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BARBARIANS at the GATE Bryan Burrough & John Helyar November 23Rd, 1989

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BARBARIANS at the GATE Bryan Burrough & John Helyar November 23Rd, 1989 BARBARIANS AT THE GATE Bryan Burrough & John Helyar November 23rd, 1989 UNLOCKING HIDDEN VALUE WITH AN LBO: The storied takeover of RJR Nabisco began when Ross Johnson, the company’s restless, free-spending CEO, looked to boost his company’s sagging stock price. RJR Nabisco ranked as the 19th-largest company in the United States, employed 140,000 workers and pumped out $1 billion a year in cash. Its brands included Oreo cookies, Ritz crackers, Life Savers candies, and Winston and Salem cigarettes. Despite hefty profits, shares languished below $50. Johnson thought Wall Street undervalued RJR Nabisco’s mix of food and cigarettes. Johnson was what the authors described as a “noncompany man”, an unorthodox executive who loved spending corporate money on swanky apartments, private planes and celebrity endorsement deals. - - - - - - - - - LEVERAGE BUYOUTS: As Johnson reaped the rewards of his cigarette cash cow, a flashy type of financial deal was gaining popularity in corporate America. The leveraged buyout took public companies private through high-debt purchases that multiplied the potential returns. The new owners ruthlessly cut costs so they could devote every spare cent to repaying debt. LBOs meant riches for management and buyout firms, and shareholders saw stock values soar. The losers were bondholders, whose investments lost value, and employees, who lost their jobs. By the late 1980s, buyout firm Kohlberg Kravis Roberts (KKR) was the established king of LBOs. Jerome Kohlberg headed the firm with his partners, cousins Henry Kravis and George Roberts. With RJR Nabisco stock stuck below $50, Johnson saw an LBO as a way to goose the company’s stock price. Nudged by industry experts, he arranged an LBO run by Shearson Lehman Hutton, a Wall Street firm that was an also-ran in the LBO niche. Shearson chairman Peter Cohen, eager to land a major LBO deal, agreed to nearly all Johnson’s demands, including management payouts which Johnson could allocate as he chose. The deal promised $75 a share for RJR Nabisco. - - - - - - - - - KRAVIS STEPS IN: When news broke that Johnson and Shearson were leading a $75-a-share buyout, Kravis leapt into action. He believed $75 a share was cheap and didn’t think Shearson could pull off an NOTABLE QUOTES $18 billion deal. Kravis phoned Shearson’s Cohen and demanded to be part of the action. However, Cohen declined. He felt that Johnson’s strong relationship with RJR Nabisco’s board would forestall any “Every penny you think I’m pissing away attempted counter bid from Kravis. He was mistaken. Undaunted at the adversarial prospects that lay here, comes back to us dressed up like a before him, Kravis hired corporate junk bond experts Drexel Burnham to help finance a competing bid. nickel.” For many buyout firms, RJR Nabisco seemed an ideal candidate for an LBO. It generated a steady cash -Ross Johnson flow to cover debt through its portfolio of recognizable brands, and Johnson’s fiefdom was a cost - - - - - - - - - - - - - cutter’s dream. Gutting his private air force would reap savings without affecting the company’s “Realize that ultimate success comes profitability. Johnson had no interest in selling his planes or canceling club memberships, but every extra dollar paid to shareholders would require steeper expense reductions. Kravis trumped Johnson’s from opportunistic, bold moves which $75 bid by offering $90 a share. Kravis’s offer was a combination of cash and so-called payment in kind by definition, cannot be planned.” (PIK) stock that made up $11 of Kravis’s competing bid. As the authors note, Drexel Burnham was an -Ross Johnson expert in PIK securities, and Kravis’s partnership with the firm gave him an advantage over Shearson. - - - - - - - - - THE BIDDING WAR: With a better offer on the table, Shearson’s bankers sharpened their pencils. Johnson had maintained that he had no interest in doing an LBO if he could no longer enjoy the privileges of his position. Even so, Shearson adjusted its numbers to reflect the savings from ditching Johnson’s planes, penthouses and Premier. Kravis, meanwhile, needed his own edge. He had almost no inside information about RJR Nabisco’s finances. Kravis approached Tylee Wilson about running RJR Nabisco, but he ultimately concluded that Wilson’s knowledge of the company was dated and that his desire for revenge against Johnson clouded his judgment. Shearson bolstered its team with investment bank Salomon Brothers. Though others pushed for a much higher offer, Salomon chairman John Gutfreund held sway, with the group electing to bid $92. Johnson knew he had lost control of the process he started. A $92 bid meant he could kiss his planes goodbye. A New York Times article on the value of his self-negotiated package further tarnished Johnson’s golden touch. The paper made his $2 billion potential payout front-page news, and RJR Nabisco board members were shocked. Johnson later claimed that he had planned all along to share the wealth with RJR Nabisco employees, although no one involved in negotiations to that point had ever heard Johnson divulge such a plan. The revelation damaged Johnson’s credibility with a board that once had been securely in his pocket. Johnson then foolishly launched Premier cigarettes without any sort of market testing, and consumers hated the product’s taste. The brand quickly flopped. - - - - - - - - - MOVING THE FINISH LINE: With two bids pending for their company, RJR Nabisco directors set a November 1988 deadline for final offers. The size of the buyout – the largest ever on Wall Street – attracted extensive media scrutiny. Tempers flared as details leaked into news reports. Behind the scenes, Kravis found a valuable source of inside information in the person of John Greeniaus, president of Nabisco Brands. Upset at being excluded from Johnson’s $2 billion payout, he secretly approached Kravis. In addition to the wasteful planes and penthouses, Greeniaus described pointless golf tournament sponsorships, foolish celebrity endorsement deals and wasteful, inefficient marketing campaigns. The inside information gave Kravis a clearer picture of RJR and the potential synergies that could be unlocked. Still, when the bidding deadline approached, Kravis upped his offer to $94 a share, or $21.6 billion. Johnson’s group raised the ante to $100 a share, or $23 billion. Johnson should have won, but a third offer arrived from First Boston Group and billionaire investor Jay Pritzker. Theirs was more an outline of a proposal than an actual offer. By taking advantage of a loophole, they said they could pay between $105 and $118 a share. The proposal was flimsy, and it was unclear whether First Boston’s novel tax approach was even possible. Yet RJR Nabisco’s directors felt they had no choice but to consider it. To everyone’s amazement, the board extended the bidding and asked the three parties to submit their highest offers. The Cohen group was enraged – they had submitted the strongest bid and were entirely ignored. - - - - - - - - - THE KNOCKOUT ROUND: In the final round of bidding, Johnson’s group boosted its bid by $1, to $101. First Boston’s bid remained too sketchy for directors to approve. Instead of a solid bank commitment, First Boston included a letter from a Citibank vice president in Harrison, New York, scarcely the imprimatur the board needed. Kravis stole the show with an aggressive bid of $106. RJR Nabisco’s board considered Kravis the winner. Johnson quickly conceded defeat, but Shearson’s Cohen wasn’t so weak. Over Johnson’s objections, he raised his bid to $108 a share. When RJR Nabisco’s board said the bidding was closed and Kravis was the winner, Cohen threatened legal action. He asked Johnson to reduce the management group’s cut of the pie, and when Johnson acquiesced, Cohen raised his bid again, this time to $112 a share. Kravis responded by raising his bid to $109. The board, relieved to be able to vote for anyone but Johnson, declared Kravis the winner once and for all. - - - - - - - - - TWO DECADES LATER: Twenty years after Johnson launched the deal of the century, the authors report that he now lives in Jupiter, Florida, where he retired to a mansion on a golf course. He never cashed in his $2 billion management package, but he did receive a $53 million severance package when the RJR Nabisco deal closed and started his own investment fund. Johnson did well investing in Atlanta real estate, and he claims to harbor no ill will over losing control of the company. After the deal, Kravis’ firm skyrocketed, gathering $52 billion in assets as of 2008. But RJR Nabisco was for all intents and purposes a major loser. The $20 billion in debt for the buyout demanded annual interest payments of $1 billion. Kravis planned to split the food and tobacco divisions but couldn’t until 1993 because of tax penalties for selling within five years of the LBO. RJR Nabisco also weakened because of various miscalculations, such as consumer blowback from raising prices for Oreo cookies and Ritz crackers while cutting marketing. “Marlboro Friday,” when Philip Morris responded to Reynolds’s discounting by slashing prices 20%, proved that the deal had egregiously overvalued RJR Nabisco. As the authors conclude, the fiasco and poor returns from RJR effectively ended the leveraged buyout craze. .
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