With Friends Like Mike Milken . . . : His LBO Advantage Is Cut From the Hides of Workers
Michael Milken, the man who revolutionized American finance, has been indicted for 98 counts of violation of laws having to do with the protection of the American investor and taxpayer.
His friends and colleagues have taken out full-page newspaper advertisements and appeared on television and radio to defend him. Their line generally runs that he is not guilty of any crimes, that he is the victim of a political frame-up, that in any event, he is being punished for his daring. This daring, say his friends, led to the revitalization of American industry, making it grow where it would not otherwise have grown, creating jobs as buyers of high-yield debt poured money into plants and equipment that would not have otherwise been financed.
It’s an important claim, because the logic of the whole free-enterprise system is that we applaud the individual who gets rich by honest means because, by so doing, he enriches the system generally. If you think of Henry Ford and the mass production of automobiles, you have the basic idea: He gets rich, but his workers are also better off, as are motorists and his investors, because he drastically improved automobile mass production.
However, insofar as the claim is made that Milken has in some way improved the lot of workers, gave them jobs and gave them security, the claim is simply not supported by the facts, not to mention the basic principles of the leveraged buyout.
Milken grew rich and powerful from his employment of high-yield bonds and other devices to finance takeovers of companies by their managements or by outsiders. This tactic, the leveraged buyout, in which a corporation is bought with borrowed money, which is then repaid from the operations of the company and/or the sale of its pieces, did not exist in any large way until the advent of Michael Milken. Now, of course, it dominates the industrial landscape like a colossus.
But the LBO necessarily involves giving the employees of the acquired company the shortest possible shrift. It is simply impossible, as a matter of basic arithmetic, for the LBO to work if workers are to be protected and their jobs kept in place.
In broad strokes, an LBO works like this: The acquired company, after the acquisition, is loaded with debt. That’s because the company’s stock was bought at a premium above the market value. Far more important, the capitalization of the company after the buyout is no longer in stock, which usually pays a dividend of 6% or less. Now that stock has been replaced with a far larger amount of debt, yielding 13%, 14%, 15% and sometimes more.
Clearly, the company must pay vastly more to its new junk bondholders than it did to its now-departed shareholders. Even with the tax savings given as a gift by the taxpayers in the form of the deductibility of bond interest, the out-of-pocket cost to the corporation is still staggeringly greater to pay interest on its junk than it was to pay dividends.
To come up with this money, sometimes parts of the company are sold. But if this is not adequate, every last bit of cash flow (roughly, income after operating expenses in this context) must be squeezed out of the company’s operations. Individual units of the company are given draconian cash-flow targets quarter by quarter, sometimes month by month. These cash-flow targets are so important that they often determine how much of the profit from the LBO goes to each manager of the post-LBO company.
The largest, most readily variable costs at almost any corporation are wages and benefits. Very logically, the new owners of the post-LBO company begin by laying off every worker they can possibly lay off. Work loads are increased. Staff is shared. Backlogs are allowed to grow. Anything goes as long as employment can be cut. Closely allied, wherever possible, benefits and wages are cut. After all, if you can get a worker for a dollar less per hour, those dollars go to meeting cash-flow targets. If you can cut his dental benefits, every dollar less of reduced premium goes to meeting the plan. Don’t worry about long-term growth, don’t worry about seniority, don’t worry about tomorrow or yesterday, squeeze out that cash today.
In turn, these dollars are paid out to the holders of the high-yield bonds. But, very crucially, before they even get to those folks, the deal-makers, most notably, the Michael Milkens, get their cut, and the lawyers get their cut. If you wonder where the money comes from to pay fees of $100 million to Drexel (or other investment banks) for a few weeks’ work on an LBO, if you wonder where the money comes from to pay law firms in seven-figure lumps for crash work on takeovers, now you know: A goodly part of it comes from the anticipated gains in cash flow of the acquired company, capitalized into the coupon of the junk bonds and the fees of the Milkens of this world.
In other words, in large measure, it comes out of the hides of the laid-off, cut- back and disenfranchised workers (to the extent that it does not come out of the hides of the prior shareholders because they were underpaid for their assets).
This might be socially acceptable if the net result were that American industry became leaner, more efficient, more competitive as a result of the worker pain associated with the LBO. In that case, a gain in national well-being would eventually offset the factory foreman’s chagrin and humiliation when he loses his job (although not to the man laid off).
But national data does not show any noteworthy gains at all in worker productivity--or even in corporate profits--in the years in which the LBO has waxed great. In fact, in this decade, which has seen mergers and acquisition activity more than sextuple in dollar amount, worker productivity has gained at an extremely slow rate by postwar standards, and corporate profits have actually stalled in real terms and as a percent of equity.
Whatever gains might be attributable to increased pre-interest cash flow in LBO companies apparently do not last, are offset by the mighty interest and deal-making charges or otherwise are not apparent.
At the end of the day, as the natural and inevitable result of the kind of deals that made Milken one of the richest men in the world, workers are not benefited, as his friends claim. They are fired, their benefits cut, their unions broken, their job security a dream made into inanimate numbers on a Lotus program for cutting costs, the faraway dots that stop moving so that the deals of a Michael Milken can go on.
Milken certainly benefited some workers--primarily those at investment banks and a few law firms and those close to his inner circle of predators. But it is an insult on many different levels to claim that he is the workingman’s friend. With friends like him . . . .
