to work something like the Save the Children program, only instead of adopting a Third World child Forstmann got to choose one of the rebel leaders and adopt his troop. He supplied money for basic necessities such as food and clothing. “I got letters from the guy,” he says.

Forstmann is single and declines to reveal much about his steady girlfriend of five years. All he’ll say is that she’s from Louisiana, is athletic and is “the antithesis of a New York society lady.”

Although clearly pleased with the way things are turning out now, Forstmann is eager not to appear smug. Reflecting on the junk bond years, he says, “I am just sorry that so much damage was done.”

A few years ago, he says, his firm probably wouldn’t even have been offered the General Instrument deal. He says the investment bank that introduced Forstmann Little to General Instrument probably wouldn’t even have bothered a year or two ago, because any deal almost certainly would have been topped by another firm backed by junk bonds.

Forstmann reflects, “It is frustrating if there’s a company that you’d really like to own, and you can’t even get into the auction, and you have all the money and none of the other guys have any (real) money at all.”