Dealmaker § The Original Buyout King

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“Well, Siegmund,” Carl Hess said to S.G. Warburg, “We’re all going to die someday.”

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Hall of Fame : The Original Buyout King

He made his first deals during the Great Depression. His shareholders included Rockefellers, Mellons, Warburgs and Du Ponts. And 40 years ago, he quietly — but revolutionarily — built the very notion of the buyout house. At 94, Carl Hess still goes into AEA’s office every day — as the last living link to private equity’s birth

By: Scott Eden
March/April 2007 , Page 90

Manhattan's Four Seasons restaurant opened in 1959, and Carl Hess has been lunching there ever since. He was a relative youngster then, a spry 47-year-old with a sharp eye for the vicissitudes of power and a growing knack for wielding it without drawing attention to himself. Today, you get the sense that he’d like to be a little less invisible.

“I’m no longer in the active fray,” he sighs.

A diminutive man made even smaller by age, he sits poised over his Dover sole in his custom-made pinstripes, and the rest of the restaurant seems to rise around and atop him like a cavernous tomb — the giant bronze sculpture hanging above the bar like an inverted pipe organ, the soaring floor-to-ceiling windows with their swags of golden chain mail.

On any given day, the most powerful men in America eat their $50 Kobe hamburgers within a few feet of this 94-year-old man who is a bridge to the history of twentieth-century finance with a deal span likely longer than that of anyone alive.

And almost none of them realizes who he is — and who he was. On this particular December Friday, the regulars are out in force: Mel Karmazin, Sandy Weill, Hank Greenberg. Into the room strides Steve Schwarzman, then in the midst of increasing Blackstone’s bid for Equity Office Properties, the largest sum ever offered for a buyout.

“Hey, Carl Hess!” says Schwarzman, stooping to shake hands. “I met you in 1976. You haven’t gotten any older.” The retired dealmaker responds cordially, civilly, giving only as much as this perfunctory social encounter warrants — and with that, the reigning king of private equity glad-hands his way to the next table. Left unsaid, as usual, is the fact that without Carl Hess there might not be a Steve Schwarzman, king of private equity.

Five days a week, Carl Hess comes to his office at AEA Investors, regarded by some as the world’s first pure buyout house, founded by Hess in 1967. He arrives on an irregular schedule, barbered, groomed and inside one of the bespoke suits made for him by master tailor Carmine Del Giudice. Hess has no specific duties at AEA — he relinquished day-to-day control in 1989 — but as Ludmila Hess, his wife of 10 years, said recently, “He feels one shouldn’t be lazy.”

Executives update him on deals and personnel moves, and he spends much of his time in his office putting his personal affairs and investments in order; he has two children and five grandchildren, and cares about his financial legacy. A lingering foot injury has lessened his mobility, but otherwise his health is good, and his memory remains crystal-clear.

When I meet Hess at his office not long ago (he wears a dark gray suit with red pinstripes), he has just returned from lunch with a new employee. He makes a point to take each fresh AEA hire out for a meal at one of a rotating cast of dining rooms — the River Club, the University Club, the Rockefeller Club and, of course, the Four Seasons — during which he will relate old war stories and tell “about some of the scars I have.”

Hess’s career has spanned a long, long time: He made his first deals during the Great Depression. He did deals with Conrad Hilton from the patio of the magnate’s Palm Springs mansion. He was the brain behind Western Union’s divestiture of its international undersea telegraph cables.

“I’m sort of a reservoir of history,” he likes to say. He uses another metaphor as well: “I’m the only living fossil still here.”

Another of Hess’s goals at those lunch sessions is to introduce new employees to AEA’s underlying principles — which happen to be Hess’s principles as well. Robert Stillman, Hess’s right-hand man for 20 years and himself now retired, has said, “The operating entity of AEA was really an extension of the values of Carl.”

Frank Stanton, the former president of CBS and a longtime AEA shareholder, once described Hess this way: “Very quiet, very buttoned-up individual — never, to the best of my knowledge, stepped off into a deal without having researched it to the point where you think maybe the seller would get impatient and say, ‘Oh, the hell with it.’ ”

Vincent Mai, AEA’s current chairman, deems Hess “the conscience of the firm.” Mai himself uses Hess as a resource; the two frequently exchange ideas about the company’s strategic direction. “He embodies the old values, which in some ways are now out of vogue,” Mai says.

One such value is discretion, which Hess possesses perhaps to a fault. His voice is so quiet one must sometimes lean in to hear him.

“People ask me all the time why I don’t push my name more,” he says. “I tell them I’m not running for political office and I don’t sell insurance; I have no need for publicity.”

Ludmila Hess, his third wife, sees things differently. “He’s incredibly self-effacing,” she says. “He’s supremely uninterested in personal accolades. And sometimes I rise up like an angry tiger when I don’t think he’s being appreciated appropriately.”

This is only the second time, for instance, that Hess has ever spoken to the press. The first was in 1989, for a story about AEA in Fortune magazine, in which Hess effaced himself so completely that the published article made it seem as if he played no role at all in the firm’s founding. Perhaps at the urging of Ludmila, Hess is now ready to tell his story.

“The best deal in my career was putting this firm together and creating it from scratch — and it was really scratch,” he says. “No financing, no business, no office, no nothing. It was just my secretary and me. And she left after about a year because she didn’t think we were gonna make it.”

In the 1950s, over the course of several years’ worth of lunchtime conversations with J. Richardson Dilworth, Hess helped invent and develop the concept of a firm dedicated strictly to buyouts. Both men worked downtown, Hess for the management-consulting firm Cresap, McCormick & Paget, and Dilworth for Kuhn, Loeb & Co., the old white-shoe investment bank, where he was the youngest managing partner in the firm’s history.

Hess had arrived in New York in 1948, lured east from his hometown, Chicago, by his first wife, an actress who longed for a resurgent career on Broadway.

Somewhere in his personal papers, Hess still has the yellow legal pads on which are scrawled the early business plans he and Dilworth drew up during those lunches. They wanted to put together a group of American and European investors, pool their capital, seek out and buy promising companies, make them more valuable, then resell them or take them public. Though banks of various stripes had long done private buyout deals as part of their normal course of business, there had never been a discrete fund run solely with that purpose in mind.

Hess, however, already had more than a decade of experience in that discipline. At Dartmouth, class of 1934, he had studied history, but immediately thereafter, at the foot of his maternal grandfather, George Barton, he helped sell and liquidate companies.

Barton was a medium-scale Chicago industrialist who owned a number of manufacturing outfits throughout the Midwest. A few years after he started working there, Hess says, Barton “decided he didn’t want his five children arguing over control of the companies when he died. So he wanted to liquidate and distribute the cash to them.” Barton charged his grandson with divesting his holdings, which included metal-fabrication plants, a paper company, a concrete company and a felt business — “for ladies’ hats,” Hess says.

To learn the firms’ operations thoroughly, he worked on factory floors and in executive offices, spent considerable time with accountants and traveled around the country visiting customers and potential buyers. Within seven years, he accomplished his grandfather’s objective. “Obviously,” he says, “I got a better education than any school of business could have given me.”

It wasn’t until the 1960s that Hess and Dilworth, suitably advanced in their careers, had the clout and connections to launch AEA. Hess was now head of corporate finance for American Securities, the still-thriving investment company founded by William Rosenwald, the son of a founder of Sears Roebuck.

Dilworth had since become the personal financial advisor to the Rockefeller family fortune, operating out of the famed “Room 5600”; he was therefore in a position to help persuade the senior members of the Rockefeller family to become the first shareholders of American European Associates, the firm’s original name. (All of them, that is, save Laurance, who ran his own investment group and therefore stayed out.) To this day, there remain Rockefellers among AEA’s “participants,” as the group’s shareholders are called.

From there, the dominoes fell. Dilworth talked with Sir Siegmund Warburg, founder of the London banking house S.G. Warburg and scion of the ancient German banking family who had, with Dilworth, been a partner at Kuhn Loeb. He agreed to put up $1 million and, more importantly, his cachet, especially when it came to attracting European investors; thus the name American European Associates.

Hess knew a man named George Weymouth, who had married into the Du Pont family; the heirs to the fortune of Pierre Samuel du Pont de Nemours subsequently added their money and name to the pot. Among his many other positions, meanwhile, Dilworth sat on the board of Chrysler and was friendly with George Love, the head of Consolidated Coal in Pittsburgh, who was also Chrysler’s chairman.

“George Love was Mr. Big in American industry at the time,” Hess says. “He was a formidable man. Dilworth told George what we were trying to do, and lucky for us he fell in love with the idea.”

Love, who sat on corporate boards across the country, brought into the AEA fold the banking Mellons of Pittsburgh, the industrialist Hannas of Ohio, the financier Harrimans of New York and the mining Littlefields of Utah and San Francisco — who, in turn, brought in the billionaire engineering Bechtels of San Francisco.

“So all of a sudden, out of absolutely nowhere, with no company and just a concept, we had the principal group in place,” Hess says. “The Rockefeller family, the Mellon family, the Harriman family, Warburg, Bill Hewlett. . . . We had all the sponsorship we could ever need.”

Despite having, seemingly, the entire American industrial aristocracy behind it, the firm almost crumbled before Hess could even think about buying his first company. One day, an attorney from the law firm Milbank Tweed came to Hess with some news from the Rockefellers, a Milbank client: “No matter how smart you guys are, and no matter who you’ve got on your board of directors, you still might do something to embarrass the family,” the lawyer said. Afraid of potential negative publicity, the Rockefellers were pulling out.

Hess’s reaction, he recalls, was “almost panic.” To lose the Rockefellers would likely mean a rush for the exit, with the other participants withdrawing their backing in kind. Hess pleaded with the attorney for more time — and after a couple of weeks, he came up with a solution: None of the Rockefellers would sit on AEA’s board — “so none of them could ever be accused of making a bad business decision.” Much more significantly, the family would put up no cash. Instead, each Rockefeller would sign a contract — a “commitment agreement” — obligating him to tender any amount he saw fit.

The timing of the commitment, however, was entirely at AEA’s discretion. “In other words,” Hess says, “we’d call them whenever we needed the money.”

Simple and elegant, the solution turned out to be the “keystone” of the private-equity concept. When Jerome Kohlberg — not yet having founded Kohlberg Kravis & Roberts — came to Hess’s office one day in the early ’70s, Hess slid across his desk a copy of the AEA commitment agreement. KKR, credited by many with being the world’s first buyout firm, later adopted the idea. AEA, meanwhile, applied the contract to every one of its participants — and still does.

One of the few decorative touches in Hess’s AEA office is an original illustration by Al Hirschfeld, the famous caricaturist who specialized in drawings of show-business grandees. In the picture, Uncle Sam is high-stepping across a theater stage. Dollar bills pour from the top hat he holds in one hand. Coins spill from the palm of the other, and his face displays a greedy, vaudevillian grin. It’s possible that the picture is intended as irony, since there is nothing of the showboat in Carl Hess — and thus, by extension, in AEA.

“We’ve always believed in doing things moderately and modestly, and doing them with some grace, some style,” Hess says. “It’s more important to be known for your quality than your quantity.”

That business philosophy has its roots in the inherently private nature of old money, as well as an aversion to risk. Early on, Hess understood that all that blueblood capital being put to use by AEA came with a set of conditions: “You’d better do things with elegance and dignity, and you’d better not embarrass [the firm] or embarrass yourself.”

At this, Hess did not always succeed. In 1970, in the first deal of its life, AEA made an abortive attempt to take over a company called Freeport Sulfur, whose stock traded on the NYSE — the first and last time Hess has ever tried to buy a public company on the open market. (The executive Hess had lined up to run Freeport backed out at the last minute; AEA sold the stock for a modest profit.)

In its second deal, AEA targeted a privately held company called the Leisure Group, a small Los Angeles conglomerate of manufacturers certain that the human race would soon develop an exponentially increasing demand for such playthings as golf clubs, tennis racquets, archery equipment and gardening tools. Hess worked hard to set up the deal, then headed to Europe for a three-week vacation.

According to its books, the Leisure Group was expected to approach a $4 million profit for the year. When Hess returned, he received the news that the company had, in fact, lost $30 million.

“It took us three years to unwind the damn thing,” he says. He commuted to California frequently. He reworked bank deals, sold off pieces of Leisure and eventually paid back his angel group, plus interest. AEA lost about $10 million on the deal. Lesson learned. The Leisure Group was overleveraged and overextended.

“It was partly our fault,” Hess admits. “We didn’t do our due diligence.” That failure has lingered over the years, and it left behind one of those scars Hess now describes to new AEA employees.

London, 1974: All the partners of S.G. Warburg found themselves arrayed around a conference table at the firm’s offices. Sir Siegmund George Warburg, the company’s founder, sat erect at the head of the table shooting lightning bolts from his eyes. The principal object of his wrath was Carl Hess, who had recently been summoned from New York.

Siegmund Warburg, of course, had provided AEA with some of its earliest seed capital — and the incalculable value of the Warburg name. To this day, Hess has an admiration for Warburg not unlike the young, ambitious businessman of myth — who, the story goes, went one day to look into borrowing money from the biggest man in high finance. “I won’t lend you money,” the titan says. “But what I will do is take a walk with you down Wall Street with my arm around you. You’ll get all the money you’ll ever need.”

But Siegmund Warburg, at the meeting in London, was about to remove his arm from the shoulders of Carl Hess. AEA had been a going concern for almost seven years, and so far, it had been a party to two failed deals. Warburg was losing patience.

Hess’s troubles stemmed from the fact that Sir Siegmund had developed a proprietary feeling toward AEA, and Hess had neglected to follow some of his famously rigorous internal protocols. That is, Hess was calling his own shots in New York without first seeking the go-ahead from the big man in London.

“You can’t imagine how he micromanaged; he might have invented the word,” Hess says today. Hess felt AEA was his baby and that he need not take orders from anyone: “I wasn’t going to knuckle under.”

To Sir Siegmund, however, Hess served at the pleasure of Sir Siegmund. From across the conference table, he leveled his finger at the American and predicted his imminent professional demise: “If you don’t do it our way,” he slowly intoned in his dramatic Wagnerian accent, “this will be the end of Carl Hess!”

Hess thought for a moment. “Well, Siegmund,” he said finally, “we’re all going to die someday.”

When Hess returned to New York shortly thereafter, he changed nothing. Within the year, he had arranged to have Warburg’s shares bought out.

Making lots of money has, of course, been the principal objective of Carl Hess’s long career. But it hasn’t necessarily been the point of his life. Next to his desk at AEA headquarters is a large globe. Many years ago, he and his brother gave it to their mother and stepfather as an anniversary gift. It isn’t just any globe; etched in bronze on its surface are all the countries Hess’s parents ever visited. He inherited their wanderlust, and the money he has made has enabled him to indulge it. He’s been to every continent except Australia. He has hiked on ice floes in Antarctica, boated up the Amazon, traveled for five weeks around China (just before Nixon got there) and spent the same amount of time in Iran not long before the fall of the Shah. He drove across Cuba in 1959, at one point with beret-clad, gun-toting revolutionaries in tow.

Hess enjoys telling these stories almost as much as the tales of his AEA deals. His keen memory brings him back to the past, but he likes to think that he has additional adventures ahead. “I’d really like to see Angkor Wat,” he says, but he knows that with an injured foot and curtailed mobility, he’s unlikely to make such a trip. He would also like to get back to Europe one last time; Ludmila Hess is of noble Czech lineage, and her family still has homes in Prague.

“The aristocracy has vanished,” Ludmila says, unabashed by nostalgia. In the past, she notes, “it wasn’t about privilege; it was about duties — your duty to your people. It had nothing to do with swarming around Monte Carlo with money.”

Her husband seems to have a similar view. Money is important to him, but he also seems to believe that past a certain point, attaining it becomes an exercise in show business, in making money for the sake of making money. He talks about the enormous leveraged buyouts for which the private-equity business has become known of late.

He cites the historical example of KKR and RJR Nabisco: “That was like packing a zoo with elephants when all the other animals were mice.” He frets about the risks assumed in such deals, and a sense of obligation creeps into his voice. “Debt is wonderful — that’s the way you make money. But it’s like gambling. If you win, everything’s fine, but when it goes against you, if the business falls and you’ve got too much debt, then you’re in deep trouble. If you pick up a package that’s too heavy, you’re going to drop it. And it doesn’t always fall when nobody’s around. Sometimes when these things drop, they break up, and a lot of people get hurt.”

For this reason, when Hess was in charge of AEA, the firm did its deals with an average 40 percent equity infusion into the companies it bought, an enormous amount even in those days.

“People thought we were nuts,” he says. The firm had numerous other old-fashioned restrictions as well: no hostile takeovers. No liquidations. No stripping of assets. No mezzanine debt or junk bonds. Says Robert Stillman: “We were considered the old lady of the buyout business.”

But AEA was thus able to reduce its risk and fatten its returns to an average of 45 percent a year. “We were seen as super-conservative,” Stillman adds, “but we were also seen as the mark others measured themselves against.”

While working Todisentangle AEA from the Leisure Group, Hess got a tip from the Rockefellers: A company called the General Adjustment Bureau might be ripe for purchase.

“What the hell is the General Adjustment Bureau?” Hess asked the Rockefeller agent.

“It’s the oldest insurance-adjustment company in the world, and maybe the biggest. It was founded before the war.”

“Which war?”

“The Civil War.”

AEA bought the company and immediately instituted an incentive plan for every employee, from adjustors in the field to senior management.

No such plan had existed at GAB before. Productivity increased, business boomed and less than three years later, AEA sold it to United Airlines for almost five times its initial investment. A participant who put up $375,000 in his fund made $4 million. “That gave us some breathing room,” Hess says. “We went on to do a series of deals, most of which were successful.”

A Hess story of an AEA deal is usually laden with the names of corporate titans of yore. Not long after it got its start, the firm developed from an investment fund chiefly for old-money families into an investment fund for former high-ranking corporate executives: George Love, of course.

But soon came Bill Hewlett of Hewlett-Packard, Irving Shapiro of Du Pont, Frank Stanton of CBS, Walter Wristen of Citicorp, John Harper of Alcoa, Reginald Jones of General Electric, Tom Murphy of General Motors, Ken Jamieson of Exxon and Howard Clark of American Express. As Hess goes through the names and details of their intricate relationships, he pauses, shaking his head.

“All these people are dead.” Another pause. “This sounds more like a necrology than anything else.”

AEA’s modus operandi was to mine its participants’ talent and place them on the boards of the companies it bought. As Fortune put it in 1989, “The firm is like a small greenhouse where companies are repotted and fertilized in carefully controlled light and temperature — a place where all the gardeners have green thumbs.”

This was another AEA innovation and was widely copied in the private-equity world. “AEA is a big deal,” says Joseph Bartlett, an attorney with the law firm Fish & Richardson, who has represented buyout shops for 30 years. “They were one of the first to bring in as partners people who had real operating experience. Everyone does that now.”

The atmosphere among AEA’s members was fraternal, collegial and clubbish. They gathered at Manhattan’s River Club each September for the firm’s annual meeting, which included, in Hess’s delicate wording, “an extended cocktail hour.”There were cigars and jokes and much backslapping. “They loved to be together,” Hess says.

John Whitehead, the former co-chief of Goldman Sachs, whom Hess persuaded to take his place as AEA chairman after he retired in 1989, once came to the annual dinner dressed in a tuxedo. No one else was wearing one. “With all these high-class people,”

Whitehead explained, “I thought everybody would be in one.” AEA’s smart set shared notes and exchanged ideas. “There weren’t many liberals in the group,” Hess deadpans. Henry Kissinger and George Shultz were shareholders for many years. Membership in AEA was capped at 100, and was strictly invitation-only.

Once invited, would-be participants would often ask what the firm’s minimum commitment was. “It doesn’t really matter,” Hess would reply. “I’m not after your money; I can always raise money. What we’re after is your experience, your wisdom and your participation — that’s what’s important.”

Carl Hess is standing in a conference room upstairs from his office. It’s 5 p.m. on this mid-January day, and the traffic and car horns are just barely audible from Park Avenue 27 floors below. Along one wall is a series of framed black-and-white head shots of the firm’s most important founding participants. It’s an AEA Wall of Fame, and Hess is its curator. He offers a guided tour.

There’s Sir Siegmund Warburg with his penetrating eyes: imperious, privileged, irritated by something.

George Love: bald, bright-eyed, round-faced, he looks like an extremely formidable cherub. “That’s why everyone called him ‘Kewpie,’ ” Hess says.

J. Richardson Dilworth: upright, stolid, like a Connecticut grandfather: “Dick was the absolute soul of integrity.”

Bill Hewlett: “A most extraordinary guy. Brilliant engineer and manager. During the Leisure Group problem, he loaned us his chief financial officer at no charge.”

Jim Dudley: “He came from Minnesota. Dedicated Harvard man. His father discovered the Mesabi range — iron ore. Very wealthy. He had his own investment firm, Dudley & Co., and had some very rich clients who became participants here. He was not well-known. When I told Siegmund that Jim Dudley was coming to see him, Siegmund said, ‘Dudley who?’ Jim was very laid-back. A wonderful fella.”

John Harper: “Chairman of Alcoa. He was a poor boy from east Tennessee. He ended up giving the largest monetary gift to the University of Tennessee in its history.”

Irving Shapiro: “Shapiro was a sensible guy. I used to love to watch him during board meetings. Someone would be pontificating about something, and he’d say, ‘All right — let’s infuse some common sense into this.’ ”

Looking at the pictures, Hess goes quiet and seems for a moment to be lost in a reverie. He remarks that everyone on the wall is dead but two: himself and a man named Carl Mueller, the former vice chairman of Bankers Trust, who now resides in an assisted-living home somewhere outside Boston. Hess shakes his head.

“Not many companies have ever had this kind of talent,” he says. “We damn near had a monopoly on it.” It’s now near 6 o’clock. Hess takes one last look at the wall, turns toward the door, shuffles slowly down the hallway and disappears back into his office.