Do You Sincerely Want To Be Rich? (39 page)

the passage of time, fund managers' appetite for letter stock grew, because it became harder to get swift gains out of orthodox stocks. The market of the latter Sixties was mostly high, but not easy. Having soared almost without interruption out of the pit of 1962, the Dow Jones average index reached the magic 1,000 at the beginning of 1966. But then it sagged, and took nearly three years to climb precariously back to 1,000. The Dow Jones, of course, is only the average of thirty valuable but orthodox securities quoted on the New York Stock Exchange, and no doubt David Meid was right to say that it can be outpaced in terms of capital gains - but which were the securities with which to do it?

    If there was one process that kept the market and the hot managers alive during that time, it was the wheeling and dealing, the tender offers, the mergers and battles of the conglomerates. Again, this was something into which IOS was drawn: partly because many of the smaller conglomerates liked to raise money by letter stock, but for other reasons as well. As in most things the IOS people did, the hectic pace of their operations helped to enlarge the limits of the possible, or anyway of the apparently possible.

    The original justification of the conglomerate idea was that a corporation with striking financial and managerial expertise should deploy it in many different markets by acquiring numerous subsidiaries. Such expertise, it was said, could be applied equally to building typewriters, managing real estate or selling life insurance: this was the concept of 'synergy' and the belief that a properly constructed whole would add up to more than the sum of the parts. No doubt it had some validity, but the idea of buying other companies that would fit into a complementary but diversified group degenerated rapidly. If Resorts International had actually taken over Pan Am, there would have been more 'industrial logic' in it than in many a conglomerate deal.

    The process developed to a point where any company with a high quoted share price could takeover one with a lower price: it merely purchased a controlling segment of the victim's stock by offering its own, more expensive stock in exchange. And the price of the conglomerate's shares was in turn maintained by the very rapidity of the growth it achieved through such manoeuvres. Of course, it was part of the proposition that the companies taken over should be reorganized to achieve bigger profits, thus increasing the profitability of the whole. But in the rush of events, it was often hard to see whether that was happening. A good many conglomerators talked freely about 'computerized decision-making', 'concentricity of interest' and 'project redeployment of assets'. Many people found their explanations of these terms as incomprehensible as their balance sheets. Existing accounting systems, according to Jimmy Ling of Ling-Temco-Vought were inadequate to reflect what the conglomerates were about. 'As for those who can't keep up with our changing financial structure,' he said, 'well, that's their problem.'

    The vital role of the conglomerate's quoted share price explains the penchant for unregistered securities when the need arose to find cash (and although shares could be used as a kind of 'funny money', cash was eventually required if only in order to pay the bills). Tremendous efforts were made to augment the company's leverage - to restrict as tightly as possible the supply of public common stock with a right to share in the increased profits of the great expansion being engineered. To this end, huge bank lonas were raised, and important executives spent their time hurrying from one bank to another, continually arranging new loans to pay off the last lot. And where the smaller conglomerates resorted to unregistered share placements, the big conglomerates raised cash through fixed-interest debt securities, selling many elaborate breeds of bonds, debentures and notes. These usually carried, like Sam Clapp's notes from Mary Carter Paint, rights to be converted into common stock at various rates and various times. Thus some compromise was made; new investors were granted the hope of eventual equity participation, while the first men in continued to enjoy leverage.

    In this climate, it was the less conventional brokers and investment bankers who flourished: those who were prepared to stick their necks out that little bit further to help some cash-hungry conglomerate place an issue of bonds that would enable it to maintain its necessary momentum. The shrewdest and quietest of them all was Charlie Allen, a former Wall Street broker's runner who started Allen & Co. in 1922. Allen's ability to back the right share at the right time was, and is, legendary. He backed Syntex, the contraceptive-pill firm, right from the start, and he made a fortune out of the Bahamas development operation, Grand Bahama Port Authority (also favoured by the IOS funds). But Allen, though unconventional, approached the market as a surefooted veteran of 1929, and he came through the collapse in better shape than many members of the financial Establishment.

    Not all of those who tried to emulate him were as surefooted: the most spectacular case was, perhaps, Burt Kleiner of Los Angeles. Kleiner was a friend of Barry Sterling, the Los Angeles lawyer who headed the IOS investment banking division. Barry Sterling's wife had been a limited partner in Kleiner Bell for some three years until the end of 1965. Kleiner did business with IOS. But it must be said that Kleiner knew, and did business with, almost everyone: he was the personification of the conglomerate market. Until his firm, Kleiner Bell, went bust in 1970 it popped up somewhere in almost every deal the conglomerates wove, taking a finder's fee here, shifting a block of shares there. It was Burt Kleiner who performed one of the classic fast-food deals: he floated Minnie Pearl Chickens which changed its name to Performance Systems and was bought by National General, the Los Angeles conglomerate-and-film-distributor. He was known as a man of powerful enthusiasms. 'That's beautiful, that's fantastic,' he was once heard to say down the phone. 'Listen, I can fly there without the airplane on that sort of situation.'

    Forces more powerful than Kleiner's links with Sterling brought the big conglomerates to IOS. In latter 1968, Washington began to grow unhappy about the ease with which fast talking financiers could raise millions of dollars to swallow up important pieces of the US economy. The Federal Reserve Bank put out a special request to the banks, asking them to stop making loans to finance takeovers. And the effect of the restriction intensified in 1969, as credit was tightened further in an attempt to moderate inflation.

    The conglomerates, along with many other us concerns, began to look to Europe for money. There they found bankers who were delighted to purchase the convertible debt securities of American conglomerates, and for another nine months the spree continued. 'Some of this was junk so bad you couldn't even sell it here,' said one of IOS's New York money managers, evaluating the conglomerate paper that was still received eagerly in Europe at the very end of the boom.

    Washington's regulatory effort was frustrated by the fact that years of deficit in the us balance of payments had built up a huge pool of dollars outside America. Its total size was uncertain: some estimates put it as high as fifty billion dollars. What was certain was that IOS was the biggest fish in that pool. And when, at the end of the conglomerate invasion of Europe, the real 'junk' came along, IOS was still showing an almost undiminished appetite.

    Jimmy Ling first needed to raise money in Europe during 1966, when his company was in electrical contracting, electronics, hi-fi equipment, missiles and aerospace, telecommunications cables, meat packing, sporting goods and pharmaceuticals. His New York bankers introduced him to Rothschilds in London. Ling next needed cheap finance in 1968, when Ling-Temco-Vought had added insurance, real estate, car rentals, airways and steel to its interests - or potential interests. Again his bankers called Rothschilds. A tour was quickly arranged. 'In a period of one week, flying from London to Geneva to Zurich, Milan, Frankfurt, and Paris, we were able to place approximately $60 million in twenty-year convertible debentures at one hell of a rate, 5 % - exactly the opposite of the high rate, tight-money situation in the us,' Ling told Fortune magazine later.

    The Fund of Funds bought $1.5 million of that Ling-Temco-Vought convertible, and IIT bought $5 million.

    If Marshall McLuhan's concept of the 'global village' can be applied anywhere, it must be applied to the great conglomerators and their friends and business associates. Sometimes, it seemed that the whole vast world of American business had shrunk to three dozen men on first name terms who spent their time getting in and out of executive jets in Los Angeles, Denver, Dallas, Mexico City, New York, the Bahamas, and Geneva, with occasional detours to Chicago, London, Zurich or Montreal. Although Cowett and Cornfeld were never especially close to Ling, the head of one of Ling's important subsidiaries, Harding Lawrence of Braniff Airways, was on the board of King Resources of Denver, which was so close to IOS that it was almost the same empire. Bernie himself ventured into the real estate business with Troy Post, the Dallas millionaire who held a big piece of Ling-Temco-Vought stock and who briefly succeeded Ling when Ling was ousted from control. Post's company had a project for a club in Acapulco, to be called Tres Vidas, and reserved for the use of leading American business men: Cornfeld was enthusiastic for the IOS real estate fund, Investment Properties International, to put $30 million into this project. By the time IOS ran into trouble $5 million of this had been paid over and its repayment was subsequently disputed.

    And the IOS men were even closer to the second most famous conglomerate empire, Charles Bluhdorn's Gulf and Western Industries. Bluhdorn, as well as Ling, went looking for big money in Europe in 1968 - to finance digestion, rather than further acquisition - and managed to raise $40 million by private placements of debt stock. The Fund of Funds took up a whacking $29 million of that, which was FOF's

investment policy in terms of inside information and special situations. Ed Cowett's idea about Famous Players was a case in point.

    Gulf and Western owned Paramount, the film company, which in turn controlled a company in Canada called Famous Players, which had cinemas and a cable-tv business. In 1967, IIT acquired $2.35 million worth of Famous Player shares, but in 1968 they were sold off by Jo Melse, the Dutchman who ran the Canadian and non-US section of IIT. Then in 1969, Melse came back from a holiday to find that a new block of Famous Players, bought on Cowett's instructions, had appeared in the IIT portfolio at a cost of $2.75 million.

    Cowett's rationale was that Famous Players had a 'hidden asset', whose potential you could only assess if you had been shown, as he had, the list of cinema sites that Famous Players owned, and which were juicy prospects for redevelopment. On the strength of the list, Cowett had elaborated a plan in which IOS funds would buy Famous Players shares, while the IOS banks would put up money to develop the properties, IOS would reap the investment banking returns, and the funds would benefit from the rocketing values of Famous Players shares. After furious objections from Melse, who was not a performance theorist, the Famous Players shares were transferred to ipi, the property fund.

    Melse's protests were justified when the great scheme sprang a fatal leak, as such schemes often do. Famous Players was also a tv company, and the Canadian Government refused to have it remodelled by a us conglomerate.

    Sometimes the chieftains of IOS pulled better deals out of the conglomerate whirl - as when Cornfeld caused the purchase of a block of Piper Aircraft shares. This was not a sentimental tribute to their role in Fred Borlin's successful escape from Brazil: it was because Cornfeld heard a whisper that a takeover battle for Piper was impending. Sure enough, there was a bid from Chris Craft, the power boat firm, followed by another from the richly named conglomerate Bangor Punta. This turned into one of the bitterest of all takeover battles, which reached a climax when Cornfeld flew dramatically to a meeting in Nassau and gave Bangor Punta the victory by selling them the block of Piper shares he controlled.

    With American companies looking to Europe for cash, conditions were ripe for the development of the ambition set out in 1961, when the infant IOS had described itself boldly as, among other things, 'investment banker'. Raising $35,000 to back the film Snobs was, in theory, the same transaction as the established investment banks perform in raising finance for industrial corporations. But it was a very small scale model.

    Now, with two billion dollars of their customers' money behind them, and with a great hunger for money among the fastest moving captains of American industry, Cornfeld and Cowett could assume something of the power and glamour attaching to the great investment banking houses of Wall Street and Europe. Indeed, with the power of IIT, FOF and the smaller funds, they possessed an advantage over concerns like Kuhn, Loeb & Co or Baring's or Wertheim.

    Normally, even the richest of investment banks do not control the large scale finance that they raise. They will use their own money when promoting a new company until it can be floated on the stock market. But when they help a big corporation to raise money, they become salesmen, although admittedly of a rarefied description. The classic mechanism is that in which the corporation offers its securities, debt or equity for sale in an issue which is underwritten by the investment bankers. Their underwriters' endorsement of the securities
¹
attracts cash from the insurance funds, pension funds, mutual funds and private investors. If the issue of securities is fully taken up, the underwriters profit by their commission on the value of securities sold. If it is unattractive, they are penalized by having to make up the deficiency with their own money. Just as the underwriters' power to attract cash depends upon their reputation

    
¹
There is a difference between New York and London practice. In London, the underwriters actually undertake to buy all the securities in an issue not subscribed for by the public. In New York, the underwriters normally make sure that all the shares are bought before the offer is made public. In each case, the essential point is that the underwriters' responsibility is financially enforced.

    for backing sound propositions in the past, so the theory collapses if the underwriters actually control large slabs of other people's money, which can ensure the success of otherwise unsound underwritings.

    Investors Overseas Services was both mutual fund manager
and
investment banker. Large quantities of the securities whose issue was underwritten by the Investors Overseas Bank and the Investors Bank were taken up by IOS funds. Indeed, the banks' main function seemed to be to pick discounts, underwriting fees and commissions off securities on their way into the funds' investment portfolios, IOS itself bore little risk, and stood to suffer no obvious short term penalties if its underwritings were poorly selected. In the end, its banks promoted, and sold to the IOS funds, an unrivalled succession of dud issues. Collapses in the value of such paper contributed some $200 million to the depreciation of the IOS funds in 1970.

    The structure of IOS thus avoided the insulation which American securities law
¹
places between the investment banking business and the managements of mutual funds. The history of IOS investment banking suggests that the insulation is a valuable one.

    

    The first steps for an American company wishing to exploit the foreign dollar pool was usually to form a finance subsidiary in the Netherlands Antilles. (Forming such subsidiaries, which help to minimize tax, is a useful trade for a small group of lawyers in Curacao.) Then a bank, or perhaps a small group of banks, is found to manage a 'public' issue of the securities of the Netherlands Antilles corporation, whose liabilities are normally guaranteed by the American parent. A prospectus is drawn up, describing the affairs of the parent company and the nature of the securities being offered, together with some account of the rationale for the raising of new capital.

    

    
¹
The point has been made to us - by IOS men - that British merchant banks both run investment trusts and underwrite issues, and that British law does not forbid this. But the Prevention of Fraud (Investments) Act 1958 does place ultimate control over the investments of a unit trust in the hands of an independent trustee with statutory duties. In a different way, therefore, investors
are
protected against what IOS was doing with impunity offshore.

    

    Having arranged for the securities to be quoted on some European exchange, often Luxembourg or Amsterdam, the managers would invite bankers and brokers in general to take up blocks for resale to clients.

    An alternative procedure is for the managing bank to place the securities privately. This dispenses with the need for a prospectus and means that the manager only had to find a few large investors who will take the securities on the strength of rather less formal explanations. IOS banks, acting on behalf of the funds, participated in many issues and private placements by other banks. They also managed three public issues themselves, and arranged a number of private placements.

    IOS took up very large slices of most American issues in Europe: nearly all of these investments subsequently had to be written down to little more than a tenth of their cost. Two companies backed by Charlie Allen, ambac International and Liberty Equities, were among them. 10s bought a lot of securities in Liquidonics, which distinguished itself and enraged some congressm