Three deals put Messrs Perella and Wasserstein on the map: in 1980 they defended Pullman from Ray McDermott & Co’s hostile bid and persuaded Wheelabrator-Fry (one third the size of Pullman) to act as a white knight;in 1981 they advised Dupont, a long-standing Morgan Stanley client, on its acquisition of Conoco for $7.8bn, then the biggest takeover of all time (for which First Boston was paid about $14m); and when Seagram attempted a hostile takeover of St Joe Minerals, the duo found a white knight in Fluor Corporation.
“These three deals made our name, and each of them was put into play by a hostile offer. That’s why I’ll always say thank you to Seagram,” says Mr Perella.
He is a man shrouded in mythology. One story goes that to encourage the Pullman board to make a decision, he rolled a dice; when it came up five, he said: “Guess it’s Wheelabrator-Fry, then.” Mr Perella laughs as he denies this, saying that he did not mess around with these people. “Roll the dice in a board meeting? You’ve got to be kidding. These were my clients.”
So, no scary shark pictures on the wall? “I’m afraid not.” Did you do back-exercises on the boardroom table in the middle of a meeting? “No.”
Even if the myths are not true – which is a little disappointing – he seems to have been in the middle of most of the groundbreaking, nail-biting, industry-transforming deals of the past 30 years. The sort of deals where protagonists sat up all night, holding conferences, negotiating terms, sweating out details, trying to outmanoeuvre the competition. Were the 1980s as cut-throat as they are portrayed?
“Some people thought about fees first and clients later; some people still do, but not many. There was a lot of tough competition, you had to have watertight strategies. Ultimately, this business has to be built on trust. What’s the point in undermining a relationship you’ve worked so hard to build?” says Mr Perella.
He also denies that the 1980s were all about pumping up purchase prices. “Look, CEOs are smart people. I’ve never told a CEO what to do. I showed them options, valuations, a model, and their CFO interpreted our work. And it’s not like we put anyone in the dock and drugged them into paying too much for a company,” he says, smiling broadly.
“Now, did some CEOs get caught up in the chase for an asset? Maybe. But if a deal failed, it was not because a company overpaid by 5% or 10%. It was because of a failed concept or failed execution.”
There are still a lot of opportunities in M&A, maybe even some new ones. Mr Perella says that the Sarbannes-Oxley Act has increased the pressure on boards to make decisions on the broadest possible range of advice and that the fear of potential conflicts of interest within larger firms has opened new doors for smaller firms. “More than 25% of deals are executed with co-advisers now. In the early days, that was very rare.”
Of the array of creative financing techniques that came of age in the 1980s, one that emerged from that tumultuous decade with its reputation intact is asset securitisation. Walid Chammah is in no doubt that those early transactions changed the financial landscape forever. Now head of investment banking at Morgan Stanley, Mr Chammah worked his way up through the asset finance and structured finance business at Credit Suisse First Boston in the 1980s, before becoming MD in charge of debt capital markets for the firm.
“Securitisation left a huge legacy,” he says. “No other product has had such an important impact on the management of balance sheets. It made banks more efficient and helped develop consumer finance. It also led to the development of the CDO [collateralised debt obligations] market and, in some cases, it changed the funding of M&A.”
Paving the way
Mr Chammah says that from the moment in 1977 when Lewis Ranieri at Salomon Brothers and Credit Suisse First Boston’s Larry Fink together helped to create mortgage-backed securities, the way was paved to securitise virtually any type of business and consumer receivables. In the process, they created the template for cutting costs on everything from credit cards to third world debt. “Asset-backed securities [ABS] were born from their mortgage businesses. These guys laid down the floor that ABS people could later walk on,” says Mr Chammah.
In the early days of creating a new marketplace, bankers were making up the rules as they went along. Mr Chammah says that the first ABS transactions were private placements between thrifts and credit union companies; they were bespoke deals worked out on the back of an envelope. “They had no rating. We simply worked out the structure and brought sellers and investors together,” he says.
In early 1985, two deals opened the public market. It is a moot point which came first. Some say it was Marine Midland’s $60m auto receivables, executed by Salomon. Others say it was Sperry Lease Finance Corporation, a special-purpose vehicle set up by Sperry Corporation (now Unisys). Sperry, in a deal managed and structured by CSFB, sold institutional investors $192.4m in fixed-rate notes backed by computer leases. It was the first time that a structure enabled securities to get a significantly higher rating than that of the issuing company, and it helped Sperry to overcome growing market resistance to its conventional debt, which was hindering the company’s efforts to lease new equipment.
Mr Chammah believes that another important early ABS milestone came in October 1986, when GMAC issued $4bn in notes backed by automobile loans. “This was the biggest deal done to that point and received coverage on all the major news networks – ABC, NBC, CBS. As a result, an ABS deal for the first time became known on main street.”
Exciting times
Mr Chammah says that some of the ABS industry’s most exciting times were in the late 1980s. The market was dominated by a few guys at a few firms. And CSFB was at the top of its game: until the early 1990s, if anyone needed a deal doing, there was only one phone number to have. To develop the market, CSFB was prepared to take deals onto the balance sheet and sell them over time. At one point, CSFB commanded more than 80% of the ABS market.
“There were no cookie-cutter deals then,” says Mr Chammah. “Each one was like pulling teeth. It was still a new asset class and we had to work with the rating agencies about each transaction. We were creating a new legal structure; tapping a new investor base.”
Outsiders found it hard to believe the potential for the growth of the ABS market, which this year is valued at more than $4800bn. “In the late 1980s or early 1990s when we predicted that the market would reach $100bn, people looked at us as if we were mad. Look at it now.”
| PRINCIPAL&FINANCE SECURITISATION: GUY HANDS |
Guy Hands was a bond trader at Goldman Sachs during the heyday of bond trading. A time of unlimited expense accounts and getting up in the night to trade with the Far East. Then it all ended. In 1987, the stock market crashed, the US savings and loans crashed, Japan hit the wall and the bond markets got technical.
“All the great characters I’d learnt from, who could smell a buyer or a seller at 20 paces, found that traders now used the kind of complicated quants that would make a MIT graduate blush,” says Mr Hands. “I had a choice: become a nerd or find something as exciting and rewarding as bond trading had been.”
That something was securitisation. For the next six years, Mr Hands and a four-man Goldman team considered any cashflow that was “curious and strange”. They securitised shopping malls and mobile home parks in the US, and bankrupt property deals in the UK.
In 1994 the team tried – and failed – to persuade Goldman Sachs to establish a business that allowed them to invest the bank’s own balance sheet. Mr Hands looked for another partner.
Thus was Nomura’s legendary Principal Finance Group born, with £1bn of the bank’s money behind it. It changed the industry’s perception of what assets could be securitised and made the bank, and Mr Hands, a lot of money.
Groundbreaking deals
In 1996, the group’s purchase of Angel Trains was the first use of securitisation in a government privatisation. In the same year, its securitisation of equipment leases to buy AT&T Capital was the first ever management buyout to be financed by securitisation. In 1997, in what was then the largest securitisation ever seen in Europe, it became the first private sector borrower to issue 25-year, zero coupon bonds when it bought a property portfolio from the UK’s Ministry of Defence (MoD).
The inaugural transaction of Nomura Principal Finance (NPF) – the first such unit at an investment bank – was 1995’s Phoenix Inns, in which it bought 1800 UK pubs from Grand Met. The aim was simple: it would move the decision-making from the national level to the publican, and switch the risk from the national level to the local level. Effectively, the chain went from being managed to being tenanted.
“The economics were blindingly simple: you received almost the same income from the tenant as when the pub was managed, but your risk was vastly less,” says Mr Hands. “You moved from an equity requirement of 15% to a debt requirement of nearer to 8%.”
The inspiration for the first ever pub franchise securitisation had come while tramping round a Phoenix trailer park, wearing a woollen suit in 110 degrees. Mr Hands suddenly realised that if you could break down a mobile home business into equity and debt, then you could do it with pubs. “In the cold light of a UK morning, the figures still held up. We effectively doubled our equity on the Phoenix Inns deal within two years.”
The profits angle
Angel Trains, the next transaction, brought home to other firms the sort of profits that could be made. About 110 companies had considered this privatisation of rolling stock, valuing the company on an equity basis. Nomura, however, looked at the cash flows and split them into contractual government and railway operating company cash flows, and non-contractual cash flows, then applied different capital costs to each one.
Such a valuation enabled Nomura to outbid other offers by £150m, and led to one newspaper headline calling Mr Hands “barking mad”. When that sum had been recouped within three months and the firm had earned £400m profit on its equity, the headlines changed. “It went from barking mad to the great train robbery in a matter of months,” says Mr Hands. Other firms had, however, taken note: by the end of the 1997, there were 35 banks competing in the principal finance field.
When Mr Hands bought a property portfolio from the MoD, creating Annington Homes, he again took a different approach from those of other bidders. The original plan was to knock down the old army accommodation and build luxury, executive homes. Mr Hands did not believe that executives would want to live next door to an army camp. Instead, he saw cheap housing: good, three-bedroom homes for £30,000 a-piece.
“My plan was to tidy them up, landscape the gardens, but spend as little as possible. Then we devised a mortgage offer with a mortgage provider and helped young couples to buy their own homes with only a £99 deposit. We had people queuing in tents for over three months waiting for the first site. We have sold about 10,000 homes since.”
Mr Hands’ seemingly disparate deals are linked by a few core elements. All of them had valuable assets, but management were trying to do too much or be too complex. He wanted to simplify the story and put in management who would focus on what the company did best. “For example, what sense is there in deciding centrally what products each pub should sell; who knows better than the landlord? Angel Trains originally wanted to design ‘clean’ trains. That’s a lovely idea but not what they did best or most profitably. I’ve learned that anytime I try to be too clever, I’m pulled back to earth pretty quickly.”
Mr Hands, whose company, Terra Firma, is focused on the opportunities in Germany, is proud of his past deals and pleased with whatever role he may have played in “de-equitising” the world. “You can take out 90% of equity and replace it with debt: its cheaper, more available and very liquid.”
While he is a staunch supporter of debt in the capital structure, Mr Hands does admit to worrying about there currently being too much leverage. “I think that the levels in some deals seem quite dangerous. We just have to hope that it is spread throughout the system. I would hate to think that securitisation technology, which has done so much good, could negatively affect the stability of the markets.”
| DERIVATIVES: ANSHU JAIN |
Anshu Jain admits that he is evangelical about derivatives. His career has been spent championing their benefits and he leads the most powerful fixed income and derivatives franchise in Europe. “Derivatives can transform a business and a market,” he says.
According to Mr Jain, head of global markets at Deutsche Bank, derivatives have made three crucial contributions to the financial markets. First, they have broadened market access. “Derivatives, such as index products, allow the little guy to have the same market access as the big guy.”
Second, they have contributed to the depth and liquidity of the markets overall. He says that as each market has opened up to derivatives, it has generated eight or 10 times higher trading volumes in the surrogate market than in the underlying, often transforming it in the process. “Until we had futures, the cash bond markets had wide spreads and prices were invisible; now they are deep, transparent, liquid markets, where price discovery happens in seconds.”
Third and most importantly, derivatives help firms to shed the “unwanted consequences” of other activities, says Mr Jain. For example, South African firm Sasol, on whose board he sits, manufactures synthetic fuels from coal. In the process, it ends up with currency and oil market exposures. “Derivatives give companies a tool with the precision of a surgical scalpel to shape or shed such unwanted consequences,” he says.
That is why he believes that derivatives are the most significant development of the past 30 years. “We went through a credit crisis of fairly big proportions in 2002, and again earlier this year in the auto sector, and yet no banks went down.”
Transformation
In support of derivatives’ transformational benefits, Mr Jain says there is no need to look further than Deutsche Bank itself, which has been remodelled and reshaped using derivative products. For example, Deutsche had a private equity portfolio that the bank no longer wanted. “For the first time, securitisation technology was applied to private equity to help us slice and dice and shed that exposure,” he says. In another area of the bank, Deutsche reconfigured its risk profile by using default swap technology to price every bit of the bank’s exposure to bad loans; “and then we used derivatives to hedge it,” says Mr Jain.
The impact of derivatives on markets and their acceptance has been speeding up with each new product. It now takes about one third of the time it took when financial derivatives were first introduced in the 1970s. “It was about 10-15 years before the interest rate swap market became established. In contrast, it took only about five years for the default swap market to become really liquid,” says Mr Jain.
And firms have no choice but to “embrace” that pace of development, he says. Banks have a stark choice. “Either you rent out your infrastructure, your muscle and your capital, or you leverage your knowledge. The first is a science, the second is an art.”
Mr Jain believes that Deutsche is an exponent of the latter. “It’s how we have transformed Deutsche Bank. And it is the best model because it puts up the highest barriers to entry and offers the best return on equity.”
Egalitarian attraction
From his first days in the markets, when he joined Kidder, Peabody in 1985, Mr Jain knew that his future lay in fixed income and derivatives and was never attracted by the glamour of M&A, he says. “I was told that fixed income was dead; that the market was antediluvian. In the 1980s, people were still selling bonds on price, not on yield to maturity. Everyone else was going to M&A but the mathematical basis of fixed income really appealed to me. It was egalitarian. You did well because you were good, no other reason.”
There is an old joke: what’s the difference between a bond and a fixed income guy? Bonds mature. And yet the fixed income guys keep coming up with innovative and helpful products, laughs Mr Jain.
And 70% of that innovation comes from responding to a client problem. “In the same way that we came up with 40-year retail price index-linked assets to solve complex asset-liability mismatches, or used option replication technology to create retail products, we are coming up with new products that no-one today can anticipate,” says Mr Jain.
He has little time for those critics who carp on about the danger of derivatives. He says that any logical person can be in no doubt that derivatives have smoothed the running of the markets. “Given the choice between concentrated and distributed risk, which would you prefer? I’m not saying there won’t ever be a blow up; there may be. But people who don’t understand that they give you the opportunity to alter the very DNA of a company don’t appreciate the potential of modern finance.”