How Teddy Forstmann Lost His Groove The Forstmann Little chief, one of the greatest dealmakers ever, has stumbled badly. Has his time passed?
By Adam Lashinsky

(FORTUNE Magazine) – There was a time when there was no more colorful character on Wall Street than Theodore "Teddy" Forstmann. It was the 1980s, the era of Big Swinging You-Know-Whats and Masters of the Universe. Along with his longtime rival Henry Kravis--and a few others--Forstmann had helped create a radical new way to acquire companies: the leveraged buyout. His firm, Forstmann Little, had made billions on a series of high-profile LBOs.

But Forstmann was always more than just a dealmaker. He was a Wall Street maverick, an often bombastic presence who wrote op-ed pieces in the country's leading newspapers bemoaning one or another of his bete noires. (Junk bonds were at the top of his list.) He also was a major Republican fundraiser, an activist for such pet causes as education reform, a globetrotting playboy who squired around the likes of Princess Diana and Elizabeth Hurley, and a hobnobber with politicians and celebrities of every stripe. Love him or hate him--but you couldn't ignore him.

It is a different Teddy Forstmann, then, who sits in the dock of a colorless courtroom in rural Connecticut on an overcast morning on the first day of June. At 64, Forstmann looks small, his shoulders hunched slightly forward as he speaks softly and haltingly. He's in the witness box because Forstmann Little stands accused of violating the terms of a contract with one of its investors, the state of Connecticut, by squandering $2.5 billion on two telecommunications companies, McLeodUSA and XO Communications, during the height of the telecom bubble. Of that amount, $125 million came from the state--and it wants the money back. As Connecticut's lawyer, Gerald Fields, grills Forstmann, it's tough to reconcile this meek witness with the larger-than-life figure that is his reputation.

Asked if he'd ever read the contract under discussion prior to the litigation, Forstmann allows that he had not. Asked to comment on investment pitches presented to the state's pension officials in 1997, Forstmann professes ignorance, noting that his younger brother, Nick, who died in 2001, typically handled such meetings. Pressed to discuss how Forstmann Little's deals were structured, Forstmann tells his interrogator that a 40-year-old partner named Thomas Lister is far more knowledgeable about such matters. Even on a subject on which Forstmann once loved to expound--junk bonds--he demurs. "Mr. Fields," he says wryly, "I am the world's foremost nonexpert on junk debt."

Up until five years ago, Teddy Forst-mann had been an expert on winning. At that point, Forstmann Little had raised more than $8 billion over 21 years in six funds--and every fund had made its investors money. Indeed, the average Forstmann Little equity fund racked up annual returns of almost 60% for its (mostly) corporate pension fund investors. Most astounding of all, with rare exceptions, Forstmann Little never lost money on the individual companies it took private in LBOs. It transformed companies that the rest of the leveraged-buyout pack was convinced were headed for the trash heap--among them Dr Pepper in 1984 and Gulfstream Aerospace and General Instrument in 1990--into multibillion-dollar winners. For Teddy Forstmann, that unbroken string was a point of tremendous pride.

And then the string broke, and Teddy Forstmann was put in the position of not just licking his wounds but defending his honor in court. Forstmann had always avoided fads. And he had always insisted on taking controlling interests in the companies Forstmann Little acquired. But with McLeod and XO, Forstmann clearly had strayed from what had made him and his firm so successful. Although the Connecticut jury returned an awkward split decision in early July--ruling that Forstmann Little was negligent in its investments but liable for no damages--the question still loomed even after the trial had ended. Why? Why had Teddy Forstmann abandoned his long-held investing principles? Why had he stumbled so badly?

As I discovered in a series of interviews that took place over several months, Forstmann's probably not the best person to answer that question. When he reflects on the recent fiascos, his mood can change abruptly. There are times when he graciously accepts the blame for what happened--and other times when he lashes out at those who advised him. He can sound combative one moment, bitter the next, and beaten down a short while later. What he will talk about is the losses he's suffered in recent years that go beyond the financial ones--the loss of his brother Nicky to cancer in 2001 and his loss of passion both for the firm he founded and the industry he helped create.

Forstmann's admirers suggest that his many successes overshadow his recent setbacks. "Nobody remembers that Babe Ruth played his last season for the Boston Braves," says John Myers, who runs investments for General Electric's pension funds, a longtime Forstmann Little investor. "Ted should be remembered for his full career." But the prevailing view on Wall Street is that time has passed Forstmann by. Says a banker who has worked on and off with Forstmann for years: "He's like an athlete who once performed at a world-class level who has taken his final laps."

No one is more acutely aware of Teddy Forstmann's diminished place in the investment world than Forstmann himself. He has only to look around his cluttered Manhattan office to be reminded of happier times. An autographed plate Nelson Mandela used in prison sits on a shelf near framed personal notes from Colin Powell, Bill Clinton, and Newt Gingrich. Lucite deal trophies from his many investments adorn his computer-less desk. On an end table is a sketch of the back of Forstmann's head--drawn by the singer Tony Bennett.

Forstmann loves to show off his mementos. They are the fruits of an interesting life--and a distraction from the subject at hand. "I really thought I'd get through my whole career without having a loss," he says. "This is not what I'd planned for myself." As he talks, Forstmann is in constant motion, waving his arms, licking his lips, patting down his hair in mid-sentence. Sometimes the words don't come out as quickly as he'd like, as if his brain is working faster than his mouth. When the subject turns to the last half-decade, he often emits a high-pitched, self-conscious laugh.

Forstmann prefers to talk about the glory days--and who can blame him? After a brief stint working for his brother Tony, a founder of the firm Forstmann-Leff, Teddy started Forstmann Little in 1978 with his younger brother, Nick, and Brian Little, a former investment banker at White Weld. Right from the start, the firm's focus was the still-obscure niche of leveraged buyouts. But in the early 1980s, Forstmann had an epiphany that helped change the game. Instead of relying on intermediaries such as insurance companies to provide the debt portion of leveraged buyouts, Forstmann realized he could start his own debt fund and cut out the middleman. That became known as mezzanine debt, and for years it was Teddy Forstmann's secret sauce. By supplying both equity and debt in a buyout, Forstmann could speed up the transaction and control all aspects of the deal--which was extremely important to him. It also allowed him to do more ambitious--and far riskier--deals than he could with an insurance company as his partner. The Dr Pepper deal in 1984 was a classic example. Forstmann borrowed $500 million from banks and invested $120 million from his debt fund and just $30 million in equity to buy an also-ran soda company that just happened to have cash-producing assets. Forstmann's equity investors got more than eight times their money on Dr Pepper when he sold it in 1986.

Internally the firm was a balancing act of two opposites, Teddy Forstmann and Brian Little. Forstmann was an odd combination of big-picture guy and control freak. Little was the trained financier who understood the fine points of every deal. Forstmann, the impulsive live wire, the shoot-from-the-lip screamer, followed his gut. Little was an affable, polished investment banker. Between them was Nicky Forstmann, seven years Teddy's junior. "Nick was ridiculously gorgeous, unbelievably nice, a sweet personality," says Stephen Fraidin, Ted Forstmann's longtime lawyer. Nicky had two primary jobs at the firm. One was to deal with the representatives of the pension funds that invested in Forstmann Little. The other was to keep the peace between his big brother and whoever got in his way, whether it was Brian Little or a competitor. "Teddy always needed a buffer around to be effective," remembers one banker.

Inside the firm, Forstmann's ego was always something of a problem. The firm stayed small, because that was the way Teddy wanted it; he needed to be in charge of everything. Nor did he seem to have much appreciation for his partners: When it came to dealmaking, he liked to say, he was Picasso, and the others guys were holding the ladder.

Outside the firm, Forstmann's ego was an issue as well. His rebukes of others on Wall Street rankled: When he criticized so-called club deals--buyouts cobbled together by several firms instead of one--he made it sound as though his go-it-alone philosophy was morally superior. When junk bonds became popular, Teddy Forstmann became a vociferous, unrelenting critic. One op-ed article he wrote was titled "Violating Our Rules of Prudence." He began criticizing archrival Henry Kravis for his reliance on junk bonds to do deals, personalizing the issue in a way that even supporters found unseemly. Says one prominent investor: "Teddy's friends were almost to a person sorry about the way he picked a fight with Henry Kravis. What was there to gain from it?"

The notoriety gained Forstmann a stage, and it also got him closer to the elites with whom he loved to rub shoulders. There were business dividends as well. His Republican pal Donald Rumsfeld turned out to be a good CEO for General Instrument. When Forstmann Little bought Community Health Systems, a collection of mostly rural hospitals, board members Bob Dole and Sam Nunn helped convince nonprofit trustees of the target organizations that the acquisitive hospital company from Tennessee was legit. Along the way Forstmann dabbled in a variety of quixotic causes, including tax and education reform and helping refugee children in Bosnia. And he was an important fundraiser for George H.W. Bush.

Forstmann's crowning achievement, though, was his revival of Gulfstream Aerospace. What made it particularly sweet was that for a long time, Gulfstream looked as though it would be his biggest flop. Forstmann Little bought the corporate-jet maker in 1990 for $825 million, $400 million of which came from its own debt and equity funds. But the recession that year crushed Gulfstream, and it teetered on the brink of bankruptcy. Forstmann's investors wanted him to walk away.

Instead he upped the ante. He installed himself as CEO, recruited a new team of executives, and in late 1992 invested another $236 million. Gulfstream used that capital to finish the jet it was readying for market, the now-famous Gulfstream V. Before long the G-V was the most desired toy of CEOs and billionaires everywhere. Gulfstream went public in 1996 and was sold to General Dynamics two years later. By 1999, when Forstmann Little was allowed to dump its General Dynamics stock, the $636 million of investors' money it had put into Gulfstream had become $3.1 billion. Maybe Teddy Forstmann really was the Picasso of LBOs.

More than once during our interviews, Forstmann told me that if his life were a movie, the story would have ended happily in 1999. Unfortunately, the movie didn't end there.

After selling off Gulfstream, Forstmann was at a crossroads. He was approaching 60 and worth around $1 billion. Increasingly, his attention was focused on philanthropy, such as the Children's Scholarship Fund, which he'd founded with Wal-Mart scion John Walton. (It gives private-school scholarships to low-income kids.) Brian Little had left Forstmann Little five years before, tired, his friends say, of fighting with Teddy. Aside from Nicky Forstmann, most of the old Forstmann Little crew had departed. And the LBO game was changing--it was harder to go it alone, harder to find hidden gems, harder to make outsized returns.

On the other hand, the firm was sitting on $3.6 billion in uninvested capital. And though there was a part of Teddy Forstmann that wanted to return the money and call it a day, there was another part of him that wanted to see the firm become the kind of institution that could live on after he was gone. Ultimately he chose the latter course.

Nicky Forstmann was gung-ho to step up his role at Forstmann Little, but Teddy was uncomfortable with his brother's taking the lead on investments. So instead he and Nicky hired an old friend of the firm, Erskine Bowles, who had recently stepped down as President Clinton's chief of staff.

Bowles, who joined in early 1999, should have been perfect for Forstmann Little. Before going into politics, he had run a small investment-banking firm in North Carolina for two decades--and had done business with Forstmann Little. Bowles was a proven administrator--in typical Teddy Forstmann bravura, he brags that Bowles practically ran the government for 18 months--with connections in Democratic circles that Forstmann lacked. He'd also been around the White House when the Telecommunications Act of 1996 was passed. That was important because Forstmann Little had already concluded that the firm should jump headlong into telecommunications and technology investments, which was where all the big money seemed to be.

Bowles immediately set about imposing some structure and discipline on Forstmann Little. He began to organize the investment professionals into areas of expertise, something the one-deal-at-a-time firm had never done. Around the same time, Forstmann Little carved out a portion of its latest fund to make its first-ever venture capital investments. The billions the firm sank into McLeod and XO were part of that radical shift in tactics.

Of the two, McLeod more closely resembled a typical Forstmann Little investment: McLeod was an established business that needed cash to grow. It was in the business of selling phone service--local, long distance, 800 numbers, and the like--in competition against the Baby Bells. But in making the investment, Forstmann Little abandoned its usual insistence on complete control; its initial $1 billion investment, in September 1999, got it only a 12% stake in the company.

Nextlink Communications (later renamed XO), in which Forstmann Little sank $1.5 billion between early 2000 and mid-2001, was even further afield. One of the many startups bent on building a fiber network, it was the brainchild of wireless pioneer Craig McCaw, who was a significant shareholder. Former MCI executive Daniel Akerson, who had taken a successful turn at running General Instrument as a Forstmann Little special partner, took the helm of XO and assured Forstmann that it would be a winner.

At meetings in which the new technologies were discussed, Forstmann admits that he was clueless. That should have given him pause, but it didn't. "My honest point of view was that the world had passed me by but hadn't passed by people like Dan Akerson," he says. Forstmann sought advice from some of his more tech-savvy friends, including IBM's Lou Gerstner, John Seely Brown of Xerox PARC, and Nathan Myhrvold, Microsoft's former technology chief. Forstmann recalls Myhrvold saying "This is the future, and you're with the best." Myhrvold denies ever advising Forstmann Little on XO or Akerson, but he does recall endorsing Craig McCaw, "which I would do again today," he says.

And then the roof caved in. Not long after the firm made the majority of its telecom and technology investments, Nicky Forstmann told his big brother that he had cancer. He succumbed to the disease in February 2001. (Five months earlier Brian Little had died of a heart attack.) Meantime, the tech and telecom bubbles were bursting, wiping out Forstmann Little's investments in XO and McLeod. By 2002 both were in bankruptcy court. Forstmann Little wrote off its stake in XO, which Carl Icahn later bought out of bankruptcy. It was able to take control of McLeod, but only after wiping out most of the equity and $3 billion in public debt. Today it owns 58% of the Cedar Rapids company. McLeod's stock price, which in 2000 reached the equivalent of about $27--or three times Forstmann Little's initial investment--now hovers around 60 cents a share.

For months after the telecom investments began unraveling, people close to Forstmann were placing the blame squarely on Bowles, who had left Forstmann Little in 2001. "There was a new player who came in and sold Ted on a new strategy," says GE's John Myers. "And that new player's not around anymore." Such talk infuriates Bowles, who is running for the U.S. Senate seat in North Carolina that vice-presidential candidate John Edwards is giving up. "Ted Forstmann calls the shots at Forstmann Little," says Bowles. "Look, Ted Forstmann is Forstmann Little. I think he always has been and always will be." In March 2002, after complaints from Bowles, Forstmann issued a press release exonerating Bowles, and labeling as "inaccurate and unfair" the "recent press coverage for certain difficult investments that the firm as a whole decided to make."

A more likely explanation is that Forstmann and his partners, like so many others on Wall Street, simply got tired of watching the oversized gains go to others, particularly venture capitalists. "I think he was surrounded by some very good people who said, 'We're missing this, we're missing this,' " says Tom Tuft, a Goldman Sachs investment banker who's worked with Forstmann Little. "He capitulated."

Today the consensus, both inside and outside the firm, is that while Teddy Forstmann may not have led the firm to those investments, he's still the one who pulled the trigger--and for that he bears the responsibility. In his more contemplative moments, Forstmann agrees. "There's no question that I could've said no," he says. But he didn't.

Now that the trial in Connecticut is over, Forstmann is extremely involved in one thing: trying to save McLeod. "I did not think that in my early 60s I'd be selling 1-800 service to people," he sighs. "It isn't as much fun as talking about a G-V." Having said that, he reminds me that his critics repeatedly wrote off Gulfstream as a failure and derided him for sinking more time and money into it. He refers to McLeod as Gulfstream II. "I cannot promise you this thing will be a big success," he says. "But McLeod could work." Given the still sorry state of the telecom business, merely nursing McLeod back to some semblance of health is a challenge. The company competes primarily as a long-distance and local-service carrier for businesses in the Midwest and Mountain States. Every time it sets a new plan to achieve profitability, however, prices erode and its revenues decline, forcing another restructuring.

To make McLeod work, Forstmann has been following the Gulfstream playbook. He started by recruiting Chris Davis, who was Gulfstream's chief financial officer. After leaving Gulfstream, she'd been CFO of a Silicon Valley startup called ONI Systems, which was about to sell itself to Ciena for $900 million when Forstmann called in mid-2001. "If anybody else had called and said, 'I want you,' I wouldn't have done it," she says. Now she commutes weekly to Iowa from her home in Hilton Head, S.C. While Davis has reorganized McLeod's sales force and reduced its costs, Forstmann is doing what he's best at--picking up the phone to persuade CEOs to give McLeod's execs a hearing.

The Forstmann star power comes in handy in other ways. In May, McLeod hosted a golf event for key customers at a posh course near Dallas. In attendance were golf superstar Vijay Singh, a buddy of Forstmann's, and ex--Dallas Cowboys great Roger Staubach, a new McLeod board member. Singh conducts an hour-long golf clinic. Staubach tosses an autographed football to a prospective McLeod customer. "I wouldn't do this if I didn't believe in Ted Forstmann," Staubach says. "I don't need to be on another board. I just really like Ted." Staubach is more than an ex-jock who can dazzle an IT manager. As chairman of a major commercial real estate project-management company, he's also in a position to pitch his clients on buying their phone service from McLeod.

Davis insists that McLeod is doing better than its bottom line and stock price indicate. Sizable contracts with big companies are near-term possibilities, she says. She interrupts an interview in Forstmann Little's New York offices to take a call from Forst-mann himself, who has been working on a strategic partnership for McLeod. In early July, AT&T agreed to merge part of its network with McLeod, causing McLeod's stock to spike and fueling speculation that Ma Bell could buy McLeod outright.

One beautiful day not long ago, Forstmann flew to Boston to speak at the Harvard Business School's Venture Capital and Private Equity Club. Ostensibly he has come to talk about the early days of private equity. But after regaling his audience of 300 fresh-faced students with some charming stories about his earliest deals, Forstmann turns serious. "Right now," he says, "I'm something of a dinosaur."

He's right about that, of course. What was once a merry band of dueling buyout shops, dominated by headline-grabbing personalities gunning for giant returns, has become a business called private equity--or, as Forstmann disdainfully calls it, "the so-called private equity industry." Where once raising $1 billion was a singular achievement, today scores of firms manage billions. And they do it as blandly as possible, aiming for safe returns, collaborating on deals to minimize risk, often selling each other their companies. "Asset shuffling," sniffs Forstmann.

Forstmann misses the old frontier days. That's when he was larger than life. His ego simply won't allow him to adapt to this new, less exciting, less freewheeling environment. He may have lost more than $2 billion in two investments, but he still believes that the only way to play is to swing for the fences. He explains it all to his Harvard Business School audience with one of his famous painting metaphors. "There's a lot of ways you can make money painting," he says. "You can paint buildings or you can paint portraits. I paint portraits. I don't know how to paint buildings. I would say that every other firm you've heard of paints buildings. You've got to be an awfully good building painter to make money in it." The first student to raise his hand when Forstmann is done speaking asks if the opportunities are the same in private equity as they were when Forstmann started out. In a word, he tells them, "No." Mentioning private-equity conglomerates Blackstone and Carlyle, where many of these soon-to-be MBAs would be delighted to find work, he says, "They're really like investment-banking firms." It is not meant as a compliment.

So this is where Teddy Forstmann finds himself in 2004. Alone. He has his homes in Manhattan, Southampton, Aspen, and Beverly Hills, and he has his business, but it's not enough. He misses his little brother so much that sometimes he wanders into Nicky's office--untouched since the day he died, on Teddy's orders--just to sit for a while. He acknowledges that the lifelong bachelor routine has grown old. He has two adopted sons from South Africa, but back in his New York offices he tells me he wishes he had married. "For the first 15 to 20 years or so, no self-respecting girl would have been married to me," he says, so dedicated was he to his breakneck schedule. Coincidentally, his girlfriend of seven years, Debbie Hagerty, left him around the time the telecom investments were going bad. She's the one who named his yacht Artful Dodger, a nod to his commitment problem and his lifelong love for the Brooklyn Dodgers. (He owns the film rights to The Boys of Summer, Roger Kahn's bestselling paean to the Dodgers.) He even had a chance to buy the Los Angeles Dodgers in 2003, when Rupert Murdoch's News Corp. put them up for sale. He wishes he'd bought the team, but with all the turmoil surrounding the Connecticut lawsuit, he didn't dare. "Think of what people could have said," he laments.

The oddly endearing thing about Teddy Forstmann is that he still cares so desperately about what other people say about him. At the age of 64, he's at another one of those forks in the road. One way or the other, the McLeod situation will be settled in the near term. Maybe Forstmann Little will break even on it, or maybe it will wind up losing the firm money. It hardly matters at this point. And then what?

Then Teddy Forstmann will face the same choice he faced in 1999: Should he call it a day or should he keep Forstmann Little going beyond his current fund's expiration date, which is June 2006? There were times during our talks when he insisted that he was done with the private-equity business. He was passionately committed to his charitable causes and was even searching for new ones. "I feel underutilized relative to what I still can accomplish in the world," he told me at one point. "What I wish for is to take whatever I've got and, to coin a phrase, leverage it, and do good things."

Besides, Forstmann Little itself isn't all that much fun for him anymore. "It's just different when you are three or four people, and one of them is your brother," he tells me in our last interview before the verdict is handed down in Connecticut. "It's like you had a great marriage. You met when you were young. You had no money. It was so intense. And then you get remarried. And she's a terrific girl, but it isn't quite the same thing."

But that last fund still has $2.2 billion yet to be invested--and there is one investment Teddy Forstmann has been looking at that genuinely excites him. "Right now I'm looking at something that is about as interesting as anything I've done in years," he says, without elaborating.

Still, his heart's not in it the way it used to be. "Is it my kind of market anymore? I don't think it is. I've told the pension funds this. You could put a gun to my head. I'm not raising another fund. It's game over. It's been a terrific game." Watching Teddy Forstmann, the aging artful dodger, it's tough to believe he really means it. You just hope like hell he does.