When legendary deal maker Teddy Forstmann ran into trouble on his billion-dollar-plus investment in telecom McLeodUSA, he placed one call -- to Chris Davis. Can she save his assets this time?
By Jenny Anderson
February 2003
Institutional Investor Magazine
It’s 3:00 a.m., and snow is blowing up, down and sideways as Chris Davis inches her blue C-class Mercedes along Iowa’s Interstate 380 past dormant cornfields and abandoned barns. She has been haggling with bondholders day and night in a desperate bid to restore solvency to her employer, phone company McLeodUSA, ten miles up the road in Cedar Rapids. Christmas is only a few weeks off. Her husband and teenage daughters are a thousand miles away at Hilton Head. As she pulls into the parking lot of the garden condominium complex she’s been calling home and steps out into the blizzard, Davis shivers and wonders, What am I doing here?
It’s a rare moment of doubt for the high-powered executive -- but she raises a good question. Davis is there at the bidding of Wall Street deal maker Theodore Forstmann, 62, who controls 58 percent of McLeod (see box) and stands to lose $1.2 billion -- mostly his clients’ money but enough of his own to hurt -- if Davis, CEO since April 2002, can’t salvage the teetering telecommunications company. McLeod’s share price has fallen from $36, its peak in March 2000, to less than two bits. But the real reason that this petite ex-tomboy is in Iowa in the dead of winter 2001 is that she has a zest for impossible challenges. In the 1990s Davis helped Forstmann pull Gulfstream Aerospace Corp. out of a nosedive.
“I’d rather jump in with both feet, work hard and accomplish stuff than sit in a back office and be bored,” she says.
The morning after her crisis of confidence, Davis, looking refreshed as always, reports for work at 7:00 a.m. sharp. “I wanted her talent, her ability -- and her stamina,” confides Forstmann."It’s unworldly. Chris Davis does not need as much sleep as other human beings.”
That’s a good thing, since many long nights lie ahead for her. McLeod remains in critical condition. One of several phone companies that cropped up to take advantage of telecom deregulation in 1996, McLeod soared in the late 1990s only to crash to earth like a spent communications satellite. It declared bankruptcy in January 2002.
McLeod’s prospects are problematic at best. The Iowa telecom offers local and long-distance phone service and dial-up and high-speed Internet access, as well as customized telecom services to residential and business customers. It spans 25 states. And for now, McLeod enjoys a sizable discount on its use of the Baby Bells’ phone lines to build its customer base.
But the Federal Communications Commission may soon do away with this crucial price break, and competing on a level playing field with the Baby Bells would be daunting for any telecom. Moreover, the crash of tech and telecom stocks so rattled investors that the McLeods of the world find it almost impossible to raise the vast sums they need to finish building their own telecom networks to be able to battle the Baby Bells. Adding to McLeod’s woes when Davis arrived as COO and CFO in August 2001 were too much debt and too little strategy, as well as poor management.
But the miseries of competitive local-exchange carriers, or CLECs, like McLeod go much deeper than slipshod management, contends Scott Cleland, founder of independent tech research firm Precursor Group. “If it were management, would 300 companies have gone out of business?” he asks. “The business model doesn’t work. It was a regulatory dream.” For her part, Davis insists that “we’ve broken the CLEC model.”
So far she has restructured the telecom to shuck off billions in debt, raise cash through asset sales, improve shoddy service and sharpen McLeod’s strategy. The company no longer tries to sell its services in all 50 states, for instance, and it takes only ten to 12 days, instead of 53, for McLeod to hook up customers. For the first time in its ten-year existence, it reported positive earnings before interest, taxation, depreciation and amortization on its core telecom business in last year’s second quarter, ending in June, of $6 million on revenues of $254.5 million. It did even better in the third quarter, ending in October: $10 million on revenues of $243.5 million. “People aren’t going to stop using telephones or computers,” Davis says. “They are not going to go backward and not go on the Internet [over McLeod’s telecom lines]. We’ll continue to grow.”
Yet the reality is that McLeod has never made a profit from offering telecom services and doesn’t expect to until after 2005, and it operates in an unsettled marketplace. Davis’s rescue mission recently got more formidable when FCC chairman Michael Powell said that he’d like to do away with the discount that CLECs get on renting established phone companies’ lines.
In many ways Davis’s attempt to save McLeod is a paradigm of corporate governance in the postbubble era. In the 1990s, of course, the CEOs of tech and telecom companies were admired for their vaunting vision, not for their down-to-earth management skills. No profits? Scant business experience? No matter -- provided you had a brilliant idea for a company. The wreckage of this genius-knows-best school of management lies everywhere. But now CEOs familiar with the nuts and bolts of finance, operations management and marketing are being brought in -- Davis at McLeod, Edward Breen at Tyco International, Patricia Russo at Lucent Technologies -- to repair the damage left by New Economy types.
DAVIS WAS BORN ON AUGUST 26, 1950, AT EGLIN Air Force Base in Florida to Colonel Joe Davis Jr. -- a test pilot who flew fighters during World War II and the Korean War -- and his homemaker wife. The middle child of three girls, Davis lived the peripatetic life of an air force brat. She was 22 before she wore jeans: “I guess I was raised to be a lady,” she says.
But Davis was also mad about sports -- waterskiing, running and playing golf with her father. When she was ten she got a go-cart, and in high school in Florida, she rode a Honda motorcycle. “I guess I was my dad’s son,” Davis laughs.
In 1968 Davis entered the University of Florida expecting to pursue premed studies. But she became intrigued by the world of business and switched majors. She excelled, eventually winning a scholarship to earn her master’s in finance at Florida -- the only woman in the program.
Davis wanted to become an investment banker, but Wall Street was in the doldrums when she graduated, so in 1976 she joined General Electric’s financial management training program. Davis would spend the next 17 years at GE, rising to become vice president of finance at the government electronics systems division, which developed weapons systems for navy cruisers and destroyers. In 1993 GE sold its aerospace business to Martin Marietta Corp., which offered Davis a good job.
But around this time her old boss at GE, Fred Breidenbach, who’d become president and COO of Gulfstream, recommended Davis to Forstmann as a financial whiz who’d be useful in turning the Savannah-based jet maker around.
When Davis interviewed in New York at Forstmann’s firm, Forstmann Little & Co., one of the partners asked her, “Will you really be comfortable hanging around aerospace manufacturers and all the guns and trucks in Savannah, Georgia?”
“What’s new about that?” shot back the colonel’s daughter. “I’ve been around that sort of stuff my whole career.”
The Gulfstream challenge appealed to Davis, and the potential financial payoff wasn’t bad, either. But accepting the job entailed some family upheaval. In 1982 Davis had married Lee Rosenberg; the couple have two girls, Angela, 18, and Kari, 15. So that Davis could work out of Gulfstream’s headquarters, Rosenberg sold his successful Philadelphia business, Victor/Sacks Furs, and the family decamped to Hilton Head, just across the Georgia line.
Davis is, almost literally, all business. “I am not a socialite,” she says in her polite but coolly professional voice. Still an athlete, she likes to run five miles on Saturdays and Sundays. Every weekday except Friday Davis works out for 45 to 60 minutes. Once, Forstmann called her at home at midnight, and she answered the phone short of breath. “Are you okay?” he anxiously inquired. “Sure. I was just on the treadmill,” said Davis.
The country was in recession when she joined Gulfstream as CFO in 1993. The maker of business and private jets was losing market share. Of more immediate concern, it was in violation of covenants on more than $400 million of bank loans. Forstmann, who’d invested $850 million in debt and equity in Gulfstream since 1990, recognized that he either had to cut his losses or take control of the company.
Gulfstream’s problem was that it focused entirely on quality -- making better jets -- rather than on building better ones for less. Cheaper-priced rivals were gaining altitude. Gulfstream responded by lowering prices to be more competitive, but costs stayed high and profits went into a tailspin.
Forstmann, putting himself in charge, formed a five-person executive committee, and this capitalist politburo proposed a breathtaking plan. Along with slashing costs through layoffs and other conventional measures, it recommended converting Gulfstream’s subordinated debt -- the bank loans -- into preferred stock to save on interest expenses. But that was hardly Forstmann and Davis’s boldest move: They decided to invest $800 million in developing the priciest private jet ever built -- the Gulfstream V. “It was the most dramatic rabbit-out-of-a-hat performance ever,” says one banker.
Davis played a pivotal role. She made owning the $35 million jets easier by devising a fractional-ownership program and launching a finance company. She forged partnerships with suppliers to share development costs, making the planes less expensive to build.
The results were dramatic. In 1993, the year Davis joined the company, Gulfstream lost $275 million on revenues of $887 million. Five years later profits were $373 million on revenues of $2.5 billion.
Davis proved herself to be no yes-woman. “There were a lot of times when I wanted to do things I thought would be neat, since my forte was selling,” says Forstmann. “She’d say, ‘That’s a nice idea, but it won’t make money.’”
Davis helped to take Gulfstream public in 1996, ran a secondary offering in 1998 and that same year negotiated the $250 million acquisition of KC Aviation, a leading finisher and refurbisher of big corporate jets. She acted as the finance brains on the executive committee when Gulfstream was approached by General Dynamics Corp. with a takeover offer in late 1998; after rejecting the initial bid, the five members accepted one for $5.3 billion in the spring of 1999.
Forstmann Little made 15 times its original equity investment. Davis herself made at least $15 million on Gulfstream stock and options. She agreed to stay on through the transition but once again started fielding calls from headhunters. One suggested she consider becoming CFO of ONI Systems Corp., a California maker of optical networking equipment. “It piqued my interest,” says Davis. “It was a start-up company, it was pre-IPO, and it was in the tech sector, and I’ve always been interested in high-tech companies.”
Davis joined ONI in May 2000, uprooting her family from Hilton Head and relocating them to Los Gatos, California. She propelled the networking company through an IPO and secondary stock and convertible offerings before Forstmann called in May 2001 to offer her a job at McLeod.
Davis was interested, but she had certain demands this time: She wanted to run the company (although she’d settle for the titles of COO and CFO); she wanted McLeod to relocate her family back to Hilton Head so her daughters could finish high school with their friends; and she wanted to be compensated for forfeiting her options at ONI. She negotiated an $8 million signing bonus plus $2 million in relocation costs, as well as options worth $4 million to $10 million.
MCLEODUSA HAD BEEN FOUNDED IN 1993 BY prominent Cedar Rapids native Clark McLeod after the Iowa Utilities Board let him offer local and long-distance service to residential and small-business customers. The former schoolteacher had built a long-distance phone company, TelecomUSA, in the 1980s and sold it to WorldCom in 1990 for $1.25 billion. Having seen other elements of the telecom industry -- such as equipment and 800 numbers -- deregulated, he reasoned that local telecom services would be freed up as well.
McLeod was prescient. In February 1996 then-president Bill Clinton signed into law the Telecommunications Act, whose proclaimed purpose was to promote lower phone rates through greater competition. The regional Baby Bells, like Bell Atlantic and SBC Communications, and the long-distance providers, such as AT&T Corp. and WorldCom, had been cordoned off from one another’s markets. But now it was to be anything goes -- with one key proviso. The act stated that to throw open the gates to competition, the Baby Bells would have to rent their local lines at discount rates not only to established long-distance companies but also to start-ups -- the CLECs, like McLeod. Only when the FCC determined that true local phone competition existed could the Baby Bells compete to offer long distance.
McLeod, whose local and long-distance service in Iowa and also Illinois had been growing steadily, went public in June 1996, raising $276 million. The company had a straightforward strategy. It would rent lines from the Baby Bells at artificially low rates and resell local, long-distance and Internet service to residents and small and medium-size businesses, while constructing its own fiber-optic network against the day when the Baby Bells could boot McLeod off their lines.
The Cedar Rapids company’s comparative advantage would be concentrating on modest-size businesses in the West and Midwest -- clients that the Baby Bells didn’t care much about but that McLeod estimated represented a $14 billion market. To help promote its plan, McLeod bought one of the largest non-Bell publishers of white and yellow pages to be essentially a direct-marketing tool: Every phone book distributed in 18 states sported the McLeod logo.
Spurred by the IPO and the Telecommunications Act, McLeod raised billions and went on a buying spree. Between 1996 and 2001 the company tapped the capital markets for $940 million in equity, in addition to the IPO, and almost $3 billion in high-yield debt. McLeod used the money to build thousands of miles of fiber-optic lines crisscrossing the country as well as acquire established phone companies with their own networks. It also sought out start-ups, such as Splitrock Services, a Houston-based national data provider, whose network could be integrated into McLeod’s.
At the heady height of the Internet frenzy, McLeod decided to expand its franchise from 11 states to 21. But it needed capital, and in late 1999 the high-yield debt markets were inhospitable. So McLeod turned to the private equity market.
Forstmann Little invested $1 billion in the company in October 1999 in exchange for 12 percent of McLeod and two seats on the 13-person board. Three months later McLeod laid out $2.9 billion for Splitrock, and seven months after that, it paid $532 million for Dallas-based broadband supplier CapRock Communications.
“There was a D-day approach to sales,” recalls Steve Gray, who at one time was co-CEO with McLeod and remains president. “After the ’96 act there were two to three years before the Baby Bells could do local and long distance. If we didn’t have a foothold, we’d have a tough time defining our position.”
Revenues, not profits, were all that mattered, and they piled up impressively. McLeod’s sales of $1.4 billion in 2000 represented a 132 percent increase over 1998’s $604 million. At the start of 1999, the company peddled its services from sales offices in 68 cities to 186,200 customers with 7,120 miles of fiber-optic lines; by year-end 2001 it had offices in 150 cities, catered to 452,313 customers and owned 31,000 miles of fiber-optic lines. The employee ranks had swollen to more than 8,600 from 2,077 in 1996.
Yet by mid-2001 it had also become brutally clear to Forstmann and McLeod’s other shareholders, if not necessarily to its managers, that the company had urgent problems. Even as it was reporting growing revenues and Ebitda, it was struggling to pay the $365 million annual interest on its $3.9 billion of debt. In July 2001 the company had to draw down an additional $175 million of its $1.3 billion credit facility just to make loan payments and finance continuing operations, leaving $550 million of reserves. Forstmann had to decide whether to invest additional capital, and time, or cut his losses. He concluded that he should try to save the company (and his investment) -- and called in Chris Davis. He told Clark McLeod, “I know who I want, and if I can’t get her, I doubt that I will do this.”
That August Forstmann unveiled dramatic measures: Forstmann Little would invest an additional $100 million in McLeodUSA and the firm would exchange its original convertible notes for new convertible preferred shares that paid no dividends, saving precious cash flow. In return, Forstmann would become chairman of the executive committee and double his stake; Davis would take over as COO and CFO; and four new directors of Forstmann’s choosing would join McLeod, including former GE treasurer Dale Frey and former Major League Baseball commissioner Peter Ueberroth.
Drastic actions were in order. Following seven consecutive quarters of rising revenues and Ebitda, McLeod reported that its third-quarter-2001 revenues were $450 million, down from $473.6 million the quarter before, and posted a loss on Ebitda of $8.3 million, a decline from the second quarter’s $34.2 million gain.
The badly shaken postbubble markets, meanwhile, were losing their appetite for financing companies that had a story to tell but no positive numbers on an income statement to back it up. For 2001 McLeod would wind up losing $3.6 billion, or $4.50 a share, on a massive goodwill write-down. In 2000 losses had been $477.3 million, or $0.95 a share. By the start of 2002, McLeod’s stock price had plummeted 97 percent from its March 2000 peak.
Clark McLeod realized that Forstmann and Davis were the best hope for rescuing McLeodUSA and the savings of thousands of Cedar Rapids investors, including many of the company’s employees. So he agreed to defer to Forstmann, bowing out as chairman in April 2002.
When Davis arrived in August 2001, McLeodUSA was a disaster that was no longer waiting to happen. It had 27 separate billing systems. Its switches -- which direct telephone traffic -- could not communicate with each other. The company’s distinct feature codes -- commands to the system for such things as call forwarding and voice mail -- numbered a staggering 5,400. Turnover was 165 percent in sales and 135 percent in customer service. “There were so many things to clean up,” recounts Forstmann. “Bad accounting -- we didn’t know what anything cost, we didn’t know what we were doing.”
Davis saw right away that she needed to find out what made McLeod not tick. So for several weeks she hauled top managers into the company’s drab gray conference rooms to grill them on what their employees did, how their performance was measured and how they were compensated. At first many balked. Davis told recalcitrant managers that she would be happy to wait but that they weren’t leaving her office until they told her what she needed to know. Some interrogation sessions dragged on until three or four in the morning. “When people get tired,” explains Davis matter-of-factly, “they break down a little bit.”
Within two months, on October 3, Davis set forth a rescue plan. She formed five teams of executives to refocus McLeod on offering standardized instead of grab-bag local, long-distance and high-speed Internet services, and in 25 states instead of 50. She announced that the company would sell off $450 million in noncore assets, lay off 15 percent of its workforce, consolidate offices, scale back capital expenditures by $50 million and write off $2.9 billion, mostly goodwill.
Davis’s marathon meetings with McLeod managers persuaded her to import talent to Cedar Rapids. She has recruited several former Gulfstream executives: G. Kenneth Burckhardt, as CFO; Shawn Vick, as head of sales; Thomas Vater, as general vice president of finance; Cheri Roach, as chief information officer; and Roy McGraw, as general vice president of materials."She’s not intimidated by people with good ideas,” says Roach. “She welcomes a lot of viewpoints, but then she is decisive.”
The GE-trained Davis expects a lot of her people. “Jack Welch really understood that there is nothing wrong with setting the bar for excellence,” she says, “and there’s nothing wrong with asking people to perform.”
But there were more-pressing matters than motivating employees. McLeod’s structural shortcomings were matched by its financial deficiencies. She and Forstmann put their heads together in fall 2001 to devise a bailout blueprint. Forstmann Little was to buy McLeod’s directories business for about $535 million and pump $100 million -- the money that Forstmann had offered in August that year but had yet to fork over -- into the company (increasing the LBO firm’s holding to 45 percent). About $560 million of the proceeds would buy out bondholders, reducing the $365 million interest nut to $50 million.
This scheme, however, also involved giving the proceeds of the sale of a valuable asset to unsecured junior lenders -- the bondholders -- rather than to the senior secured lenders -- the banks. “It was a huge issue,” says Jeff Werbalowsky, head of restructuring at investment bank Houlihan Lokey Howard & Zukin, which represented McLeod in its prepackaged bankruptcy."How do you get the banks to agree to let money flow to the juniors? What’s in it for them?” Forstmann and Davis proposed to placate the banks by paying down part of their credit lines.
In early October 2001 Forstmann and Davis set forth their strategy for James Lee, vice chairman and head of bank lending at J.P. Morgan Chase & Co. Lee bought the broad outlines of the deal. “The bankers actually liked Forstmann,” marvels Werbalowsky. “They patted him on the back and smiled at him.” Says Forstmann: “The bank agreed to the deal because I said, ‘I will run this thing, and Chris will run it on a day-to-day basis.’ They knew us from Gulfstream.”
Now it was up to Davis and Forstmann Little partner Thomas Lister to sell the deal to 40 other banks. Several opposed it. “One bank said, ‘We will get our money, we will liquidate the company, and we’ll just call our loans,’” recalls Davis. Her blunt response: “You don’t have any right to call your loans. We’re not in breach, we’re not in default, we’re not missing any covenants.” Such direct talk, delivered late at night on occasion in the snows of Iowa, got the rest of the banks on board by December.
Next Forstmann and Davis turned to the bondholders. Their offer: $560 million in cash and a 14 percent stake in the postrestructuring McLeod in exchange for giving up $2.9 billion in junk bonds. An argument in favor of the arrangement -- from the bondholders’ perspective, at any rate -- was that the bonds were then worth about 19 cents on the dollar. Nevertheless, the bondholders, advised by New Yorkbased Chanin Capital Partners, held out for a bigger bag of cash and a larger chunk of equity. What’s more, they insisted that the company’s common shareholders end up with no stock whatsoever.
Forstmann, however, held out for shareholders getting equity. Terms were struck late last January: Bondholders secured $670 million in cash, 15 percent of the postrestructuring equity, and warrants to purchase a further 6 percent of the stock. Common shareholders received 17 percent of the stock. U.K.-based Yell Group bought the directories business for $600 million.
Forstmann and Davis recognize full well that saving McLeod remains a huge undertaking. Though more focused, better run and on a surer financial footing, the company faces enormous challenges. Competitors dwarf it and also increasingly outflank it in product offerings. SBC, for instance, has a market capitalization of $100 billion (versus McLeod’s $196 million), annual sales of $45 billion and net income of $7.2 billion.
Nor is the FCC making McLeod’s plight any less precarious. The agency is likely to act this month to end the discount McLeod and other CLECs now enjoy on renting local lines from the Baby Bells. That would significantly increase McLeod’s cost of doing business, though the company has been steadily shifting its customers onto its own lines; they handle some 83 percent of McLeod’s total traffic, versus 73 percent at the end of September 2001. And in an added setback, regulators have awarded licenses to the Baby Bells to offer long-distance service in 35 states. That should allow them to compete more aggressively with CLECs like McLeod.
“Do I believe we should get a free lunch forever?” asks Davis. “No. Companies need an opportunity to compete, and we need to make sure that we build businesses that can really compete.” If anyone can do that under adverse conditions -- the corporate equivalent of a Cedar Rapids snowstorm -- it just may be Chris Davis.
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The temptation of Teddy Forstmann
Theodore Forstmann used to roll his eyes whenever anyone mentioned a Wall Street firm that did high-yield business. Once, a a subordinate at Forstmann Little & Co invited a Drexel Burnham Lambert banker to the firm. “Don’t ever bring another piece of slime like that in here again,” Forstmann allegedly told the employee. In the early 1990s Forstmann Little was the only major LBO firm that shunned large amounts of leverage and relied for financing mainly on its own in-house mezzanine fund, backed by blue-chip investors like Boeing Co. and Eastman Kodak Co.
Such conservatism about debt -- Forstmann sounded like an old-time preacher denouncing demon rum when he railed against junk bonds -- and a sharp deal maker’s eye made Forstmann’s funds enormously successful. But, like Elmer Gantry, Forstmann was not above temptation.
Caught up in the technology and telecommunications stock frenzy, he invested in not one but two telecoms -- both of them highly leveraged. Between 1999 and 2001 Forstmann Little poured $1 billion into McLeodUSA and $1.5 billion into XO Communications, so-called competitive local-exchange carriers, or CLECs, which sprang up to take on the Baby Bells as Washington deregulated local phone markets.
By June 2002 both companies were bankrupt, victims of a capital markets meltdown, ferocious competition and deregulatory upheaval in the telecommunications industry. In October Forstmann Little walked away from XO (it had written off its entire investment as of September 30, 2001).
To many observers, McLeod’s prospects today don’t look a whole lot better than XO’s. Considering that McLeod’s market capitalization is only about $196 million, Forstmann Little’s now $1.2 billion investment -- equal to a 58 percent stake -- has declined, on paper, by 90 percent.
But Forstmann is going all out to save McLeod and has brought in a one-woman salvage crew, Chris Davis, to rescue the company (story). “McLeodUSA had a defensible business plan in what we now know is a very difficult industry,” reasons Forstmann. “Whether the industry is all that it was hyped up to be -- which it’s not -- the business plan was defensible, and that’s what we are prosecuting now. The difference is we have vastly superior management.”
But how did Teddy “Check the fundamentals!” Forstmann ever get lured into the wild and wacky world of telecoms in the first place? His usual quarry is mature companies with steady cash flows and dominant positions in established industries. Previous Forstmann Little investments include General Instrument Corp. and Gulfstream Aerospace Corp. -- reasonably priced, basically sound businesses that needed new products or major tune-ups. Forstmann Little ultimately made a profit of about $10 billion on that pair.
McLeod and XO, by contrast, had never made money. They were operating in a newly but only partially deregulated market that had yet to shake itself out. Moreover, as Forstmann now acknowledges, McLeod lacked solid management.
Then whose bright idea was it to toss $2.7 billion into a volatile, high-risk sector like telecoms? “As head of the firm, I take responsibility,” Forstmann declares. But sources close to the firm say that in private he casts some of the blame on others, including Erskine Bowles, an exinvestment banker and a former chief of staff for president Bill Clinton. Bowles joined Forstmann Little as a partner in January 1999. That April the firm informed its investors that it was exploring “growth” investments in telecoms, health care and outsourcing, and business investments education. But in a memo to clients, Forstmann Little insisted that it would “apply the same standards and prudence in selecting these investments that it has adhered to in achieving its past record.”
“Forstmann was 59 years old, he had just sold Gulfstream for $5.3 billion, and there were younger people in the firm with ideas,” says a source close to the company. “Erskine was one of them. They said, ‘The world has changed, and Forstmann Little should change with it.’” Bowles, who left to run for the Senate from North Carolina in 2002, declines to comment.
Not all the firm’s investors agree that Forstmann Little applied the “same standards and prudence” to its telecom investments. One aggrieved client is suing. In February 2002 the State of Connecticut charged Forstmann Little with breach of contract and fiduciary duty for exceeding its limits on concentrating capital by investing so heavily in McLeod and XO. The Nutmeg State demanded that the firm return some portion of its $200 million. Forstmann Little’s actions raise “serious concerns” about the “professional conduct expected of a fiduciary,” said Denise Nappier, Connecticut’s treasurer. Forstmann Little, fighting the charges, got the case remanded to federal court, but it has been sent back to Connecticut courts and will be heard as soon as possible, say Nappier aides.
Forstmann Little’s equity returns, as well as its reputation, have taken a hit because of the firm’s telecom troubles and the wider market malaise of the past three years. Yet they remain pretty impressive, all things considered: From 1978, when the firm was founded, through December 2001, Forstmann Little’s equity fund returns averaged 31.6 percent a year, and its subordinated-debt fund returns, 15.1 percent. That’s nothing to sneer at, though it pales beside the 60 percent average annual return on equity and 25 percent return on debt that the firm made between 1989 and 1999.
Forstmann still loathes leverage. Ironically, though, he recently found himself in the middle of a massive restructuring of McLeod’s high-yield debt. He winces at the recollection: “I was in the business for 24 years before this happened and never had anything where we had any problem whatsoever except Gulfstream, which was private, and we didn’t have any public anything. This experience was unique -- and will never be repeated in my life.”
Meanwhile, Forstmann has hunkered down to dig himself, and his investors, out of a hole."It’s 2003, not 1999,” he says grimly. “I’m not headed off to the golf course. I’ve worked ten times harder on this [McLeod restructuring] than I ever worked on Gulfstream. I thought my life would be different at this point, but no one can bat 1.000. My returns will still be phenomenal.” -- J.A.
