By his own account, Fred Joseph and his colleagues run the hottest investment game in town -- his town or anyone else's.
Joseph is senior executive vice president of Drexel Burnham Lambert Inc., the Wall Street firm that controls the market in hostile corporate takeovers through the use of junk bonds.
Hostile takeovers aren't new. Neither are junk bonds -- the popular name for the fast-growing category of speculative, high-yield securities that are either unrated or considered below investment grade by the companies that rate debt issues (BB+ or lower, in Standard & Poor's grading).
What is new -- and troubling to some in Congress and Wall Street -- is the synthesis of these two into a new, untested form of corporate takeover. Sen. Pete Domenici (R-N.M.) has proposed legislation to block the use of junk bonds in hostile takeovers for the balance of this year. Domenici, a veteran of the Senate Energy and Natural Resources Committee, has a sympathetic ear to the oil companies that have been the prime targets of junk bond raiders.
Today, Joseph and other Drexel officials find themselves commuting to Washington to try to quell the anxiety in Congress over junk-bond financing. That's understandable. By its foresight and good fortune, Drexel dominates the business.
"We do sit at the switch, which is not uncommon in investment banking," Joseph said in a recent interview. "Investment banking firms sit at all kinds of switches all the time."
" . . . In the takeover business, which is a business guys don't like to fool around in, if you want to raise money you've got two choices.
"You can go to Drexel, who's raised all the money that's been raised through junk bonds . Or you can go to someone else and see if they can do it.
"It's the usual thing of any intermediary -- which is all we are -- if you get credibility with both sides you're going to have some stroke," said Joseph, an affable, shrewd Harvard MBA and Wall Street veteran who will be Drexel's next president.
Drexel, one of the top half-dozen investment firms with $750 million in capital, has stroke.
Many of the institutions buying the junk bonds -- particularly savings and loan institutions -- rely heavily on Drexel to tell them whether the deals are sound or not.
A successful junk bond financing ends up leaving a company more deeply in debt. In the case of hostile takeovers, with heavy bidding pushing up the final price, the increase in debt can be huge.
As Business Week has noted, about $24 billion in outstanding new issue junk bonds -- or 80 percent -- were floated in the past three years, when the economy was growing and interest rates were generally stable or declining. Could these companies issuing these bonds generate enough cash in a recession to meet their debt obligations? Could they remain solvent if interest rates spiked upward again? Drexel's betting they can. There is a lot riding on its judgment.
The first reason not to worry, says Joseph, is that Drexel knows what it's doing. The second reason is that the junk bond-hostile takeover market isn't that big, despite the noise it creates, he says.
The total amount of capital available to finance junk bond takeovers at any one time is no more than $6 billion, he estimates. That's a fraction of the $425 billion in rated bonds and $75 billion in high-yield junk bonds now on the market.
But there are apparently many others who want in on the game. At least 10 other investment firms want to follow Drexel's footsteps, he says. And there are plenty of would-be raiders. "The fact is," Joseph said, "we have turned down at least two dozen deals for each one we've taken on.
"The guys that are calling us with deals are just mind-blowing, and we have, in fact, virtually not taken on a deal from someone who wasn't an existing client or very responsible."
But even if Drexel's judgment is as good as its record thus far indicates, its luck could turn, or other less prudent firms could start making deals.
There is a lot of money that could conceivably chase the high returns paid by junk bonds. "The market is very broad. As a practical matter, almost every casualty company, half of the life companies, almost every big money manager, almost every big bank trust department, the mutual funds, pension funds through their advisers, all are active players in the high-yield market."
"Junk bonds used in leveraged takeovers are being sold to people who shouldn't buy them -- like S&Ls," said Nicholas F. Brady, chairman of the investment banking firm Dillon, Read, which represents Unocal. "If somebody is going to be the guardian angel to be sure all the S&Ls have a diversified portfolio, that's fine. But the ones that are the most desperate will buy the highest yielding junk bonds."
It's true that restricting the use of junk bonds in hostile takeovers would limit the ability of raiders like Pickens to force corporate management to do right by its shareholders. But it would not prevent takeovers.
A cooling-off period would provide time to measure the longer-term implications of the junk bond-hostile takeover phenomena. That is something Joseph and Drexel don't have a solid answer on: "I don't know and I don't think I can really begin to tell you whether, long term, it does or doesn't hurt."