Could turn secretive Koch Industries into a partly public concern.
July 26 1982
By Louis Kraar
Keeping a company with estimated annual revenues of more than $14 billion out of the public eye is a task that one of its principal owners describes as "sort of like trying to hide an elephant behind a telephone pole." Nonetheless, elephantine Koch Industries of Wichita has done remarkably well at maintaining a slender profile. Surprisingly few people‑even among those who deal with it‑appreciate the full extent of its operations. With assets that appear to approach $2 billion, Koch (pronounced "coke") possesses all the basic elements of an oil major, including 13,000 miles of pipelines and a supertanker, as well as vast cattle ranches and other real‑estate holdings. Last year Koch even managed to plunk down $265 million in cash for a Sun Co. refinery in Texas without attracting a lot of attention.
But these days the shy elephant is stomping around in a traumatic fit. A family feud has erupted among the four Koch brothers, who own about 75% of the company, dividing them into two rival camps. Blood and money, that most volatile of mixtures, makes their fight over the corporation's future especially bitter. Some of the brothers are not speaking to each other, and the competing factions are wooing the support of other shareowners who hold the balance of power.
Much of the fuss swirls around Chairman Charles Koch, 46, who runs the company with a firm hand. His adversaries depict Charles as no less maliciously creative than the willful J.R. Ewing of the television show Dallas in devising ways to control his brothers and the family fortune. In Wichita, as this real‑life drama might be called, Charles says that he is merely working to maximize growth. If Charles loses the struggle, the likely outcome will be a public stock offering.
After years of being remote from the family company's affairs, Frederick Koch, 48, a New York‑based producer and patron of the arts, has obtained a board seat for his lawyer.
In part, Koch has been able to keep out of the public eye because its far‑flung activities are mainly those of a middleman. Koch produces only a tiny fraction of the 1.5 million barrels daily of crude oil refined products, and gas liquids that it sells. Well over half its revenues come from transporting and marketing‑which is why Koch did not appear on the recent FORTUNE list of the 50 largest private industrial companies, all of which it exceeds in sales. Of these activities, buying and selling are the most important. "Everything we do starts with our ability to trade," observes a Koch executive.
Koch takes advantage of its obscurity to masquerade as a small company and squeeze out the last nickel in deals. Its biggest customers are the oil majors, which send crude to their own refineries through Koch's pipeline and terminal system concentrated in the mid‑continental US. and Canada. In turn, Koch refineries sometimes supply gasoline to Gulf stations, among others.
Its varied other enterprises‑ranging from manufacturing specialized oil‑industry equipment to removing sulfur from natural gas and selling the chemical‑are individually modest. But whether Koch is manufacturing or trading, it exhibits a knack for picking up bits and pieces of other businesses that complement its existing lines or exploit obscure market niches. Koch purchases petroleum coke, for example, a substance most refiners view as an undesirable byproduct. But blended with coal, it makes a good boiler fuel, which Koch sells to industrial customers. In the characteristic Koch way, that business has led the company into marketing and mining coal too. (For a list of Koch's activities, see the box at right.)
A country boy's legacy
Koch's spirit of ingenuity is the legacy of Fred C. Koch, its late founder and father of the principal owners today. "Fred was a typical old country boy," recalls one business friend, "except everything he touched turned to money." He got his company off the ground in 1928 by developing a version of the then widely used thermal cracking process for refineries, which increased gasoline yield. But his success in selling his process to independents in the petroleum industry provoked lawsuits from the oil majors, which controlled refinery patents in those days. Although he finally prevailed, the controversy‑which went on for two decades‑frightened away many U.S. customers.
Consequently Koch made his first big profits in the Soviet Union, which purchased 15 of his cracking units for Stalin's first five‑year plan. But in the late Thirties Koch's best Russian friends‑scientists and engineers‑were liquidated in one of the purges; appalled, Koch turned into a fervent anti‑Communist and went on to become a founding member of the John Birch Society. Starting in 1940, he gradually assembled his stake in the US. oil business, then his cattle ranches‑his favorite enterprise during his last years.
Before joining the family company, Charles earned no fewer than three engineering degrees at MIT and put in several years as a staff consultant at Arthur D. Little Inc. He returned to Koch in 1961. As he tells it, "Father said that if I didn't come back here, he was going to sell the company." Charles's initial assignment was setting up an operation for Koch's engineering division in Bergamo, Italy. "I had to look at the map to see where I was going," he admits, "and I wasn't that familiar with the products or markets." But he learned quickly, and soon he was running the entire division, which makes equipment for the petroleum and chemical industries.
Charles was 32 and had worked full time for the corporation only six years when his father died of a heart attack while hunting ducks in 1967. For all Fred's entrepreneurial gifts, Koch Industries was a modest hodgepodge, including part of a refinery near St. Paul and a little oil‑distribution pipeline in Oklahoma. As one executive says, Koch then was "all but out of the oil business." But Charles had some grandiose ideas and moved quickly to expand the company. Several months after his father's death, he staged a New York press conference‑his first and only one anywhere to announce that the company would diversify, and might even go partly public. To trumpet the new management, he changed the firm's name from Rock Island Oil & Refining to Koch Industries.
Charles made good on his promise to expand and diversify, at least, and over the past 14 years Koch Industries' sales have grown 56‑fold. As for earnings, Charles says only, "It's a profitable company."
Buying up the junk
Much of Koch's success was due to Sterling Varner, 62, who had been the founder's right‑hand man and who is now president. As one board member puts it, "He's the brains." Varner seems to have been the chief architect of Koch's singular acquisition policy, which Charles's brother David describes as "intelligent opportunism." Varner is reminiscent of a country lawyer who masks his shrewdness with a down‑home manner. Thus, he explains the strategy by saying that Koch "always wants to buy junk." And "junk" is what the other companies thought they were selling. But all the acquisitions‑oil pipelines, storage terminals, and other facilities‑enhanced Koch's trading activities and were got at bargain prices. Koch invariably bought at what Varner calls "bad periods." He adds dryly, "There are more potential opportunities when others get discouraged."
Charles's main preoccupation, by contrast, is with the details of management. "Charles is more of an organization man than his father was," says Varner, "and he brought a lot of ideas we never used before"‑among them profit plans and quarterly reviews. He cultivates an intensely personal management style. "We don't have a big bureaucracy here," says Charles. Though the company has 7,000 employees, his only staff support is a secretary he shares with another executive; he still eats lunch in the company cafeteria among his employees, whom he urges to work as if they were in business for themselves. Putting in ten‑hour days at Koch's headquarters, he deals directly with the heads of the company's far‑flung divisions and makes his decisions by fielding proposals from Varner and other subordinates. The object of this style, says Koch, is to invest his large corporation with "the borrowing power and an Aa rating from Moody's. The resources to finance Wyman's bets (see chart, page 76) are going to be ample.
The hand of history
For half a century the monarch of broadcasting, CBS didn't bother to develop the habit of coping with unpleasantness. Making the most of the favored position conferred by FCC regulation on the networks, the company strode profitably along: for 21 years until 1975, the CBS network was a steady No. 1. Paley's favored child, the network was a great cash generator and loaded the company with money.
Since the regulation that helped CBS compile so much wealth also limited the ways it could be invested, Paley in the mid‑Sixties began to strike out vigorously into fields beyond the FCC's reach. He usually paid cash for his acquisitions and preserved his treasured earnings per share. But Paley proved an inexpert conglomerateur. He sometimes paid peak prices for declining companies: one was the New York Yankees, bought after they won five successive pennants. The Yankees never won a pennant for CBS, which sold the team at a loss eight years later. Activities in which Paley and his immediate subordinates had less interest, such as records and musical instruments, were allowed to go downhill to the lowlands where they now reside.
By the time Wyman arrived in June 1980, decline was everywhere. The network was being assaulted by cable and independent stations; CBS had too much idle plant capacity for producing records; a rackful of ailing magazines and paperback book lines narrowed the margins in publishing; musical instruments were barely breaking even; and a chain of stores selling hi‑fi equipment was deep in the red. Last year fully 40% of the company's $2.4 billion in assets were producing only marginal returns.
Chief executive of CBS since 1980, Tom Wyman, 52, is its third president in ten years. A big man‑he's six‑three and looks taller‑Wyman seems as comfortable as anyone could be in a cavernous five‑room office suite that is also inhabited by the shades of former occupants.
Wyman brings plenty of strengths to the job. He developed so rapidly at Polaroid that he became No. 2 to Land at the age of 42. After leaving Polaroid to run Green Giant, he brought his new company along so well that it was snatched up in a hostile takeover by Pillsbury four years after Wyman got there.
Throughout his career, Wyman has displayed an unusual talent for getting along‑with superiors of unusual temperaments, with peers, with subordinates. While seeking to move CBS toward a more integrated managerial structure, Wyman has characteristically been careful not to bark orders‑people who know CBS say that would be fatal‑and he hasn't lopped off heads: most of the top executives around him were there when he arrived. Some critics say that Wyman has too much trouble making hard decisions. Others fault him for lacking expert knowledge about the areas that CBS works in. But after two years on the job, Wyman's abilities seem far to outweigh those deficiencies.
Wyman's sense of balance shows up in the relationship he has established with Paley. The patriarch, who has run CBS since 1928, still owns 7% of the stock. His memory sometimes slips, but he is vigorous enough to spend long working days in his office. He discusses all major plans with Wyman; he also freely bypasses Wyman and subjects some of the people below him to tough questioning on the telephone.
Instead of protesting, Wyman seems careful to defer to Paley. He learned to be self‑effacing early in his career: at Polaroid, Wyman quit smoking after being told he'd stubbed out a cigarette in one of Land's irreplaceable American Indian plates. He has supported a cherished Paley project that turned into the outstanding failure among CBS's new ventures, CBS Cable. CBS Cable transmits such highbrow programs as Swan Lake performed by the Royal Ballet, and it is losing money at the rate of $30 million a year.
Deferential or not, though, Wyman has managed to stake out a position that looks more independent than those achieved by any of his predecessors. Last year Wyman hauled home a salary of $920,000. The first president of CBS ever to make more money than the chairman, he also got a bonus of $1 million for coming to the company, and will pick up another million or so if Paley should bounce him. Wyman's independence shows up on the organizational chart: the important decisions are now made by a ten‑man management committee, of which Wyman is the chairman. Paley is a member, but he almost never shows up.
"Be honest with ourselves"
Wyman's first exercise of managerial forcefulness came with his early insistence that CBS had a need to level with itself. "We had to inventory what we had going for us, and to be honest with ourselves about the things we weren't good at," Wyman recalls. To speed along that corporate self‑analysis, Wyman brought in one of the top analysts of the broadcasting industry, David Londoner from the brokerage firm of Wertheim & Co., to tell CBS's executives what investors thought of the company. In the 35th‑floor boardroom, with Paley present, Londoner reminded his audience about Wall Street's disapproving "perception of revolving door management" at CBS‑a comment that could hardly have delighted Paley‑and added, "You still need to show a clear sense of direction."
Wyman's strategy aims to impart that sense of direction. His basic idea of forcing the company into new markets, which he started pushing soon after he came to CBS, is costing a bundle. Since Wyman took over, some $516 million has gone into new activities and into strengthening some old ones. Many of these investments are bringing in significant revenues. But losses from developing businesses, such as the cable network and films, ran around $47 million last year. Wyman thinks new ventures will continue to lose something in the neighborhood of $50million‑annually‑for the next couple of years.
Squeeze on the big earner
When the turnaround does come, the television network will have to be the prime mover. Although it produces around $200 million a year in pretax operating profits, the network remains squeezed between rising production budgets and slowing revenue growth. Viewers are abandoning their loyalties to network TV: in the last five years the three networks' share of prime‑time TV viewers has gone down eight points to 83%. Even in the view of Gene Jankowski, the optimist who has been running the broadcasting group for five years, the share will drop to 70% by the end of the decade. Jankowski prays each morning at St. Patrick's Cathedral in New York before reporting to the CBS building for work. He may need divine intervention to pass rising costs on to advertisers, who already pony up as much as $220,000 for a 30‑second commercial, in a period when the number of prime‑time viewers is not increasing.
Neither Wyman nor anyone else has a magic fix for that situation. But Wyman, who can be an optimist himself sometimes, is betting that projected increases in the viewing population will actually help.