The EconomistSeptember 21st 2019 Finance & economics 872
Buttonwood Rich Pickens
I
n the early1950s Thomas Boone
Pickens worked as a geologist at Phil-
lips, an oil firm based in Bartlesville,
Oklahoma. He hated it. His working day
was regimented. His colleagues lacked
ambition. He found the waste and ineffi-
ciency sickening. “At Phillips, I met the
monster: Big Oil,” he wrote. Mr Pickens
left to form his own firm, Mesa Petro-
leum. Impatient with its progress, he
devised an audacious plan. He would
slay the monster by using Mesa to buy
out larger, badly managed firms.
Against the odds Mesa’s first big bid,
for Hugoton, a far larger natural-gas firm,
succeeded in 1969. But Mr Pickens, who
died on September 11th, is best remem-
bered for the daring takeover bids he
made in the 1980s, not least for his old
employer, Phillips. These failed, but not
before driving the targets’ shares up and
making Mr Pickens a small fortune.
The one that had the most lasting
impact on corporate America was his tilt
at the Gulf Oil Company. Gulf was one of
America’s top six oil firms in 1984; Mesa
was a minnow by comparison. So it was a
gutsy move. But what set it apart was that
it was the first big attempt at a hostile
buyout to be backed by junk bonds.
Drexel Burnham Lambert, an upstart
investment bank, supplied the financial
muscle; Mr Pickens provided the oil-
industry know-how. Corporate finance
would never be quite the same.
Leveraged buyouts (lbos) were not
entirely new. In the 1960s they were used
as a way for small, family-owned firms to
sell out to managers without the cost of a
public listing. But by the early 1980s the
financial landscape was changing. Spe-
cialist buyout firms were coming to
prominence, including Kohlberg Kravis
Roberts (kkr). Mergers were looked
upon more kindly by trustbusters. Anddebt financing was on tap. Michael Mil-
ken, Drexel’s junk-bond king, had cultivat-
ed a network of investors who were hungry
for new issues. He boasted that he could
raise $4bn-5bn for T. Boone’s run at Gulf.
Ideas about corporate finance were
changing, too. Decades previously, Franco
Modigliani and Merton Miller proposed
that a firm’s capital structure—its mix of
equity and debt finance—should not affect
its value. It is firms’ cashflows that matter,
not the nature of the claims on them. But
the theory does not work well in the real
world, with its bankruptcy costs and tax-
deductible interest payments. The ideal
capital structure came to be seen as a
trade-off between the penalty for holding
too much debt (bankruptcy) and the penal-
ty for holding too little (forgone tax bene-
fits). A paper in 1976 by Michael Jensen and
William Meckling said that even this
theory was incomplete. Debt, they argued,
was a device used by shareholders to keep
a firm’s management honest. Bosses feel
greater pressure to cut costs and raise
revenues if they are faced with a hefty
interest burden each quarter.The debt-is-good doctrine appealed to
a new breed of corporate raider. Mr Pick-
ens dusted off the Hugoton blueprint. He
would seek out a big, undervalued energy
firm, take a large stake in it and then seek
to take it over—or at least push the man-
agement to improve returns. Gulf Oil met
his criteria. His bid failed, but a compet-
ing bid by Chevron, another oil giant,
succeeded. Mesa made hundreds of
millions of dollars on its stake. And Mr
Pickens’s run at Gulf became the model
for many successful lbos.
The legacy of the Mesa-Gulf bid is all
around today. High-yield (junk) bonds
are no longer the shameful offspring of
the fixed-income family; they are an
established asset class. The median
credit rating for an American corporate
has fallen to bbb, a notch above junk.
That is largely because of corporate-
finance strategy: lots of established firms
have chosen to load up on debt to boost
shareholder returns. If a firm declines to
“optimise” its balance-sheet by taking on
more debt, a band of capital-rich buyout
firms stand ready to do the job.
Trends in finance tend to go too far
before reversing. But there is already a
sense of the forces that might eventually
make debt finance less attractive. Tax
reforms, in America and elsewhere, have
sought to limit the tax breaks on debt.
Another catalyst is the changing nature
of firms. With the advent of the Internet
of Things, the leading digital companies
need to demonstrate that they are sure to
stay in business for decades in order to
persuade customers to sign up with
them. Firms that hold a lot of debt will be
seen as riskier counterparties. Who
knows? Perhaps a future T. Boone Pick-
ens will make the case for a bigger buffer
of equity as the essential element of an
optimal capital structure.How T. Boone Pickens changed corporate finance in AmericaEstimates for the total cost of cum-ex
trades in Germany vary wildly. At the low
end the finance ministry, which has identi-
fied 499 suspected cases, puts the damage
at €5.5bn, of which the taxman has recov-
ered €2.4bn. The ministry says it closed the
loophole in 2012. Critics say it should have
done so much sooner.
Christoph Spengel of Mannheim Uni-
versity reckons the bill is far higher:
€31.8bn between 2001 and 2016. And a team
of investigative journalists gathered by
Correctiv, an investigative-journalism
group, from newspapers in several coun-tries, including Die Zeit in Germany, Le
Mondein France and Politikenin Denmark,
concluded in a report published last Octo-
ber that the trade is still flourishing. Cor-
rectiv estimates the losses to cum-ex trades
across Europe to be as high as €55bn.
Whatever the correct figure, cum-ex
deals were much more common than Ger-
many’s finance ministry thought when it
was first warned of them a decade ago.
About 100 financial firms have been linked
to them, including Germany’s dz Bank and
HypoVereinsbank, and JPMorgan Chase,
Morgan Stanley and Bank of America Mer-rill Lynch. On September 10th investigators
raided the headquarters of Commerzbank,
another German lender, seeking evidence
of involvement. A few weeks earlier they
searched the offices of Clearstream, Ger-
many’s central share depository.
The trial of Mr Shields and Mr Diable is
due to end on January 9th. The maximum
penalty they face if convicted is ten years in
prison. They have co-operated with inves-
tigators: Mr Shields says he attended more
than 30 interviews. Bankers across Europe
will await the verdict with bated breath.
The case could be the first of many. 7