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This didn’t mean that the executives who led Purina Mills were excited about selling it. The company had a storied history in St. Louis and a legacy of independent leadership. Senior executives at the firm weren’t instantly seduced by the idea of being owned by an energy company out of Wichita. Purina’s chief operating officer, Arnie Sumner, counted himself among the skeptical. He had been with the company more than twenty years. He was a New Englander, a transplant to suburban St. Louis who still had a slight trace of a longshoreman’s accent. Sumner wasn’t a flashy guy, and he wasn’t too impressed when Koch first approached the company.
Koch’s ambitions for Purina were vast. The company would transfer all of Purina’s grain purchasers to a central desk in Wichita, where they would become a trading desk to buy and sell commodities. These traders would be able to supply all the grain that Purina needed, while also supplying other major customers like Tyson Foods and Cargill.
“I think they thought they were going to buy commodities for the world . . . because they could do it better than anybody else,” Sumner recalled. Koch also planned to build a new network of specialized “wet” feed mills that could process food waste into animal feed. Those mills would create whole new sources of feedstock for Purina—wet potato peels instead of soybeans, for instance. Purina could sell the feed through its unrivaled network of dealers.
Because of these ambitious plans, Koch was able to offer a surprisingly giant sum of money for Purina. Dean Watson and others offered a price for Purina Mills that included the value Koch thought it would produce after its improvements had taken hold. Purina itself was worth about $109 million. Koch would pay $670 million to buy it.
Such a rich price was impossible for Purina’s management to deny. “Koch came along, and they made a huge offer for the stock,” Sumner recalled. “That’s the whole reason it was sold. People wanted to cash out. We were all led to believe that this was going to be a great thing.”
Koch made one pivotal decision when it bought Purina: it financed almost the entire deal through debt. This was a stark departure from earlier deals, when Koch had used its own cash reserves to buy new businesses. It was extremely difficult to borrow hundreds of millions of dollars from one place, so Koch Industries went on a road show of sorts, convincing different groups of bankers to lend it money for the Purina deal.
Koch ended up borrowing the money with two massive sources of debt. The first was a $200 million loan (called a term loan) that was provided by a network of banks. The second source was a group of corporate bonds (called notes) worth $350 million. Koch also set up a line of revolving credit in case it needed extra cash. Koch made up the rest of the purchase price with roughly $100 million of its own money in the form of equity that it handed over to the new Purina Mills. The deal was closed in March of 1998.
Koch wasted no time in making good on its investment. Koch employees began to infiltrate Purina’s offices in suburban St. Louis. Koch had more than $550 million in debt hanging over its head, but the Koch people didn’t seem worried about it. “I think everyone within Koch thought they knew more than anybody else,” Sumner said. “It kind of got crazy.”
* * *
One of Dean Watson’s first and most important jobs was to integrate Purina Mill’s operations into the broader machinery of Koch Industries. There was more to this than figuring out how to process Purina’s payroll out of Wichita or how to train Koch’s traders to buy and sell grain for Purina’s mills. That was the easy part. The more difficult element was psychological. Watson had to figure out how to subsume Purina’s corporate culture into Koch’s. Watson referred to the entire acquisition, in fact, as a “long-term culture-shift play.”
The process began with a seminar in Market-Based Management. Watson needed to teach the philosophy to Purina’s top leadership, just as Charles Koch had first taught it to his own senior managers. The parameters of MBM demanded total conversion on the part of new employees. But Purina Mills already had a corporate culture of its own.
You could call it the Danforth culture, named after Purina’s founding family. The Danforth name carried a mythical reverberation that could only be heard by Missouri ears. The Danforth family was the state’s equivalent of royalty, having mastered all three important realms of midwestern civic life: business, church, and politics. The patriarch, William H. Danforth, founded the Ralston-Purina Company more than a hundred years before Dean Watson showed up. Danforth’s son, Donald, took over the company and became a fixture of the St. Louis business community. Danforth’s grandson, John Danforth, was an ordained Episcopal priest who went into politics and became a US senator.
The Danforths had their own way of doing business at Purina, generation after generation. Even the company’s logo—a famous checkered logo with nine squares, four white and five red—were a symbol of the founder’s philosophy. The four corner squares in the logo represented the four necessary elements of human well-being, according to William Danforth: physical, social, mental, and religious. These four elements blended together to make a corporate culture that executives would describe as being like family. As such, employees were not discarded. If an employee’s job was eliminated after he’d been with the company for forty years, he could rely on Purina to find a place for him. He could totter into work until he no longer cared to—his joints would give out far earlier than his job security. Such an arrangement was considered perverse under the philosophy of Market-Based Management. Letting someone work past their prime only robbed precious resources from potential new employees.
Shortly after Koch Industries took control of Purina, Purina’s senior management team was called into a meeting. The executives arrived at a hotel in the western St. Louis suburbs, where the wide windows look out over rolling green hillsides and the rooftops of suburban cul-de-sacs. Roughly two dozen Purina executives sat down in the conference room. These were men who’d been with their company for decades, many of them with the white hair to prove it. They were not a class of eager college graduates attending a Market-Based Management training session in Wichita.
Dean Watson stood before them and explained that the first step toward being an employee of Koch Industries was learning MBM. Learning the philosophy wasn’t a benefit of being at Koch—it was a precondition to working there. Purina’s executives would need to understand the five dimensions to MBM. They would need to internalize Koch’s Ten Guiding Principles—not memorize them, but internalize them. These principles included integrity, compliance, and value creation.
Arnie Sumner, Purina’s chief operating officer, listened to the presentation and thought it sounded like management consultant sloganeering. The nature of a good merger, in his mind, was when two companies meshed their corporate cultures. But Koch wasn’t trying to mesh with Purina’s culture; it was trying to eradicate it. The Purina executives didn’t swallow it. They didn’t think it was necessary to erase their neural pathways and start anew under Charles Koch’s tutelage.
Dean Watson became agitated in the face of this resistance. “He got up on the stage and started screaming and yelling,” Sumner said. He remembered Watson shouting: “Who the hell do you think owns this damn thing? You guys are going to do what the hell we tell you to do. If you don’t like it, get your ass out!”II
If this was a sales pitch, it was less than inspiring. Senior executives began quitting the company soon after the meeting. They took retirement packages or moved on to new jobs. Watson seemed to realize his mistake immediately.
“Afterward, he said to me, ‘I really screwed up, didn’t I?’ ” Sumner said.
* * *
Things started to go south for Purina Mills because of a change in government policy. It wasn’t an OPEC-style embargo that unleashed an era of volatility in food production. It was Congress. For the preceding half century, the world of agriculture had been remarkably stable. Prices for crops like corn and soybeans moved around, but they moved within a narrow band. The food industry was a lot like the oil industry d
uring the 1960s. It was predictable.
This changed in 1996, shortly after Republicans took control of Congress. Newt Gringrich, the Speaker of the House, led the Republican Revolution, and farm programs were one of the conservatives’ first targets. Farm programs were the cornerstone of the New Deal. Back in 1933, farming was a pillar of America’s middle class, but the business was whipsawed by violent booms and busts. The Great Depression had been the biggest bust of all. In response, President Franklin Roosevelt created an intricate system of price supports and crop quotas using pages stolen from the books of Soviet-style central planning but burnished with a patina of capitalistic freedom. Farmers had production limits, but the limits were voluntary. The guidelines were encouraged by subsidies. Many farmers got checks in the mail to ensure they let part of their land lay fallow—they got money for nothing. In 1996, Congress passed a bill called “Freedom to Farm” that largely abolished the New Deal farm programs. Subsidies did not disappear, however. They were simply replaced with a complex system of insurance payments and “disaster” relief. (It turns out that virtually every year is a disaster of one kind or another for farmers. The so-called disaster payments turned into a dependable flood of cash to large-scale farmers.) What did get abolished were the production controls. Farmers were encouraged to grow as much food as they could, market prices be damned.
This caused a wave of volatility to flood through every nook and corner of the farm economy in 1997 and 1998. Purina Mills was sitting right in the center of it. Purina bought grain from farmers and sold feed to livestock producers. Both of those businesses rose and fell in wild and unpredictable swings, each one hurting Purina Mills in a different way.
The brain trust of Koch employees around Dean Watson had to figure out how to respond, and they were utterly unprepared to do so. A lot of his team members were the “freelancers”—the MBAs from business schools on the East Coast or in Chicago. “We had no depth when it came to local knowledge, which was our ability to understand the nuance of the businesses we were in,” Watson said. “Most of what we relied on was from the free agent markets. . . . You had no idea how these guys and gals would react when the shit started hitting the fan.”
The heaviest damage started to emerge from an unlikely place: Purina’s business selling pig feed.
Before the deal to buy Purina closed, Watson had been warned about Purina’s pig business. It turned out that Purina owned some pigs, which was odd. Purina sold feed; it didn’t raise animals. Watson was told that Purina had signed some contracts to buy baby pigs and then turn around and sell those baby pigs to farmers. The idea seemed to be that Purina would lock in the business to sell those farmers feed as the pigs matured. Watson asked one of his lieutenants, a former Cargill employee, about the pig contracts. He told Watson that the exposure was limited. Purina didn’t own the pigs for very long; it was basically acting as a middleman.
As it turned out, Purina’s exposure to the hog business was not limited at all. The volatile markets exposed that fact. In 1998, the US hog market experienced a shock comparable to the stock market crash of 1929—a market convulsion that obliterated all the rules everyone thought applied to the business. The root of the problem could be traced to the very industrialization that created Purina Mills’ feed business in the first place. Now that hogs were raised on factory farms, the supply of animals was enormous and inflexible. Farmers were raising herds of tens or even hundreds of thousands of pigs. When prices started to fall, these industrial farms couldn’t adapt quickly. They had mortgage payments to meet on the big pig houses, and they needed to keep production high. Factory farms were a machine that wasn’t easily turned off. The flow of pigs continued into the slaughterhouses, and prices fell even further. Then everything spun out of control. Hog prices plummeted, sucking the entire business into the ground almost instantly. The price of hogs fell from about 53 cents per pound to 10 cents per pound in a matter of months. When adjusted for inflation, this was the lowest price for pigs in US history. It cost far more to raise a pig than the animal was worth.
Purina Mills should have been insulated against this crisis. It only sold feed, not the hogs themselves. But with its decision in 1997 to start buying baby hogs, Purina had exposed itself to the risk of falling pork prices. Dean Watson began to discover just how large that exposure was. As one farm economist put it at the time, the rational number of hogs to own in 1998 was zero. Purina discovered this fact quickly. It bought baby hogs, and turned around to sell them to the farmers. But there were no buyers. The farmers refused to take them.
“The people who we were supposed to be selling the pigs to were basically saying: ‘Sue me.’ The people we had bought the pigs from were saying: ‘You’re not getting out of my contract or I am suing you,’ ” Watson said. “All of this ownership risk that I was assured didn’t exist started to just come out of the woodwork.”
There was no central repository in which all these hog contracts were kept. That meant there was no easy way to figure out how much money Purina stood to lose. The company was discovering its contractual obligations with each new angry phone call that came into its pig division. One giant pig contract was sent into the company via fax from a large pig company in Pennsylvania. No one on Watson’s team had been aware of the contract before it arrived.
“I remember asking the question ‘How in the hell can this show up in a fax without us knowing about it?’ ” Watson said. “You kind of get these deer-in-the-headlight looks.”
* * *
In December of 1998, Watson was named CEO of Purina Mills. His job was to stanch the bleeding. At the time, he was still working at Koch’s headquarters in Wichita, but Koch chartered him a private jet to St. Louis that departed each Monday morning at five thirty. He spent his weeks at Purina headquarters and flew home on the weekends to see his family.
The hog market crisis raced forward faster than Purina Mills’ leaders could respond. And Purina could not respond quickly to the market convulsions because it was shackled with debt. In mid-1998 it owed about $557 million. The company had to post periodic payments of several million dollars just to pay interest.
Watson tried to mollify crowds of angry bankers. One group of lenders, who had about $200 million on the line, traveled to St. Louis to hear Watson tell them how he planned to pay their money back. His ideas were less than convincing. In early March of 1999, just three months after Watson became CEO, the ratings agency Moody’s downgraded Purina’s debt. The likelihood of anyone getting their money back started to look slim.
Watson struggled to keep his troops in line. The freelancers with MBAs knew very well that the ship might be going down. Loyalty was not at a premium. At one point, Dean gathered employees around him as he stood on a desk in one of Koch’s trading rooms. He exhorted the crowd, saying, “Look, I’ve got to have everybody. All hands on deck. You’re grabbing an oar [to help paddle], or you get your ass off the boat, because I can’t wait anymore.”
* * *
Brad Hall was dispatched from Wichita to St. Louis to start digging through Purina Mills’ files and figure out just how big its losses might be. The picture that emerged was terrifying. Starting sometime in 1997, before Koch Industries bought the company, Purina Mills had hatched a plan to boost hog feed sales by purchasing baby pigs and then providing them to farmers to raise. The farmers agreed to feed the pigs Purina products. The company had locked in guaranteed sales, and it was easy money for a while. So Purina expanded the program. It provided more pigs under contract to big companies like Tyson Foods, selling more feed and then buying even more pigs. By the end of 1997, Purina effectively owned six million pigs, making it one of the largest hog producers in the nation. When Koch purchased the company, it missed this fact because it hadn’t looked closely enough. The deal was too hurried; growth had taken precedence over diligence.
By 1998, Purina Mills was on the hook to purchase about $240 million worth of hogs that had literally zero financial value. Brad Hall went back t
o Wichita to inform Charles Koch about what he’d found.
Charles Koch was just returning his full attention to the business. His months of distractions from Bill Koch’s litigation were finally coming to an end. The federal jury in Wichita ruled in Charles Koch’s favor in June of 1998, finding that he had not deceived his brother Bill when he sold the company. It was a complete and unambiguous victory for Charles Koch—he owed Bill nothing. Bill appealed the verdict and called Charles a “crook” in the resulting newspaper stories, but this was to be expected. The appeals went forward, and Bill Koch lost them all. Charles Koch wasn’t given time to celebrate. The disaster at Purina Mills was awaiting his attention.
Most people who have worked with Charles Koch have never seen him get angry. Charles Koch doesn’t yell, or even raise his voice. During one meeting of senior executives, a manager said there was no “fucking way” he would comply with an order from Charles Koch. In response, Charles Koch simply closed his meeting folder, stood up, and left the room.
When Brad Hall explained what was happening inside Koch Agriculture, Charles Koch became as angry as Hall had ever seen him. Hall stood in front of Koch and walked him through the pig contracting scheme at Purina. It was hard to guess just how much money Koch Agriculture would lose from its stake in Purina Mills. Koch was able to escape some of the contractual commitments to buy hogs. It might be able to hedge some of its other contracts. The losses might approach $80 million—or they could be higher, Hall said.
It wasn’t just the financial losses that seemed to enrage Charles Koch. It was the fact that Koch executives missed the lethal liability hiding within Purina’s business. Charles Koch snapped.