Forstmann Little & Co.
Forstmann Little & Co.
Forstmann Little & Co.
Sales: $25 million (1998 est.)
NAIC: 52312 Securities Brokerage
Forstmann Little & Co. acquires or invests in highquality, high-growth companies, allotting substantial amounts of its own capital, which is contributed by a small number of pension funds and wealthy individuals who are limited partners in the firm. It is a specialist in the technique known as the leveraged buyout, whereby a company is converted from public to private ownership, mostly by the use of borrowed funds. Between 1978 and 2000 the firm acquired businesses valued in excess of $16 billion. It invested almost $10 billion in 28 acquisitions and investments and delivered compound annual returns of 20 percent on subordinated debt and over 50 percent on equity after carried interest, according to its own analysis.
Leading LBO Player: 1980-86
Nicholas Forstmann was working for the leveraged buyout (LBO) firm Kohlberg Kravis Roberts & Co. (KKR) in 1977 when he suggested to his brother Theodore—who was working for older brother J. Anthony Forstmann’s money-management company—that they form their own LBO firm. William Brian Little, another investment banker, joined them in forming Forstmann Little & Co. the following year, initially employing only one staffer, a secretary. Each founder had his specialty, with a 1987 article describing Nicholas as the numbers cruncher, Little as the dealmaker, and Theodore—the senior partner and dominant personality—as the man who corralled the investors. Their original stake was $400,000 from ten investors. The firm charged a modest management fee ranging from 0.5 to 1.5 percent of the investment and took a standard 20 percent of the profit after completion of the sale of acquired assets. By late 1983 the firm had raised $300 million from 30 limited partners, who consisted of pension funds and wealthy individuals. Pension-fund investors, in early 1987, included AT&T Corp., Boeing Co., Boise Cascade Corp., Eastman Kodak Co., General Electric Co., GTE Corp., and Minnesota Manufacturing and Mining Co.
In a leveraged buyout, a public company is purchased from stockholders by investors who generally put up only ten percent or less of the purchase price. The rest is raised by bank loans or subordinated debt—usually in the form of bond issues—with company assets as collateral. Payment on the debt and profit beyond that often comes from the sale of undervalued corporate assets. Another source of profit may come from taking the company public again. Between 1980 and 1983 Forstmann Little invested a total of $329 million in six companies. All but one were sold by the end of 1986, yielding annual return on equity ranging between 27 and 147 percent. “Inflation was 14 percent, and interest rates were 8 percent,” Ted Forstmann recalled to Dyan Machan of Forbes in 1998. “You made a 6 percent gain just doing a deal.”
Forstmann Little’s first high-profile transaction was its 1984 acquisition of Dr. Pepper Co. for $650 million. Dr. Pepper earned 8.5 times the original amount for its equity investors, according to one estimate. This spectacular gain—in less than three years—was partly due to high prices obtained from the separate sale of the company’s core operation, its bottling plants, the Canada Dry subsidiary, and other assets, including a television station and a specialty textile company. Observers also credited a slash in corporate overhead and an annual 20 percent increase in the marketing budget for an appreciable rise in operating profits between 1984 and the sale of the core operation in 1986. Also in 1984, Forstmann Little purchased The Topps Co., Inc. for $98 million. After recapitalizing the firm and taking it public in 1987, the firm had—by 1990—earned $204 million and still owned 55 percent of the stock, which it sold the following year.
In 1985 Forstmann Little purchased 12 ITT Corp. divisions for $408 million and named the grouping FL Industries Inc. Unencumbered by the bureaucracy and paperwork of a public company, the electrical- and industrial-products firm’s managers—13 of whom received equity stakes—closed several factories, improved customer service, and reduced inventory. When the business was sold in 1992, equity-fund partners profited at a 56 percent annual rate of return. But this gain was minor compared to the profit from the 1986 acquisition of Sybron Corp., a manufacturer of laboratory, dental, and medical products and specialty chemicals, for $335 million. Sold in 1988, this company yielded an annual equity fund return of 270 percent.
Investors took notice, and by the beginning of 1987 Forstmann Little’s buyout fund of $1.4 billion was second only to KKR’s $2 billion. By the end of the year this fund had grown to $2.7 billion.
Eschewing Junk Bonds: 1987-89
Forstmann Little’s philosophy was to work hard at managing, as well as buying, its companies. The managers of the acquired company usually remained, with stakes—generally 20 percent collectively—in the resulting private firm. Forstmann Little general and limited partners supervised their investments by assuming positions on the acquired companies’ boards and, if deemed necessary, pressing for strategic and personnel changes. In making acquisitions, the firm avoided relying on issues of high-yield but risky “junk bonds” to meet its needs for subordinated-debt financing. This put the finances of acquired companies on a sounder basis by reducing the debt load; moreover, the privately placed bonds—unlike junk bonds—did not have to be paid off until the company was sold. Investors in Forstmann Little’s partnership fund for buying the subordinated debt of acquired companies therefore generally had to accept yields below market rate for this kind of investment. But participants in this fund received the option of taking a piece of the 37.5 percent equity stake in each buyout reserved for debt-fund investors on the same terms as the managers and equity-fund partners.
By the end of the 1980s Forstmann Little had acquired six more companies. By far the largest was Lear Siegler, Inc., a diversified manufacturer purchased in 1987 for $2.1 billion. In outbidding its rivals for Lear Siegler, the firm was aided by a temporary drying up of the junk-bond market following the disclosure of an insider trading scandal involving speculator Ivan Boesky. But this did not turn out to be one of the greatest deals for the firm. Forstmann Little eventually had to invest another $1 billion in Lear Siegler. Although it sold more than $1.5 billion of the company’s assets by 1990, the firm was not able to cash in completely until the sale of Safelite Glass Corp.—formerly Lear Siegler’s automotive-glass arm—in 1996. The sale brought in only about $300 million. Safelite filed for bankruptcy protection in 2000.
During the 1980s Forstmann Little claimed to achieve an average compounded annual return of 85 percent for equity-fund partners and 33 percent for subordinated-debt partners on completed transactions, after taking its own profit and fees. “Forstmann Little,” Anthony Bianco of Business Week concluded in 1992, “thrived by paying reasonable prices for mature businesses with steady cash flow and a dominant position in industries less volatile than the economy as a whole.” One observer pointed out, however, that the uncompleted deals at the time (by Forstmann’s definition, a deal could not be considered completed until a company was either sold or taken public) included Lear Siegler and The Pullman Co., another poor-performing acquisition (in 1988) that filed for bankruptcy protection in 1994.
Ted Forstmann had long railed against the issuing of junk bonds to finance leveraged buyouts. In October 1988 the Wall Street Journal published a column in which he blamed junk bonds for “debt that has virtually no chance of being repaid.” His concern was far more than theoretical, for rivals such as KKR and Ronald Perelman’s MacAndrews & Forbes Holdings were outbidding Forstmann Little for lucrative LBO deals by employing junk-bond financing. In the opinion of some observers the senior partner had developed an obsessive desire to outperform—and if not outperform, discredit—Henry Kravis, senior partner of KKR. But it was KKR that captured the prize in the frenzied bidding in late 1988 for RJR Nabisco Inc. In by far the largest LBO deal ever, KKR paid more than $25 billion for the company, thereby saddling it with crushing debt but earning a lot of money for grateful lawyers, investment bankers, and loan officers. The Forstmann Little founders entered the bidding but dropped out after concluding they could not finance a takeover without junk bonds. “[Ted] Forstmann’s antijunk diatribes had painted them into a corner,” was the verdict of the authors of Barbarians at the Gate, the best-selling account of this episode.
LBO activity dropped sharply the following year, in the wake of at least $4 billion of junk-bond defaults and debt moratoriums. For the first time in the decade, Forstmann Little made no acquisitions. The bankruptcy of Drexel Burnham Lambert Inc. in 1990 and conviction of Michael Milken—its junk-bond chief—seemed to vindicate the firm’s position, as did KKR’s problems servicing the huge debt incurred by RJR Nabisco as a result of its buyout. Although Forstmann Little’s investors were not happy to see their money sitting on the sidelines, the firm did not immediately relax its standards. “I still don’t think that winning is doing the deal no matter what,” Ted Forstmann told Bianco in 1992. “Winning is making money for your partners.” Reportedly, he tried to assemble a new equity fund to revive companies ravaged by LBO debt but was rebuffed by prospective investors who felt he did not have the track record for such an undertaking.
- Forstmann Little & Co. is formed.
- The firm makes its first large-scale acquisition, purchasing Dr. Pepper Co.
- The firm buys General Instrument Corp. and Gulf-stream Aerospace Corp. for large sums.
- After turning around Gulfstream, the firm sells $1 billion worth of its stock.
- Forstmann Little owns or has investments in seven companies.
Forstmann Little in the 1990s
By 1991, however, Forstmann Little, fortified by $2.8 billion in its existing funds, had adopted a riskier, more aggressive strategy. The acquisition of General Instrument Corp. for $1.75 billion and (with Allen E. Paulson) of Gulfstream Aerospace Corp. in 1990—a recessionary year—for $850 million involved technology enterprises with growth prospects but the need for major investment in research and technology. “With these companies, clearly there is more volatility in the numbers than we’re used to,” Nicholas Forstmann conceded to Bianco. The firm had so much money in its coffers, however, that it was able to take a conservative approach, financing the acquisitions with less debt and more equity than previously. In fact, the $285 million purchase of Department 56, Inc., a manufacturer and supplier of specialty giftware, in 1992 was made without any bank financing—the first self-financed transaction in the history of leveraged buyouts.
General Instrument, a large manufacturer and supplier of telecommunications equipment, was taken public in 1992 for nearly three times a share what Forstmann Little had paid. By the spring of 1994 the firm’s investors had realized more than $1.6 billion in cash and current stock value for $202 million in equity. To avoid default, Gulfstream had to be recapitalized in 1993 by converting $450 million of subordinated debt to preferred stock, thereby eliminating $38 million in annual interest. Ted Forstmann then assumed chairmanship of the company himself, guiding it to three consecutive years of profit, including a record $47 million in 1996. In that year Gulfstream raised $1 billion from a public offering. Forstmann Little sold its remaining stake in the company for about $1 billion in 2000, bringing its total proceeds from its investment to about $2.8 billion.
Forstmann Little did not make another acquisition until late 1994, when it purchased Thompson Miniwax Holding Corp. for $700 million and 95 percent of Ziff-Davis Publishing Co. for $1.4 billion. It sold its stake in the latter less than a year later for $2.1 billion to Japan’s Softbank Corp. Thompson Miniwax was sold to Sherman-Williams Co. at the end of 1996 for $830 million. In 1996 the firm acquired 97.5 percent of the shares of Community Health Systems, Inc., a for-profit hospital chain, for nearly $1.4 billion. This company made its initial public offering in 2000, selling about one-quarter of the outstanding stock for $243.75 million in gross proceeds.
Forstmann Little did not acquire a company in 1997 and only one—Yankee Candle Co.—in 1998. During this period more than $70 billion was committed by all institutions for leveraged buyouts, but Ted Forstmann thought prices had gone too high. “It’s amateur hour … like the Italian restaurant business in New York,” he told Machan. “The owner was headwaiter at a previous restaurant. That owner was headwaiter at another previous restaurant, etc.” He added, “I don’t do auctions. I would sooner take my pants off in public.… Price is about the fifth thing I consider. You steal the wrong company and you slowly go broke.”
Forstmann Little’s next major commitment, in 1999, was a $1 billion investment for a 12 percent stake in the telephone carrier McLeod USA Inc., which was operating in some 16 states, primarily west of the Mississippi. In 2000 the firm increased its stake in the telecommunications industry by investing $1.25 billion in NEXTLINK Communications, Inc., a national provider of broadband communications services in top 50 markets. NEXTLINK was renamed XO Communications in late 2000.
Forstmann Little’s portfolio in late 2000 consisted of partial or entire ownership of the following seven companies: Capella Education Company; Community Health Systems, Inc.; McLeod USA Inc.; Metiom, Inc.; NEXTLINK Communications, Inc.; Webley Systems, Inc.; and Yankee Candle Company. All these acquisitions or investments had been made since 1996. The firm had seven general partners at the beginning of 1999, when Erskine Bowles, former White House chief of staff, joined the firm. At the same time Forstmann Little became affiliated with Carousel Capital, a private equity firm cofounded by Bowles. Little, who had retired in 1994, died in 2000.
Blackstone Group; DLJ Merchant Banking Partners; Hicks, Muse & Co. Inc.; Kohlberg Kravis Roberts & Co.; Thomas H. Lee Co.
Andrews, Suzanne, “Won’t Someone Please Pay Attention to Teddy Forstmann?” Institutional Investor, February 1993, pp. 27-35.
Bianco, Anthony, “Gulfstream’s Pilot,” Business Week, April 14, 1997, pp. 65-69, 72, 74, 76.
——, “Look Who’s Got the Last Laugh Now,” Business Week, February 10, 1992, pp. 112-14.
Burrough, Bryan, and John Helyar, Barbarians at the Gate, New York: Harper & Row, 1990.
Darby, Rose, “Financial Buyers Return in Big Healthcare Deals,” Investment Dealers’ Digest, December 9, 1996, p. 32.
Forstmann, Theodore, “Violating Our Rules of Prudence,” Wall Street Journal October 25, 1988, p. A26.
Fromson, Brett, “Dealmaker of the Decade,” Washington Post, June 4, 1995, pp. H1, H5.
Henriques, Diana B., “Refilling Forstmann’s War Chest,” New York Times, December 15, 1994, pp. Dl, D7.
Hylton, Richard D., “How KKR Got Beaten at Its Own Game,” Fortune, May 2, 1994, pp. 104-07.
“Investors Loyal to Buyout Firm,” New York Times, January 11, 1991, p. D8.
Machan, Dyan, “A Hero Among Barbarians,” Forbes, July 6, 1998, pp. 132, 134.
Rothman, Andrea, “Ted Forstmann Doesn’t Have to Say ‘I Told You So,’” Business Week, March 5, 1990, pp. 77-78.
Spragins, Ellyn E., “Forstmann Little: Going Fast by Going Slow,” Business Week, January 26, 1987, pp. 76-78.