In a corner office on the 44th floor of Manhattan's General Motors Building, six men are quietly making Wall Street history.
They are doing the deals that other financiers dream about. The payoff is staggering, with compound annual returns in excess of 80 percent on millions of dollars of equity investment.
"The true great stories of Wall Street are very rarely written," said Lew Lehrman, the businessman/politician who is one of the firm's outside investors. "They are often deep within the privacy of the Street itself."
From deep within this privacy emerges the remarkable story of the tiny firm of Forstmann Little & Co., formed in 1978 by brothers Theodore and Nicholas Forstmann, and Wm. Brian Little. Utilizing a powerful financial technique called the leveraged buyout, in which companies including Dr Pepper Co. and Topps Chewing Gum Co. have been acquired using mostly borrowed money, they are amassing a fortune for themselves and their partners.
The talents of the firm's founders are complementary -- Ted Forstmann, 46, concentrates on raising money from pension funds and wealthy individuals; his brother, Nick, 39, specializes in raising capital from the banks; Brian Little, 44, concentrates on analyzing potential deals. The firm's other takeover specialists -- John A. Sprague, 33, Steven B. Klinsky, 29, and Winston W. Hutchins, 28 -- also work in the firm's New York office.
The three founders had significant Wall Street experience doing deals before they joined forces in 1978.
"The key is you have to be selective and you can't do every deal that comes along," Little said, adding that the firm has $600 million from its partners that is waiting to be invested. "We will continue to invest money in quality deals where we can see ourselves making five to 10 times our money in a three- to five-year time period."
Five to 10 times their money in three years? How do they do it?
"They are dispassionate, unemotional and terribly honest," said Derald Ruttenberg, one of the firm's outside partners. "There is an enormous amount of integrity and patience there."
Forstmann Little is a response to an era dominated by giant financial supermarkets that employ thousands of brokers and bankers and offer a vast array of products. This tiny financial boutique, specializing in only one kind of transaction, has significant advantages over most of the giant investment banking firms which also are doing leveraged buyouts.
One key advantage is that Forstmann Little approaches the deals with the mentality of an owner, primarily interested in maximizing financial returns to the firm and its partners as rapidly as possible. In contrast, giant firms, which both advise companies on leveraged buyouts and invest in deals, face a greater conflict of roles which sometimes leads them to do marginal deals primarily so they can generate advisory fees.
Ted Forstmann, a former Yale hockey goaltender, Nick Forstmann, a 1969 graduate of Georgetown University, and Little, a Harvard MBA who left Merrill Lynch because of a desire to work for a smaller firm with potentially greater rewards, have decided to keep the firm small and nimble. They have added only three full-time professionals in New York and one in Los Angeles. Their top talent has all come from the larger investment banks -- Sprague, 33, left Salomon Brothers to join the firm in 1982, and Klinsky, 29, a graduate of Harvard Law and Business Schools, joined the firm in January of 1985 after several years at Goldman, Sachs & Co. Hutchins, 28, a Dartmouth graduate, joined Forstmann Little from the accounting firm of Deloitte, Haskins & Sells.
The firm's newest partner, based in Los Angeles, is Peter C. Jacquith, who came from Lazard Freres & Co.
While Forstmann Little makes money by charging its outside partners management fees, the firm primarily benefits from its share of the equity, or stock, in successful deals. In return for putting successful deals together, Forstmann Little receives 20 percent of the profits that go to its equity partners, including Lehrman, Boesky and Ruttenberg.
When Forstmann Little makes an acquisition, the firm typically receives a fee of about one percent of the purchase price. For example, the pending acquisition of Sybron Corp. for $360 million will generate a fee of about $3.6 million. In addition, the firm charges its outside partners annual management fees ranging between one percent and 1.5 percent of the capital they have committed for future deals. With about $600 million of committed capital on hand, Forstmann Little earns management fees of between $6 million and $9 million a year.
In addition, Forstmann Little collects a smaller percentage fee from its outside partners for the capital already invested in deals. The firm does not collect special fees for selling the companies it acquires, nor does it collect director's fees for serving on boards of acquired companies.
Forstmann Little's latest deal illustrates why none of the outside partners are complaining about fees. On Feb. 20, Forstmann Little announced that it was selling Dr Pepper to Coca-Cola Co. If the deal with Coca-Cola is completed, Forstmann Little and its partners will make 10 times their initial $30 million equity investment, or $300 million, in about two years.
Dr Pepper is the latest in a successful series of leveraged buyouts, in which borrowed funds have been repaid through a combination of cash flow and asset sales. In 1981, Forstmann Little purchased California's Union Ice Co., a large commercial manufacturer of ice. In that deal, the firm and its partners made 15 times their equity investment in three years. They will make four times their money in less than three years once the pending sale of WRGB-TV, Schenectady, N.Y., is completed.
Forstmann Little doubled its money 15 months after buying the soft drink division of Beatrice Cos. Inc. in 1982. The firm's first acquisition -- the $420 million purchase of Hudson, N.C.-based Kincaid Furniture Co. in 1980 -- led to the public sale of stock three and a half years later at 10 times its initial equity investment.
The easiest way to understand how Forstmann Little's leveraged buyouts work is by analyzing the firm's most successful deal, Dr Pepper. Dr Pepper was a publicly held company when Forstmann Little purchased it in February 1984 for $623 million, of which all but $30 million was borrowed. The deal was criticized by Wall Street analysts because the price -- more than 24 times reported earnings -- was considered too high.
Within the first 18 months, Forstmann Little sold nine domestic Dr Pepper bottling plants and excess real estate for $285 million. Dr Pepper's Canada Dry soda business was sold to R. J. Reynolds Industries Inc. for $177 million.
Forstmann Little's remaining investment in Dr Pepper's core business -- the manufacturing of concentrate -- was $200 million. Of that $200 million, $30 million was equity, or stock investment, and $170 million was borrowed money.
Meanwhile, Forstmann Little increased marketing expenditures significantly, one of the factors that helped to increase Dr Pepper's operating profit from $38.9 million in 1983 to $60.6 million in 1985.
Fearful of rival PepsiCo, which recently agreed to buy Seven-Up, Coca-Cola agreed to buy Dr Pepper for $470 million. The $470 million includes repayment of $170 million of debt. That leaves $300 million for Forstmann Little and its partners.
This Forstmann Little deal and the others actually are management buyouts, in which the management of the company buys some of the stock when the company is acquired. Rather than paying management high salaries and bonuses, Forstmann Little's partners, who serve on the board of directors of companies they acquire, motivate managers by giving them the chance to realize significant gains on future sale of stock.
Along with Kohlberg Kravis Roberts & Co., which is acquiring Beatrice for $6.2 billion, Forstmann Little is considered to be one of the premier firms doing leveraged buyouts.
Despite the firm's hefty use of borrowed money in buyouts and the risk that entails, Ted Forstmann insists that he is cautious. His fear of doing a bad deal is one of the reasons for the firm's success.