Return Of The Buyout Kings

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Forstmann and others hope to acquire more companies now that values have tumbled. "It's still not easy," cautions Joe Rice, managing partner at LBO firm Clayton Dubilier & Rice. "In some cases you can offer double what a stock is trading at, but that's still half where it was a year ago--and the company says no thanks." After spending $1 billion on three overseas companies in the past 18 months, Rice says he's eager to hunt in the U.S. again.

The biggest values are in what are known as deep cyclicals--paper, chemical and metals companies. Those don't usually make good takeover candidates for anyone but a strategic buyer looking to get bigger or fill out a business need. lbo firms and other "financial buyers" prefer recession-resistant businesses whose stable incomes securely cover the large interest expense incurred in a buyout. Such buyers now say they see values in the food, energy and utilities industries.

So where will the sharks strike? Struggling whales such as Xerox, Polaroid and AT&T are vulnerable; so are Perelman's Revlon, and Chiquita Brands (40% owned by onetime raider Carl Lindner)--all in vicious down cycles.

Irwin Jacobs, whose '80s buyout/bust-up raids on AMF, Kaiser Steel and Enron, among others, helped win him the nickname "Irv the Liquidator," has changed his style and gone back to work in this new climate. Last year he bought nearly 5% of the all-but-dead insurer Conseco--some 16 million shares, at about $7 each. Jacobs helped install former GE star Gary Wendt as CEO, and with Conseco now trading at $16, he has a paper profit of $144 million.

The buyout game is more complicated today. The typical LBO has three layers of financing--equity (put up by the buyer), senior debt (borrowed from a bank), and junior debt, or junk bonds (most often provided by junk-bond mutual funds). Banks are reluctant to lend for speculative buyouts with the economy slowing, though the Fed's rate cuts are easing that condition.

The mathematics of obtaining capital has been the single biggest obstacle to the raiders' staging a full-fledged return, says Howard Marks, chairman of Oaktree Capital Management. "Buyout firms were able to purchase venerable U.S. icons in the '80s because they could borrow 20 times their money," he notes. (Remember those "highly confident" letters, as in, "I'm highly confident I can borrow the money to take over your company, bub," that Milken and pals used so effectively to terrorize CEOs?) "If you wanted to buy a company for $10 billion, you could probably do it on $400 million in equity. You can't do that anymore. Today you get maybe 3 1/2 times your equity investment--not 20 times."

Leverage--popularized in the '80s as OPM (other people's money)--is what makes LBOs work. Think of it like this: You buy a house for $200,000 with 20% down, or $40,000. Say you later sell the house for $400,000. Your profit is $200,000 on a $40,000 investment. That's a fivefold return on a property that merely doubled in value. Now imagine the math if you put down only 5%, which is how raiders did it in the '80s.

There have been other impediments to raider activity. Better management, for instance. Gone is the widespread corporate fat that marked the '80s. Two decades of shareholder activism and a hotly competitive global economy in the '90s have led ceos to trim fat without prodding.

Besides, today "most LBO funds won't engage in hostile activity," says Greg Polle, who co-heads the mergers-and-acquisitions department at Salomon Smith Barney. "They spend more time trying to have good relations with boards so they will be viewed as a warm and friendly place."

Warm and friendly dealmakers. These are indeed very different times. But with capital getting easier to find and plenty of stocks still down, buyout kings may find that even the Ramones can still make sweet music.