The Companies They Raided Had It Coming.

Introduction

The companies that got raided in the 1980s had been building the problem for two decades before anyone showed up to exploit it.

The 1960s produced a particular theory of corporate value. It held that a large company run by professional managers could outperform a small company run by its owners, and that this advantage scaled across industries regardless of what those industries actually made. A company did not need to understand the business it was acquiring. It needed to understand management. Size was the product, and acquiring in unrelated lines was the strategy that produced size.

The arithmetic that made this look like growth was simple. A company trading at a high earnings multiple could buy a company trading at a lower one, and the combined earnings per share would rise without any operational improvement required. Harold Geneen grew ITT from $765 million in sales in 1961 to $17 billion through more than 250 acquisitions spanning dozens of countries: Sheraton Hotels, Avis Rent-a-Car, Continental Baking, insurance companies. None of this required synergies to appear. It required the multiple to stay high long enough to do the next deal. When it stopped, the whole construction was visible for what it was.

The operating results were already making the argument before the researchers arrived to measure it. Studies published in the 1990s found that diversified firms traded at a discount to single-business competitors of between 10 and 15 percent, confirming what the performance of individual conglomerates had been signaling for years. The question was not whether the model had failed. It was why so many management teams were still running it.

The average number of separate business segments operated by large U.S. companies fell significantly across the 1980s. Something had forced the reversal. The argument about corporate raiders spent almost no time on the question of what that something was, or whether the companies being targeted had played any role in creating the conditions that made them targets.

What Made the 1980s Different

The financial instrument that allowed the deconglomeration to happen quickly rather than slowly was high-yield debt, called “junk bonds” by the people who objected to what it was being used for. Michael Milken, operating out of Drexel Burnham Lambert’s Beverly Hills office, grew that market from approximately $10 billion in 1979 to nearly $200 billion by the end of the decade. Before Drexel’s innovation, a buyer without substantial existing assets could not credibly threaten a large corporation. The size of the target set an effective floor on who could pursue it.

By 1983, Drexel had created the “highly confident letter,” a document in which Milken stated that Drexel was highly confident it could raise the financing for a given acquisition offer. A letter from Milken carried the practical weight of cash. A buyer who held one was not a nuisance. He was a credible acquirer. If you want the mechanics of what happens between a letter like that and the close of a hostile offer, that structure is covered in detail here. The more useful question for understanding this particular decade is what all that newly available capital was pressing against, and why the pressure found so many willing surfaces.

Gulf Oil, 1984

T. Boone Pickens and Mesa Petroleum had built an 11 percent stake in Gulf by late 1983. Gulf was the sixth-largest oil company in the United States. Gulf’s management offered Pickens a straightforward settlement: a premium above market for his shares, at a price no other Gulf shareholder would receive, in exchange for his agreement to stop. The practice had acquired its own word by then, “greenmail,” part blackmail and part greenback, coined to describe the moment when a company’s board paid one investor to go away at the expense of all the others. Pickens refused it. The board chose Chevron as a friendly acquirer instead, and the merger closed in 1984 at $13.2 billion, then the largest corporate transaction in American history. Pickens and his investors netted between $400 and $500 million on their Gulf stake from the transaction Gulf’s board chose to pursue rather than deal with Pickens directly.

The shareholders of the company described as the victim of a raid were significantly better off when the raid forced a resolution.

Crown Zellerbach, 1985

James Goldsmith ran a different version against Crown Zellerbach in 1984 and 1985. Crown was a 135-year-old forest products company based in San Francisco. Goldsmith had identified the company’s timberland as substantially undervalued, and he understood why: Crown’s management was planning to de-emphasize the timber business and move further into paper manufacturing, away from the assets Goldsmith considered the core of Crown’s value. He accumulated shares through late 1984, triggering the company’s poison pill provision when he crossed 20 percent ownership, a defensive mechanism that releases discounted shares to all existing shareholders when a buyer crosses a set threshold, diluting the buyer’s position before it becomes a majority. He was elected to the board, refused a $100 million payment to go away, and continued buying past 40 percent, at which point he became chairman.

He split Crown into three businesses: Cavenham Forest Industries, holding the timberlands; Gaylord Container Ltd., holding the brown paper operations; and a computer supplies division. He sold the pulp and paper operations to James River Corporation in a stock swap that contemporaneous press accounts valued at between $720 million and $800 million, retaining what he had come for: the timberland. The restructuring that followed was operational. He had bought a company whose management was planning to move away from its most valuable assets. He moved back toward them.

TWA, 1985 to 1992

The TWA case is the one that kept the label credible, and it deserves the same level of directness. Carl Icahn began accumulating TWA shares in the summer of 1984. By April 1985, his group held 5 percent of the company. He won control in a contest against a rival bidder and completed a leveraged buyout in 1988, taking the airline private. He sold TWA’s London routes to American Airlines for $445 million in 1991. He made a personal profit of $469 million. He left the company with $540 million in debt. TWA filed for bankruptcy in 1992. During the proceedings, it emerged that the airline’s pension fund had been underfunded by more than $1 billion.

Icahn’s diagnosis of TWA was accurate. The airline had been mismanaged before he arrived. His execution was not. The distinction matters because the public debate collapsed the two together, and TWA became the evidence for a conclusion that the Gulf and Crown Zellerbach cases did not support.

Who Named It and Why

Martin Lipton invented what he called the “shareholder rights plan” in the early 1980s, first deploying it to defend El Paso Electric against a hostile offer from Burlington Northern. By the late 1980s, hundreds of major U.S. corporations had adopted versions of it. Congress imposed a 50 percent excise tax on greenmail profits in 1987. The Business Roundtable, representing the chief executives of America’s largest public companies, spent the decade lobbying the SEC and congressional committees for restrictions on hostile takeovers. The Delaware Supreme Court validated the poison pill in Moran v. Household International in 1985, and the full legal architecture surrounding the practice was built during the same years the raids were happening.

These are not neutral parties administering a neutral vocabulary. They are the people who were the subject of the critique the raiders were making, and the campaign was conducted in their interest. That does not make every raid legitimate. It means the word “raider” was chosen by one side of an argument to describe the other, and it was chosen before the argument was heard.

Conclusion

Michael Jensen and Richard Ruback summarized more than a dozen event studies in 1983 and found that target shareholders gained an average premium of 30 percent in successful hostile takeover transactions. The Brookings Institution examined all 62 hostile takeover contests between 1984 and 1986 that involved a purchase price above $50 million. In those contests, 50 targets were acquired and 12 remained independent. The post-takeover changes included divestitures, layoffs, and asset sales, with 72 percent of divested assets moving to buyers operating in related industries, consistent with the thesis that the targets held businesses they had no particular advantage in owning. Research on which companies were selected found that diversified firms faced substantially higher takeover risk than focused ones. The raiders were not selecting at random. They were selecting companies that matched a specific profile, and that profile had been built during the two decades of acquisition activity that preceded them.

The label worked. What is now called activist investing operates on the same mechanics that earned it: accumulating a stake, demanding board representation, pressing for divestitures or a strategic review. The letterhead changed.