Dan Grossman, Esq., has been Victor Niederhoffer's business partner for four decades.
Write to us at: (address is not clickable)
(Photo: Vic and Dan at the former Jay Gould estate, Lyndhurst, N.Y., Sept. 2005)
Copyright © 2003 Daniel V. Grossman
How to Buy Companies
I have been working on a book about my acquisitions and other business deals and, as in the attached chapter, some deals of others that I have liked. My general theme is how an ordinary guy, without sizable capital or the backing of a well-known financial institution, can accomplish deals with large public companies. While I think the individual chapters tell interesting stories, it is unclear to me what the overall market for such a book would be. Who exactly would pluck down his or her money for a book with such a title or theme? Perhaps readers of Victor’s and Laurel’s Daily Speculations website will have some ideas along this line. Also, since each chapter is a working draft, I would be grateful for any comments from readers on ways to add to or improve the chapter. Many thanks -- Dan Grossman <dvgman [@] gmail.com>
A Deal I Wish I’d Done
What was the best deal ever? When magazine articles ask this question, they usually cite such historic deals as the purchase of the Louisiana Territory from France, or the purchase of Alaska from Russia.
Viewed as purely a real estate transaction, it is hard to argue against the 1803 purchase of the Louisiana Territory as history’s greatest deal. For a purchase price of $15,000,000, consisting of $11,250,000 in cash and $3,750,000 in assumption of claims of American citizens against France (whatever exactly that means), the United States acquired the entire area from the Mississippi River to the Rocky Mountains, a total of 600,000,000 square acres. The transaction doubled the size of the U.S., and instantly made it one of the largest nations in the world. Thirteen large and prosperous states were eventually carved from this purchased territory.
But is it fair to put a rearrangement of the globe negotiated between sovereign nations in the same category as a business deal that you or I could conceivably do (assuming the financing could be arranged)? I think not, for reasons as obvious as noting the negotiators on each side: Napoleon and Tallyrand for the French, and Jefferson and Monroe for the Americans. If President John Kennedy was correct in his welcome to a gathering of Nobel prize-winners – that they represented the greatest collection of intellectual talent at the White House since Thomas Jefferson dined alone – then the combined abilities of the Louisiana Purchase negotiators probably exceeded by a substantial margin that of the Business Roundtable or any collection of business dealmakers you wish to name.
Even assuming business dealmakers of the caliber of Jefferson and Napoleon, they are at a considerable disadvantage to national leaders in that they do not possess the powers of great armies and populations available to governments. Surely this was a major factor influencing the Louisiana Purchase negotiations. The Louisiana Territory was too far from France and too indefensible by it on a long-term basis in the face of an expansionary United States. Since it was probably inevitable that the Territory would someday be part of the U.S., either with or without France’s acquiescence, this underlying reality had to affect both France’s willingness to sell, and the price it could realistically hold out for. Thus the terms won by Jefferson cannot be compared with the terms available in a private business transaction.
The same was undoubtedly true of the purchase of Alaska, which could rank a close second to the Louisiana Purchase if viewed as a pure real estate transaction. After some years of off-again, on-again negotiations interrupted by the Civil War, in 1867 the U.S. purchased Alaska from Russia for $7,200,000. The land mass acquired was equal to one-fifth the size of the continental United States, for a price of about two cents per acre. This was less than the two and a half cents per acre price paid for the Louisiana Purchase, but a significant part of the Alaska is under ice. On the other hand, Alaska turned out to be a tremendous repository of oil and other natural resources. From a real estate and asset standpoint, you have to rank the Alaska purchase right up there with Louisiana as among the greatest deals in history.
But what was the full story of the Alaska purchase? What were the pressures and implied threats that influenced the negotiations? During a vacation trip to Sitka, the former Russian capital of Alaska, I looked around in museums and bookstores trying to find out. One old governmental book, containing part of the transcript of the negotiations in Washington between U.S. and Russian diplomats, caught my eye. In the transcript was a discussion that I would never have associated with Russian Alaska, a discussion about the Mormons.
In the 1860s the Mormons were what today would be considered a large and scary cult. Persecuted for their unorthodox religious beliefs and practices, the Mormons had left the populous parts of the U.S. by wagon train to create their own society in the Utah desert. But the murderous attacks on them by their neighbors had caused the Mormons to respond in kind. By the time they were established in the desert, they had become fierce fighters, massacring other settlers’ wagon trains and even attacking the U.S. Cavalry.
In the transcript, the American diplomats were discussing the Mormons and the probability that they would move on from Utah further into the Northwest, in order to isolate themselves from the growing influx of other American settlers.
“Not into Alaska!” the Russians reacted, presumably fearful of the possibility that their sparse fur-trapping settlements would be overwhelmed by these well-organized, heavily-armed zealots.
“Maybe the Oregon Territory, maybe Alaska,” responded the American negotiators, turning the screws on the apprehensive Russians.
This not-so-subtle “playing the Mormon card” in the diplomatic transcript was enough to convince me that there was more than $7,200,000 involved and that, as in the case of the Louisiana Purchase, the geopolitical reality of who could take what from whom was a major influence underlying these sovereign purchases of vast territories.
A Famous Leveraged Buyout
If not territorial purchases then, would one of the famous leveraged buyouts of the 1980s qualify as the best deal of all time? Leveraged buyouts, or LBOs, thrived during the relatively low public stock market prices of the 1970s and 1980s, and involved the purchase of asset-rich companies by putting up as little equity capital as possible and borrowing heavily against the assets being purchased.
Kohlberg Kravis Roberts did the largest deals (Beatrice, Safeway, Duracell, RJR Nabisco) and was by far the best-known LBO firm. But it was Wesray Captial’s purchase of the Gibson Greetings card company, an acquisition and subsequent public offering in which Wesray’s equity investment of $660,000 grew to more than $140,000,000, that was the signature LBO of the 1980s. And it was New York magazine’s cover story on the deal that first revealed, not only to the public but to many financial players as well, the extraordinary profits LBOs were capable of generating.
Wesray was a partnership formed in 1981 by former Treasury Secretary William E. Simon and a young dealmaker named Ray Chambers (WES + Ray). While I never met either of these New Jersey neighbors of mine, it was my distinct impression that Chambers was the hardworking brains of the partnership and Simon was there to lend his high-profile name and credibility to Wesray’s “smoke and mirrors” leveraged deals. Simon had been something of a loudmouth in the Nixon and Ford administrations and, while posing as a staunch advocate of free markets, had actually been a prime architect of the government’s disastrous gasoline market intervention during the 1973-74 oil crisis. “I’m the guy who caused the lines at the gas stations,” he idiotically boasted.
Gibson Greetings was Wesray’s first deal and what provided the purchase with its underlying favorable economics was that Gibson was owned by RCA. Given that RCA’s acquisition of a greeting card company made absolutely no sense to begin with, it was hardly surprising that RCA would decide to unload the company at precisely the wrong time – just when Gibson was gaining market share based on its license of Garfield and other popular cartoon characters, and just at the 1982 start of an 18-year bull market. The purchase price to Wesray was $80,500,000, but Wesray was able to finance 99% of this, putting up only $660,000 of a total of $1,000,000 in equity capital. And importantly, this financing was entirely without liability or personal guarantees by Wesray, Simon or Chambers – the lenders were willing to assume 99% of the downside risk, looking solely to Gibson Greetings’ business and assets for repayment.
$13,000,000 of the financing for Wesray’s purchase price came in an equipment mortgage from Barclay Bank. The remainder came in a so-called “mezzanine” financing (that is, intermediate level financing between conventional debt and equity) from General Electric Credit Corp. GE Credit was willing to provide such a large loan because Wesray allotted it the remainder of the equity in Gibson, and because Wesray was simultaneously arranging to raise $31,000,000 from a sale-and-leaseback of Gibson’s real estate, which amount was immediately turned over to GE Credit to pay down its loan to a tolerable level.
Wesray’s purchase of Gibson closed in January 1982, and just thirteen months later it was able to complete an initial public offering of Gibson shares at a price which valued Chambers’ and Simon’s shares at $130,000,000. These shares were sold off by Chambers and Simon in the initial offering and over the next four years for a total of $140,000,000. By then the partners had been feuding for some time, mainly over Simon’s abusive treatment of Chambers, Wesray employees and pretty much everyone else he came in contact with. In a 1985 letter, Chambers told Simon that he “never minded ‘being in the trenches’ and being responsible for getting the deals done and then making them work [while you basked in] the Wesray limelight.” But given Simon’s behavior, Chambers wrote, it was time to terminate their relationship as to all future transactions. After the split, Simon tried to continue doing deals with other partners and on his own, but in a few years Forbes dropped him from its 400 wealthiest Americans list citing “bad investments”.
Wesray’s cash-on-cash gain from $660,000 to $140,000,000 was certainly extraordinary but the extraordinariness was almost entirely dependent on leverage. Without leverage the $80,500,000 purchase price paid for Gibson Greetings appreciated over four years to $140,000,000, a compound annual gain of slightly more than 20% but not a transaction you would select for consideration as the best deal ever. From my perspective, I would prefer to nominate a deal that a regular business owner like me, not a famous former Treasury Secretary, could finance and close. And even though I probably have one of the best records in the country in buying and building businesses, I can assure you that no bank or finance company would ever lend me $79,500,000 of a $80,500,000 purchase price.
The Spirits of St. Louis
The deal I nominate is not the Louisiana or Alaska purchase, and not Gibson Greetings or some other famous leveraged buyout. It is a transaction that even plugged-in dealmakers have probably never heard of. It is the buyout of the Spirits of St. Louis basketball team in the 1976 merger of the American Basketball Association and the National Basketball Association.
The ten-year saga of the ABA from founding to merger was probably as close to pure frontier capitalism as one could get in late twentieth century America. In 1966 the NBA had only twelve teams across the entire U.S. Seizing the opportunity to expand to additional cities, a motley collection of basketball enthusiasts – businessmen looking to add glamour to their lives, speculators hoping for a quick merger with the NBA – came together to form eleven new teams in a league they named the American Basketball Association.
The ABA competed with the NBA for college basketball stars, drafted and signed leading players from the NBA itself, brought lawsuits against the NBA for antitrust violation, and in turn had to defend against multiple lawsuits brought by the NBA. Legal expenses were running in the millions.
True to its role as an innovator, the ABA pioneered changes that improved and added excitement to the game. The most well known was the three-point shot, a scoring change eventually adopted by the NBA and by all of college and high school basketball. Slam dunk contests at ABA All-Star Games proved highly popular with spectators and players alike. And the ABA’s wide-open style, as exemplified by the league’s best player, Julius Irving, Doctor J (“he operates on his opponents”), came to significantly affect play in the NBA, which had initially dismissed the ABA as amateurish.
Many of the ABA teams were seriously under-financed. Although they signed leading players to million-dollar, deferred-payment contracts, teams sometimes struggled to come up with a few hundred dollars to pay creditors threatening to foreclose on their uniforms or otherwise shut them down minutes before a scheduled game. Star players, even including Doctor J, were sold off so that a team could survive for the following season. Teams were sold and resold, relocated to new cities overnight, or closed down entirely. But the more successful and well-run ABA teams like the Indiana Pacers and the San Antonio Spurs attracted loyal fans and provided them with exciting, high-level basketball.
Three-point shots, slam dunks, million-dollar contracts, sex, drugs – in the midst of this chaos and excitement two brothers in the textile business in New York, Dan and Ozzie Silna, and their lawyer, Donald Schupak, decided they wanted to own a professional basketball team. An inexpensive way into the ABA presented itself in 1973 when the Carolina Cougars were close to being dismantled after selling off a number of their leading players. For $500,000 in cash and an additional $1,000,000 to be paid over time, the Silna group purchased what was left of the team and moved it to St. Louis, at the time the largest U.S. city without a pro basketball team. They renamed the team the Spirits of St. Louis, after Lindbergh’s famous plane that carried him on his solo flight across the Atlantic.
To make their team competitive, the new owners quickly went after leading players, successfully signing Marvin Barnes, the second pick in the NBA draft. With the nickname Bad News Barnes, he was a six-foot-nine forward of prodigious talent but perhaps the most undisciplined player ever to play pro basketball, which is saying quite a lot. Barnes would typically emerge from his hotel room late in the day with a woman on his arm (sometimes more than one), with only the vaguest sense of the team’s schedule or where he was supposed to be.
Make a morning flight was exceedingly difficult for Barnes. As recounted in Terry Pluto’s lively book on the history of the ABA, the classic Barnes airline story came when the Spirits played a game in New York and had an early flight from LaGuardia Airport the next morning for a game in Norfolk. Naturally Barnes was not at the airport. One of the owners, Donald Schupak, called Barnes at his hotel and ordered him to get to the airport immediately. Barnes mumbled something and went back to sleep.
Then the Spirits’ coach MacKinnon called and warned, “Marvin, if you don’t get to the game, I’m going to have to suspend you. I’m not kidding this time.”
“Don’t worry, man,” Barnes answered and again went back to sleep.
When Barnes finally made it to LaGuardia, he had missed the 9:00am, 11:00am and 1:00pm flights and there were no further scheduled planes to Norfolk. Realizing he was in big trouble, Barnes begged the counter people at the airport to help him and they were finally able to locate a pilot willing to make a deal to fly him to Norfolk in a private charter plane. Landing in Norfolk, Barnes jumped into a cab and arrived at the locker room ten minutes before game time, opening his floor-length mink coat to reveal his Spirits uniform on underneath.
MacKinnon was so angry that he refused to start Barnes in the game, although he put him in later and Barnes still ended up with 43 points and 19 rebounds. As the game wore on a visitor appeared beside the Spirits’ huddle during each timeout. It was the pilot demanding his charter fee and refusing to leave Barnes’ side until he was paid. Barnes was finally forced to send the trainer into the locker room for his checkbook and, with sweat pouring off his face and his teammates and opponents waiting, write the charter pilot a check for his fee.
But by the end of the 1975-76 season, the ABA, with only seven teams still operating, was in pretty desperate financial shape. One of the team owners likened the ABA’s bargaining position to that of Japan at the end of World War II. It was willing to do a deal at virtually any price. Fortunately for it, the NBA, tired of losing star players to the ABA and apprehensive about the ABA’s antitrust suit, was also willing to do a deal.
In marathon negotiations conducted in Hyannis, Massachusetts, a merger between the two leagues was finally agreed. Only it was not a merger in any true sense, merely an agreement by the NBA to admit (in return for an admission fee of $3,200,000 each) the four strongest ABA teams – the San Antonio Spurs, Indiana Pacers, Denver Nuggets and New York Nets. The remaining ABA teams not being admitted – the Virginia Squires, Kentucky Colonels and Spirits of St. Louis – were required to fold, but it was the responsibility of the four admitted teams to buy them out.
The Virginia Squires actually shut down in the weeks before completion of the merger. This turned out to be a financial mistake, a really big mistake, since it meant the four admitted teams could avoid paying Virginia anything.
The Kentucky Colonels settled for $3,000,000. Their owner, John Y. Brown, had made his fortune as CEO and major shareholder of the Kentucky Fried Chicken restaurant chain. Brown, who had assigned his wife to run the Colonels, was happy to get out at a reasonable price. His attention was already turning to politics and he successfully ran for Governor of Kentucky a couple of years later.
This left the Spirits, who protested right up to the eve of the merger that they deserved to be admitted to the NBA. When they finally came to accept the reality that this was not going to happen, the Silnas designated their partner Donald Schupak to negotiate with the other ABA owners the Spirits’ buyout price.
The astuteness of Schupak’s approach was to focus on a form of payment currently being devalued by the other parties but still having exceptional future potential – NBA revenues from national television contracts. The four teams admitted to the NBA would of course share in these revenues over the long-term. However, as one of the onerous conditions imposed by the NBA, the four admitted ABA teams were excluded from national (as opposed to home city) television revenues for the first three seasons following the merger. This of course significantly discounted the upfront value of these revenues at a time when the four admitted ABA teams were desperate for cash, cash to pay their $3,200,000 NBA admission fees, to pay off the teams that were folding, and to pay player salaries and other expenses of their first NBA season.
Based on my own negotiating experience I also feel it was crucial that Schupak’s request for a portion of national television revenues had a ring of fairness to it. By all reports Schupak conducted his Hyannis negotiations on a take-the-other-teams-to-the-brink basis. He knew the owners of the four admitted teams had to reach a deal with him in order to complete their merger with the NBA. On the other hand, if he pushed things too far, if he caused the owners to feel he was being totally unreasonable, they might go back to the NBA negotiators and convince them to admit the four teams without a paying off the Spirits. Or, if excessively angered by Schupak’s negotiating position, the owners of the four teams could simply say, “To hell with you and to hell with the merger.”
But it would be hard for them to get too angry if Schupak in effect just said: “We were all in the ABA together, the Spirits, the Spurs, the Pacers, the Nuggets, the Nets, all of us. We suffered the losses together. We fought the NBA together. And now when we are finally able to force them into a merger, all I am asking is that we receive our fair share, our 1/7 share, of the ABA’s portion of the TV revenues. Why isn’t that the right thing to do?”
For whatever reason – focus on the right form of payment, a ring of fairness, or simply negotiating persistence – Schupak was able to prevail with his television revenue demand. In exchange for the Spirits’ accepting that they would not be included in the merger, the four admitted teams agreed to pay the Spirits $2,200,000 in cash ($800,000 less than Kentucky), but with the further agreement that the Spirits’ owners would receive 1/7 of each admitted team’s share of NBA revenues from national television contracts. (The 1/7 share was based on the fact that, prior to the merger, the Spirits were one of seven remaining ABA teams.) Thus the Spirits’ owners would receive a total of 4/7 of a share of NBA network television revenues. For how long a period would they continue to share in these television revenues? In the legal language of the agreement, “in perpetuity.” In other words, forever.
$13 Million Per Year
A few years were required for the outcome of Schupak’s deal to fully reveal itself. In the 1970s, the NBA was not considered a prime television property. It took the upsurge of television sports in general, and the rise to national popularity of superstars like Larry Bird and Magic Johnson followed by the even more popular Michael Jordan, for NBA television contracts to really heat up. Also, as indicated, the NBA had denied the admitted ABA teams any share in national television revenues for the first three seasons and thus the Spirits, along with the admitted teams, had to wait four years for their first television payments.
But once television revenue payments began, they built steadily. In the first twenty years of payments, the cumulative amount received by the Silnas and Schupak totaled some $50 million. Not a bad return on the $800,000 in upfront cash given up in comparison with the Kentucky buyout deal. But $50 million was just the beginning. During the1990s, leading sports attractions became crucial to the television networks in building audiences for the remainder of their schedules and the networks were willing to forego all profit, even suffer losses, in order to outbid each other for multi-year football and basketball contracts. The NBA’s $2.6 billion television package negotiated in 1997 resulted in the revenue share of the Silnas and Schupak reaching a spectacular $13 million per year. And a new NBA television contract currently being negotiated will likely result in their receiving an additional increase in the near future.
To put this in perspective, there are only a few professional teams in any sport – in Major League Baseball, the National Football League or the NBA – that earn $13 million of bottom-line, pre-tax profit. And each of these teams must over an extended period invest many tens of millions to sign and develop players and win fan loyalty. The right to receive $13 million a year automatically, without the need to build a successful team, without the need for skilled management or an extensive organization, without the need for capital or risk-taking, is fantastically valuable. It is the equivalent of owning a senior bond issued by the NBA paying yearly interest of $13 million, with an added escalation feature that increases the interest pay-out as national television revenues grow. Depending on prevailing interest levels, such a bond would have a fair market value in the range of $200 million.
Further analyzing Donald Schupak’s negotiation with the four admitted ABA teams, what was it that allowed him to realize such a spectacular result, a capitalized value of $200 million negotiating on behalf of an almost defunct basketball franchise that had cost him and his partners only $1.5 million to begin with? Did he simply pull the wool over their eyes?
As I have discussed, the concept of the Spirits sharing in the television revenues of the Spurs, Pacers, Nuggets and Nets was justifiable. Along with the four admitted teams, the Spirits had borne the risks and the losses of the ABA, had helped build the exciting play, fan loyalty and goodwill the NBA was now willing to acquire (or, viewed more cynically, had helped fund the antitrust suit the NBA now anxious to rid itself of). So the request for a share of national television revenues was a fair and reasonable one.
But the goodwill and value the Spirits had helped create in the ABA would dissipate in time. After a few years the exciting ABA players would be gone and each admitted franchise would become like any other established NBA team, dependant on its then-current success in building a successful core of players and winning fan loyalty. By this logic, the Spirits’ share of national television revenues should reasonably have continued for a term of years, possibly for ten or fifteen years until the beneficial effects of the ABA’s ten-year independent existence would be considered to have long since disappeared. But not for fifty or a hundred years, not forever.
Representatives of four teams were negotiating with Schupak so there was no reason for them to be at a disadvantage. Perhaps Schupak just had a better sense of the value of perpetual payments. Or perhaps the Spurs, Pacers, Nuggets and Nets were so focused on the moment, on getting their NBA deal done, that they did not worry about financial effects many years down the road. Of course when they started to pay out millions each year to the Silnas and Schupak, the long-term nature of the deal they had made was brought home to them with considerable emphasis. As the President of the Pacers recently described it, “In perpetuity is a long time.”
As the annual payments grew and grew, the four teams hired leading law firms to develop every conceivable argument under which their agreement with the Spirits’ owners could be reinterpreted, modified or terminated, but to no avail. They tried for years to buy out the revenue stream, but also to no avail. The deal negotiated by Donald Schupak – my nomination for the greatest deal ever by a “regular guy,” a small business owner negotiating without government influence or a multi-billion-dollar company behind him – continues in effect.