MICHAEL MILKEN: THE MIDAS OF THE EIGHTIES TELLS US WHERE TOMORROW'S WEALTH LIES...BUT SAYS HE'S NEVER BEEN MOTIVATED BY MONEY...WHAT TO MAKE OF MIKE? IF MIKE WERE 25...THIS IS WHERE HE'D LOOK FOR TOMORROW'S POTS OF GOLD.
(FORTUNE Magazine) – "When I saw the problems of the Soviet Union...in the latter part of the 1980s, and realized that I had been trained my whole life for the solutions to this problem but could not help, it was stressful."
Let it never be said that Michael Milken thinks small. Who else would call Lee Iacocca--collect, from prison--to offer the unsolicited advice that the Chrysler chairman needed to pump more equity into the company, which was then in one of its periodic downturns? Who else would look out at Latin and South America, as Milken did in the mid-1980s, and conclude that the whole region needed to change its capital structure--and he could show it how? And who else would claim that he could have rescued the Soviet Union--if only those problems hadn't cropped up at the same time he was dealing with certain unmentionable legal problems of his own?
No question about it: Michael Milken has an appreciation of his own abilities that can fairly be called grandiose. In a series of interviews he held with FORTUNE over the past few months, nothing came through clearer than that. Again and again Milken told anecdotes that hinged on his capacity to see things before others did--and to act on them. But while one's natural tendency is to roll one's eyes at such egregious narcissism, in Milken's case it is a tendency that ought to be resisted. After all, if he proved anything in the 1980s, it was that he really could figure things out before others did--huge, important things--and act on them profitably.
The fact is, while you can disagree on whether Milken was a saint or a sinner during his 1980s heyday (see next story), you simply can't argue anymore about the singular importance of the junk-bond market he created. "We securitized business loans," Milken says, and he's right. And look, too, at the businesses he backed with his junk bonds! He was present at the creation of the cable industry and the cellular industry. Milken's junk bonds made it possible for MCI to compete with AT&T. He backed companies like Turner Broadcasting and McCaw Cellular because he saw something others didn't. Yes, this is the party line we've been hearing from Milken apologists for years, but that doesn't make it any less true.
What is also true is that a number of the people Milken originally backed--including Rupert Murdoch and Ted Turner--still talk with him on a regular basis; some have even made joint investments with him. It is possible, of course, that they do so because they still feel indebted to him. But the Rupert Murdochs of the world tend not to spend much time wallowing in gratitude, and it seems far more likely that they talk with him because they think that what he has to tell them will be valuable to them in the future.
Which got us to thinking: Wouldn't it be intriguing to find out what Milken's saying these days--to eavesdrop, if you will, on those conversations he has with Rupert Murdoch and the like? So we put it to him directly: Where does he see the next cable industry, the next cellular? If he were betting on the future, where would he place his bets? Here is what he told us.
REAL ESTATE. "If I were 25 years old today and had no restrictions," says Milken, "one of the areas I would move into is real estate." Real estate? Yes, real estate.
In fact, when you listen to what he has to say about real estate, it's not hard to understand his enthusiasm. He's got an idea that is big and powerful and radical all at once--an idea not unlike his original insight about junk bonds. Then, the idea (or at least an important part of the idea) was to create a true market--a liquid market--out of something that had been fundamentally illiquid, namely, business loans that were made to companies that didn't have good credit ratings. Now, Milken believes that the same can be done with real estate. He is convinced that real estate--whether it be residential housing, apartment buildings, or giant commercial buildings--can become as easily tradable, and as liquid, as a stock or bond. And he is equally convinced that the effect of such a thing on the investment world would be nothing short of revolutionary. As he puts it, "There's a clear need for financial technology in this area."
Milken begins with the rather unsurprising premise that real estate, having fallen out of favor for most of the 1990s, is about to become attractive again to the American investing public. But for most people, investing in real estate means buying something tangible, like a plot of land or a building, and then holding on to it in the hope that it will eventually appreciate in value. Other investors have begun to gravitate toward real estate investment trusts, which now have, in total, some $68 billion in market capitalization. REITs obviously constitute a market, and the larger ones offer a decent amount of liquidity. In fact, Milken points to the apartment REIT set up by Chicago real estate mogul Sam Zell as a model. Zell's REIT now has $1.8 billion in market capitalization, which means that getting in and out of it is not particularly difficult.
But REITs are structured in a way that Milken feels is both awkward and overly complicated. For instance, REITs can sometimes have such complex capital structures that the securities don't always reflect the true value of the assets. Further, a person who puts money in a REIT may actually be investing in the general partner of a larger partnership--which, in turn, owns the underlying properties. Milken's real estate securities would allow the investor to own a piece of the underlying properties directly, without the partnership baggage. Indeed, a developer who wanted to build a series of apartment buildings, say, could issue securities directly to investors--just as companies issue stock in IPOs. And the owners of these securities could trade them whenever they wanted.
Milken has two other problems with REITs in their current form. First, their liquidity is largely dependent on their sheer size: The smaller they are, the harder it is to get out of them when you want to. That can be a problem, especially for institutional players with large sums to invest. Second, he simply doesn't think they are specialized enough. Even REITs that have gone public in recent years have tended to be broadly diversified. Milken's idea is that his real estate securities would be far more narrowly constructed. In the marketplace he envisions, an investor who wanted a piece of the condo market in Louisiana would be able to find a product that specialized in that niche, while someone else who wanted to invest in apartment buildings on the West Coast would also find a product that suited his desire.
And this marketplace, as Milken sees it, would operate very much the way the mutual fund industry operates today. Indeed, the mutual fund companies would be likely candidates to create these real estate securities. "How about if Fidelity tomorrow had 200 funds"--each of which concentrated on some slice of the world's real estate market, Milken muses. "If they got to critical size, say, $50 billion to $100 billion, you'd have created real liquidity in the real estate market." But how would you place a value on these securities? he was asked. "The marketplace will value them," he replied. "If you were a fund company, you'd need an entire research effort, which would say that these are the pieces that make up this security and they are worth this amount. And then some other company might have a different assessment, but that's what makes a market."
And how big is this potential marketplace? Huge, in Milken's opinion. "The debt market today is between $400 billion and $500 billion in the public market and another $400 billion to $500 billion in the private markets," he says. "So that's $1 trillion. Real estate in the U.S. alone is between $6 trillion and $8 trillion." Ultimately, he believes, a securitized real estate market could be every bit as big as the entire debt market is today.
"The need," he concludes, "is there. And whoever addresses this issue will wind up creating a whole new industry. It will be just like the enormous growth of the mutual fund industry."
EDUCATION/ENTERTAINMENT. Milken has two basic ideas in this realm, and while he tends to link them, they would seem to be fairly distinct. His first belief is that there is a big business opportunity in simply making education more engaging, whether through the use of CD-ROMs, videotapes, or even comic books. He freely admits that he has come to this view from his experience in Los Angeles classrooms, watching great teachers teach. "We have some phenomenal communicators in these classrooms," he says. "Once I sat in a class where there was a lifeboat in the middle of the room. The teacher walked in dressed up like George Washington. Those kids were engaged; they had just heard George Washington talk to them." The idea of engaging people with technology and "special effects" and cool software to get them to learn is central to his vision of how entertainment can be used to enhance education.
To this end Milken has put up, with Oracle's Larry Ellison, some $300 million to start a company called Education Technology. "Our view," says Milken, "is that entertainment, technology, telecommunications, and education will continue to come together to create a new dynamic for education." One investment EduTech has made is in Hasbro, the toy manufacturer and owner of brand-name toys that Milken believes are "enormous icons that could be used in the educational area."
Be that as it may, Education Technology's first big move was a $169 million investment for a 50.1% stake in a British company that runs computer and voca-tional training schools. And that speaks to Milken's other education idea. We are entering a period, he says, where "lifelong learning" is going to be required of people who hope to be successful and productive in their work lives. This will include people who spend their entire career with one company--where learning new skills will be an important part of corporate life in the future--as well as those who flit from company to company, or project to project. He points out that corporations are now spending between $50 billion and $60 billion on worker retraining--and he believes that number will only get larger.
But he also thinks the American workplace is going to become far different. "You are going to have people who are going to want a variety of different jobs in the course of their lives," he says, which will also feed the growth of what he calls the "human capital industry." Right now, he adds, this industry is very fragmented, with some companies concentrating on retraining, others on temporary labor, and still others on workplace education. "I think there'll be a vertical integration of all of that," he says.
MEDICINE. As someone who started an organization dedicated to eradicating prostate cancer (called CaP CURE) and has consequently spent a great deal of time in recent years thinking about the way medical research is conducted, Milken has strong ideas about the future of medicine. His core belief is that computer technology will change the world of medicine to a far greater extent than it has already. He also thinks that biology and chemistry have the potential to become the dominant force in the 21st century that physics was in the 20th century--and that this will be largely due to the adoption of technology by biologists. He adds, "The biotech industry is probably around 1% of the equity market today. It has the potential to be 5% in the next century."
Finally, he has firm ideas about how medical research can be improved through the use of technology--and he points in particular to one of CaP CURE's most innovative efforts as an example. CaP CURE is funding the creation of a medical database consisting of the DNA of families in which two or more members have prostate cancer. "We'll eventually load the DNA of 5,000 people--which means there'll be 20 trillion data points. Computers allow you to do that!"
The crucial point, though, is that once collected, this information will be posted on the Internet, where any researcher--or medical entrepreneur, for that matter--can have access to it. Milken believes free access to data could spur innovation and radically increase the pace of medical research. "It's like the Crisp tapes at the University of Chicago that have stock market data...that anyone can analyze," he says. Of course, it was reviewing the tapes back in the late 1960s that helped Milken realize the potential for new financing possibilities.
DEBT. Beware high-tech companies doing convertible bond deals, is Milken's message. Plainly he is not wedded to debt as the be all and end all of financing--and he claims that was never the case. He says there are times when debt is the most appropriate way to finance a company's capital needs, and times when equity makes the most sense. And "with relatively high equity valuations," this is one of the latter times.
What most troubles him is that a number of high-tech companies are using the current equity market to issue convertible bonds. These bonds allow investors to turn the debt into stock, which they are likely to do only if the stock reaches a certain price. Because of this equity "kicker" the bonds usually pay out a lower rate of interest, which is what makes them so attractive to companies in search of capital. More than $1.8 billion in convertible debt has been raised by high-tech companies in 1996. "It reminds me of the airline and aerospace industries of several decades ago," he says. When those industries ran into trouble--and the stocks did poorly--no one converted the bonds, and the companies had to struggle to get out from under the debt burden. The same thing, he thinks, could happen in technology today--and he singles out Apple, which this summer issued $86 million in convertible bonds, as a case in point. Interesting choice there, since his friend and business partner Larry Ellison considered buying Apple late last year--but passed. "A terrible mistake," Milken says of Apple's decision to use convertible bonds.
LATIN AMERICA. Bet on it, he says--especially Mexico. "If you could tell the future and you could have foreseen that the leading presidential candidate would be assassinated, the former president would be in exile, his brother would be arrested as a suspect in a murder, the currency was going to be devalued, there would be social unrest--if you could have seen all that, you would have said, 'Sell! Liquidate and go home.' So why is the Mexican stock market at an all-time high?"
The answer, he believes, strikes at "the fundamental issue, that the future of Mexico and the future of the U.S. are intertwined. Fifty percent of that country is under 18 years old. If they don't have opportunity there, they are going to have it here. Their culture has moved into our culture, and this assimilation will continue." He adds, "The education gap between the two countries has closed tremendously. There are enormous opportunities there.
"You know, we had a conference in 1988 on Latin America, and it was a real illumination for many of the U.S. businessmen who attended. They met a hundred business leaders from Latin America who had all gone to the same business schools they'd gone to and who had all faced horrific problems at home. And they had survived, and even prospered. And a realization took hold that these people were going to be formidable competitors down the road."
DEMOGRAPHICS. "We now have the same number of people over 50 as under 18," Milken says, and the aging of America will continue as baby-boomers get older. But aging baby-boomers are not going to act the way elderly people have historically acted. They'll keep going to Rolling Stones concerts, says Milken, and they'll go to extraordinary lengths to retain at least the illusion of youth.
Milken then ticks off just a few of the businesses he thinks will eventually crop up to serve the aging boomer market. Since he feels that baby-boomers are going to become extremely health conscious, he envisions fast-food restaurants that are much more focused on healthy eating. A new exercise boom. The dramatic growth of what he views as the not quite nursing home industry. He also thinks that there will be a big boom in products that speak to people's desire to look and feel younger.
"You mean like hair transplants and things like that?" we asked, unable to suppress our skepticism.
"Sure," he said. "Didn't FORTUNE just have a big cover story about the growth of exactly those kinds of products?" he asked. We had to admit: He had us there.
REPORTER ASSOCIATES Erin M. Davies and Anne Faircloth