Lessons from the 1980s for disruption.
New movements that threaten the power structure always have a backlash. When and how great will it be?
The following article was originally published in “What I Learned This Week” on November 16, 2017. To learn more about 13D’s investment research, please visit our website.
If one studies history, it is clear that new movements that threaten the power structure always have a backlash. The only question remains, when and how great will it be? Consider the story of how 13D Research began.
After the bear market of 1973–74, and the double-digit inflation of the late 1970s, thousands of U.S. public companies were selling below breakup value. When any company or individual buys more than 5% of a public company, they must file a 13D statement with the SEC within ten business days. In those days, the filing required the investor to state its average purchase price, total investment, transactions in the last 60 days and investment intentions.
We had become the expert on 13D filings, after having studied them since the mid-1970s. In the process, we discovered investments by Warren Buffett, Carl Icahn, T. Boone Pickens, the Bass Brothers, the Tisch family, etc., who are household names today, but were totally unknown back then. After the election of Ronald Reagan, the greatest period of deregulation began since the 1920s. This fueled the rise of Mike Milken, Drexel Burnham and his junk-bond-financing machine. He raised hundreds of billions of dollars for takeover artists, activists, corporate raiders, wealth builders, use whatever name you wish. He did this by offering investors “high yield” bonds.
At one point in the early 1980s, there were over a hundred such people being financed by the Milken machine. It was a period of extraordinary raw capitalism — unseen since the 1920s — where vast amounts of capital were mobilized to take over poorly-managed and very undervalued companies that were not run for the benefit of their shareholders.
In the short space of three years, we had over 175 of our investments and recommendations taken over by a corporate raider or forced to merge with another company to allow management to retain some of its corporate power. This was a wonderful game and Wall Street loved it. A lot of wealth in the U.S. was created during this period. It is hard to remember now how fearful the C-suites of America were at that time and how almost every company in America was a potential target. The best legal and investment banking forces were arrayed on both sides in a brutal fight for corporate power. The trend appeared relentless, overpowering, irreversible.
And then came the backlash.
Through his Mesa Petroleum, T. Boone Pickens was one of the earliest takeover artists and had made $700 million in his first five forays. Then, in 1985, he tried to take over Unocal. Unocal was an oil company based in Los Angeles and its CEO, Fred Hartley, was a very tough man, who adopted a scorched-earth policy by offering a debt-for-equity deal. Eventually, after a battle royal, Pickens had to withdraw his offer.
The second death blow was dealt by Rudy Giuliani, who was the U.S. Attorney for the Southern District of New York. Milken had been under nearly constant scrutiny by the SEC from 1979 onwards. But it was Giuliani who began the unravelling by a series of indictments beginning in May 1986 with the arrest of Dennis Levine of Drexel Burnham on insider trading. By March 1987, a number of prominent Wall Street figures were indicted, ranging from Boyd Jefferies to the head of arbitrage at Goldman Sachs to arbitrageur Ivan Boesky. By 1989, Milken agreed to a plea bargain and was permanently barred from the securities industry.
After the Pickens-Unocal decision, we saw clearly that times had changed.
We switched gears quickly — as we have so many times. Our focus went from trying to find the next company to be taken over to looking for shorts in the high-yield bond market. It was clear that Milken would be indicted years before the event. And since he was the high-yield market, his demise meant the end of market-making for that market and prices would drop sharply. More importantly, it was the end of corporate raider activity.
This brings us to today and the long-awaited backlash against disruption.
Circumstances today are not vastly different from those in the early to mid- 1980s. Just like in the early 1980s, today is an excellent time to make money if you are long the “new economy” and short the “old economy”. But just like the 1980s, the powerful forces that are being disrupted and the capital that is being destroyed and the jobs that are being lost and the fear that people have for the future is mounting a growing backlash against the big tech companies and disruption. Recall how Wall Street CEOs were excoriated after the losses triggered by the housing and financial crises, and how the government tightened the noose around their activities.
Are we close to a reversal? We have followed this very carefully for years because we are students of history. An important turning point might have occurred with the decision on November 10th by an Employment Appeal Tribunal in London. This Tribunal rejected Uber’s arguments that its drivers were self-employed — the second negative ruling against Uber in London in recent months. This raises questions about the hiring model in the so-called gig economy, which depends on workers who don’t have a formal contract as permanent employees.
As The New York Times reports:
“The company’s operations in London are crucial to its global expansion.
It first began offering its services in the city in 2012, but is now present in dozens of cities nationwide. Some 40,000 people drive for Uber in the British capital, and it claims three million customers have used the app in London at least once in the past three months.
The arrival of Uber in London has, however, created a clash with the city’s iconic black cabs. The centuries-old taxi system requires its drivers to pass an exacting test known as The Knowledge, where they must memorize around 25,000 streets and 100,000 landmarks. Black cabs are typically far more expensive than Uber’s services, which cabbies complain are too lightly regulated.
The challenge over its hiring practices strikes at the heart of Uber’s business model. The company faces a similar challenge in Europe — the region’s highest court is expected to rule by the end of the year in a case over whether the company should be regulated as a taxi service, which would make it subject to rigorous safety and employment rules, or as a digital platform that simply connects independent drivers to passengers.
Labor experts say that laws in most countries have failed to keep up with the development of technology and the spread of the gig economy. In Britain, for example, the main piece of legislation that regulates how workers are treated was passed in 1996.”
Earlier this month, there was a heated debate in Brazil’s Senate over whether or not to regulate Uber as a form of public transportation. Brazil is Uber’s second largest market outside of the U.S. Uber desperately needs a win in Brazil and its new CEO has joined forces with other car-booking apps to mobilize public opinion. The leftist Workers Party, which is supported by the taxi unions, is committed to force through regulation.
As we’ve dissected often (WILTWs November 9, and September 7, 2017), big tech has by-and-large been exempt from operational guardrails due to the imprecision and inadequacy of laws crafted for the Industrial Age. However, as the backlash escalates and lawmakers adapt regulations to counterbalance monopolistic power, counted-on advantages may soon become costly liabilities. From Facebook, Amazon, and Google to Uber and AirBnB, tech-giant business models were formulated based on the assumption the exception would forever be the rule, no matter the ripple-effects of creative destruction, automation, and wealth consolidation. Clearly, they neglected the lessons of history.
So the cycle goes on over and over and over again. From capital accumulation to capital distribution. From rising interest rates to falling interest rates. From rising inflation to falling inflation. From stability to chaos to autocracy. From the accumulation of power to the distribution of power. As George Washington wrote in his famous Farewell Address: “It is in the very nature of power that it will expand until it is checked by an opposite power.”
This article was originally published in “What I Learned This Week” on November 16, 2017. To subscribe to our weekly newsletter, visit 13D.com or find us on Twitter @WhatILearnedTW.
