When Admiral Bobby Inman decided that his job was done at the Microelectronics & Computer Technology Corp at the end of 1986 and started looking around for something else to do, he decided to ally his new-won experience of high-tech electronics with a return to his roots, and formed Westmark Systems Inc as a private holding company to invest in defence electronics companies. In September 1987 he found just what he was looking for right there on his doorstep in Austin, Texas, and his $714m cash bid for Tracor Inc (CI No 766), was accepted. The financial orthodoxy, then as now, was that you borrowed most of the money needed to make the acquisition, and put up the company’s own assets as collateral, satisfied that the cash flow generated by the acquired business would be adequate to service the interest payments on the enormous mountain of debt. Of course you would have to offer a pretty juicy coupon on the debt – something in the region of 14% to 16% – in order to compensate buyers of it already troubled savings and loans, high-yield mutual funds for the risk that they were clearly taking that the business would not be able to generate enough cash to meet the interest payments. On on that concept, the disgraced Michael Millken built a fortune for himself and another for Drexel Burnham Lambert Inc, which ungratefully cut all ties with him when regulators decided that he had been a bit too greedy in one or two deals. So there was the doughty Admiral in the fall of 1986, all set for a new career as defence electronics mogul. How do things look two years on? The Wall Street Journal has been taking a look and the picture is a sad one for the retired Admiral, former head of the US National Security Agency. A little over a year ago, Merrill Lynch & Co believed that the outlook for Tracor was sufficiently bright, what with the government contracts the good Admiral’s Pentagon connections could put its way that it was delighted to place a $400m line of junk bonds for the company. Today those bonds are standing at a 35% discount to their issue price at a time when junk issues from companies with no particular clouds in view are much where they were at the time of the Tracor issue. But then Tracor’s sales, profits and margins are all down, and the company is going to have to start divesting assets to raise the cash to service its mountain of debt. The conclusion I have come to is that you shouldn’t leverage in the defence business says a rueful Bobby Inman. There wasn’t any track record that could meaningfully predict the future. When the US government stops spending, defence companies are the first to feel the chill wind. But the same negative forces that afflict defence companies are writ large in the computer business, and the fact that Moody’s is worried about Unisys Corp’s ability to generate enough cash to service its debt mountain (CI No 1,231), which shrank but little last year, should have us all worried. And as for junk-stuffed MAI Basic Four Inc and J H Whitney Co offers for Prime – they’re nothing short of lunacy.
