The Predators’ Ball (9 page)

Gobhai's groups are reminiscent of the sixties' encounter or T-groups; the goal of those earlier human-potential movements, of course, was spiritual or emotional development, while Gobhai's—fittingly for the late seventies and the eighties—is the achievement of business purpose. But the process is similar. About a dozen people participate in intense, almost unbroken morning-to-night sessions held in a hotel suite and usually lasting for two or three days. There is comfortable furniture and a blackboard, on which Gobhai writes ideas which seem exciting. There are no telephone calls, no intrusions from the outside world. And there are rules for the interaction. Gobhai is enforcer and leader.

Born in Bombay, India, Gobhai graduated from MIT with a degree in chemical engineering and worked for a number of years with another creativity-facilitating group before branching out on
his own. One of Gobhai's key premises is that most great ideas are, as he says, “born bad”—by which he means that one is more likely to make one's way to the great idea from the seemingly crazy or outrageous than from the cautious and sensible.

Gobhai believes, however, that most of us—certainly investment bankers, by and large a conservative, literal-minded group—are conditioned to attack these outrageous ideas “with heat-seeking missiles” as soon as they appear on our intellectual screens. The sine qua non of his groups, therefore, is that they provide a climate in which all ideas are allowed expression and respect. For example, one idea that would emerge in his group in later years, shortly after Joseph had become chief executive officer of the firm, was that Joseph quit his new post and become Milken's assistant. (The problem for which this was posed as a solution was that Milken was working too hard, and Joseph was the only one whom Milken would trust to shoulder some of his burden. No solution was found, however.)

“The big bad idea they started with at this session,” Gobhai says of the 1979 meeting, “was, what if there were no difference between corporate finance and the high-yield-bond department?”

At another firm, such a thought might have been unthinkable, with or without Gobhai to ward off the “heat-seeking missiles.” Traders and bankers had long occupied enemy camps on Wall Street. Ten years earlier, the investment bankers in establishment firms were a pedigreed class who originated underwriting business because of their family, school or social-club connections. The traders, disdained by the bankers as brutish types with microsecond attention spans, existed mainly to offer supplemental services to the bankers' clients.

The seventies, however, had seen a revolution on Wall Street. The end of fixed commissions in 1975 incited free-for-all competition, and traditional, long-standing investment-banking relationships came to an abrupt end. Relationship banking, in which corporations gave their business to investment-banking firms they had known for years, gave way to “transactional banking,” in which investment banks competed anew on every deal. At the same time, wildly fluctuating interest rates caused tremendous volatility in the market. As new financial products were introduced, what became crucial was the ability to perform transactions, and to do it instantly before the opportunity passed.

As life was becoming more difficult for the bankers, then, the traders' star was rising. Trading became a strong profit center in most major investment-banking firms, often surpassing the bankers. Notwithstanding the traders' much-amplified contributions to the bottom line, however, the bankers continued to scorn them. And the contempt was mutual: the traders generally regarded their corporate-finance partners as masters of little but the long lunch. The clash of these two cultures was endemic on the Street.

But not at Drexel Burnham. There, there was no war, because there was nothing about which to fight. The firm had had no investment-banking culture, and no trading culture. What had come down the pike was an almost miraculous trader who was single-handedly responsible for the profits of the firm. These Drexel investment bankers weren't proud; they wanted to be part of the Milken trading bonanza.

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).

The issue on the table, then, was whether they should become more entrepreneurial—like Milken, and like the clients whom they were financing with the junk bonds. Someone drew a bar graph of investment-banking firms from one to ten, with one being the most institutional and ten being the most entrepreneurial (firms which made a practice of putting their own capital at risk in deals). Merrill Lynch was at one. At two were Morgan Stanley, Goldman and Salomon Brothers. E. F. Hutton and Dean Witter were at three. Lehman Brothers was at five, Lazard Frères at six. Kohlberg Kravis Roberts and Company, Oppenheimer, and Allen and Company were all at ten. Milken was beyond ten, off the chart. After a vote, this group decided they wanted to be at about eight.

Then there was the matter of Milken's closest clients. Should they continue to do business with the Lindners, the Riklises and the Steinbergs of the world—and if they did, would they lose the chance of ever being able to do a better grade of business?

They made a number of resolutions, all recorded as part of the notes of the meeting by a young corporate-finance associate who had recently joined Drexel, Leon Black. While this meeting was attended mainly by the more senior investment bankers, Black was exceptional. He was very bright. And, as one Drexel investment banker put it, “He had more contacts than all the rest of us put together.” Leon Black was the son of Eli Black, the rabbinically trained corporate chieftain of United Brands Company who in 1975 had jumped from his forty-fourth-floor office in New York's Pan Am Building, shortly before it became known that United Brands had been paying bribes in foreign countries. Eli Black had had many friends in the business community, and his son could have capitalized on his father's contacts to go to one of the prestigious investment-banking firms. But he wanted to make his own way. So he had interviewed with Fred Joseph and, as he would later say, “bought Fred's act.”

Now Black wrote that they should find those “robber barons” who would become the owners of the major companies of the future—but they should not do this to such a degree that they would share the stigma of such clients.

Most of the resolutions, though, had to do with strengthening their Milken connection:

Service Milken as a new business source—pick his brain.

Get Milken to share investment opportunities.

Get Milken to manage corporate finance's money.

At one point during this session, investment banker Fred McCarthy said something that Gobhai immediately wrote on the blackboard. Years later some of this group's members would use that phrase as a buzzword for much that happened in the amazing times that followed.

Gobhai wrote: “Merge with Mike.”

A
S
D
REXEL
B
URNHAM
metamorphosed from a nondescript brokerage to a Wall Street powerhouse over the next five years, it was cast more and more in the image of its principal-minded trader. On the entrepreneurial one-to-ten scale, the firm coalesced with Milken, off the chart. And by the end of that time Drexel's and Milken's power would be so great that the other major investment-banking firms would be forced to imitate them.

Drexel became a pioneer in what Wall Street would by the mideighties loftily call merchant banking (a term borrowed from the British), which simply meant that a firm was using its own capital to finance deals (as a debt and/or equity participant). Harking back to the merchant banks of the robber-baron era, and to J. P. Morgan in particular, Fred Joseph declared to
Business Week
in mid-1986, “We're going back to our roots.” By that time, Drexel had equity stakes in more than 150 companies that it had financed.

Some of these equity stakes were acquired through Drexel's investing directly in deals as equity participants, some through exchange offers (where Drexel owned debt which was then exchanged for stock), and some through warrants, securities exercisable into stock at a given price (which the firm routinely demanded as part of its fee in junk-bond underwritings, starting in the late seventies, and especially in its financing of leveraged buyouts, beginning in the early eighties). Taking warrants as part of a fee was not a novel practice, but was shunned by the more respectable investment-banking firms. At Drexel, however, it fit the firm's principal-mindedness. The deals Drexel was underwriting were high-risk, at least by conventional perception, and the capital it was providing was not widely available; so, the reasoning went, Drexel deserved to share in the upside with these companies. Furthermore, equity
stakes provided some discipline. Theoretically at least, they were a deterrent to doing bad deals, and they added extra incentive for Drexel to devise some solution if a company got into trouble.

The owner-manager was a natural corollary of Drexel's own principal-mindedness. Drexel wanted to share risk and reward with companies controlled by managers who were driven by the same incentives of ownership.

Milken points out that he had seen the value of an owner-manager for many years before Drexel began doing original issuance of high-yield debt for its entrepreneurial clients. He had seen it when he called on Riklis, Tisch and Charles Bluhdorn (of Gulf + Western) and bought their bonds. He says he first understood its importance as a child, when he was helping his father prepare tax returns and had the opportunity to meet some of his father's clients. The difference in the attitudes of those who were owners and those who only felt like employees was clear to him.

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

It may be that the only clients available to Drexel were the aggressive entrepreneurs who seemed to reflect the firm's image—but Joseph claims that those were also the clients that he and Milken wanted. From the early days of the Predators' Ball, introductions of clients giving presentations typically included a reference to the size of those clients' stakes in their companies.

Often it seemed as though they all—this entrepreneurial, underdog firm and its entrepreneurial, underdog clients—were in business together. Not only did Milken and Drexel have a substantial stake in many of these companies, often owning both their debt and their equity, but Drexel's corporate-finance professionals would typically sit on their boards, in order to further solder the relationship.

And the connections did not go only vertically between client and Drexel but also horizontally between clients. For many would be both issuers and buyers; client A would buy client B's paper, and client B would buy client A's. This was not simply fortuitous. While with the inner circle it may have happened more naturally, later
issuers—for whom Drexel would typically raise more capital than was needed, in a deliberate overfunding—would be told that investing in other junk was part of being in the game. So the matrixing never stopped.

Milken liked it that way. He thrived on connection. He placed these companies' debt; he knew where virtually every bond was (and had it all entered on his supercomputer system); he owned some of the debt himself; he owned some of the equity. Connection was generative. It helped to insure client loyalty, increased the flow of information, acted as a means of control.

Lines would blur in the investments too. Sometimes Milken invested his own capital, sometimes that of the firm, or of his group, or of a group from corporate finance. For, by 1981, corporate finance had finally prevailed upon Milken to start an investment partnership for them. In order to make it a large enough pool (the investment bankers did not have huge sums to invest), Milken agreed to match the assets invested by corporate finance with those from his people.

Most of the people in corporate finance to whom this partnership was open chose to participate. One who did not was Julian Schroeder, who would leave the firm in 1985 and wage an unsuccessful campaign for Congress. Schroeder said he passed on the investment because he “never felt comfortable about it, and didn't like the liability.” It was structured as a general rather than a limited partnership, which meant that all who participated would have been individually liable.