Look Who's Got The Last Laugh Now

Just a few years ago, Theodore J. Forstmann's fellow Wall Street dealmen scorned him as an annoying anachronism. In the epic takeover battle fought over RJR Nabisco Inc. in 1988, Forstmann Little & Co. didn't even make a bid, standing on principle, of all things. In the best-selling book Barbarians at the Gate, Forstmann came across as a self-righteous blowhard, raging against the reckless venality of the deal game even as his nemesis, Kohlberg Kravis Roberts & Co., engineered history's largest leveraged buyout. At one point, Forstmann's own banker asked in exasperation: "What are you, a priest?"

Oh, how times have changed. Today, it's evident not only that KKR overpaid but that the RJR deal marked the peak of 1980s deal mania. Teddy Forstmann was right, and for the right reasons. It's said that virtue is its own reward. On Wall Street, though, there's a financial angle to everything. Having avoided the catastrophic deals that now burden so many high-leverage investors, Forstmann Little boasts unequaled rates of return(table). And while many LBO promoters are virtually moribund for lack of financing, Forstmann Little is constrained only by its own investment discipline.

`PHENOMENAL.' The latest evidence of Forstmann Little's prosperity surfaced on Jan. 29. Just two days after R.H. Macy & Co. (LBO, Class of '86) collapsed into Chapter 11, Forstmann Little announced plans to bring public Gulfstream Aerospace Corp. Two years ago, Forstmann Little joined with Allen E. Paulson, Gulfstream's founder, to buy the executive-jet maker from Chrysler Corp. If Gulfstream fetches the $20 per share it is seeking, the Forstmann group's $100 million equity investment will have a market value of $500 million. That's an imputed return of 123% a year.

A few weeks earlier, Forstmann Little closed the sale of its FL Industries Inc., a manufacturer of electronic components. Forstmann Little now has fully divested 11 of the 18 companies it has acquired since the firm was founded in 1978. On the $2.67 billion of capital invested in these 11 completed investments, Forstmann has returned 32.2% a year, on average, to its debt investors and 86.4% to its equity investors--or more than double the average equity return claimed by KKR. "Forstmann's numbers are clearly phenomenal," says Steven Gaines, publisher of the Private Equity Analyst newsletter.

These astronomic averages are likely to decline somewhat as Forstmann Little divests the seven operating companies still under its control. The group includes the buyout firm's only real clinker, Pullman Co., which manufactures industrial components. With cash flow running 40% below projections, Forstmann decided last fall to defer interest payments on Pullman's $250 million of subordinated debt. John A.Sprague, the Forstmann partner in closest contact with Pullman, predicts that the company will make good on all its debt payments. As for the $65 million in equity, however, "the prospect of a positive return is remote," Sprague says.

Forstmann's institutional investors are taking Pullman's troubles in stride. "When you invest in an LBO partnership, you expect two or three deals to be losers and another five to eight to be just O.K.," says John B. Carroll, president of GTE Investment Management Corp., an investor since the early 1980s. "The fact that Pullman is Forstmann's only problem is quite remarkable. Teddy Forstmann has always walked the way he's talked, and in this business that counts for a lot."

GROWTH MODE. Vindication has mellowed Teddy Forstmann a bit. In five hours of interviews with BUSINESS WEEK, he did not once disparage Kohlberg Kravis--directly, anyway. "I still don't think that winning is doing the deal no matter what," he says. "Winning is making money for your partners."

Forstmann, 51, now is confronted by the traditional challenge of the flamboyantly successful--what to do for an encore. Forstmann's answer: more LBOs, but of a different sort.

With the exception of Pullman, Forstmann Little thrived by paying reasonable prices for mature businesses with steady cash flow and a dominant position in industries less volatile than the economy as a whole. With such straightforward asset plays scarce today, Forstmann has refocused its designs on companies capable of growing faster than the economy. The buyout firm began tilting toward growth in 1990 with the acquisitions of Gulfstream and General Instrument Corp., the dominant supplier of cable-television electronics.

Forstmann's shift in strategy exposes it to new risks. In acquiring Gulfstream Aerospace, for example, Forstmann accepted greater exposure to the swings of the economy than it willingly accepted in the past. With the executive-jet market in a recession-induced slump, Gulfstream's revenues fell to $887 million last year from $1 billion in 1989. Orders are picking up, though, and the numbers suggest that Gulfstream is a more efficient company than it was under Chrysler Corp. Despite a 9% revenue drop in 1991, Gulfstream posted $21.3 million in operating earning, compared with a loss of $4.3 million in 1990.

Then, too, growth companies expose Forstmann Little to the vagaries of big-time research and development. Gulfstream is developing several new models, including a minisupersonic transport in partnership with a Russian group. General Instrument Corp., meanwhile, is a leader in the race to develop high-definition television. Aldila Inc., which Forstmann just acquired, is a pioneer in graphite golf club technology.

"With these companies, clearly there is more volatility in the numbers than we're used to," acknowledges Nicholas C. Forstmann, Teddy's brother and, with Wm. Brian Little, a co-founder of the buyout firm. "I can't tell you for certain whether the HDTV market is going to do this, that, or the other thing."

Forstmann Little has tried to compensate for the added uncertainty by adjusting its financing approach. For one thing, the firm is leveraging less. The buyouts of Gulfstream and General Instrument were financed with $7.5 of debt for every $1 of equity, compared with ratios ranging from 10 to 1 to 20 to 1 in most of its past deals.

In addition, Forstmann enjoys a marked financing-cost advantage over its LBO rivals, thanks to its long-standing junk-bond abstinence. During the 1980s, KKR and most major LBO houses grew heavily dependent on the junk-bond underwritings to supply the subordinated debt crucial to large LBOs. Today, such financing is available only in piddling amounts at usurious interest rates.

Instead of playing the junk-bond game, Forstmann Little in 1983 decided to approach its equity investors, mainly the pension funds of such blue-chip corporations as Boeing, Eastman Kodak, and AT&T. A dozen of them not only agreed to invest $250 million in a new subordinated-debt partnership controlled by Forstmann Little but accepted a rate of interest well below market levels. In return, these investors were given an option to buy a 37% equity stake in each future buyout. Since 1983, Forstmann has raised four additional debt funds on identical terms.

Today, LBO loans are as scarce as communists in the Kremlin, and Forstmann Little is beginning to make more aggressive use of its financing advantage. With $2 billion in debt financing locked in at a rate only one percentage point higher than the U.S. government itself pays, the buyout firm famous for shunning junk bonds has decided it no longer necessarily needs banks, either.

In mid-January, Forstmann Little made the first wholly self-financed bid in LBO history, offering about $600 million for the Cessna Aircraft Co. subsidiary of General Dynamics Corp. On Jan. 16, Teddy Forstmann and a General Dynamics executive shook hands on a deal. However, their preliminary agreement unraveled as Forstmann Little's review of the fine print prompted it to refuse to assume open-ended liability for Cessna's past operations. Enter Textron Inc., which on Jan. 20 announced its acquisition of Cessna for $600 million.

The financial structure of Forstmann Little's Cessna bid suggests that it can compete with most any corporate acquirer. Except for a small contribution from Cessna executives, all $600 million would have come from partnerships run by Forstmann Little--$175 million in equity and $425 million in debt borrowed at 7.125%. Forget Forstmann's LBO rivals: not even a corporation rated AAA could have borrowed at lower cost.

`QUALITY ASSETS.' To Teddy Forstmann, though, the overriding advantage of self-financing is freedom from burdensome loan covenants and amortization schedules. Under Forstmann Little's agreement with its institutional lenders, the companies it acquires need not begin repaying the LBO debt for 11 years. These days especially, banks are not nearly as patient. Had the buyout firm taken out a bank loan, Cessna would have had to begin principal payments after one year and repay the full sum in five or six years.

Ever the contrarian, Teddy Forstmann sees abundant LBO opportunities even with stock prices at record levels. Growth companies in particular are trading at lofty multiples. As Forstmann notes, though, generally high stock prices prove little relief to the numerous large corporations struggling to cope with the double whammy of protracted recession and the basic structural changes transforming many U.S. industries. "If I told you the names of the companies that have come through here looking for capital, you'd faint," says Forstmann. "There are quality assets available, believe me."

SCUTTLED DEAL. While LBOs are Forstmann's preference, he is warily open to other investments. Last September, he preliminarily agreed to pay $350 million for a one-third stake in Whittle Communications, a diversified media company. A month later, though, the deal was off, scuttled by Forstmann's skepticism over Whittle's optimistic growth forecasts. "Teddy will not get into a deal that is anything far from 99.9% risk-free," says Chairman Christopher Whittle. Yet Whittle remains hopeful of working something out: "I will be very surprised if we don't do business together in some way."

When Teddy Forstmann raised his last debt fund a year and a half ago, he told his investors that he would remain with Forstmann Little until all the money is invested. After that, who knows? "I'm definately not going to spend my whole life doing this," says Forstmann, who says he can envision retiring in five years or so. Don't bet on it, though. That's a gamble Forstmann himself would never take.

FORSTMANN'S
      HOLDINGS:
      GRIMES AEROSPACE
      ACQUIRED 1986
       $730 MILLION
      PURCHASE PRICE
      LEAR SIEGLER
      ACQUIRED 1987
       $2,100 MILLION
      PURCHASE PRICE
      PULLMAN
      ACQUIRED 1988
       $670 MILLION
      PURCHASE PRICE
      GULFSTREAM AEROSPACE
      ACQUIRED 1990
       $850 MILLION
      PURCHASE PRICE
      GENERAL INSTRUMENT
      ACQUIRED 1990
       $1,750 MILLION
      PURCHASE PRICE
      ALDILA
      ACQUIRED 1992
       $83 MILLION
      PURCHASE PRICE
      DATA: FORSTMANN LITTLE & CO.