Beyond the Rubicon: Highly Confident
By Aly El Shalakany
When we think of revolutions, we think of protests and a common calling by the masses to radically change things or to replace the political regime altogether. But revolutions can happen in the business world as well and the roaring 1980s saw extreme turbulence on Main Street and Wall Street that had a profound impact on the way we do things that have lasted until this very day.
On Main Street, Maggie Thatcher and Reagan were spearheading a new era of “deregulation” that lay the groundwork for a revival of a no holds barred brand of capitalism. For many, this meant that their way of life was obsolete and the jobs and job security they had enjoyed for the past few decades were a thing of the past. For some, this was the opportunity of a lifetime to go from rags to riches, providing you had the right stomach for it.
On Wall Street, banking was transformed from a boring, low-risk, steady as you go type of business into an innovative, ultra-aggressive, winner takes all culture that could make you a multi-millionaire or out of a job before you turned 30. In this new age, nobody was safe, and the decade quickly witnessed its first high profile victim in Salomon Brothers, a top investment bank and cornerstone of Wall Street since 1910, as a result of aggressive risk taking that is best captured by Michael Lewis’ Liar’s Poker. But nothing quite symbolized this new world order like the “Highly Confident” letter issued by the Junk Bond King himself, Michael Milken.
A decade earlier, the world of bonds was divided in two. The “investment grade” bonds issued by sovereigns and the elite corporates of America, which were managed by the top investment banks, such as Goldman Sachs, and stacked with blue bloods with country club connections to the C-suite execs at these elite corporations. All the other bonds below investment grade, which were condescendingly labelled as “junk bonds,” were managed by the second-tier downward of the investment banking establishment.
For a young, brilliant and ambitious Michael Milken, this entire landscape just didn’t sit right with him. From the day he graduated top of his class from Wharton Business School, he decided he would do things very differently. Instead of joining one of the elite investment banking firms, he joined Drexel Harriman Ripley (as it was then called), an established, white-shoe investment banking firm that had a lot of pedigree, but had seen better days and was no longer a top-tier firm.
Despite being a middle-class arrogant loner, Milken was recognized as so-high powered intellectually that he was moved early on from back office work, where he excelled, to do other “special projects” as assistant to the firm’s presidents. Soon after, Michael Milken was catapulted to the top of the food chain at Drexel, as the head of research for fixed-income securities and from there he moved into bond sales and trading. Milken did not have an appetite for trying to pick up the scraps from the elite investment banks for investment grade bonds work, but he was fascinated by junk bonds and their potential.
Milken’s research demonstrated that, while low-grade bonds suffered more defaults than investment grade bonds, holding a very a large and diversified portfolio of low-grade bonds provided larger yields over time. Not only that, but because most corporates were not members of the elite investment grade club, they had greatly diminished access to finance and would be willing to pay much higher fees to investment firms who could deliver on low-grade bond financing.
This was, to say the least, a massive opportunity. The only thing standing in Milken’s way would be to create a market sufficiently large enough to ensure liquidity, diversity and confidence in junk bonds. Milken took on this challenge with gusto and for the next 20 years, became the nexus point for junk bonds globally. As it happened, Milken’s clients, who, unlike the elite corporations, were owner/managers who could lose everything if these junk bonds didn’t work out, had their confidence in Milken repaid in full and they were transformed from obscurity to the nouveau riche that we commonly associate with the 80s. Milken’s real claim to fame, however, came next.
The demand for junk bonds was huge, but not nearly enough for Milken and Drexel’s insatiable appetite. Building on Milken’s earlier work on convertible debt, Milken could add intimate knowledge of equities to his repertoire. What he identified is that many of these equities, even for elite corporates, were undervalued and could be lucrative targets for someone ambitious enough to take on the elite of America. Milken, unlike in the past, had funding to complement his ambition in this endeavour. This would generate incredible new demand for his junk bonds.
Milken provided the ammunition to the corporate raiders of America in the form of a “Highly Confident” commitment letter that hundreds of mns of USD in junk bonds would be raised for acquisition finance against any target, no matter how large or established. The IBMs and General Motors of this world were no longer safe and many of them famously fell to the corporate raiders of the 1980s. The revolution was in full force.
Many believe that, not only did Milken support these aggressive upstarts, but in fact created and directed them from behind the scenes. Every year, the transactions and ticket sizes would get bigger and bigger, ever more daring. Drexel would notoriously showcase this power every year at what insiders called the Predators Ball (for a fascinating account of Milken, Drexel and these corporate raiders, I highly recommend reading the Predators’ Ball by Connie Bruck).
However, Milken’s success and “democratization of capital” would, however, come to an acrimonious end. One of the corporate raiders Milken was closely associated with, Ivan Boesky, the inspiration behind Gordon Gekko’s character in Wall Street, pleaded guilty to insider trading and turned into a cooperating witness for the the US government. The pressure on Milken and Drexel intensified and, eventually, in 1990 Milken pleaded guilty to several securities and tax violations.
When I think about this wonderful story and about Egypt today, I have two immediate observations. The first is that the elites of America, rightly or wrongly, held the same level of contempt for these nouveau riche upstarts that we in Egypt held for our own entrepreneurs of the 1980s, who seized opportunities after Sadat’s liberalisation policy. I feel very conflicted about this. On the one hand, I grew up with scandalous tales woven by the elites about “this or that cigar-smoking big shot” who must have made their money illicitly, while today we begrudgingly laud many of these entrepreneurs who are successful private sector leaders and titans of industry. I don’t believe we have ever truly resolved this conflicting image of Egyptian businessmen.
Finally, I have long questioned why Egyptian financiers have not managed to “democratize capital” in the way that Milken did almost 40 years ago. I truly believe that Egypt’s potential will never be fully realized so long as the power of capital is restricted to the elite few, as opposed to the numbers of talented entrepreneurs who did not graduate from your school and who do not frequent your sporting club or compound’s clubhouse. Surely, there is a formula for empowering these talented entrepreneurs while making money in the process?
Beyond the Rubicon is a column written exclusively for Enterprise every other weekend by Aly El Shalakany, senior partner at Shalakany Law Office, which he joined from Linklaters in London. Aly is a noted specialist in finance, projects and mergers and acquisitions; his column appears exclusively in our Weekend Edition, offering an “inside baseball” look the intersection of business, economy and finance from the point of view of a practitioner at the top of his game.