Alabama's Pension Fund Learns How Not To Do A Deal
It was a chilly January afternoon in Washington, D.C., but inside the glass-walled conference room the mood was decidedly upbeat. After six hours of signing papers and last-minute haggling, the $710 million sale of Park Communications Inc. to Media General Inc. was finally complete. The dozen or so lawyers and executives gathered around the conference table to celebrate with the traditional champagne toast, according to one of those present. None savored the bubbly more than Park's two former owners. Moments before, $108 million had been wired to each man's bank, suddenly vaulting them into the ranks of the megarich.
Thus ended the brief but extraordinarily lucrative media careers of Donald R. Tomlin Jr. and Gary B. Knapp. Less than two years earlier, the pair had been obscure, small-time financiers with little money and even less media industry experience. But they had something far better: connections. Both were longtime friends of David G. Bronner, the CEO of The Retirement Systems of Alabama, the state's $17 billion pension fund.
UNORTHODOX. Back in late 1994, Bronner had stunned the media industry when a group organized by his pension fund won a hotly contested auction for Park, a small media conglomerate with interests in TV, radio, and small-town newspapers. Every penny of the $578 million in cash for the purchase came from the coffers of the Alabama fund. Representing 4% of the fund's assets, it was an unusually large and aggressive investment for a state pension fund. (The total price was $711.4 million, with the rest coming from Park's own cash on hand.)
But the unorthodox nature of the deal didn't end there. Rather than have his fund own Park outright, Bronner had a new company called Park Acquisitions Inc. set up and lent it the money to buy Park Communications. Park Acquisitions was owned jointly by Tomlin and Knapp, and its debt was secured by the assets of Park Communications. In return, the two financiers agreed to pay above-market rates to the pension fund for the financing it provided. Shortly after the winning bid was announced in October, 1994, Bronner said that he had "seldom if ever seen such an opportunity."
Park turned out to be a spectacular deal, all right, but not for Alabama's pensioners. Tomlin and Knapp, who never invested any money of their own in the Park deal, resold the company early this year, walking away with about $216 million in profit after just 20 months. Bronner's fund, which had put the Park deal together, provided all the cash, and shouldered most of the risk, emerged with a 13.5% return over a 12-month period. Although hardly shabby--Bronner says it was the fund's best fixed-income investment for 1996--it doesn't compare with the staggering profits made by Tomlin and Knapp. There is no evidence that Bronner benefited personally.
How did two buddies of a public-pension-fund chief make so much money while contributing so little? Media insiders have been asking the same question for months. "Either they're real smart or the Alabama pension people are real dumb," says Deborah R. Jacobson, a vice-president who handles acquisitions for LIN Television Corp. a fast-growing media company based in Providence.
In fact, the bizarre outcome of the Park deal had less to do with one side outsmarting the other than with the pitfalls of concentrating too much power in one person for too long. As head of the Alabama pension fund for more than 23 years, Bronner operates with a high degree of autonomy. The fund's two boards of trustees consist mostly of teachers or state employees who have little expertise in complex financial dealings. "It's a rubber-stamp board," says James C. White Sr., a former state finance director who served on both of the boards during the Park deal and who often clashed with Bronner. "He really runs that thing unchecked." The board members say they depend on Bronner and his staff for expertise. "We're not in a position to make decisions. That's why we have a professional staff," says Richard M. Kennamer, vice-chairman of one of the boards that oversees the fund.
So when Bronner decided to venture beyond the tamer world of securities trading and dabble in big-league dealmaking, nobody asked a lot of hard questions. Indeed, not a single question was raised at a key 1994 board meeting when Bronner introduced the Park deal to one of the two boards, the minutes show. "I put a great deal of faith and confidence in (Bronner's) ability," says Sarah Swindle, a teacher who is vice-chairman of one of the two boards. "That's true for all of us on the board." Several members of the boards' two investment committees, which are supposed to approve all transactions, say they can't recall anything but cursory discussion of Park. None of the seven board members contacted by BUSINESS WEEK recall receiving any information about Bronner's prior relationship with Tomlin and Knapp.
So far, the Park deal has received almost no attention in Alabama. But several prominent outside pension experts say they're surprised by the apparent lack of oversight. "This is not the way I'd expect to see a pension fund operate," says Ian D. Lanoff, a Washington attorney who advises big public pension plans in California, Texas, and Florida. "The trustees are supposed to protect the assets of this fund, but it doesn't sound like they knew enough to make an informed decision." Board members deny they were lax. "We looked at the investment enough to where we were satisfied," says Jerry L. Shoemaker, a member of one of the investment committees.
With hindsight, it's clear that Bronner and his advisers made some crucial errors in structuring the Park deal. Many state pension funds would have shied away from making a big investment in an unconventional deal such as Park. Most would have hired a battalion of outside experts to comb through the terms. Bronner, however, decided to forgo the usual investment bankers and securities lawyers and structured the deal mostly using his tiny in-house staff.
Tomlin and Knapp did not respond to repeated interview requests. Bronner strongly defends the Park transaction. He concedes that there may have been flaws in the deal but says that Tomlin and Knapp's windfall was mostly the result of such factors as a change in radio- station ownership rules that nobody could have foreseen. And, he hastens to add, "the mistakes were not detrimental to us. We made a lot of money" on Park.
Bronner also says the mistakes won't be repeated. The Alabama fund has modeled several subsequent deals on Park but has made sure the fund will get any windfall profits. Meanwhile, Bronner doesn't seem disturbed by Tomlin and Knapp's sudden good fortune: "It's not a whole lot different than the lottery. They were in the right place at the right time."
As the Park deal suggests, Bronner, 52, hardly fits the stereotype of a cautious state pension-fund manager. A transplanted Midwesterner with a politician's facile charm, he has become both a powerful player in Alabama. Most of the fund's portfolio consists of conventional stocks and bonds, which have outperformed market averages over the five years ended in 1995. "Alabama's returns are definitely very solid, above the pack," says Carlos Resendez, executive director of the National Conference On Public Employee Retirement Systems. "I'm quite impressed with what David has done in Alabama."
By late 1994, Bronner was ready to venture beyond stocks and bonds and was shopping around for an entire company to take over. He was drawn to the media industry with its strong cash flows. Park's string of properties in small and midsize markets gave it broad geographic diversification, making it safer than buying, say, a couple of big TV stations.
Bronner wanted an outside adviser to take a thorough look at Park's stations and publications. He decided to bring in Tomlin. A former real estate developer whose company had foundered in the late 1980s, Tomlin had since acted as a consultant and workout specialist. In one of his more recent projects he had been hired to fix up and help sell a tiny TV station in Dothan, Ala. "I didn't know anybody in the media business," says Bronner. "At least [Tomlin] would know the names of people at NBC or CBS."
OLD BUDDIES. Tomlin's main qualification, though, may have been his longstanding personal ties to Bronner. The two met back in the early 1980s, when Tomlin's company was building a condominium development in Gulf Shores, Ala. According to several sources, the two men quickly became close friends, though Bronner downplays the extent of their relationship. Not long after they met, Bronner became an outside director of Tomlin's real estate development company, U.S. Capital Corp., a position he held from late 1983 to late 1985.
The two also did business together. In 1983, Bronner bought two condos in Gulf Shores, property records show, financing one with a $70,000 mortgage from U.S. Capital. That was just weeks after Bronner's fund bought $15 million worth of mortgage-backed securities issued by U.S. Capital. In a written response, William T. Stephens, the Alabama fund's general counsel, says the pension plan bought the U.S. Capital securities through an investment bank without Tomlin's knowledge and the transaction was unrelated to the condo purchases. He also notes that Bronner put down deposits on the condos in 1982, bought them at market prices, and sold them at a loss in 1991. And, he says, the purchases were disclosed in annual ethics statements at the time. Bronner did not disclose that the 1983 mortgage loan came from U.S. Capital. Stephens says he was not required to do so.
Not too long after hiring Tomlin to review Park, Bronner decided against having the fund make a direct bid for the media company. The fund chief was still smarting from a political drubbing he took back in 1989 when his plan to buy a Montgomery television station was torpedoed by political adversaries who claimed that government ownership of a news outlet would violate the First Amendment. Bronner says he was afraid of running into a similar problem with Park and therefore decided to get somebody else to own the company. The Alabama fund would provide the cash, but instead of holding equity, its stake would be in the form of debt.
Whom could Bronner trust to own the company? He turned to Tomlin and Knapp, who barely knew each other before the Park deal. A college friend of Bronner's, Knapp was a Lexington (Ky.)-based securities broker. His ties to Bronner had already proved lucrative. His firm had earned hefty commissions on sales of mortgage-backed securities to the Alabama fund over the years. His media experience: none. But that didn't matter, says Bronner, who says he wanted "two guys who were really smart and were willing to work on an idea."
The three men, along with Bronner's staff and an outside lawyer brought in by Tomlin and Knapp, devised a complex financial structure. The Alabama fund put up $578 million in senior debt. The 13.5% annual interest on the debt would soak up most if not all of Park's cash flow. Tomlin and Knapp got 100% of the equity but no salary. They were given three years to pay off part of the debt by raising a slug of new equity--from an outside investor or a public offering--equal to 30% of total capitalization.
If they failed to raise the new money, the Alabama fund would exercise a warrant to acquire 80% of Park's equity in the form of nonvoting stock. If they succeeded, the warrants would lapse. In each case, the interest rate on the fund's debt would drop to 10.5%. "Either way, it looked like a great deal," says Thomas G. Milne, a former senior staffer at the fund, who left last year. "If they didn't pay it down, we had 80% ownership. And if they did, we had a 10.5% coupon." Bronner argues that the deal's novel structure allowed the fund to get junk bond-like returns with much less risk since the Park debt was fully collateralized.
There were, however, a couple of gaping holes. Although Bronner negotiated a hefty interest payment, he failed to anticipate the possibility of substantial capital appreciation. If Park increased in value, there was no way for the Alabama fund to share in the gains unless it was able to exercise its 80% warrant. That gave Tomlin and Knapp a three-year window in which to flip the company or find new equity investors. Just as egregious, Bronner failed to guard against the possibility that Tomlin and Knapp could simply pay off the Alabama debt early and retain full ownership, in essence cutting Bronner's fund out of its own deal. "It was a mistake not putting a prepayment penalty in there," says Milne. "You could say it hurt."
At best, say investment-banking experts, the Park structure would warrant a failing grade in Dealmaking 101. "It's unbelievable," says Robert B. McKeon, a former Wasserstein, Perella & Co. investment banker who now runs a leveraged buyout fund. "The pension fund put up all of the money and took all the risk but gave away the ownership. If you put up 100% of the money, you should get 100% of the return, or close to it." In a written response, Bronner said that public pension funds often prefer the steady returns of debt to the increased risk of equity, even if the returns are lower.
The loopholes in the Park transaction would soon make Tomlin and Knapp very rich. The deal closed in May, 1995. Soon after, radio station prices unexpectedly surged, in part because Congress relaxed the rules on the number of radio licenses in a given market a company could own. Tomlin and Knapp quickly sold Park's 22 radio stations for $230 million, nearly double their 1994 value. They used part of the proceeds to pay down the Alabama debt.
THREE'S A CROWD. The next spring, Tomlin and Knapp suddenly announced they would repay the rest of the pension-fund debt by mid-May, 1996 by issuing $476 million in junk bonds that carried roughly the same interest rates as the Alabama debt. Bronner says he "went ballistic" when he heard his fund was being elbowed out of its own deal. But because of the lack of a prepayment prohibition, there was nothing he could do to prevent it. After exactly one year, Bronner's first foray into media dealmaking was over.
Meanwhile, Tomlin and Knapp, unencumbered by Bronner's pesky warrants, moved quickly. They approached Media General initially about taking an equity stake in Park, but as the two sides talked, they instead hammered out a deal, announced in July, 1996, to sell all of Park to Media General for $710 million. That was almost exactly what the Alabama group had paid for the company, but Tomlin and Knapp had already sold the radio stations and used cash that had been on the company's balance sheet.
But Bronner seems to harbor no ill will toward Tomlin and Knapp, attributing their sudden wealth mostly to luck. He also argues that the basic concept behind the Park deal was sound. "Nobody had ever done what we did there," he says. "There was nothing wrong with the creative idea or the vision of it, just the application."
"WE LEARNED." Bronner's interest in the media industry wasn't blunted by the surprise outcome of the Park deal. Since last summer, the Alabama fund has paid $1.4 billion for three companies that own nearly 30 TV stations, combining them in a company called Raycom Media Inc. The deals were similar in structure to the Park transaction, but this time, Bronner says, prepayment of the debt is prohibited and the fund has a warrant to acquire 80% of Raycom's equity if the company does a public offering or is sold. "We learned from the Park deal," Bronner says.
The Alabama fund did one other media deal earlier this year. After Media General bought Park in January, it sold many of the company's newspapers to a management-led buyout group for $107 million. Where did the managers get the money? From the Alabama pension fund. Amazingly, Bronner was putting up the cash to buy newspapers that his fund had paid for and then lost in the first Park deal. "It is a little ironic," says Bronner, chuckling. "But as long as I get my yield, I'm happy."
For investment-banking advice on the Raycom and newspaper purchases, Bronner chose a familiar name: Don Tomlin. According to the fund's internal documents, Tomlin was paid about $2.2 million for his services on the Raycom deal alone. Why did Bronner choose a guy who had just cut his fund out of ripe profits? "It's better to deal with the devil you know," he says, "than the one you don't." After all, who better to make sure Alabama's pensioners come out on top the next time around?