Some historical perspective from The Predator's Ball

I just finished reading The Predator’s Ball: The Inside Story of Drexel Burnham and the Rise of the Junk Bond Raiders by Connie Bruck and I liked it a good amount.  It’s about junk bonds, Michael Milken and Drexel Burnham Lambert in the 1980s.  Probably my first exposure to the subject came from Margin of Safety by Seth Klarman a few years ago as an example of what not to do as an investor.  What struck me reading about junk bonds in the 80s was how similar it was to subprime over the past decade.  It’s really some eerie stuff due to the similarity of human actions during both periods.  The book really gives some worthwhile perspective on the era.

I read Den of Thieves the other month and that was fine as well, but if you had to read one book on the subject, I'd opt for Predator's Ball.  Both books are journalistic efforts, but that doesn’t mean an investor can’t learn some interesting stuff.  While Den of Thieves paints the inside story of the crimes behind the fortunes, I found Predator’s Ball to be more relevant to my understanding the events of the time.  Call me crazy, but I wasn't shocked to hear that greed and ethical issues exist in Wall Street or anywhere else for that matter.  While Milken, Boesky, Siegel, and the other characters in Den of Thieves were major players at the time, they are less relevant today.  Predator’s Ball has about 100 pages on Nelson Peltz, Carl Icahn, and Ron Perelman, which I found particularly interesting since they remain relevant to this day and I’ve looked at companies with which they are involved.

Nelson Peltz is particularly relevant today as far as I’m concerned, because he is an activist at businesses I find fundamentally attractive: Heinz, Tiffany’s, Wendy’s, etc.  I wrote about Wendy’s a while back and Peltz plays a key role there.  What was interesting to learn is that Peltz was very much a minor figure at best in the world of finance in the early 1980s.  He had been in business for a few years prior to his Triangle Industries takeovers, but nothing in the public eye.  As Bruck portrays it, Peltz was doubly lucky in fortuitously being offered Triangle by Milken in a situation outlined in the book as well as the subsequent decrease in interest rates, which made the buyout really pay off.  Everyone has to start somewhere.

Has Peltz changed?  I’d say in most ways except one: debt.  One thing that bothered me about Wendy’s was the debt.  Maybe I’m just too dumb to realize that companies can do just fine with a far from modest debt load, but I’d rather play it safe.  Peltz still seems to like it a lot.  This is just speculation, but if you have had the success he had in the 1980s with Triangle and its debt load, you might think that the presence of debt correlates with positive outcomes.

Ron Perelman – still chairman of MFW and REV – was and still is an even bigger fan of debt judging by the current debt loads at the businesses 20 years later.  The book details his takeover of Revlon, which is certainly an interesting tale.  His buccaneering coincided with an attempt to take over Gillette, which opened up the opportunity for Berkshire Hathaway to swoop in with a white knight investment.

Just how much leverage did Peltz use?  When Triangle Industries took over National Can for $465m, Triangle contributed $70m, did a $30m preferred offering, and raised $365m in debt.  That’s kind of nutty.  It gets nuttier!  Since National Can already had $200m in debt, Triangle refinanced that with junk to bring the total debt up to $565m on a strict $70m equity base of $100m broadly defined equity base.  As Peltz reveals though, “We put the hundred million in the sub [the subsidiary, Triangle Acquisition Corporation, formed for the buyout].  But it was all debt!  We called it equity here [at Triangle Acquisition Corporation], but it was debt over here [at Triangle].”  

This is what bothers me about debt.  The “what if I’m wrong” side of the equation.  Clearly Triangle Industries worked out well.  According to Bruck – and I don’t think these are deep analytical insights, I just haven't independently verified this – consumer spending picked up, energy and aluminum prices went down, and glass pricing became positive for the business.  This basically happened in year 1 of the aftermath of the acquisition, so the debt load immediately became more manageable measured by cash flow.  Then they were able to refinance the debt at lower interest rates.  It’s not that debt negates the possibility of positive outcomes, it’s that it increases the possibility that one might not witness them.  

Carl Icahn is still doing the same old stuff.  I like these stories he tells in some comedy routine on YouTube (here and here).  They do as good a job as the book as giving you the gist of what was going on at the time.  I don’t really get intrigued when I see a 13-D by him.  He has made plenty of money, but it’s more difficult for a passive value investor to profit from it.  I would have lost money following him into Clorox.  I remember the other month when he revealed a stake in Oshkosh that it shot up a good amount, but it’s down 30% from that price.  This has nothing to do with Carl, but with people looking to piggyback.  He enters situations with downside protection for him, but not any subsequent investors in the business.  There's gossip that Carl will try to do something with his position in Oshkosh and Navistar, but he could just as well move on to a cheaper situation.  He can just as easily decide to cut his losses and move on if the share price falls as he can decide its worth the effort to push through some changes.  I wouldn’t be in a similar position if he decided to move on, so I’d probably be facing a loss of capital.  

Probably my favorite piece of tangential trivia was a Mitt Romney appearance at the end.  When Drexel was under investigation by the SEC, Bain was doing an LBO of Palais Royal and Bealls, clothing chains in the Southwest.  Drexel was dong the financing for the LBO.  Milton Pollack was the judge for the case the SEC was pursuing and his wife was chairman and a major shareholder in Palais Royal.  Anyways, Mitt called up Drexel to make sure that the deal would still go through since Drexel was asking that the judge step down from the case.  Oh, how the times have changed.

Anyways, if you’re looking to get some historical perspective on financial markets, Predator’s Ball isn’t a bad book to pick up.  Will it directly help with your investment process or result in any ten baggers?  No.  It’s interesting to see how the past decade was not some unique occurrence of Wall Street all of a sudden facilitating transactions solely to generate fees, even though all the discussion about proper incentives at banks would have you think otherwise.  It’s interesting to see how some people were perceived many years ago, while they are now just viewed as smart money based on having billions.  My impression is that a lot of people reference the events of the 1980s based on more recent interpretations of the era, so while it doesn't markedly differ, I'd prefer to get a more in-the-moment representation of the period.  And as a final note of meta thoughts on the book, it’s not a particularly dense book so it’s a nice combination of education and entertainment while on the train or waiting on people, etc.