Leon Black: Wall Street's Dr. No
When Drexel Burnham Lambert Inc., the high-flying U.S. junk-bond firm, collapsed in 1990 amid admissions of widespread securities fraud, the career prospects of Drexel investment banker Leon D. Black did not seem auspicious. 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 45, he runs one of America's largest and most successful private buyout firms, Apollo Advisors LP. Black's $7 billion-plus empire consists of stakes in 26 diverse companies, 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.
DICEY DEALS. 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 in 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 Manhattan office buildings it wrested from the collapsed Olympia & York Developments Ltd. international 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 predicts that 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 Apollo to have plenty of chances to put his $1.5 billion war chest into similar situations in the coming months and years. He raised the money from investors that included CalPERS, California's pension-management giant; General Motors Corp.'s pension fund; foundations; and banks. In keeping with Apollo'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 U.S. stock prices are too high and that the market is in for a sharp reversal. That would create plenty of distressed opportunities. "The only thing I'm sure of is that markets will change," he says. The recent sharp sell-off suggests that these opportunities could emerge sooner rather than later.
Black's view is echoed by 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 downturn, Kissick says, Apollo is ready to snap up bargains, much as it did when the junk market crashed in the early '90s. It has tagged about 60 vulnerable companies it might acquire once the market breaks. "Our sense is that in the next downturn, there could be some blood," says Kissick.
In its market approach, and with its roster of former Drexel execs, Apollo is Drexel reincarnate. It maintains close ties to other onetime Drexel managers and functions as the nexus of a network of ex-Drexelites who occupy key positions in U.S. finance. Black's success represents a kind of vindication, if not of Drexel, then surely of its more virtuous methods--notably a devotion to rigorous, sophisticated credit analysis and financial engineering. Indeed, 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 somewhat frustrated these days. 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, for example, 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 production company 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 spring, 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.
In the current market, Black can only dream of replicating the 40% returns achieved on earlier Apollo funds. "I'd be happy with 30%," he says. It has been three years since Apollo completed a troubled corporate-debt deal. "There just isn't much quality distressed," he grins, 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 1,200-store U.S. jewelry chain, generating an estimated 40% 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 views real estate as one of the few promising buying opportunities and is scouring the U.S. for undervalued properties, including tax-sheltered limited partnerships and real estate limited partnerships. 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. The 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 in three years. 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," Black predicts.
Black's reputation as a sharp-elbowed dealmaker is somewhat at odds with his background. The son of the late Eli Black, a rabbi turned socially conscious businessman, Leon majored in philosophy at Dartmouth College and had a passion for Shakespeare. At his father's urging, he then 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.
Black was in his second year at Harvard when his father committed suicide in February, 1975, by jumping from his 44th-floor window in a mid-Manhattan skyscraper--an event Leon still has difficulty discussing. Eli Black's death did not exactly leave his family penniless, but they surely were not rich even by 1970s standards. "I had to go out and support myself and my family [his mother and sister]," says Black.
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. He soon became head of Drexel's fledgling cable-TV business in the late 1970s.
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 what they were really worth than Leon Black and his colleagues.
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, with the help of Credit Lyonnais, the French bank. Even though Apollo outbid its nearest rival by a wide margin, the transaction remains an emotionally charged one. 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."
Some Wall Streeters claim Black was able to use his inside knowledge of ex-Drexel clients' holdings to turn fat profits buying and selling these companies' junk debt. "They had to have had a headstart," says one. Black dismisses these charges as "nonsense." One of Black's defenders is Wilbur L. Ross Jr., senior managing director of Rothschild Inc. "Five years is a long time for inside information to have an effect," Ross says. Since Black acquired the Executive Life portfolio at the bottom of the market, he adds, "it would have done well had he done nothing at all." Black's response to charges of preferential information: "Nonsense." And he says his claimed 40% return excludes his gains on the Executive Life portfolio.
Whatever the case, Black, with his $16.6 million bonus check from Drexel and $800 million from Credit Lyonnais and other, mostly non-U.S. backers, emerged from Drexel's ruins to found Apollo Advisors, named for the Greek god of sunlight, prophecy, and healing.
Black left Drexel with definite ideas about the kind of firm he wanted Apollo to be and how to pick his targets. For one thing, he knew he didn't want to have to deal with the politics of a big firm. He also ruled out hostile takeovers, figuring they would turn off prospective business partners. And he knew corporate creditors would avoid doing 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 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 was a prime example of Apollo's ability to adapt to complex circumstances. Most prospective investors stayed clear because they regarded it as a legal quagmire. One Apollo option was to take control of the entire U.S. operation. To gain leverage in the negotiations, Apollo deftly persuaded bondholders and bankers to sell their paper at an average of 50 cents on the dollar. Failing control, it knew it would end up with some of the buildings. At worst, it would earn a coupon on the bonds. Mack figured Apollo could not go wrong unless New York City was hit by a depression.
GUTSY MOVE. Apollo had to maneuver around a panorama of complex personalities and shifting alliances. 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, the Bronfmans, and others agreed to divvy up the spoils, with Apollo getting O&Y's Park Avenue headquarters and a building on Avenue of the Americas. Mack says he expects Apollo to hold the buildings for the "intermediate term."
For all of its due-diligence skills, Apollo has endured a few embarrassing, high-profile blunders. Its biggest headache now is surely its Family Restaurants Inc. unit, a company it formed by merging its own troubled restaurant unit into Foodmaker's Chi-Chi's, a Mexican restaurant chain. In July, 1994, when a report by a nutrition-advocacy group panned Mexican food as unhealthy, Foodmaker panicked. It discarded 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 position and installed new management. A Foodmaker spokeswoman says sales declined after the report.
Sneaker maker Converse Inc. has been another major disappointment. Last May, 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 John J. Hannan, a top Black aide. "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 get a lot easier.