Barbarians at the Gate

by Bryan Burrough

  He landed with friends at a small Wall Street firm, where he learned the ins and outs of stock underwritings and other sundry financial tasks. Soon he chafed at that as well, impatient for more responsibility and outraged at what he considered his underpayment. Forstmann spent six months at another small investment firm, Fahaerty & Swartwood, where he toiled side-by-side with a hardworking young Oklahoman named Henry Kravis. Forstmann soon left, joining still-another obscure, now-defunct investment firm. For three years there, he dabbled in underwriting, investment banking, and merger work. In the end, though, it was the same old story: Forstmann found the constraints of office work under senior executives’ watchful eyes suffocating. “The fact is, I was never a good employee,” Forstmann said. “I never did what I was told, and I always screwed up the chain of command.”

  In 1974 Forstmann was thirty-five years old, out of work, and running out of money. He was too proud to ask his mother for more, and cringed at the idea of soliciting his older brother, Tony, who had founded a successful money-management firm, Forstmann Leff Associates. After selling his car, Forstmann had $20,000, which he figured would last a year. To pay the rent he hustled at the bridge table and on the golf course and worked sporadically attempting to arrange deals among his Wall Street friends. Approaching middle age, Ted Forstmann was a Wall Street refugee, a minor-league playboy, and a sorry bet to ever make his mark in life.

  One thing Forstmann had, though, was a seat on the board of directors at Graham Magnetics, a small Texas company he had helped take public in his last Wall Street job. Running out of options, he convinced the company’s president not only to sell his firm, but to let Forstmann handle the auction. With no office, Forstmann conned his brother’s secretary at Forstmann Leff into taking his phone calls. He promised her a mink coat for telling callers he was in a meeting and quickly relaying messages to his apartment.

  It took eighteen months to sell Graham Magnetics—“I was very inept,” Forstmann would recall—but when the deal closed he was $300,000 richer. He took an office at Forstmann Leff and tried putting together more deals. Forstmann would try anything, at one point even attempting to peddle spare furnace parts to the Shah of Iran’s government.

  Among Forstmann’s golfing buddies at Long Island’s exclusive Deepdale Country Club was Derald Ruttenberg, then president of an industrial company named Studebaker Worthington. Forstmann was forever attempting to arrange deals for Ruttenberg, so when Forstmann’s younger brother Nick, then working at a start-up firm named Kohlberg Kravis Roberts & Co., said he wanted to arrange a meeting with the executive, Forstmann, smelling a commission, did so promptly.

  It was a meeting that changed Ted Forstmann’s life. In it, he and Ruttenberg listened to Henry Kravis and Jerry Kohlberg propose something they called a leveraged buyout. Forstmann was familiar with the concept, but had never attempted anything like it during his own Wall Street career. Ruttenberg heard them out politely, then turned to Forstmann after the pair left.

  “Isn’t that kind of what you were talking about?”

  Forstmann wasn’t quite sure what Ruttenberg meant. “Well,” he said guardedly, “yeah, sort of.”

  “Well,” Ruttenberg continued, “what do those guys have that you and I don’t have?”

  “Nothing.”

  “Okay. How would you go about doing this?”

  “I would need some money first.”

  The conversation led to Ruttenberg’s proposing to bankroll Forstmann in a new firm. The executive and a group of his friends would chip in, and Forstmann and his brother would try their hand at leveraged buyouts. Ruttenberg told Forstmann something the younger man would never forget. “I have a reputation, it’s all I have, and I don’t want to lose that reputation,” he said, and Forstmann embraced that principle as a creed. Teaming up with a former investment banker named Brian Little, Forstmann Little & Co. opened its doors in 1978: three men, two salaries—Ted didn’t take one for years—and one secretary.

  Forstmann Little was among the first LBO firms to raise money directly from giant pension funds, a practice pioneered by Kohlberg Kravis. Like a real estate salesman, Ted Forstmann’s pitch was simple: reputation, reputation, reputation. Crisscrossing the country on money-raising tours, Forstmann—bluntly honest, at times self-righteous and a bit naive—perfected a spiel that became his trademark. It was endearing to partners, irksome to allies, and outrageous to opponents. It began with The Reputation—“the best on Wall Street, ask anyone”—escalated into a discussion of Forstmann Little’s financial strengths and old-fashioned ways, and, especially in later versions, climaxed with an all-out attack on the evils of junk bonds.

  For all the bluster, Forstmann Little’s returns were first-rate. In three to five years it sold the companies it bought for four to ten times the purchase price. By the mid-1980s only one firm’s pioneering success overshadowed Forstmann Little’s: Kohlberg Kravis Roberts.

  The first signal that Forstmann Little’s world was changing came in 1983, when the firm won a bidding battle to acquire Dr Pepper Co., the Dallas soft-drink franchiser. Forstmann’s opponent, Castle & Cooke, was backed by Drexel Burnham’s Milken, then an obscure California bond trader. Forstmann Little’s management-supported cash bid was faced by a Castle & Cooke junk-bond bid, but won after a long, drawn-out fight.

  Though Forstmann won that battle, he soon lost the war. His next scrape with a member of Milken’s junk-bond coterie would not only be his most bitter defeat but also would lead to a fateful shift in Wall Street’s power structure. In 1985 Revlon, the international cosmetics giant, came under attack from little-known Philadelphia investor Ron Perelman. Perelman’s principal asset, a grocery store chain named Pantry Pride, was a fraction of Revlon’s size, but he was armed with Drexel Burnham junk bonds. Its defenses crumbling, Revlon’s management rushed to the open arms of Forstmann Little, saving their jobs, it seemed, and raising the specter of untold personal riches. But Perelman won out when a Delaware court, in a precedent-setting move, ruled that key components of Forstmann’s merger agreement unfairly discriminated against Pantry Pride.

  Revlon was the first hostile takeover of a major public company by a junk-bond-backed buyer, and it opened the gates for a string of similar battles, including a string of attacks by raiders such as Paul Bilzerian and Sir James Goldsmith. In an odd way, Ted Forstmann held himself responsible for the carnage junk-bond-financed raiders wrought on Corporate America.

  The triumph of junk bonds was more than an affront to Forstmann’s morals, of course. It was laying waste to his business as well. Because the use of junk bonds allowed corporate raiders to raise money cheaply and easily, it tended to drive up the prices of takeover targets. Forstmann found himself being outbid for companies where once he had no competition. In many cases, he refused to enter a takeover battle when junk-bond buyers had driven up prices beyond reason, and as a result, he found himself completing fewer and fewer deals. Finally, the unthinkable happened. In 1987, after raising a then-record $2.7 billion buyout fund from investors, Forstmann Little failed to propose a single new leveraged buyout. What should have been the height of Ted Forstmann’s power on Wall Street was, instead, its nadir.

  At first Forstmann directed his anger at Drexel Burnham. Once, a Milken lieutenant visited Forstmann Little and, in a meeting arranged by a young Forstmann associate named John Sprague, suggested the firm jump on the junk-bond bandwagon. Forstmann chatted politely with the Drexel banker, shook his hand farewell, and then called Sprague into his office. “John,” he told the younger man, “you’ve got a long and profitable life ahead of you here. But don’t ever bring another piece of slime like that in here again.”

  Forstmann’s alarm grew as other Wall Street brokerages, initially cool to junk bonds, flocked to grab a piece of the burgeoning market. “Imagine ten debutantes sitting in a ballroom,” Forstmann told a gathering of Securities and Exchange commissioners. “They’re the heads of Merrill Lynch, Shearson Lehman, and all the other big brokerages
. In walks a hooker. It’s Milken. The debutantes wouldn’t have anything to do with a woman who sells her body for a hundred dollars a night. But this hooker is different. She makes a million dollars a night. Pretty soon, what have you got? Eleven hookers.”

  Never before had Forstmann known such frustration. Only during periodic disruptions in the junk-bond market was Forstmann Little able to compete on an equal basis for large takeovers. The firm succeeded in grabbing its largest prey to date, a California defense contractor named Lear Siegler, after the market for junk bonds temporarily dried up following disclosure of the Ivan Boesky insider-trading scandal in November 1986. Again opposed by a Drexel Burnham client, Forstmann took his crusade right to Lear Siegler’s board.

  “Before I tell you who we are,” Forstmann told the assembled directors, “let me tell who we are not. We are not, nor will we ever be, a client of Drexel Burnham Lambert.” Forstmann detected an audible gasp from the direction of a Drexel banker present. “We have not, and we will not, issue crazy paper to put the companies we buy in jeopardy. We are real people with real money.” Forstmann recalled that the directors then applauded.

  Remarkably, Forstmann had gone head-to-head with Kravis in just one deal, but it was a deal that left an indelible mark on Forstmann’s psyche. In the spring of 1988, six months before the RJR Nabisco fight, Kraft put its Duracell battery unit up for sale. Forstmann had ardently and successfully wooed Duracell’s management. So close did he grow to Duracell’s president, C. Robert Kidder, that the executive took the extraordinary step of pleading with Kraft’s senior management not to sell Duracell to a junk-bond buyer such as Kohlberg Kravis. Kidder warned in a letter that such a move would ruin the company. With Forstmann’s fingers tightly crossed, Kidder made the same plea to Kravis, who also coveted Duracell. Kravis not only rejected the executive’s plea, he upped his offer for the company, swamping a bid by Forstmann Little and leaving Ted Forstmann to rage anew.

  Through the summer and fall of 1988, Forstmann’s ire rose unchecked. He looked on, aghast, as Kravis broke one of the LBO industry’s most sacred tenets, secretly accumulating stock positions in Texaco and Kroger, much as a hostile raider would. The aggressive tactics forced Forstmann into an agonizing reappraisal of his own beliefs. Maybe I’m wrong, he wondered in quiet moments. Maybe I’m the one who’s missing the dawn of a new financial age. His younger partners suggested he rethink his opposition to junk bonds. His girlfriend urged him to “forget Kravis,” quit worrying, and enjoy his riches. Forstmann tried to relax, but found his long-held convictions only grew stronger.

  Just weeks before the RJR deal broke, Forstmann finally vented his feelings publicly, taking friends’ advice and authoring an anti-junk-bond diatribe for The Wall Street Journal’s editorial page. The article was to appear Tuesday, October 25.

  “Today’s financial age has become a period of unbridled excess with accepted risk soaring out of proportion to possible reward,” Forstmann wrote. “Every week, with ever-increasing levels of irresponsibility, many billions of dollars in American assets are being saddled with debt that has virtually no chance of being repaid. Most of this is happening for the short-term benefit of Wall Street’s investment bankers, lawyers, leveraged-buyout firms and junk-bond dealers at the long-term expense of Main Street’s employees, communities, companies and investors.”

  LBO specialists would recognize key passages of Forstmann’s article—criticism of investments in such cyclical industries as oil and forestry, for example—as thinly veiled attacks on Henry Kravis. “Watching these deals get done,” Forstmann concluded, “is like watching a herd of drunk drivers take to the highway on New Year’s Eve. You cannot tell who will hit whom, but you know it is dangerous.”

  Monday morning, as he looked out over the East River, Ted Forstmann knew what he had to do. Suddenly the Nabisco deal wasn’t just a big deal. It wasn’t just another Henry Kravis deal-of-the-week. It had become the deal. It would, he realized, be the culmination of his five-year crusade to show the world the truth about junk bonds and Kohlberg Kravis Roberts. It would be Ted Forstmann in the white hat against Henry Kravis in the black. This, Forstmann vowed, would be the deal in which Kravis would be revealed as the fraud he was.

  But first he had to get his foot in the door. The articles laid out on Forstmann’s antique dining table held few details of Ross Johnson’s buyout proposal. But what he saw he liked. Reading between the lines, Forstmann guessed Johnson’s group had been forced into premature disclosure of its deliberations. If so, that meant they could be days, or even weeks, from putting together a formal offer and lining up the banks necessary to finance it. That gave Forstmann Little some time.

  The presence of Shearson was also encouraging. Although he knew almost no one at the firm, he realized that Tom Hill’s troops had no great expertise in leveraged buyouts. On top of that, they would probably need a boatload of money to complete any deal. Forstmann Little’s $9 billion of buying power could be invaluable.

  Ross Johnson was another plus. Forstmann knew Johnson and his young wife, Laurie, and liked them both. He had first run into Johnson in the early 1980s when Forstmann Little considered buying the Fleischmann’s division of Standard Brands. Their talks at the time left Forstmann with the impression that Johnson was sharp, although a bit of a salesman. Later Forstmann recommended Johnson for membership at Deepdale, where Forstmann sat on the board of governors. (Ironically, it was the same club where Don Kelly would later woo Johnson into meeting with Kravis.)

  Several years later, Forstmann had called Johnson seeking an investment in a Forstmann Little buyout fund. Johnson was eager to help and was effusive in his praise. “My God, what an opportunity!” Forstmann recalled Johnson shouting into the phone. “How phenomenal. We’d love to!” Forstmann hung up thinking RJR’s president was an okay guy, even if he came off a bit like a game-show host.

  As he pored over the papers that morning, the makings of a plan formed in Ted Forstmann’s mind. He recalled a conversation he had had four days earlier with his most trusted investment banker, Geoff Boisi of Goldman Sachs & Co. Boisi, one of Wall Street’s top deal makers, was attempting to arrange a consortium of Goldman’s blue-chip clients to mount a third-party bid for RJR Nabisco.

  “Do you have a problem with owning a tobacco business?” Boisi had asked.

  “Yeah, why?” Forstmann had replied.

  “What’s the problem?”

  Forstmann’s reply had been off-the-cuff. “I don’t want to be selling cancer.”

  When Boisi had persisted, Forstmann had said he’d think about it. Afterward Forstmann had touched base with his partners and found that they, too, harbored a vague distaste for the tobacco business. His brother Nick, like Forstmann a reformed smoker, was chortling as he added up the money Shearson and others would make from Johnson’s deal. He calculated that the fees alone would top the value of a $500 million buyout Forstmann Little was considering. “It’s like throwing a hundred pounds of bloody meat into a shark pool,” he mused.

  Still, the prospect of tackling history’s biggest buyout was an undeniable attraction. To cover himself, Forstmann had phoned his longtime lawyer Stephen Fraidin at the lower Manhattan firm of Fried, Frank, Harris, Shriver & Jacobson. “Don’t do anything with anybody else before you talk to me,” Forstmann had said. He had left the matter unsettled when he left the office on Friday.

  After breakfast, Forstmann slipped into his black, chauffeur-driven Mercedes and headed to his office in the General Motors building across from the Plaza Hotel, just a stone’s throw from the Kohlberg Kravis headquarters at Nine West Fifty-seventh Street.

  “Get me Jim Robinson,” he told his secretary.

  “Look, Jim,” Forstmann said, when Robinson called back later that morning, “I don’t know what’s going on. But you know my reputation….” He was off on the Forstmann Little pitch.

  Robinson interrupted before he got too far. “Teddy, I know all that,” he said. “I’ll have somebody call you.�
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  Forstmann was satisfied. It was a first step. The showdown was fast approaching; he could feel it. It was time to make a stand.

  But there was something else, some other emotion Forstmann wasn’t proud of and whose existence he wouldn’t admit to himself until months later. Down deep, Ted Forstmann knew he wanted to hurt Henry Kravis.

  Fuck them. This is not going to be the next KKR deal, Forstmann vowed to himself. I know Ross Johnson. I know Jim Robinson. Henry Kravis will not run off with this deal.

  Chapter

  10

  Pandemonium reigned at Shearson Monday morning. Amid the Audubon prints, green plants, and fine Oriental rugs of its nineteenth-floor executive offices, the stunned members of the management group gathered. Rather than face the obvious folly of their earlier preparation, Cohen, Hill, and the others directed their anger toward Kravis. Everyone had a theory why Kravis had jumped the gun.

  Johnson stalked in and took a seat at the long table in Shearson’s boardroom. Dumbstruck, he demanded an explanation for Kravis’s ambush attack. Wasn’t Cohen supposed to meet with him? What on earth could have propelled Kravis into this course of action?

  “Something’s gone haywire here, Peter,” Johnson said, citing Cohen’s initial meeting with Kravis. “Somebody must have pissed off somebody. You don’t get from a meeting like that, franchise or no franchise, to a meeting scheduled on Monday unless somebody put their finger up somebody’s ass. I mean, there must have been something that happened at that meeting on Friday to make him do this.”