Kochland Page 38

  Three years later, Georgia-Pacific’s stock price was still struggling. Wall Street analysts just couldn’t figure out how to value a firm that was halfway in the wood products business and halfway in the consumer paper business, two industries that were very different in their particulars and also in their business cycles. Shares of the company bounced around unimpressively, and it was never quite clear how the Fort James purchase was going to deliver strong growth.

  Georgia-Pacific was looking for a way out of this morass, and executives on the fifty-first floor of the Pink Palace believed that one way forward was to sell off some assets, like its pulp mills. Koch’s Corporate Development Board had become a national hub for the private equity firms that trafficked in such deals, so Koch’s team quickly became aware that Georgia-Pacific was looking to unload some of its properties.

  On the day that Koch visited Atlanta, Georgia-Pacific’s presentation on its pulp mills was given by a long-time G-P employee named Wesley Jones. He gave them an overview of the pulp business, the cornerstone of which was a massive mill located in Brunswick, Georgia. The mill produced something called “fluff pulp” and was the largest such mill in the world. The term fluff pulp was a little misleading. The factory actually produced giant rolls of compressed wood fiber that looked like paper towel rolls about the size of a car. The rolls were sent to factories around the world that processed the pulp into soft, absorbent material used in diapers and feminine hygiene products. Georgia-Pacific built the Brunswick mill to feed growing demand for fluff pulp in Asia, as a burgeoning middle class in China and India had more money to spend on disposable diapers. But the bet hadn’t paid off yet—exports remained more sluggish than the company would have liked.

  After Jones finished his presentation, Hannan began to dissect everything he had just heard with question after question. Hannan asked about Brunswick’s raw material markets. How did the mill procure its trees? What was the market for timber like? Was it volatile? Did the mill buy its wood under long-term contracts or at a spot price? Jones answered the questions gamely, even if it was a little unclear to him why an oil and gas outfit out of Kansas was interested in any of it.

  When the questions were finished, the delegation from Koch Industries got up from their seats, exchanged pleasantries, and headed back to Wichita. The biggest expansion in Koch’s history was about to get underway.

  * * *

  After their trip to the Pink Palace, Hannan and his team agreed to buy Georgia-Pacific’s two major pulp mills. Koch Industries formed a new shell company, called Koch Cellulose LLC, which took possession of the two major pulp mills for $610 million.I

  This acquisition would have been among Koch’s biggest in the 1990s, but in 2003 it was just a down payment. Charles Koch favored a trading strategy that he called “experimental discovery.” It entailed making a small bet in a new market and seeing if the bet paid off. Even if a Koch trader lost money on the trade, they gained insight. If they made a profit, the bet could be expanded.

  The pulp mill purchase was just one of many experimental discoveries. Almost as soon as the pulp mill deal was closed, Jim Hannan was switched onto a new team. This one examined the assets of a different company, the old-school chemical conglomerate DuPont.

  In 2003, DuPont was like Georgia-Pacific in one key way—investors didn’t quite know what to make of DuPont’s unwieldy collection of business divisions. DuPont had a highly profitable biotechnology division, but its earnings were dragged down by some of its old-line chemical plants. DuPont’s management thought it could boost its stock price if it sold some the company’s legacy plants. One division DuPont was keen to unload was one of its oldest and best known: the synthetic materials unit that made products like Lycra and Stainmaster carpet. The synthetic fibers helped make DuPont a household name, but global competition turned Lycra into a commodity, and, like most commodities, it was suffering from booms and busts in the market. Naturally, all of this was attractive to Charles Koch and the Corporate Development Board.

  Koch could secure natural gas and oil supplies better than almost anyone in the world, which would shield it from some of the price risks that were hurting DuPont. There was another attractive feature to DuPont that was similar to the Georgia-Pacific deal. Koch had gotten good at running refineries, and many of the skills it learned in that field could be applied equally well to making fluff pulp, Lycra, and Stainmaster carpet. The business involved paying people to sit in large control rooms and monitor machines that process raw, sometimes dangerous materials. At the Brunswick mill, the people in control rooms oversaw towers that dissolved wood pulp and spinning wheels that turned it into rolls of pulp. At the DuPont plants, the people in control rooms oversaw towers that mixed petrochemicals into compounds that could make clothing. Charles Koch believed that the company could do these jobs equally well, while using each new company as a way to branch into new industries.

  In November of 2003, Koch agreed to buy DuPont’s synthetic fiber plants for $4.4 billion.II Just as it had done with the Georgia-Pacific pulp mills, Koch Industries installed layers of corporate veil around the project to protect Koch’s investment. It purchased the assets from DuPont by using two shell companies, called KED Fiber Ltd. and KED Fiber LLC. The chemical plants themselves would be housed under a new company, called Invista, that had its own board of directors and nominal independence from Koch Industries. The deal more than doubled the size of Koch Industries’ workforce, adding eighteen thousand employees to Koch’s fifteen thousand.

  Hannan was named president of the intermediates business at Invista (“intermediates” in this case meaning chemical products that were used to make synthetic material). This was the first time that Hannan, a finance guy, was put in charge of operations. He oversaw complicated, sometimes dangerous, chemical processing machinery and was responsible for the safety and competence of employees who worked around that machinery. It was a steep learning curve. And the learning curve had to do with a lot more than just overseeing operations.

  Over the next two years, Hannan got a front row seat for Koch’s actions as a private equity firm. He would play an instrumental role in “Kochifying” both Invista and Georgia-Pacific, absorbing both firms into the Koch Industries system. Koch managed these new divisions in ways that were both typical of private equity firms, but also iconoclastic. It used common tools of the private equity boom—heavy debt, a strong corporate veil, and deep financial analysis—but it also imposed a vision that was particular to Charles Koch. While Koch pushed down costs in some areas, it also spent billions on its new holdings rather than stripping them for parts, as some firms did.

  Invista became a laboratory to impose another key feature of Koch’s operating philosophy: its new, unbending insistence that all Koch operations obey every law and regulation that was applied to them. This strategy emerged from the painful lessons of the 1990s, when Koch Industries had developed a regulatory rap sheet that gave the company a reputation for borderline criminality. And this strategy was particularly vital to the Invista purchase, with which Koch instantly inherited a network of large factories full of dangerous equipment and chemicals. Each factory was a collection of potential federal violations, and Koch was relying on a workforce of strangers to comply with these rules. The Invista workforce was larger than Charles Koch’s entire company, and now he would have to make sure that each and every one of them had his very best interests at heart. It was Hannan’s job, in part, to make sure that this was the case, at least for the division that he oversaw.

  * * *

  After Koch took over Invista, it placed help-wanted ads in the business press, advertising open positions for compliance attorneys. This is how Koch came to hire a liberal environmental lawyer named David Hoffmann, who lived in Cleveland.

  Hoffmann had never even heard of Koch Industries before, and he was intrigued when he saw the want ad. He wanted to leave the world of billable hours and go in-house at a corporation. The job posting at Koch seemed like the perfec
t chance. But first, Hoffmann had to sell his wife on the idea of moving to Wichita. She was involved in the theater scene in Cleveland, loved urban culture, was an outspoken liberal, and didn’t like the idea of living in central Kansas. Her father was a medical professor and an environmental activist. He didn’t respond well when he found out where his son-in-law wanted to work.

  “When he found out I was working for Koch Industries, he was like: ‘I gotta sit down and talk to you,’ ” Hoffmann recalled. “We had this really bad dinner conversation. I almost got disowned.”

  With the disapproval of his father-in-law and the grudging acceptance of his wife, Hoffmann moved to Wichita in 2005. He spent more than two days sitting in an auditorium, learning about Market-Based Management. He and his wife found the one coffee shop in town where the liberals hung out. They bought a house in the historic district. Hoffmann still didn’t know if he would be helping Invista comply with environmental laws, as the job posting had promised, or if he would be aiding and abetting a corporate conspiracy to pollute the environment, as his father-in-law had feared.

  When Hoffmann arrived at work, he discovered something that would have surprised outsiders who considered Koch Industries to be little more than a rogue corporation. Hoffmann became part of a corporate compliance SWAT team. Its dedication to obeying the law wasn’t just genuine, it was fanatical. They were about to fundamentally transform Invista.

  Hoffmann worked in the new Invista headquarters, a low-slung annex of offices that were connected to the east side of the Koch Tower in Wichita. He joined a team of so-called subject matter experts, or SMEs, in Koch parlance. The team had fewer than a dozen people, and each one was an expert in a different area of regulation, like health and safety rules or industrial waste management. It was significant that this team was based in Wichita rather than in the facilities that they would oversee. The compliance team would no longer be broken up among the various facilities, occupying second-rate offices and vying for the attention of the plant managers. Back in the 1990s, Koch’s legal compliance team followed the lead of the operations managers. At the Pine Bend refinery, Heather Faragher and her team had been subordinate to the process owners. Now, the power dynamic would be transformed. The operations managers had to listen closely to the compliance team. The environmental lawyers had power.

  The centralized compliance team was located a short walk from Charles Koch’s office. The team was sent out into Koch’s new factories to meet with plant managers and make site visits. The occasions were similar to an army general visiting a forward operating base for inspection. The managers knew that Hoffmann’s team was carrying the full weight of Koch Industries’ leadership team. The visits were often a surprise. They were not always pleasant.

  Hoffmann worked with Jim Mahoney, a large man with bright blue eyes and a blunt manner of speaking. Mahoney could be affable and friendly, but any trace of collegiality seemed to disappear when he set foot onto Invista property. He and Hoffmann were led through the facility to inspect its compliance program, and Mahoney didn’t so much ask questions of his tour guides as he demanded answers from them. In one facility, Mahoney grilled a manager about a set of pressure relief valves—Mahoney wanted to know about the safety inspections of the valves. It wasn’t that the valves were malfunctioning, broken, or posed any kind of danger. Mahoney simply wanted more information about how the valves were being inspected, and the manager was not providing satisfactory answers.

  Mahoney snapped.

  “He said at one point, ‘I’ll close this plant right now if you can’t tell me the answer to this question,’ ” Hoffmann recalled. “It scared the shit out of people.” To strengthen their enforcement, Hoffmann’s team hired local attorneys near the plants to act as eyes and ears on the ground, monitoring compliance when the subject matter experts from Wichita weren’t visiting. Hoffmann and Mahoney were spreading Charles Koch’s new doctrine, called the 10,000 percent compliance rule. The mantra described a simple idea: Koch’s operations would be in 100 percent compliance with the law, 100 percent of the time.

  Koch Industries backed up the philosophy with drastic actions. In Victoria, Texas, Koch discovered that a benzene treatment system wasn’t operating according to code. The system was immediately shut down. In Camden, South Carolina, Koch discovered that DuPont had expanded its processing equipment without getting proper permits beforehand and was running the machines out of compliance. Similarly, DuPont had expanded a boiler in Seaford, Delaware, without getting the proper permits and was running the boiler without the proper pollution control technology. In the past, Koch had tried to solve such problems on its own, before regulators discovered what was happening. This time Koch reported everything to the EPA, disclosing nearly seven hundred violations to the agency just months after Koch took ownership of the new factories. Koch entered into an agreement with the EPA that gave the agency power to audit Koch every quarter to ensure that it was complying with a schedule of improvements. Koch spent about $140 million to get everything up to code. Then it sued DuPont for $800 million in damages.

  This 10,000 percent compliance regimen was applied across Koch’s operations, from Invista to Georgia-Pacific, to the refineries at Flint Hills Resources. There was more behind it than the good-hearted desire to be a solid corporate citizen. The strategy was a pragmatic tool to maximize profits. When Koch bought new factories and companies, it simply needed them to run smoothly and efficiently. It needed to keep them out of legal trouble and keep federal inspectors off company property. Violating the rules cost money and created distractions. Ten thousand percent compliance eliminated them. With those distractions gone, Koch could execute the more important elements of its growth plan. Those elements could be observed at Georgia-Pacific’s pulp mills, where things changed immediately after Koch became the new owner.

  * * *

  The Brunswick pulp mill plant was a surreal landscape that mixed pastoral southern charm with a futuristic, mechanized world scaled up to the size of giants. The wooded hills around the plant were traversed by two-lane country roads. Confederate battle flags hung from the beams of old wooden porches where small groups of people sat and sipped cold drinks in the afternoon, waving to motorists as they passed by. As the road descended down toward the mill, the idyllic landscape gave way to the industrial. The narrow road outside the plant was often crowded by long rows of trailer trucks loaded with recently cut pine trees. Just inside the gates, truck after truck deposited its load onto an impossibly tall pile of tree trunks. The pile was arranged in a semicircle at the foot of a giant mechanical claw that towered several stories in the air. The claw pivoted and grabbed a bunch of limbs like a drunken giant, feeding them to a chipping machine the size of a small apartment building. The fountain of golden wood chips was funneled inside the plant, where they were liquefied and pressed into the paper-like rolls of fluff pulp.

  Wesley Jones, who had given the investor presentation to Hannan and his team, was the head of Georgia-Pacific’s pulp division in 2004. He saw firsthand how Koch Industries revitalized the operation. Jones had watched the pulping operation decline during a long era of deprivation and underinvestment. The problem traced back to Georgia-Pacific’s corporate culture. When he first joined the company, there had been a scrappiness to it. Georgia-Pacific managers liked to employ the word “maverick” to describe their corporate culture. Then Georgia-Pacific went on its corporate buying spree in the 1990s, and the company started focusing on administrative function and cost reduction. Experimentation and failure were not quite so prized, while paperwork and superior process were. Decisions had to be approved by committees, investments were slowed, and autonomy was shifted from the ground level to the ranks of middle managers or above. The problem grew worse after the deal to buy Fort James in 2000. After that, the executives slowed down capital investment plans as they steered more money into paying off debt. The neglect was causing wear and tear on the plant’s equipment. Jones was worried that the machinery would start t
o break down, in large and noticeable ways.

  Then Koch bought the company. Soon after that, Jones wanted to buy a complicated new processing tower that would help speed up production. The tower would cost somewhere between $35 million and $40 million. At Georgia-Pacific, Jones would have gotten together a formal proposal for the investment and then pushed the proposal uphill through a dense thicket of bureaucratic channels where any vice president could veto it and any two vice presidents could debate its merits indefinitely. In 2004, he mentioned the investment idea, almost offhandedly, to someone from Koch. Then he found himself on the phone with someone in Wichita who asked him about the tower and what it could do.

  Jones was given approval to spend about $40 million. Over the phone.

  “It was like a month or two after the acquisition. I was kind of floored,” Jones recalled. “I remember putting the phone down and thinking, Damn . . .”

  Koch carried out other changes at Georgia-Pacific that exploited Koch’s private ownership. Koch jettisoned the use of budgets, for example, just as it had done back in the 1980s. Because it was a publicly traded firm, Georgia-Pacific’s employees invested countless hours of their time to write quarterly and annual budgets, setting out targets to be met to please shareholders. This created a circular logic—invent a budget, then work to meet it—that caused strange distortions to the work flow and wasted effort inside Georgia-Pacific.