TEN YEARS AFTER WE'RE A DECADE PAST ONE OF THE STEAMIEST YEARS IN THE AGE OF EXCESS, LOADED WITH MEMORABLE MEGADEALS CUT BY JACK WELCH, ROBERT CAMPEAU(!), AND THE KKR CROWD. HEREWITH, A LOOK BACK AT THE GOOD, THE BAD, AND THE UGLY OF 1986.
By CAROL J. LOOMIS REPORTER ASSOCIATE MELANIE WARNER

(FORTUNE Magazine) – Thomas Sawyer Murphy, bookend. That's not how the former chairman of Capital Cities/ABC is normally described, but in a certain sense he precisely bracketed the past decade. At its start, Murphy's Capital Cities Communications made one of 1986's biggest buys, paying $3.5 billion for American Broadcasting. Ending the decade, in a deal struck in 1995 and carried out in February 1996, Murphy sold, to Disney, for $18.9 billion.

That price suggests just how deals have exploded in size over the past ten years. The largest of 1996, British Telecommunications' planned $25.4 billion swallowing up of MCI, was nearly quadruple the size of 1986's largest, General Electric's $6.4 billion acquisition of RCA. But what Cap Cities wrought in the decade also tells a neat tale of shareholder value. An investor who owned the company's stock in early 1985, before the ABC deal was announced, and who held on--and many a fan of Chairman Murphy and Cap Cities' president, Daniel Burke, did exactly that--made a profit of 626%, for an average annual gain just short of 20%.

A list of the biggest deals of the year used to be an annual feature in FORTUNE. When we decided to revive the idea this year and went back to some lists of the past, we found that a number of the big deals of a decade ago still resonate. That year, 1986, harbored both loony failures--Robert Campeau, anybody?--and impressive successes, of which Cap Cities' triumph was not even the greatest. GE's boss, Jack Welch, calls his RCA buy "sensational," and two Kohlberg Kravis Roberts leveraged buyouts, of Beatrice and Safeway, ran some risky rapids and ultimately cruised into big money. Safeway, in fact, is the best deal that KKR has ever done. The price the firm paid for Safeway was $4.3 billion, but the equity that KKR's partnerships put up was only $130 million--and that has turned into more than $5 billion of realized and unrealized profits.

Equity-strapped financial structures like Safeway's wouldn't fly in today's credit markets: George Roberts, co-head of KKR, says $700 million to $1 billion of equity might be the requirement now. But that tightening of the screw is a sharp reminder of just what 1986 was like. It was an especially steamy time in the Age of Excess. LBO dealmakers aggressively scoured the land; thin floors of equity supported giant silos of debt; and behind the scenes, Establishment corporations froze in fear of hostile takeovers. On Wall Street, Michael Milken and Drexel Burnham were at the height of their powers--though not for much longer. Before the year was out, Ivan Boesky began to spill insider-trading secrets to the law, the event that put the first crack in the financial phenomenon we call the Eighties.

In that climate it was possible to go relatively easy on leverage and still make a bad deal: Burroughs did that when it merged with Sperry in 1986, converting two condos of weakness into a structure of instability called Unisys. But it was also preposterously easy for men short of financial discipline to concoct fatally flawed LBO transactions. Consider, for instance, the interlocked disasters of Edward Finkelstein and Robert Campeau.

Finkelstein, then chairman of R.H. Macy, the fifth-biggest U.S. department store chain, took the company private in 1986 by way of a $3.6 billion leveraged buyout. Campeau, a Canadian real estate developer with a history of mental illness, did a hostile takeover of the sixth-biggest chain, Allied Stores, sealing his victory on a fitting day, Halloween. By New Year's Eve, though, with deal-destroying tax changes due to arrive at the stroke of midnight, Campeau was still frantically looking for the last dollar of financing he needed to complete his $3.5 billion deal. That piece finally popped into place, and one Campeau adviser left the scene recalling a half-jesting question posed earlier by another negotiator: "What have we created?"

"A crazy mess" would have worked as an answer, although it took three more years of weird, erratic, overreaching behavior by Campeau for the point to be cemented. Along the way, still weighted with debt and having proved in no way that he could manage Allied, Campeau won a 1988 bidding war for the biggest department store chain, Federated--beating out none other than Macy's Finkelstein. From the start, many thought that the $6.5 billion Campeau paid was too high. But others argued that the price must be okay given that Finkelstein, a master retailer, had been willing to pay essentially as much. Of course the real truth was that Finkelstein had kept right up with Campeau in losing his head.

After that Campeau and Finkelstein in effect competed to see who could fall into bankruptcy first. Campeau won the race, with Allied and Federated going into Chapter 11 in January 1990. Macy's, which made up for its failure to get the whole of Federated by overpaying for two of its big divisions, held on until January 1992. And even then the interlocks between these big retailers didn't dissolve. In 1994, Federated, by then freed from bankruptcy, sprang Macy's from the courts by buying it for $4.1 billion.

Today Ed Finkelstein runs a consulting business in Manhattan. Bob Campeau lives on a lakefront estate in the Austrian Alps and, using bank capital of unknown origin, is developing a large residential real estate project outside Berlin. The German press sometimes calls him "Mr. Bankrupt."

Another of 1986's bad deals--the $4.8 billion merger that created Unisys--was engineered by Werner Michael "Mike" Blumenthal, then CEO of Burroughs (and formerly Secretary of the Treasury under Jimmy Carter). What Blumenthal sought in going after Sperry, a reluctant bride, was size, which he thought would give him market clout--particularly in mainframes--when competing against IBM. That opinion has its irony, since the IBM that in 1986 still looked invincible to competitors was in fact already tumbling into trouble. The opinion also has some echoes in today's dealmaking world: Many of the big telecommunications and banking mergers of 1996 were hatched in the name of size and market power.

One thing about Unisys: Almost everybody correctly predicted it wouldn't thrive. FORTUNE quoted an analyst as saying that the joining was "like merging the Lusitania with the Titanic." Blumenthal, however, at first confounded the skeptics by producing more than two years of good results. And then reality grabbed hold, in the form of large losses that led to Blumenthal's departure in 1990 and to a string of downsizings and restructurings since. Unisys's stock was recently $7 a share, vs. a high of $48 in 1987--and this boat's still got a leaky bottom.

In the deals of 1986, Unisys had a predictive opposite: KKR's $6.2 billion buyout of Beatrice, which everybody declared would be an enormous success--"a triple grand slam," as one KKR limited partner put it--but that didn't play out exactly as scripted. True, KKR scored early with the company, selling off a string of its operations (such as Avis and Playtex), paying down debt speedily, and promptly returning to its partners the $402 million in equity capital they'd put up. But the base-running then stalled, upon KKR's discovery that it couldn't unload Beatrice's huge food operations--Hunt-Wesson, Swift-Eckrich, and a cheese division--for an all-star price.

Finally, in 1990, Charles M. "Mike" Harper, CEO of Conagra, bought Beatrice's food package for $1.36 billion. The negotiations were a tug of war. KKR's Henry Kravis, still thinking grandly, wanted more money. Harper wouldn't budge because he thought a higher price would do damage to a return-on-equity goal so dear to him that he even had "20% ROE" imprinted on undershorts he gave his executives. Ultimately KKR agreed to do the deal partially on the come, accepting ConAgra shares as one slice of its payment and hoping to see the stock rise. It did, smartly, and within two years KKR sold its stake and distributed the last bite of Beatrice cash to its limited partners.

The final returns on Beatrice? The calculation is complicated because cash payouts from the deal went to those partners both early and late. But on a discounted cash-flow basis, and after subtracting the splendiferous fees that KKR takes for itself, the firm figures that the limited partners reaped an average annual gain of 43%. Considering the risk built into leveraged buyouts, that's hardly a triple grand slam, but it's probably enough to put Beatrice in the Cooperstown of LBOs.

KKR's other big deal of 1986, Safeway, has a shot at qualifying as the Babe Ruth of LBOs. In buying Safeway, KKR acted as a white knight, rescuing the company from the Haft family. Safeway's CEO at the time was Peter Magowan, a grandson of Merrill Lynch founder Charlie Merrill, whose firm had originally bankrolled Safeway. Magowan, straight out of San Francisco's aristocracy, had run the company genteelly and with minimal concern for labor costs. KKR, working with Magowan and a management consultant named Steven Burd, quickly got tough, moving into its standard cost-cutting mode and driving especially hard to get rid of operations in which it couldn't cut labor costs. Unsurprisingly, Safeway's unions rose in bitter protest.

In 1990 a public offering of Safeway stock and the buyout's prominence led Susan Faludi of the Wall Street Journal to write about the company in one of the longest articles ever published in that newspaper. Titled "The Reckoning: Safeway LBO Yields Vast Profits but Exacts a Heavy Human Toll," the article described employee traumas--all said to be directly linked to the LBO--that included suicides and job-related heart attacks. The following year the article won Faludi a Pulitzer Prize.

The "vast profits" mainly referred to capital gains and fees extracted from the buyout four years before and definitely didn't describe Safeway's finances in 1990: The company wasn't making much money, and the public offering itself had received only a tepid welcome. But these were matters swallowed up by the wave of emotion that greeted the article. Many readers brought to it their own opinions about LBOs, some finding the article monstrously one-sided, others chorusing in agreement with its harsh indictment of the business mores of the Eighties. In short, the article not only immediately became emblematic of the Safeway buyout but also came to frame the entire debate about LBOs.

The article also rocked KKR, whose principals thought it hung the firm with a totally unjustified reputation for, in George Roberts's words, "coming in and firing everyone." That image, he says, both hurt KKR's negotiations with certain acquisition candidates and riled some of its limited partners, particularly public pension funds whose constituents included unionized workers.

It is probable that these limited partners began to feel better about Safeway a couple of years later, when Steve Burd replaced Peter Magowan as CEO and the company began to rocket. Since 1992, Safeway's profits have gone from $44 million to $460 million and its stock has jumped from $5 a share to $48. About Burd, Roberts has nothing but good things to say: "If we could only clone Steve--if we could just find a few more like him-- there'd be all sorts of deals we could do."

Roberts also says that he still thinks Safeway's prospects are great. He makes that case despite the fact that KKR sold $500 million of its stock last year at just over $25 a share, and is preparing right now to sell 32 million shares back to the company at $43 a share, for proceeds of almost $1.4 billion. That will leave KKR with about a third of Safeway's stock, a stake currently valued at more than $3.5 billion. Explaining the sales, Roberts says KKR has been obliged to begin cashing out, because its Safeway partnerships have a nominal term of 12 years. "Believe me," says Roberts, "if it weren't necessary, we wouldn't be selling a share."

GE's Jack Welch didn't do his RCA deal with all-out leverage, as KKR might have. But in some ways he looked like an LBO revolutionary in the aftermath, going into a swirl of action selling off the gear he'd just acquired. That included a carpet company, a record business, and a life insurance operation. But Welch mainly dwells on some bigger pieces. Said he recently, as he prepared to apply his 5 handicap and competitive might to a Florida golf course: "We combined RCA's consumer electronics business with ours and traded them off to Thomson in exchange for its medical equipment business--that fit right into our stuff--and $800 million in cash. Then we put RCA's defense business with ours and sold that to Martin Marietta for $3 billion. And we essentially ended up owning what was left--NBC--for free."

There have been times since 1986 when Welch thought about selling NBC too. Its operating profits have hardly been stable, taking one especially sickening fall from $600 million in 1989 to $200 million in 1992. But there is no talk of sale now: Robert Wright, Welch's choice from the start to run NBC, has made it both the powerhouse network--though it's good to remember that TV leadership comes and goes--and a force in cable. ("How GE Made NBC No. 1," February 3). Operating profits for 1996 are estimated at $960 million. Conjecture about NBC's value lands on figures like $10 billion to $12 billion--not bad for an asset the boss judges to have come on board "free."

Ten years from now, FORTUNE may be doing an article about the deals of 1996 and recalling that Tom Murphy sold a network--and Michael Eisner of Disney bought one--at a time when Welch himself was supremely satisfied with the bargain he'd made in the days of 1986. Could be an intriguing look back. And what about the size of deals? Will they expand in the next decade as they did in the past? If so, that would mean deals of $100 billion in 2006. Sounds fanciful, but you'd better hope it happens. Deals could never grow to that size without a stock market that keeps looking glorious.

REPORTER ASSOCIATE Melanie Warner