Franklin Hugh Money

In nineteen eighty-seven, Reginald Lewis bought a company for nine hundred and eighty-five million dollars.

He put in sixteen million of it.

That is not a rounding error and it is not a metaphor. Sixteen million dollars of his own cash bought fifty-one percent of a business with sixty-four operating companies in thirty-one countries. The other nine hundred and sixty-nine million came from somewhere else, and where it came from is the entire subject of this episode.

This teaches the leveraged buyout: what it is, where the money comes from, why the target company ends up paying for its own purchase, and what the arithmetic does to the buyer's return in both directions.

Start with the mechanism, because the mechanism is the whole story.

A leveraged buyout is a purchase made almost entirely with borrowed money, where the thing being bought is also the collateral for the loan. You do not pledge your house. You pledge the company. The lenders are repaid out of the company's own cash flow, and if the company cannot generate enough of it, the lenders take the company.

Think about what that changes. If you buy a business with your own money, the question is how much money you have. If you buy it with debt secured by the business, the question is whether the business produces enough cash to service the debt. Those are completely different questions, and only one of them is about you.

That distinction is why the instrument mattered so much to this particular man.

Reginald Lewis was born in East Baltimore in nineteen forty-two. He ran a newspaper route at ten, grew it from ten customers to more than a hundred, hired his mother to do the deliveries, and sold the route at a profit. He went to Virginia State on a football scholarship, quit the team, and graduated in economics in nineteen sixty-five.

Then something happened that has not happened since. He was selected for a summer program at Harvard Law School, impressed the faculty over those weeks, and was admitted to the law school without ever having applied. By the school's own count, across a hundred and forty-eight years he is the only person that is true of.

He graduated in nineteen sixty-eight, went to Paul, Weiss in New York, and two years later helped found one of the first Black law firms on Wall Street. He spent the nineteen seventies structuring deals for other people. Then he decided to stop structuring them for other people.

His first one was a pattern company.

In nineteen eighty-four he bought the McCall Pattern Company, the tissue-paper sewing patterns sold in fabric stores, for about twenty-two and a half million dollars. He borrowed nearly all of it. His own contribution was one million dollars.

He then ran it, which is the part people skip. He added knitting patterns and greeting cards, cut costs, and pushed cash flow up. In nineteen eighty-seven he sold it for sixty-five million dollars, and kept real estate and other assets on top of that, bringing what he took out of a one-million-dollar investment to roughly ninety million.

Ninety to one.

Understand where that number comes from, because it is not genius and it is not luck. It is arithmetic. He owned the thin slice of the capital structure called equity: the piece that gets paid last, after every lender is made whole. When you own a small slice and the whole thing appreciates, the gain lands almost entirely on your slice. Leverage does not create value. It concentrates whatever value shows up onto a very small base.

Which means the same arithmetic runs backward with the same force. Had McCall's cash flow fallen instead of risen, the lenders would still have been owed every dollar, and the one million dollars of equity would have been the first thing erased. Ninety to one in one direction is total loss in the other. The structure does not care which way it points.

Then came the deal that made him.

Beatrice Companies had been bought by the buyout firm Kohlberg Kravis Roberts and was being taken apart and sold in pieces. The international food division was one of those pieces: sixty-four companies in thirty-one countries. Potato chips in Ireland, ice cream across Europe, supermarkets in France.

Lewis bid nine hundred and fifty million dollars. He raised it to nine hundred and eighty-five million to win, beating out Citicorp and a French bidder.

A banker at the time put the problem to him in one sentence: nobody knows who the hell you are.

That was the actual obstacle, and it was not really about credentials. He had Harvard, Paul Weiss, and a ninety-to-one deal already behind him. What he did not have was the thing that usually moves money at that size, which is a room full of people who had known him for twenty years.

So he used the instrument that does not require that room. Michael Milken and Drexel Burnham Lambert wrote a letter saying they were highly confident they could finance the bid, and then they did: four hundred and fifty million dollars of high-yield bonds.

High-yield bonds are corporate debt from borrowers rated below investment grade. The old nickname is junk bonds. They pay more interest because there is a real chance of not being repaid. Milken's insight, and it was a genuine one, was that a diversified pool of them paid more than the losses cost.

Say the rest of it plainly. Milken pleaded guilty in nineteen ninety to six felony counts, was sentenced to ten years, served two after cooperating, and was pardoned in twenty twenty. He remains barred from the securities industry for life. All of that is true. So is this: the market he built priced borrowers on their cash flow instead of their pedigree, and that is the only reason this deal had a lender at all.

Drexel took twenty-six percent of the equity for arranging it. Lewis put in sixteen million dollars in cash and held fifty-one percent. Control.

Now watch the last piece, because this is where a leveraged buyout becomes almost self-financing.

On the day the deal closed, Lewis sold Beatrice's Canadian business for two hundred and thirty-five million dollars, its Australian business for a hundred and five million, and a Spanish operation for ninety million. Four hundred and thirty million dollars, raised out of the company he had just bought, applied against the debt he had just taken on to buy it.

He kept going. By the end of nineteen eighty-nine he had sold another four hundred and thirty-eight million dollars of it, Latin America and most of Asia, and cut the debt down to about a hundred million dollars, holding onto a Western European core.

That is deleveraging, and it is the standard second act of every buyout. Borrow to buy the whole thing, then sell the parts you do not want and use the proceeds to pay off the borrowing. The company purchases itself, in installments, out of its own balance sheet.

It worked. Nineteen ninety was the peak: one and a half billion dollars in sales and forty-five million dollars of net income. In nineteen ninety-one Reginald Lewis was on the Forbes list of the four hundred wealthiest Americans, at three hundred and forty million dollars, and he was the only Black person on it.

He was diagnosed with brain cancer in late nineteen ninety-two and died on the nineteenth of January, nineteen ninety-three. He was fifty years old.

Here is the assessment, and it has two halves.

The first half is that he judged the instrument correctly. Every door that ran on relationships was closed, and he stopped knocking on it. A leveraged buyout is underwritten on the target's coverage ratios, not on the buyer's family, and that made it the one path into a billion-dollar transaction that could not be quietly denied him. He did not get financed because Wall Street decided to be fair. He got financed because the numbers worked and someone was willing to price them.

The second half is the part the retellings leave out. A structure with that little equity in it has almost no room for a bad year, and the bad years arrived. The company lost seventeen million dollars in nineteen ninety-two. In that same year its board approved a twenty-two-million-dollar bonus for Lewis, described as supplementary pay covering the previous five years. After his death, the shareholder holding Drexel's old stake sued, arguing the board had failed in its duty to the company. None of it was ever proven. The case settled in nineteen ninety-seven, with the estate returning about fifteen million dollars. His widow, Loida Lewis, ran the company for several years and then sold its core, and by the end of the decade the empire was a set of smaller businesses being sold off one at a time.

Leverage is not a strategy. It is an amplifier, and it amplifies whatever is actually there.

What was actually there, in nineteen eighty-seven, was an operator who had already taken a sewing-pattern company from twenty-two million dollars to ninety, and who understood that the question the bond market asks is not who are you. It is: can it pay.