Forbes Magazine - Issue Date July 1, 1996
Herbert Allen and his merry dealsters
It employs no analysts and its capital is petty cash by Wall Street standards, yet Allen & Co. is right in the middle of some of the juiciest deals.
By Dyan Machan
"OVER A LONG WEEKEND, I could teach my dog to be an investment banker." Herbert A. Allen, 56, president of Allen & Co. Inc., has scant respect for the industry in which he has spent his career. "It's the only industry working at full overcapacity," he says. "How many mergers and acquisitions people are really needed?"
Not many, in Herbert Allen's view. Most of what Wall Street does is redundant, he believes, and so are most of its high-paid people. "Corporations can find their own deals, and boards should take responsibility to make sure they do," Allen asserts. Finance isn't all that complicated, Allen would argue; if a deal makes sense, you shouldn't need a Wharton degree to see that it does.
Allen makes no effort to hide his contempt for most of what passes as investment banking. "The capital-raising function is legitimate; the rest is all hot air. Two hundred and eighty analysts showed up for a recent Coca-Cola meeting, each writing forecasts within a penny of each other. How many are necessary? Probably two." All those mergers and acquisitions people? "They might as well be hot dog vendors. Boards hire all these bodies to supply a fatty analysis that no one reads. It's padding for [the boards'] rear ends. They [the boards] might as well look at those reports upside down."
"The big firms with access to public capital will probably be around, but the other guys will go away, being acquired or folded into one another," Allen concludes.
What deals are left will be done for far less than the eight-figure
fees typical these days of run-of-the-mill mergers and acquisitions work. Allen
says, "People will compete in pricing because basic economics always wins."
"Ultimately Wall Street will be eliminated," he says.
So, is Allen worried? Is he telling his son and heir apparent to seek work in another business? No way. He believes his kind of shop will survive because of what it is and the way it's structured.
"Deals just don't get done in Hollywood unless they [Allen & Co.] are involved," says Barry Diller, chairman of Silver King Communications, a broadcast television company, and an Allen & Co. client of long standing. In the giant Disney-Capital Cities/ABC merger last year, Allen & Co. was the only investment adviser used by that redoubtable pair, Warren Buffett and Cap Cities chairman Thomas Murphy. Also last year Allen represented the buyer or seller in two other entertainment megadeals: Westinghouse's $5.4 billion purchase of CBS and Seagram's $5.7 billion purchase of 80% of MCA from Matsushita.
If Wall Street is a dinosaur, how is Allen & Co. different?
To begin with, it's small. It employs 174 people in one office, on Manhattan's Fifth Avenue. Compare this with Salomon's 6,400 employees and its offices in 22 countries. Or with Merrill Lynch's 46,400 people and 550 offices worldwide. Allen & Co. has just $275 million in capital and no debt. By contrast, Goldman, Sachs and Salomon each have roughly $5 billion in capital but have $13 billion in debt.
Of course, Allen doesn't pretend to do all the things its bigger competitors do. No real estate investing, currency hedging or derivatives. It has no research department--none. The research is done by the principals themselves. Allen & Co. does venture capital, underwriting, private placements and money management.
"It's a unique culture," says Allen, in his soft-spoken way. "We have a welfare state for our employees, and raw capitalism for the principals."
Let's parse those statements, because they express the crux of a highly effective management philosophy. Allen & Co. is a welfare state because last year it paid its salaried employees annual bonuses equal to 100% of their pay. It's capitalist because it's made Allen close to a billionaire and made multimillionaires of its 14 managing directors. With only a few mouths to feed, Allen can afford to feed them well, and he does.
The rawness consists of this: There are no guarantees, no safety net. The firm pays only nominal salaries to principals. On every deal he or she brings in, an Allen managing director gets 30% of the take in cash after expenses are paid. They don't have to wait until year's end. When the client pays, Allen pays. Because Allen runs a lean shop and doesn't require huge amounts of borrowed capital, the overhead and expenses that come off the top are relatively modest.
The lean overhead and slim staffing allow Allen & Co. to stress a principal-to-principal approach. "There is no bait and switch at Allen" is the way managing director Nancy Peretsman puts it. She refers to the common practice of sending a senior person to solicit an account and then turning it over to juniors. "In bigger firms, the name gets the business," Peretsman claims. "The actual execution gets handed to a team of new M.B.A.s, who are clueless. Working for big firms is like living in New York City. Allen is like living in a little town."
Allen & Co.'s principals, in short, are not just agents of the firm; they are personal participants in every deal they bring in. When an Allen principal wants the firm to invest, Allen first asks: "How much of it do you want? If he's not willing to make the personal sacrifice and gamble on the investment, I'll say, `We'll pass.' " It's a put-up-or-shut-up culture. "Most Wall Street firms give what they call `objective advice,' which means they have nothing to lose by giving bad advice. I say, forget objectivity."
Could this compensation principle be applied to other businesses?
Allen says he actually tried to promote such a compensation system back in the late 1970s and early 1980s when he controlled Columbia Pictures. He suggested the moviemaker pay studio executives a small salary and a portion of profits.
"I couldn't get anyone interested," he says.
"It might not work in a large company," Allen muses, "but in a small place, a system like ours can work." Yet another reason Allen wants to remain relatively small.
The original Allen & Co. partnership was formed 74 years ago by Allen's uncle, Charles Allen, who died in 1994.
Herbert's father, also named Herbert, now 88 and ailing, joined his brother in 1927. They backed and invested in new and established companies, the biggest success being the pharmaceutical company Syntex, which was sold in 1994 to Roche Holding Ltd. for $5.3 billion. Other big Allen successes: Benguet Consolidated, a Philippines-based gold mine, and Ogden Corp., a food service company. Allen & Co. never did lots of deals. Not burdened with overhead, it didn't have to. It was an outfit that worked more by gut instinct and feel than by lengthy study. In 1975 Charles Allen was interviewed by Forbes. He cited his immensely successful purchase of a controlling interest in Syntex: "Lazard was analyzing and analyzing, and we just said `fine.' All our deals are that way." We asked him why he made such a snap judgment:
"Interesting product," Charles Allen replied. "Liked the people." This could be Herbert speaking.
Brought up in the family business, Allen was given responsibility early on. In 1966, at 26 and a few years out of Williams College, he was tapped by his uncle and his father to be chief executive at their investment bank, Allen & Co. Inc. This was only a tiny part of their holdings. Much as they wanted to see the boy make good, the elder Allens weren't betting the farm on him. Allen & Co. Inc. started with just $1 million in capital.
Herbert Allen soon showed his dad and his uncle that he could handle the responsibility. In 1973 he put up $1 million of his own money and $500,000 of the firm's to buy a controlling interest in Columbia Pictures at $4 a share. His father and uncle didn't think much of the idea but, what the hell, give the kid a chance to learn from his mistakes. It looked as if he had made a big one. Six years after Allen bought control, Columbia studio chief David Begelman was caught embezzling studio money.
But Allen turned the company around and sold Columbia to Coca-Cola in 1982, receiving Coke stock worth $72 for each of the Columbia shares that had cost him $4. Allen & Co. Inc. still holds all of its Coke, and each of those $4 Columbia shares is now worth $2,400 in Coke stock. Herbert Allen personally, and Allen & Co. Inc., have, so far, together made a cool half-billion dollars.
Despite a general perception to the contrary, Coca-Cola made out pretty well, too. After investing a total of $750 million in the film company, Coke and its shareholders ultimately realized a $3 billion gain when Columbia was spun off and sold to Sony nine years later.
The deal made Allen a power in the entertainment business. He never forgot that he succeeded because his elders let him take risks provided he put up his own money alongside the firm's. He treats his associates the same way. It shows in the type of people the firm attracts.
After getting a law degree from Harvard and an M.B.A. from Stanford, Richard Fields passed up more lucrative offers at other Wall Street firms to join Allen as an associate for roughly $60,000 a year in 1986. "I liked that there was no structure," says Fields. "I didn't mind the lower pay. I was young and didn't have many responsibilities, and Allen & Co. was the only place I could invest and do agency work at the same time."
His chance to invest came five years later. He brought to Allen
Omnipoint, a company that owned intriguing wireless communication technology.
It needed $5 million to get off the ground. Would Allen & Co. prime the
pump with $1.5 million? Allen put the usual question to Fields: Will you personally
take 10% to 30% of the deal? Sure, Fields replied, if I had the money, but I
haven't a dime. Allen arranged a loan of $150,000. Fields took 10% of the Allen
stake in Omnipoint.
Fields received from Omnipoint five-year warrants that converted to common stock, a seat on the board and a three-year contract to handle all of the firm's investment banking. It would be years before the investment would pay off, but Fields would have income from investment banking work for rent and spending money.
In January this year, Omnipoint went public at $16 a share; the stock sold recently at $31. Allen & Co.'s $1.5 million in stock and warrants is worth $103 million. Fields, 40, now an Allen & Co. managing director, has taken out more than his original investment in fees. His Omnipoint holdings are worth $15 million.
Fields' fellow managing directors are an assortment of ruggedly individualistic buccaneers. Managing director Paul Gould, 50, can well afford the antique toys and stuffed animals that fill his office to overflowing. Managing Allen & Co. Inc.'s $150 million arbitrage fund, Gould has earned a 19% annualized return since l979, compared with the market's 15%. Gould has a nose for finding companies that are merger bait, often at first glance unlikely prospects. One was Resource Recycling Technologies. In 1993 Gould, along with Allen & Co., bought a 35% piece of the company for $2 million. Its business of collecting and selling recyclables like cardboard and glass was itself in the dumpster. Then prices started to rise, with cardboard going from $30 a ton to up to $150 a ton. Last year Gould sold the company to WMX Technologies at four times what he and the firm paid.
At 61, managing director Stanley Shuman is a 35-year veteran of
Allen & Co. Shuman is one of media magnate Rupert Murdoch's closest advisers,
and he's close to wealthy Manhattan real estate developer Bernard Mendik. Shuman
is no shrinking violet, and his large ego is a source of amusement to some of
his colleagues. "When you tell Stan you know someone, he always goes one
step better," jokes managing director John Schneider. "I'll say, `I
know Bob Wright,' and he'll say, `I know Jack Welch.' " Allen chimes in:
"Everyone of any consequence was once Stan's roommate."
All those mergers and acquisitions people? "They might as well be hot dog vendors."
Allen & Co.'s chairman is Donald Keough, 69. The day after retiring from Coca-Cola as president in 1993, Keough became chairman of Allen & Co. With his legendary Rolodex, Keough helps open doors. And occasionally, he assists in a side of the business that Herbert Allen despises: the ceremonial. At a recent event, Keough was schmoozing with clients and potential clients when Allen, who likes dinner at 5:30 p.m. and bed at 9 p.m., was probably fast asleep.
Allen himself is a somewhat aloof and physically restless man. He's constantly on the move between a house he helped design in Williams town, Mass., his condo in Sun Valley, Idaho, a rustic ranch in Cody, Wyo. and his apartment in New York City's Carlyle Hotel. One gets the sense that even as he answers your questions, part of his mind is simultaneously somewhere else. Early to bed, he's early to rise, usually walking his dog before 6 a.m. and occasionally working out at the Allen & Co. gym before 7 a.m. Says managing director John Simon: "I don't know him at all. I wish I did." Keough, with his warm, avuncular manner, is as close as Allen has to a business confidant.
"Herbert Allen is not a conventional person and doesn't try to run a typical operation," says Warren Buffett. That is something of an understatement.
That atmosphere attracts interesting people. John Simon has three graduate degrees and is known as Dr. Sour because he's never met a deal that at first sniff he's liked. Second sniff, however, has led him to Applied Imaging, a medical instrumentation company that is about to go public through Montgomery Securities at around seven times Simon's original $2 million investment.
Managing director Enrique Senior, 53, is a Cuban immigrant who has three undergraduate degrees and an M.B.A. He played a key role in Cap Cities/ABC's merger with Disney, as well as in the original Columbia sale to Coke. "Senior really knows our business," says Tom Murphy, retired chief executive of Cap Cities. Adds Buffett: "We only had three days to do the merger, or not at all. Senior did a masterful presentation."
John Schneider, 57, the firm's institutional salesman, is cut from a different cloth. He's a raucous practical joker. He once rode a horse into a Sun Valley cocktail party, during Allen's annual conference. "He knows every body," says superentrepreneur Wayne Huizenga, who has used Allen & Co. to raise $400 million in the last 12 months to fund acquisitions for Republic Industries (Forbes, Nov. 20, 1995). Schneider lined up the first $100 million for Republic by signing up eight investors while they were sitting around a pond at the Sun Valley conference.
Nancy Peretsman, 41, is one of the rare recent hires. She came
over from Salomon last year. Allen had been looking Peretsman over for a long
time. As a student at Princeton in the 1970s, she baby-sat for Allen's children
and had a summer internship at Allen & Co. working for Paul Gould. She kept
in touch and, in 1980, Herbert Allen handed her some business when he was running
Columbia Pictures. Kirk Kerkorian had made a hostile bid for Columbia Pictures.
Allen gave Peretsman, then an associate at Blythe Eastman Dillon, the assignment
of writing a fairness opinion on his offer. She parlayed that success and moved
on to Salomon as a media specialist. Last year she finally signed on at Allen
Peretsman says she joined him in part because she wanted a chance to invest in the deals she develops rather than just getting paid for them.
Not everything Allen does turns to gold, which has encouraged
him to keep the firm small. Allen Value Partners, a $100 million fund for institutional
investors, is being liquidated after earning an average of 12% annually for
its seven years, a return Allen sheepishly calls mediocre. Besides not doing
especially well, the fund created some conflict of interest problems for the
firm. It comes down to this: Dealmaking and investing is Allen's strength; running
In short, Allen & Co. is chiefly a function of what its principals are good at. It is a loose confederation of individual dealsters. In 1986 Allen created a special class of "B" shares that would be handed out to his managing directors. The idea was that increased stock ownership might encourage more cooperation among the principals, more synergy. He's not sure it's worked. Now he prefers rewarding people with options on some of the firm's holdings rather than stock in the firm.
Allen once said he has lunch with his managing directors every Wednesday "to keep them from killing each other." What holds them together is their relationship with Herbert Allen and the system that gives them support but imposes few rules on them.
This is not a place where you have to appear busy if you are not. Stanley Shuman usually takes a month off a year to ski at Vail. Short of utter disaster, Enrique Senior leaves the office for the tennis court promptly at 4:30 p.m. You get no brownie points here for working long hours or churning out impressive reports. Quite the contrary: If you appear to be working too hard, Herbert Allen may order you off to a safari in Africa, which he once did with Jack Schneider over his protests.
What these people have in common, besides unconventional personalities and a liking for risk, is a relationship with key clients that goes beyond the usual investment banking relationship and makes them key advisers. Nancy Peretsman, for example, is close to Laurence Tisch, to the senior partners of Boston Ventures and to Gustave Hauser of Hauser Communications.
Jack Schneider counts among his best clients, besides Wayne Huizenga,
Nike's Philip Knight, retired Wesray partner Ray Chambers and WMX's Phillip
Paul Gould deals with John Malone of Tele-Communications, Inc.; Edgar Bronfman Jr. of Seagram; and Brian Roberts of Comcast.
Still laboring in relative obscurity in the bowels of the firm is Herbert Allen III. The young Herbert, 29, walks and talks like his father, right down to his boisterously uninhibited laugh. Fresh from Yale in 1989, he worked for mutual fund house T. Rowe Price and London investment firm Botts & Co., before joining the family firm. If he acquits himself well, there's little doubt he can succeed his father. His father owns slightly less than 45% of Allen & Co., and his family owns 35% more. The 14 managing directors and a few other employees own the rest.
Is Allen's low overhead, principal-to-principal, virtually paperless dealmaking the wave of the future?
A prominent competitor who insists on anonymity disparages some of Allen's more sweeping predictions. He says: "Look at their market share. It's minuscule in every category--from IPOs to underwriters to investment banking. Allen charges lower fees because it can't always command the highest fees. They charge what they can get. Herbert Allen should be less of a hypocrite, saying that he doesn't care about doing more investment banking business. They even cultivate an image that they don't care about their image, which is far from the truth. When they were representing QVC they were talking to the press every day."
Yet even this competitor sees shrinkage in the merger and acquisition fees that bring in billions of dollars every year to The Street. Allen & Co. got just $2 million for its role in the giant Disney-Cap Cities/ABC deal. Warren Buffett, an Allen client on the deal, points out it wasn't typical because, unlike most corporate chieftains, he and Tom Murphy were experienced dealmakers. They didn't need reams of computer printouts and platoons of M.B.A.s. All they wanted was a fairness opinion to present to their board. Herbert Allen had been helpful, and so his firm got the relatively modest fee. "I asked them to pay me what they wanted to," says Allen. In putting it that way to the penny-pinching Buffett, he must have known he wasn't in for a king's ransom.
The future lies somewhere between Allen's radical view and the present situation. Many corporate executives, little more than hired hands, don't have the confidence or the power to do giant deals without plenty of support. On the other hand, sheer economics are certain to drive down fees and eliminate a lot of financial busywork.
Herbert Allen thinks sell-side analysts--the folks who peddle investment ideas to institutions on behalf of investment houses--are a useless breed. "How dare they push stock they do not own," he says. He is contemptuous of investing institutions that sit around waiting for sell-side analysts to bring them ideas. "Instead of spending time with analysts, the institutions should spend it with the companies," says Allen. "They should bypass Wall Street." In a bear market, whenperformance is harder to come by, this could well come to pass.
If Allen is right, all you M.B.A. candidates out there might want to rethink your plans of looking for a job on The Street. And all you corporate executives can stop wining and dining with investment bankers--and get out there and do your own deals.
Forbes Magazine - Issue Date July 1, 1996