Leon Black: Wall Street's Dr. No
When Drexel Burnham Lambert Inc. collapsed in 1990 amid admissions of widespread securities fraud, the career prospects of Drexel investment banker Leon D. Black did not seem particularly auspicious. Much of the fraud related to Drexel's deals, and as head of the firm's mergers-and-acquisitions operation, Black worked closely with Michael L. Milken, who went on to serve 22 months in prison.
Black emerged with a clean record, and now, six years later at age 45, he runs one of the largest and most successful private buyout firms, Apollo Advisors LP. Black's $7 billion-plus empire consists of controlling or minority stakes in 26 diverse companies from coast to coast, including luggage maker Samsonite Corp. and Empire Kosher Poultry Inc. His personal fortune is estimated at upwards of $500 million. Apollo's net annual returns of about 40% dwarf the 29% and 24% returns posted as of Mar. 31 for buyout funds formed in 1990 and 1992, respectively, according to Venture Economics, a Boston research firm.
Although Black has striven to put a lot of distance between himself and Drexel, his dealmaking methods remain quite similar to those that made Drexel so successful during its heyday: finding outsize profits in adversity and misfortune. It was Drexel, of course, that pioneered dealings in so-called distressed companies and securities, especially junk bonds. This fall, Apollo expects to take possession of two choice midtown Manhattan office buildings it wrested from the collapsed Olympia & York Developments Ltd. real estate empire. That will essentially bring to a close one of the longest, largest, and most tangled financial restructurings in recent history. One banker thinks Apollo will double its $100 million investment over a two-year period. No deal better illustrates Black's guile and readiness to plow big bucks--including his personal funds--into complex, dicey, troubled transactions.
Black, who has put $7.5 billion to work in the past five years, expects that in the months and years ahead, Apollo will have plenty of opportunities to employ his $1.5 billion war chest in similar situations. He raised the money from investors that included CalPERS, General Motors Corp.'s pension fund, foundations, and banks, exceeding Apollo's original target by $500 million. In keeping with the firm's practice of placing its own net worth at risk, about $100 million, or 7.5%, is the partners' money.
Black has believed for some time that equity valuations are excessively lofty and that the stock market will sharply reverse itself, creating plenty of distressed opportunities. "The only thing I'm sure of is that markets will change," he says. The market's recent sharp sell-off suggests that these opportunities could emerge sooner rather than later.
"BLOOD." Black's view is echoed by other buyout artists, including Carl C. Icahn, Black's former client and erstwhile rival. Another is John H. Kissick, the former Drexel West Coast corporate-finance chief who works with Black and manages $500 million in junk debt for Credit Lyonnais and other investors. At the first sign of a major market reversal, Kissick says, Apollo is prepared to snap up bargains, much as it did when the junk market crashed in the early 1990s. The firm has tagged about 60 vulnerable companies it would consider acquiring once the market breaks. "Our sense is that in the next downturn, there could be some blood," says Kissick.
In its approach to the market--as well as its roster of former Drexel execs as Apollo officers and its close ties to other onetime Drexel managers--Apollo, in a sense, is Drexel reincarnate, the nexus of a network of ex-Drexelites who now occupy key positions in U.S. finance. Black's success represents a kind of vindication, if not of Drexel, then certainly of its more virtuous methods--notably, its devotion to rigorous, sophisticated credit analysis and financial engineering. Indeed, one reason Black established Apollo was to help dispel the taint of insider dealings and take-no-prisoners reputation that haunted anyone associated with Drexel in the years immediately after its demise in 1990. Says Black: "I'd be lying if I didn't say part of my agenda was to show that [Drexel] wasn't an evil machine."
Sitting in his spacious but unpretentious corner office high atop Manhattan's Avenue of the Americas, Black seems frustrated. Lately, his colleagues have dubbed him "Dr. No" because he rejects so many deal prospects. Every week, Apollo studies more than 30 deals, 90% of which are discarded after a half-hour's discussion, mostly because the companies lack good management. Last year, Black passed on a buyout of Kloster Cruise Ltd. The reason: too much new-ship capacity in an industry dominated by two strong players.
CARTOON COUP. Companies Apollo already owns have lately made a number of relatively small acquisitions, and the firm is also beating the bushes for minority stakes, typically through convertible preferred stock, in companies that are public or expect to go public. He would surely like to find more companies like Hanna-Barbera Productions, the cartoon producer he bought in mid-1991 with media baron Ted Turner. He sold his position for a 43% annual return two years later. Black says the firm is mulling about 10 large deals, of which it might complete two this year.
But Apollo hasn't closed on a major new corporate transaction since the spring of 1995, when it bought the largest interests in grocery chains Ralphs Grocery Co. and Dominick's Finer Foods. The supermarket business is one of the few on which Apollo remains bullish.
Under current market conditions, Black can only dream of replicating the 40% returns of earlier Apollo funds. Some detractors downplay these results, saying Black made a fluke killing in the early 1990s picking up billions of dollars of distressed securities issued by Drexel clients. Says Black: "I'd be happy with 30%." More than three years have passed since Apollo completed a troubled corporate-debt deal. "There just isn't much quality distressed," he grins, obviously pleased with his oxymoron--if not with market conditions.
Not surprisingly, much of Apollo's activity these days is selling. Black says it's generally "a better time to harvest than to buy." The firm has profited handily from the market frenzy. Most recently, Apollo announced plans to shed its 13.8% stake in Zale Corp., a national 1,200-store jewelry chain, generating an estimated 40% annual return on a $39 million investment made in 1993. Despite, or perhaps because of, the high growth prospects for retirement centers, Apollo sold its Forum Group Inc. to Marriott International Inc. for a similar return. And late last year, it sold National Law Publishing for $150 million--a price some experts consider outrageously high--to an investor group led by Boston Ventures Management Inc. In June, Apollo agreed to sell its Crocker Realty Trust Inc. for $540 million, generating an annual return of approximately 50%.
Apollo now views real estate as one of the few promising buying opportunities and is scouring the country for undervalued properties, including tax-sheltered limited partnerships and REITs. To that end, it expects to close this fall on its second $500 million real estate investment fund; the first one posted an annual return on equity of about 50%. William Mack, head of Apollo's real estate unit, says office buildings and hotels are now selling for 45% to 75% of replacement cost. "There's not a lot of faith in real estate, so this is the best time to invest," he says. "Money is made when the market is improving and the perception is negative." The real estate market should continue upward for five more years, says Mack, a neighbor of Black's, whose son also works for Apollo.
Notwithstanding the slow pace of non-real estate activity, Black says he expects to be out raising fresh capital for a new fund of the same size three years from now. To keep Apollo's hand in the capital markets, the firm plans to start a high-yield fund. "We'll be making more [minority] investments as liquidity tightens, more control investments as the stock market falls, and more distressed as the economy weakens," he predicts.
AT ODDS. Black's reputation as a sharp-elbowed dealmaker is somewhat at odds with the one he projected growing up as the son of the late Eli Black. A rabbi turned socially conscious businessman, the elder Black rose to become chairman of United Brands Co. but committed suicide in February, 1975, by jumping from his 44th-floor window in what is now the Met Life Building in mid-Manhattan. Understandably, that had a profound impact on Leon, and he stiffens at the mention of it.
Early on, Leon's instincts, like his father's, seemed more those of a scholar and humanist than a businessman. A philosophy major at Dartmouth College, Black was passionate about basketball and Shakespeare and once wrote a 17-page essay on King Lear's fool. Black considered becoming a teacher, but his father urged him to go to business school. He later received an MBA from Harvard, which he loathed. "Most of what I learned about how to do business I learned from Shakespeare, not Harvard business school," he says. Recently, Black endowed a chair at his alma mater for Shakespeare studies.
Black was in his second year at Harvard when his father took his life. Eli Black's death didn't exactly leave his family penniless, but they surely were not rich even by 1970s standards. Leon wound up with a $75,000 trust fund and an equal amount from a life insurance policy but promptly blew a third of it speculating on copper futures. From that, he learned to put his money only in places he understood. "I had to go out and support myself and my family [his mother and sister]," says Black. He is now married, with four children. After his father's death, he wound up at what is now KPMG Peat Marwick and later worked at a publishing house. But it was a meeting with Frederick J. Joseph, then head of corporate finance at the third-tier investment firm of Drexel Burnham Lambert, that launched his dealmaking career.
As head of Drexel's fledgling cable-TV business in the late 1970s, Black made his mark by snaring Cablevision Systems Corp.'s chief, Charles F. Dolan, as a client and financing other cable ventures. In 1984, he underwrote John W. Kluge's buyout of Metromedia Co., one of Drexel's largest deals at that point. Two years later, he handled the sale of Metromedia's TV stations to Australian media mogul Rupert Murdoch. They formed the core of his TV network, Fox Broadcasting Co. Black acknowledges he did some ill-advised deals at Drexel. One was backing raider William Farley's ill-conceived takeover of bedding maker WestPoint Pepperell, which landed Farley's company in bankruptcy. But former colleagues credit Black with being well ahead of the curve in betting on key trends, such as cable in 1979 and leveraged buyouts in the early 1980s.
Of his 13 years at Drexel, the first 12 were "pretty terrific," says Black. There was a "fabulous feeling of camaraderie, esprit de corps." The last 12 months, however, were a "nightmare."
At the time, Black, like many of his Drexel colleagues, was angry at federal prosecutors, the financial press, and some "envious" members of the Wall Street Establishment, for, in his view, conspiring to undermine the high-flying firm and Milken, whom he still regards as one of the all-time geniuses of American finance. Black believes a lot of good came out of the junk-bond-fueled takeover wave of the 1980s. "Management was put on guard," he says. "And junk became established as a real market."
HEADSTART? Drexel's failure punctured the already deflated junk-bond balloon. Unable to obtain new financing, many Drexel clients stumbled. Suddenly, billions of dollars of distressed debt securities flooded the market, and no one was better positioned to evaluate their real worth than Leon Black & Co.
Much of the debt was issued by Drexel clients, in some cases Black's. The biggest deal was in 1992, the purchase of the $3 billion (face amount) junk-bond portfolio of collapsed Executive Life Insurance, a California insurer and a Drexel client, with the help of Credit Lyonnais, the large French bank. Even though Apollo outbid its nearest rival by a wide margin, the transaction remains emotionally charged. Critics such as Warren Hellman, general partner at the San Francisco investment firm Hellman & Friedman, who lost his bid for the portfolio, charge that Apollo capitalized on the naïvete of then-California Insurance Commissioner John Garamendi. "Nobody knew the portfolio better than Leon," says Hellman. "They helped create it." He adds: "What they were able to do is establish the ground rules and get the commissioner's office in a position where they were the favored bidder." Garamendi "made the worst deal of any grown person I've ever met in my career," says Hellman.
Some Wall Streeters claim Black was able to use his inside knowledge of ex-Drexel clients' holdings to turn fat profits buying and selling the junk debt of these companies. "They had to have had a headstart," says one. Black bristles at these charges, dismissing them as "nonsense." One Black defender, Wilbur L. Ross Jr., senior managing director of Rothschild Inc., says: "Five years is a long time for inside information to have an effect." Since Black acquired the Executive Life portfolio at the bottom of the market, "it would have done well had he done nothing at all," Ross says. Black says his claimed 40% return excludes his gains on the Executive Life portfolio.
In any case, Black, with his $16.6 million bonus check from Drexel and $800 million from Credit Lyonnais and other, mostly foreign, backers, was able to emerge from Drexel's ruins to found Apollo Advisors, named for the Greek god of sunlight, prophecy, and healing.
Drexel's failure had created an instant pool of skilled talent, and Black handpicked the best of them. Top aides include Black's alter ego, John Hannan, second-in-command in the Drexel M&A unit, Kissick, and Tony Ressler, Black's brother-in-law. Apollo quickly became known for its intellectual capital. Measured in sheer I.Q., Apollo's brainpower is daunting: Of its 30 professionals, about half, including Black, graduated at least magna cum laude from top universities. Meetings to deliberate over deals are typically loud, boisterous screaming matches. "The toughest thing at Apollo is to finish a full sentence," says partner Marc J. Rowan, 34. Partners unwind by playing "old guys vs. young guys basketball."
Although Apollo's M.O. over the past six years has been shaped by the vagaries of the market, Black left Drexel with definite ideas about the kind of firm he wanted Apollo to be and how he planned to pick his targets. For one thing, he knew he didn't want to have to deal with the politics of a big firm. Good thing, too: Colleagues say managing a large staff is Black's weakest suit.
Black also ruled out hostile takeovers, figuring they'd turn off prospective business partners. And he knew corporate creditors would avoid business with Apollo if it always held out for the last nickel. "[Black] may leave a nickel on the table. But no more than a nickel," quips one Wall Streeter close to the firm.
Apollo's strategy, Black says, is opportunistic yet long-term and risk-averse: "If you cover your downside and keep the discipline, the reward side will take care of itself." Apollo is also unusually loose in its approach to deals. Unlike most other major buyout firms, which insist on acquiring control through equity investments in companies, Apollo determined at the outset that it would be flexible in the kinds of investments it made in a company and in its willingness to share control. "Control is just one possible outcome," says Black. Apollo often invests with a view to getting control, but its fallback is an investment that will itself pay high returns.
The O&Y episode is a prime example of Apollo's ability to adapt to complex circumstances. Most prospective investors stayed clear, considering it a legal quagmire. One Apollo option was to take control of the entire U.S. operation. To gain leverage in the negotiations, Apollo persuaded bondholders and bankers to sell it their paper at an average of 50 cents on the dollar. Failing control, it knew it could end up with some of the buildings. At worst, it would earn a coupon on the bonds. Mack figured Apollo couldn't go wrong unless New York City was hit by a depression.
Apollo had to maneuver around a panorama of complex personalities and shifting alliances. From the beginning, two camps were clear. On the one hand, Canada's Bronfman family, banks--including Citibank, the largest lender to O&Y--and other creditors were seeking to minimize their losses. On the other hand, Apollo hoped to make a profit by injecting new money. It did extensive due diligence--learning, for instance, that tenants of the buildings were happy with their leases, indicating that cash flow was reliable. Says Meyer "Sandy" Frucher, executive vice-president of O&Y (USA): "Everybody had the same opportunity they did. [But] no one else had the guts to do it."
In the end, the creditors, Apollo Advisors, the Bronfmans, and others agreed to divvy up the spoils, with Apollo getting 1290 Avenue of the Americas and 237 Park Avenue, O&Y USA's headquarters. Mack says he expects Apollo to hold on to the buildings for the "intermediate term."
Apollo chafes at being typecast as a distressed or "vulture" investor. But it was distressed-debt investments that got the company off and running in the restructuring business and that have produced the best returns. In 1990, says Ressler, Apollo recognized these investments as "real companies with real franchises. They weren't going away, even though people were saying high-yield bonds were bad." Adds Black: "One of the reasons we liked distressed was because others didn't have the capital-markets background and weren't comfortable playing" in that arena.
The transaction that marked Black's return to dealmaking's center stage was Apollo's acquisition, beginning in 1990, of 40% of the senior subordinate debt of what was then Harcourt Brace Jovanovich, which overleveraged itself in 1987 to block a takeover attempt by British newspaper baron Robert Maxwell. Most prospective investors were frightened by junk bonds. But at a time when many companies were valued at about eight times cash flow, HBJ debt was only about 3.5 times its $200 million cash flow. Black figured the investment was virtually risk-free. After he offered about $1.2 billion in cash and notes for the company, Richard A. Smith, head of Boston-based General Cinema Corp., topped it by $400 million with an all-cash bid. Ever flexible, Apollo was still able to cash out after nine months with a $100 million profit.
GAME PLAN. Once Apollo takes over a distressed company, it usually follows a fairly predictable formula: It dumps marginal assets, replaces or motivates management with a package of incentives, recapitalizes the company, and takes it public. Take troubled E-II Holdings, formerly American Brands Inc. and later known as Astrum International Corp. Holdings included Culligan Water Technologies, the water-purification company, and luggage maker Samsonite Corp. As has been his practice in perhaps 40% of Apollo's deals, Black acquired major positions in various debt traunches, which gave it a "blocking position," the ability to control the deal's outcome and eventually convert its interest into a big equity stake. Apollo in 1993 led senior debt holders in a prolonged, acrimonious battle against junior debt holders, notably Carl Icahn. Eventually, Icahn made a bundle on the junior debt, while Apollo wound up with a controlling stake in the reorganized company.
After Apollo took over, it replaced Culligan's management, which it regarded as uninspired. And it fired up new management with a package of incentives, including stock options. Apollo proceeded to sell off a T-shirt maker and a meatpacking company, whittling Astrum down to Samsonite and Culligan, which it spun off in August, 1995. Apollo is the largest shareholder of the two companies. Lately, Culligan and Samsonite have been in hot pursuit of closely related companies and are moving to expand their traditional businesses outside the U.S. It seems to have paid off: Culligan and Samsonite are trading for a combined $51.50 a share, compared with Astrum's $23 a share before restructuring.
For all of its due-diligence skills, Apollo has endured a few embarrassing, high-profile blunders. Its biggest headache is surely its Family Restaurants Inc. unit, a company it formed by merging its own troubled restaurant unit, which included the El Torito, Carrows, and Coco's chains, into Foodmaker's Chi-Chi's, a Mexican-style restaurant chain. Apollo appears to have been less than vigilant in overseeing the new operation. Maintenance and service had deteriorated dramatically even before July, 1994, when a report by a nutrition-advocacy group panned Mexican food as unhealthy. Foodmaker panicked, discarding traditional menus in favor of healthier selections that went over poorly with customers. Apollo declines to comment on its opinion of Foodmaker. But in cleaning up the red ink on the kitchen floor, Apollo assumed Foodmaker's interest in Family Restaurants and installed new management. A Foodmaker spokeswoman said sales declined after the report.
Sneaker maker Converse Inc. has been another major disappointment. There, everything that could go wrong has. Last May, for example, Converse bought sports-apparel maker Apex One Inc. but shut it down three months later, taking a $41.6 million pretax loss. Then, in December, Converse's "performance" sneakers leaked cushion fluid at the start of a high school basketball game in a Chicago suburb, causing the players to slip and slide across the court. "It's a tough business," shrugs Hannan. "They [Converse] have their work cut out for them."
Dealing in distressed situations, of course, is always tough. But if the market downturn Black anticipates occurs, his life, if not those of most of his competitors, should be a lot easier.