The management of Pacific Southwest Airlines could scarcely have anticipated having trouble finding an investment firm willing to take it public last year. After all, the chairman of E. F. Hutton, one of the nation's leading investment banking firms, was on its board of directors.
But PSA was wrong. Hutton and other firms looked at its financial results, which included more than $13 million in red ink for the 15 months following federal deregulation of the airline industry, and passed.
That put PSA in a bind. Under the terms of its union contracts, in which the airline was to contribute a portion of its stock to employee funds in return for labor concessions, PSA was required to have the stock trading publicly by the end of 1986.
Foresaw Merger Mania
In near desperation, J. P. Guerin, the chairman of the airline's parent company, called on Michael E. Tennenbaum, a Bear, Stearns & Co. investment banker who earlier in the year had taken public Guerin's small genetic engineering company.
The burly Tennenbaum, who had helped establish a Southern California beachhead for his firm in 1976 and had promptly installed himself in a home in Malibu, saw something the other firms had apparently missed. A PSA stock offer could be priced not on the basis of the airline's past earnings, he reasoned, but on the likelihood of a profit recovery in the industry and, even more important, its value as a merger target.
"Michael was smart enough to see that the merger mania in the airline industry would soon enough come our way," Guerin recalls. Tennenbaum was so sure that PSA's West Coast routes would be indispensable to a larger airline seeking to establish a coast-to-coast business that he insisted, as a prerequisite for taking on the deal, that Bear Stearns have the right to act as middleman in any subsequent sale of PSA.
He was right. PSA went public at $7 a share and promptly fell to $6.50. Then American Airlines moved to acquire PSA competitor AirCal, and PSA jumped to $10. In December, 1986, PSA accepted a takeover offer from USAir for $17 a share.
For underwriting the stock issue, Bear Stearns had gotten a fee of several hundred thousand dollars. On its bet that PSA's value was really as a takeover candidate, the firm made real money: $3.8 million.
It is unsurprising that Bear, Stearns & Co. would take what amounts to a trader's plunge on an otherwise unloved investment banking opportunity. The New York firm, known principally as a securities trading house and for its profitable business of handling securities trades for smaller firms, has been moving into the investment banking business by cooking up deals that larger powers in the industry would not have conceived, and doing those its rivals have shunned.
Advisory Business Lucrative
While other firms have been shying away from handling hostile acquisitions, Bear Stearns has moved from simply accumulating large holdings of stock for corporate raiders cheaply and efficiently--a skill for which the firm and its chairman, Alan C. (Ace) Greenberg, have long been prized--into the takeover advisory business, a potentially much more lucrative trade.
Among its takeover clients are Coniston Partners, a New York investment group that bid earlier this year for Allegis Corp., and Charles Hurwitz, the head of Maxxam Group and a veteran client of Drexel Burnham Lambert, the investment firm most closely associated with financing hostile takeovers.
Bear Stearns has also enterprisingly marketed to blue-chip corporations a wide range of innovative corporate finance products. These include currency exchange warrants, which allowed General Electric Credit Corp. and other clients to sell retail investors a parlay on foreign exchange rates, and Australian- and New Zealand-dollar denominated securities that pried clients such as Ford, Pepsico and Disney away from more established investment firms.
"The financial officers of corporations don't consider themselves tied directly to an investment bank anymore," Greenberg says. "If you have an idea, you can get in to see almost anybody."
This strategy has inspired skepticism among some observers on Wall Street, where Bear Stearns is otherwise admired for its consistently strong earnings and a return on equity exceeded in the industry only by Morgan Stanley & Co. With investment banking a highly competitive business dominated by several well-established firms, Bear Stearns, securities analysts say, must count on developing its one-shot deals with top clients into long-term relationships that give it a dependable flow of "plain vanilla" financings.
That is something that has not yet happened, but Greenberg says it is not crucial to the firm's success in investment banking. "It would be a nice dessert, but we don't need it," he says.