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Time, Nov 7, 1988 v132 n19 p94(4)

Duel of the takeover titans. (battle of Kohlberg, Kravis, Roberts and RJR
Nabisco management allied with Shearson Lehman Hutton for RJR
Nabisco) Janice Castro.
Full Text: COPYRIGHT Time Inc. 1988
Takeover wars have raged on and off for decades, but corporate America has never seen
anything quite like the battle for RJR Nabisco. The combatants are brandishing tens of billions of
dollars and mobilizing squadrons of bankers and lawyers on a scale previously unimagined. On
one side is the firm of Kohlberg, Kravis, Roberts, until now the undisputed master of the
leveraged buyout. On the other is an alliance between a group of RJR Nabisco executives and
Shearson Lehman Hutton, an old-line investment firm determined to break KKR's dominance of
the hottest, most lucrative business on Wall Street. If either side pulls off the deal, the course of
U.S. corporate history could be changed forever.
The contest has already pushed the price for RJR Nabisco above $20 billion, which means that
the potential buyout would dwarf the largest previous takeover, the $13.3 billion acquisition of
Gulf by Chevron in 1984. The megastakes battle has taken the starch out of corporate chiefs
everywhere. After all, if RJR Nabisco, the 19th largest U.S. corporation (1987 revenues: $16
billion), can be taken over by the new breed of dealmakers, is any company safe? Is Du Pont
doable? Can General Electric be hot-wired? Worse, must every chief executive view a healthy
balance sheet as his worst enemy, a potentially rich source of leverage for a pushy buyer?
Concludes James Scott, professor of finance at Columbia Business School: ''There is no magic
number anymore. There is no safety in size.''
The big-time leveraged buyout is one of the cleverest financial gimmicks of all time. An investor
group, which often includes some of the target company's top managers, borrows billions to take
the firm private by buying its stock from the shareholders. The company's own assets are used as
security for the financing. After the deal is completed, the new owners usually try to bring their
debt down to a manageable level -- and pick up enormous profits along the way -- by selling off
parts of the company piecemeal. In the case of RJR Nabisco, the total market value of popular
individual brands like Oreo cookies and Winston cigarettes may be far higher than the $20
billion price tag for the company as a whole.
Buyouts have become so attractive that they are sweeping through corporate boardrooms like no
other business fad in memory. In the first ten months of 1988, according to IDD Information
Services, a Manhattan research firm, 143 companies were taken private in buyouts worth $91
billion, in contrast to 105 deals worth $36 billion during the same period of 1987. These
transactions are enriching shareholders and buyout specialists, but the takeovers could be causing
grave damage to U.S. industry. Never before has debt been substituted for shareholders' equity
on such a huge scale. No one knows how these highly leveraged companies will fare in the next
re cession.

The buyout binge is causing concern among U.S. financial regulators. Responding in writing to
questions from the Senate Banking Committee last week, Federal Reserve chairman Alan
Greenspan said the Fed had cautioned banks about extending loans for leveraged buyouts. He
suggested that Congress take a closer look at tax provisions that encourage such buyouts.
Greenspan's views sent a tremor through the stock market, and share prices of companies
involved in takeovers took a tumble, as many investors turned fearful that the buyout boom could
suddenly go bust.
The market was also disturbed by reports that Federated Department Stores, which was acquired
by Campeau Corp. earlier this year in a highly leveraged $6.6 billion deal, had withdrawn a $1.2
billion issue of junk bonds because there were not enough buyers. Federated's problems sent a
message that financing for huge takeovers may be increasingly difficult to arrange.
Both KKR and Shearson are confident they can raise the money to buy RJR Nabisco, but it will
not be easy. KKR has built up a $5.6 billion buyout fund with capital contributed by insurance
companies, pension funds and other big investors. With that capital base, KKR has the ability to
borrow as much as $56 billion, but how much it can raise for a single takeover remains to be
seen. As in past deals, KKR will get part of the money by issuing high-yield junk bonds through
Drexel Burnham Lambert. But that financing could be jeopardized if Drexel and its junk-bond
wizard, Michael Milken, are indicted, as expected, for securities fraud. As insurance, KKR has
also recruited Morgan Stanley and Merrill Lynch to help sell bonds.
In response, Shearson has called in yet another Wall Street firm, Salomon Brothers, to assist in
attracting investors. Ultimately, Shearson can draw on the financial resources of its parent
company, American Express (1987 revenues: $18 billion).
Neither KKR nor Shearson can finance the takeover of RJR Nabisco without some $12 billion in
loans from commercial banks. Already the opposing bidders are lining up commitments from
major banks in the U.S., Western Europe and Japan. Says a skeptical Wall Street investment
banker: ''The t wo sides are now competing to see how big a mountain of debt they can put on
the head of a pin.''
It was KKR that first brought leveraged buyouts into the headlines. Founded in Manhattan in
1976 by three men from the Bear, Stearns investment firm -- Jerome Kohlberg, 63, Henry
Kravis, 44, and George Roberts, 45 -- the company started out modestly, with friendly deals in
which it joined forces with management to take companies private. Among its first targets were
U.S. Natural Resources (price: $22 million) and Pack River ($136 million).
But KKR's early success gave it a taste for bigger and bolder deals. By the mid-1980s, KKR
started to make unsolicited takeover bids, though the company still does not like to go through
with a buyout unless the target firm's board of directors eventually agrees to the deal. Kohlberg
left KKR last year because he was concerned about the aggressive course his junior partners
were taking.
Under the guidance of Kravis and Roberts, KKR has become a Wall Street steamroller. Its
biggest buyouts include the Beatrice food conglomerate for $6.2 billion and the Safeway grocery

chain for $4.5 billion. But while KKR is well known as an investment adviser, few people realize
that it has become one of the largest industrial holding companies in America. Though KKR
readily sells off pieces of the firms it buys, it usually retains some core businesses. Of the 35
companies it has acquired, KKR still has control of 23. As a result, KKR has become a huge
conglomerate. The companies it controls produce everything from French colonial furniture to
dairy products. If KKR were classified as an industrial company, according to FORTUNE
magazine, its estimated $38 billion in annual revenues would make it the seventh largest in the
U.S., just behind General Electric.
KKR has also become a cash machine with many ways of making money. To begin with, KKR
charges investors in its buyout funds annual management fees amounting to 1.5% of their
investments. Companies taken private by KKR pay the firm 1% to 2% of the purchase price for
handling the transaction. But the really big money rolls in when KKR starts to sell off divisions
of the companies it acquires. So far, KKR has taken in $7 billion by unloading parts of Beatrice.
In recent years the investors in KKR's buyout funds have earned annual returns of about 30%.
Says James George, manager of Oregon's $9 billion public-employee retirement fund, which has
invested $640 million with KKR: ''The secret of KKR's success is that it makes an awful lot of
money for its partners.'' Agrees Gus Oliver, a general partner in Coniston Partners, another
Manhattan investment firm that specializes in takeovers: ''KKR's success reflects the
compounding effect. Because of its track record, it can attract all the capital in the world.
Because of its capital base, it can do any deal in the world.''
Maybe, but the RJR Nabisco deal will put that assertion to a stern test. The struggle for the huge
company began two weeks ago, when it was announced that a group of managers led by chief
executive Ross Johnson, 56, was considering making a $17.6 billion buyout bid, to be put
together by Shearson -- not KKR. The announcement came after Johnson delivered a startling
message to the RJR Nabisco board of directors: ''This company ought to be in play.'' News of the
buyout proposal stunned Henry Kravis, who felt betrayed by Shearson's chairman, Peter Cohen.
For one thing, Kravis and Cohen, 41, were friends and former classmates at the Columbia
Business School. Moreover, Kravis had previously spoken to Johnson about a buyout of RJR
Nabisco. Now it seemed to Kravis that Cohen was trying to steal the deal. Actually, Johnson had
brought the idea to a trusted friend: James Robinson III, chairman of American Express and
Cohen's boss.
Determined not to let the RJR Nabisco deal get away, Kravis demanded that Cohen come by
KKR's Manhattan offices. Chewing out Cohen in front of Shearson aides, Kravis demanded a
major role in the buyout, sputtering, ''This is my franchise!'' Cohen walked out, suggesting they
talk again in a few days. But before that talk took place, Kravis delivered a thumping
counterpunch: a $20.6 billion buyout bid for RJR Nabisco.
Once both proposals were out in the open, the two sides began to think about working together.
On Tuesday, Oct. 25, Kravis and Cohen made their peace over breakfast at the Plaza Hotel. In a
two- day series of round-the-clock meetings that followed, the KKR and Shearson/RJR teams
discussed alternative buyout plans. George Roberts, who normally works out of KKR's offices in
San Francisco, and Robinson of American Express joined Kravis, Cohen and Johnson in the
negotiations.

Early on, KKR reportedly offered Shearson a $125 million ''kill fee'' to step aside. Cohen
brushed off the idea as ''personally insulting.'' Once serious talks began, the participants saw the
y had different strategies in mind. KKR preferred to sell the tobacco business to pay back the
buyout loans and retain the food businesses, a good fit with the Safeway chain. Johnson's team
wanted to keep the tobacco company and sell off Nabisco, Del Monte and the other non-tobacco
parts of the business. Positions hardened shortly after midnight Tuesday, when KKR partner
Roberts made what may prove to be the most expensive personal gaffe in the annals of corporate
negotiations.
Arriving at RJR's Manhattan offices about 1:15 a.m., Roberts flinched at the sight of Cohen
puffing away on his ever present cigar and asked sarcastically if RJR, which sells some 290
billion cigarettes a year, also made cigars. Roberts, who moved to a seat across the room,
seriously misjudged his audience. The last thing the embattled RJR team wanted to hear at that
hour was another antismoking crack, especially from a would-be ally.
But the real sticking point was the issue of power. KKR has always insisted on controlling the
companies it acquires. That policy went squarely against Shearson's promise to Johnson that he
could keep 51% of the voting shares. The talks broke off on Wednesday, after Johnson said he
would have nothing further to do with KKR.
At week's end KKR had the highest offer on the table, but the Shearson team was preparing a
new bid. Ultimately, RJR Nabisco's board of directors, which includes such outsiders as Charles
Hugel, president of Combustion Engineering and Martin Davis, chairman of Gulf & Western,
will probably have the final say on who, if anyone, buys the company. Some Wall Streeters think
the financing will prove so difficult that KKR and Shearson will have to work together. In a
conciliatory move on Friday, KKR said it would not press for selling off the tobacco division.
If the mammoth deal is completed, it will intensify the debate about whether leveraged buyouts
are good or bad for American business. Proponents point out that the stock market has severely
undervalued many companies. Thus the only way shareholders can get fair value for their
investment is through a buyout. Another argument in favor of the trend is that by breaking up
conglomerates, buyout specialists create more efficiently run businesses.
But what is good for shareholders and investment bankers is not necessarily good for the
country. Certainly the thousands of workers who have been laid off as a result of KKR's deals
see little virtue in leveraged buyouts. Top executives go along with or even instigate buyouts
because as major shareholders they stand to profit. The resulting companies may be leaner, but
often they are also weaker, with little money to invest in expansion or innovation. Says Michel
David-Weill, the French senior managing partner of the Lazard Freres investment firm: ''The
wave of leveraged buyouts is weakening the competitiveness of many U.S. companies that have
fought so hard to regain it.''
A more immediate danger is the debt being loaded on corporate America. This summer Revco, a
chain of 2,000 drugstores based in Twinsburg, Ohio, defaulted on $700 million worth of bonds
and went into bankruptcy proceedings just 19 months after going private in a leveraged buyout.
Some experts fear that Revco will be one of many major failures resulting from the buyout

binge. In the first half of this year, Standard & Poor's lowered the investment ratings for $216
billion worth of corporate securities, while raising the standing of only $130 billion in such debt.
Warns economist Henry Kaufman: ''If this deterioration of corporate debt is occurring in the
course of an expansion, you can imagine what will happen to a lot of corporate debt in a
recession.''
In his letter to the Senators last week, Fed chairman Greenspan noted that current tax law
encourages corporate borrowing. Companies, for example, can write off the interest on their
loans. Greenspan suggested that Congress consider whether the tax incentives that are helping
fuel the trend are still prudent. If Congress takes Greenspan's advice, the heyday of big-time
buyouts could come to an end.

Time, Nov 14, 1988 v132 n20 p50(1)


Buddy, can you spare a billion? (RJR Nabisco takeover worries
investors) Janice Castro.
Full Text: COPYRIGHT Time Inc. 1988
A fresh burst of takeover cross fire rattled through corporate boardrooms last week as acquirers
battled for control of companies that make everything from bath towels (West Point Pepperell) to
cake mixes (Pillsbury). Costliest of all was the struggle for RJR Nabisco (1987 revenues: $16
billion), whose price tag set a record with each new offer. Top RJR Nabisco executives, backed
by Wall Street's Shearson Lehman Hutton and Salomon Brothers, raised their bid from $17.6
billion to $21 billion, topping the rival offer of $20.6 billion from Kohlberg Kravis Roberts, the
high-flying leveraged-buyout firm. Now the two sides may be getting new competition. At
week's end Forstmann Little, a Manhattan investment firm, said it might make an even higher bid
for RJR Nabisco, backed by Procter & Gamble and other large corporate investors.
Whichever bid ultimately succeeds, the RJR Nabisco buyout may be too big for one team to
handle. Hoping to join forces, KKR and the company's managers met around the clock in
Manhattan. A major dispute was resolved when RJR Nabisco chief executive Ross Johnson
agreed to share control of the company with KKR.
Talks then stalled over KKR's insistence that Drexel Burnham Lambert manage the buyout's
junk- bond financing. KKR contends that only Drexel has the savvy to sell the record $5 billion
in high- yield bonds that is needed. But RJR Nabisco's managers are concerned that the buyout
could be jeopardized if Drexel and Michael Milken, its junk-bond wizard, are indicted for
securities fraud, which is expected to occur soon.
While the suitors struggled to come to terms, a sudden truce was called in another huge takeover
fight when Kraft ('87 revenues: $10 billion) agreed to be acquired by Philip Morris ($28 billion).
Hamish Maxwell, chairman of Philip Morris, said he will not have to sell off chunks of Kraft to
finance the buyout. Said he: ''For the vast majority of Kraft workers, this won't have any impact
at all.'' The Philip Morris coup was an unusually smooth resolution. Another KKR fight fizzled
last week when the Macmillan publishing firm accepted a $2.5 billion offer from British
financier and press lord Robert Maxwell. In Georgia, Joseph Lanier, chairman of West Point
Pepperell, which makes Arrow shirts and Martex towels, was determined to beat back a bid for
his company from Chicago investor William Farley, whose company makes Fruit of the Loom
underwear. Said Lanier: ''We intend to whip him, and are going to fight him until hell freezes
over.''
The feeding frenzy is making some financial experts nervous about the growing degree of
corporate debt. In a whimsical proposal for the biggest takeover of all, James Grant, editor of
Grant's Interest Rate Observer, has outlined a strategy for a $115 billion leveraged buyout of
IBM. But could Big Blue meet payments on the $97 billion in new borrowing? No problem, said

Grant. The computer giant could manage if it slashed R. and D. 80% and scrapped most of its
new products. The real winners: bankers and lawyers, who would make a quick $4.9 billion in
fees on the deal.

U.S. News & World Report, March 22, 1999 v126 i11 p50(1)
The barbarians are no longer at the gate. (management of RJR
Nabisco)(Brief Article) Fred Vogelstein.
Full Text: COPYRIGHT 1999 U.S. News and World Report Inc.
Eleven years ago, attorney Steven Goldstone was certain that a leveraged buyout of RJR Nabisco
was a horrific idea. Goldstone warned then CEO Ross Johnson that announcing an LBO would
start a bidding war that Johnson might lose. Even if Johnson won, he added, the company might
be burdened by a colossal amount of debt. Sitting on the porch of Johnson's Florida condo,
Goldstone told him point-blank: It just wasn't worth the risk.
Needless to say, his warning went unheeded. Johnson launched his LBO in October 1988, but
buyout specialist Henry Kravis paid $25 billion to outbid him six weeks later. And, just as
Goldstone and others predicted, the company's debt became a giant ball and chain. Disappointed
in their returns, Kravis and his partners at Kohlberg, Kravis & Roberts unloaded their position in
1995.
Now Goldstone, who became RJR's CEO in late 1995, finally has a chance to fix the very
problem he warned about. Last week he announced that RJR plans to sell its international
tobacco business to Japan Tobacco for $7.8 billion and spin off the domestic tobacco operations
into a separate company. RJR's tobacco division makes Winston and Camel cigarettes, among
other brands. Its food division's products include Oreo cookies and Ritz crackers.
The transaction will get the company out from under its giant debt load and separate the tobacco
business's woes from the well-regarded food business. When the deal is completed, RJR will pay
off more than half its $10.3 billion debt. Right now as much as half of the company's operating
income is eaten up by interest costs. By comparison, cigarette rival Philip Morris, which has
been gaining market share from RJR, loses only about 9 percent of its operating income to
interest expenses.
Other fronts. The announcement came not a moment too soon. Two days later, shareholder Carl
Icahn said he planned a proxy fight at RJR's May 12 annual meeting. Frustrated that RJR's stock-about $30 a share- has hardly budged during Goldstone's tenure, Icahn wants RJR to spin off the
food business, not the tobacco business. Goldstone says he would if he thought he could, but he
believes tobacco foes would successfully block such a deal on the grounds that RJR was trying to
place assets out of their reach. Shareholders have been fuming about RJR's poor performance for
so long that the vote could be close.

Goldstone had been shopping the overseas division for years--with little luck. But after British
American Tobacco acquired Netherlands- based Rothmans International's tobacco business in
January, RJR's international tobacco division suddenly became a hot property. RJR's was the last
large international tobacco business on the market, and Goldstone pounced when Japan Tobacco
bid. Though American tobacco companies are considered high-risk investments because of
tobacco liability lawsuits, few such legal attacks are pending or seem likely against companies
that sell cigarettes overseas.
Investors reacted cautiously to the deal. Even after RJR spins off its domestic tobacco division,
the parent company--which will then be renamed Nabisco Group Holdings--will remain liable in
many tobacco lawsuits. RJR's stock is up only $1 since the announcement. Tobacco liability will
gradually shrink as a result of the deal. For example, lawyers won't be able to sue Nabisco if RJR
is caught next year illegally marketing cigarettes to minors. But transgressions while the two
companies were joined will remain fair game. And any liability to tobacco lawsuits makes
investors exceedingly nervous.
Still, analysts are hopeful. "The only scenario that could hurt the value of [Nabisco] would be the
bankruptcy of the U.S. tobacco industry," said Martin Feldman, an analyst at Salomon Smith
Barney. Indeed, he sees RJR's stock rising some 30 percent in the next three to six months. The
key to the deal, he and others say, is that RJR is finally cutting its debt and, in the process,
closing the books on an ill-fated LBO whose excesses, documented in the bestseller Barbarians
at the Gate, came to symbolize much of what was wrong with the go-go 1980s.

Time, Dec 5, 1988 v132 n23 p66(4)


Where's the limit?: the biggest takeover battle in history raises
questions about greed, debt and the well-being of american industry.
Full Text: COPYRIGHT Time Inc. 1988
ROSS JOHNSON. A native of Canada, the RJR Nabisco president, 56, has always risen to the
top. In 1985, as head of Nabisco Brands, he advocated the merger between that company and
RJR Reynolds. Just three years later, as head of RJR, Johnson apparently changed his mind. In
October he and a group of top managers offered shareholders $17.6 billion to take the company
private, a price they later increased to $22.7 billion. HENRY KRAVIS. With his reputation as
the No. 1 leveraged-buyout specialist on the line, he was not about to let RJR Nabisco go private
unless he consummated the deal. A founding partner in the buyout firm of Kohlberg Kravis
Roberts, the Manhattan socialite, 44, countered Johnson's proposal by offering to pay as much as
$21.6 billion for the Atlanta-based company. As RJR's new owner, Kravis, whose firm also
controls Beatrice and Safeway Stores, would probably keep the food divisions and sell the
tobacco business. JAY PRITZKER. The publicity-shy chairman of the Hyatt Corp., Pritzker, 66,
with his brother Robert, 62, surprised both Kravis and Johnson by joining the First Boston
investment firm in an informal last-minute bid for RJR Nabisco valued at as much as $27 billion.
Allied with the Pritzkers is Philip Anschutz of Denver, a billionaire oil and mining magnate.
They have since combined forces with an acknowledged master of the hostile game, HARRY
GRAY, 69, the taciturn former chairman of United Technologies, who heads his own investment
firm. The First Boston group is offering a highly complex package of cash, securities and stock
warrants, which is still only a hazy proposal rather than a firm bid. The sheer size of First
Boston's bid persuaded RJR's board to give the group until Nov. 29 to make the offer more
concrete. If successful, the high-rolling group would probably keep RJR's tobacco business and
sell its food groups to such consumer-product companies as Ralston Purina and Procter &
Gamble.
COVER STORIES WHERES THE LIMIT THE BIGGEST TAKEOVER BATTLE IN
HISTORY RAISE
The date was portentous: on Oct. 19, precisely one year after the stock market crashed, the chief
executive of RJR Nabisco was the host of a lavish meal at Atlanta's Waverly Hotel. Ross
Johnson's guests had come to expect such treatment. A brash and hard-driving manager with a
fondness for fine living, he liked to treat RJR Nabisco's board members to an elegant evening out
before the next day's regular meeting.
On this night, however, Johnson's purpose was not just to be convivial. Declaring that he had
tried everything he could during the past two years to boost RJR Nabisco's stock price, Johnson
said he had found a solution: he and his fellow top managers would take complete control of the
company in a leveraged buyout (LBO). Johnson would then sell off some of the company's food
brands and run the remaining divisions as a private company. Surprised that a chief executive
would initiate a raid on his own company, the directors nonetheless allowed him to mount what
would be the largest takeover ever.

But the directors -- and much of the public as well -- were soon shocked to read news accounts
reporting that Johnson's plan would enrich him and seven of his top executives beyond the
dreams of Midas. In exchange for $20 million they would put up for an 8.5% stake in the new
company, Johnson and the seven other executives would see the value of their investment jump
to $200 million when the sale was completed. That was only the beginning. By doing some
simple arithmetic, critics of the plan calculated that the eight men's holdings, which were
scheduled to grow to 18.5%, could be worth $2.6 billion within five years if they turned RJR
Nabisco into a leaner and more profitable enterprise. Johnson's share alone would have been
worth $1 billion.
Swamped by a wave of resentment, Johnson rushed last week to reassure the RJR board that he
had intended all along to share the newly created wealth with the 15,000 employees who would
remain after the breakup. ''I wasn't going to take 18% of this company for seven people,''
Johnson told TIME in his first interview since the buyout offer. ''If I'd known it was going to be
in the newspapers, I would have said, 'Look, there's going to be 15,000.' ''
Even as Johnson backed away from his huge initial stake, rival bidders rushed in to get theirs.
The competing offers turned the fight for RJR Nabisco, whose brands range from Animals
Crackers to Winston cigarettes, into the brassiest and potentially most damaging brawl in Wall
Street history. By last week three groups were locked in a titanic struggle for the company (1987
revenues: $15.8 billion), and the offering price has climbed above $26 billion -- more than the
gross national product of Peru or Portugal and twice the sum that Chevron paid for Gulf Oil in
1984 in the largest previous merger. The ordeal turned into a feeding frenzy for hangers-on as
well: hundreds of lawyers and investment bankers involved in the bidding stand to earn a total of
as much as $1 billion for their expertise.
The sums are so vast, and so apparently out of line with any foreseeable benefits that the deal
might bring to American industry, that they raise deep and disturbing doubts about the direction
of U.S. business at a time when many firms lag badly in foreign competition. Seldom since the
age of the 19th century robber barons has corporate behavior been so open to question. The
battle for RJR Nabisco seems to have crossed an invisible line that separates reasonable conduct
from anarchy.
Except for its scale, the proposed RJR breakup was like many of the fruitless paper-shuffling
deals that have proliferated in the past decade. The management group is planning to take apart a
merger, between RJR and Nabisco, that they hailed only three years ago as a brilliant strategic
move. ''What is being done threatens the very basis of our capitalist system,'' said John Creedon,
president of Metropolitan Life Insurance company, which is suing RJR because the potential
buyout has undermined the value of all bonds that the food and tobacco company sold before the
announcement. Not everyone was alarmed. Said Harry D'Angelo, a finance professor at the
University of Michigan: ''I don't see any major social dangers. The real challenges have been to
the conventional wisdom that large numbers of shareholders provided the best means of
financing industry.''
The RJR battle has brought several U.S. business trends of the past decade under greater scrutiny
in Washington. Among the political concerns: -- The relentless focus on dealmaking rather than

on long-term investment. -- The apparent disregard for company employees and the communities
in which firms are located. -- The rapid pileup of debt that has alarmed everyone from small
investors to Federal Reserve chairman Alan Greenspan, who recently called for measures to curb
borrowing. -- The cost to American taxpayers, who wind up underwriting the buyouts to the tune
of billions of dollars because interest payments on the giant borrowings are deductible as a
business expense.
The RJR buyout aroused anxieties even in the investment community, where some executives
feared that the Johnson-initiated scramble would swallow up too much of the available money
for deals and, moreover, give mergers and LBOs a bad name. ''This is the sort of excess that
investment bankers have worried about for years,'' said economist Robert Reich of Harvard's
John F. Kennedy School of Government, ''because it so clearly exposes the greed and
rapaciousness of so many of these takeovers.'' Martin Weinstein, managing director of Kubera, a
Wall Street arbitrage firm, concurred: ''Do I sense fear? Yes. At some point there is going to be a
rebellion against greed.''
The first sign of revolt, interestingly, came from the outside directors who had come to dinner at
the Waverly Hotel. Appalled by the gall shown by Johnson, whom one director called a ''raider
from the inside,'' a committee of five directors three weeks ago opened the bidding to all comers.
First to accept the invitation were the most aggressive LBO artists of all, the Wall Street firm of
Kohlberg Kravis Roberts. Headed by Henry Kravis, 44, and George Roberts, 45, KKR pioneered
the leveraged buyout in the 1970s and nurtured it into one of the best-paying financial
arrangements of the decade.
Many Wall Street insiders thought the KKR bid was as self-serving and hasty as Johnson's offer
had been. ''They broke the golden rule by injecting their egos into a business decision,'' said one
financier who knows KKR well. ''They went after RJR Nabisco to protect their franchise as the
largest dealmaker.''
The directors' invitation attracted a third and scrappy new bidder who helped turn the fight into a
virtual Who's Who of finance and industry. Assembled by the First Boston investment firm, the
group of newcomers included Jay Pritzker, the Chicago-based chairman of Hyatt Corp., his
wealthy family and Philip Anschutz, a Denver oil billionaire. First Boston also wooed Harry
Gray, the retired chairman of United Technologies, and several other high-rolling investors. The
group came into the bidding with a show-stopping but tentative offer of cash and securities worth
up to $26.8 billion, or $118 a share, for RJR stock that traded for $56 a share in mid-October.
That bid, quickly dubbed a ''Chicago submarine'' because it would torpedo the competition,
easily surpassed both rival offers. The Johnson team had bid $23 billion, or $100 a share, while
KKR had proposed a package worth $21.6 billion, or $94 a share. Board members extended the
deadline until Tuesday, Nov. 29, to take any counteroffers and allow time to study each proposal.
If none is accepted, the directors could supervise an RJR restructuring themselves.
The donnybrook was only the most colossal of the deals that persisted last week in rearranging
the U.S. corporate landscape. Hospital Corporation of America, the nation's largest hospital
chain, ended more than a month of dickering and agreed to be acquired for $3.6 billion in an

LBO put together by the company's management. Triangle Industries, which just two years ago
acquired the packaging division of American Can in an LBO, agreed to be bought for $1.3
billion by Pechiney, the state-owned French metals firm.
Leveraged buyouts seemed like a small-time, unglamorous financial gimmick when KKR began
hawking them on Wall Street in the mid-1970s. But the arrangements were an immediate hit with
managers who saw the wisdom of taking their companies private to escape corporate raiders.
LBOs were also a boon to promising firms that wanted to grow outside Wall Street's harsh
spotlight.
Perhaps the most attractive feature of LBOs is that they give managers a sizable chunk of equity
in newly structured companies. By using borrowed money to buy out the stockholders,
executives can cash in their old shares at a profit even as they become owners of their firms. The
managers are then free to sell parts of the business at a handsome profit. The ultimate payoff
comes when they put their companies back on the market. The sale of well-run corporations can
return up to 100 times the amount of a manager's original investment. With investors lured by
such prospects, the value of completed LBOs soared from just $13.4 billion in 1984 to $76.8
billion so far this year. Since 1985, four of the ten largest LBO acquisitions have been made by
KKR.
Some deals have fallen short of their fanfare. KKR hailed the purchase of Beatrice as the ''deal of
the century,'' but wound up getting stuck with businesses that have not yet found buyers.
''Beatrice was overadvertised as a spectacular deal when it was really just a good one,'' said one
investor. ''Everybody's making money; they're just not making as much money as they thought
they would, or as fast as they could.''
At RJR Nabisco, the benefits of LBOs were hardly lost on Johnson. Born in Winnipeg, Man., he
had parlayed a keen eye for a deal and the nerves of a gunslinger into the top job at three major
corporations. He was president of Standard Brands, the producer of Planters nuts and Baby Ruth
candy bars, when it merged with Nabisco in 1981. Four years later, as Nabisco's president,
Johnson sold out to RJR Reynolds for $4.9 billion and soon became president of the merged
company. After adding the title of chief executive officer in 1987, he swiftly moved RJR
Nabisco headquarters from Winston-Salem to Atlanta, sold the Heublein liquor business and
slashed the corporate staff from 1,000 to 400. The dapper Johnson, a friend of such sports figures
as hockey star Bobby Orr and broadcaster Frank Gifford, is described as a ''charmer'' by one
associate. Another warned that when the boss was displeased, ''swift as a sword, he would chop
your head off.''
Amid the brawl for his company, Johnson has remained aloof from most outsiders and workers
at RJR Nabisco headquarters in the elegant Galleria complex north of Atlanta. ''We don't know
what is going on,'' says an employee. ''Some of us are going to lose our jobs, but we don't know
who, or where.'' Feelings of helplessness were hardly confined to the South. Said a 15-year
employee at an RJR Nabisco cookie plant in Fair Lawn, N.J.: ''When you're at the bottom of the
ladder and you got money men at the top, you take it one day at a time.''

Whoever wins the grab for RJR, a highly leveraged takeover could add more debt to the U.S.
economy than any previous business deal. All told, corporate debt has climbed from some $965
billion in 1982 to $1.8 trillion this year, a rise from 32% to 37% of U.S. gross national product.
LBOs can be especially worrisome of borrowing, because they replace virtually all of a
company's equity with IOUs that must be repaid. A sudden downturn can thus put a firm heavily
in hock out of business. ''High leverage is unsafe, not just for a company but for the entire
economy,'' says M.I.T. economist Franco Modigliani, a Nobel laureate. Modigliani adds that
while the debt mountain has not yet grown perilously high, ''LBOs are reducing the safety.
Management loses the power to do many things. It has no margin for error and less margin for
additional risk.''
A company mired in debt can ill afford to build new plants or develop new products, since most
of its earnings go to pay off borrowings. The shortage of investment can then dampen U.S.
growth and damage the ability of American firms to compete abroad. In a slump, the impact can
be dramatic. A study by the Washington-based Brookings Institution, a liberal think tank,
estimated that a new recession could jolt 10% of major U.S. companies into bankruptcy.
Bankers, too, are taking a harder look at the risks, and some junk-bond buyers are becoming
picky. While cash has poured in from such staid investors as the Harvard and Yale endowment
funds and many state pension plans, other money managers are refusing to play. Says New York
City comptroller Harrison Goldin, who oversees the investment of some $30 billion in pension
funds: ''I cannot condone activities that divert so much time and energy from investments that
create new jobs and opportunities to those that reshuffle chairs. Pension-fund managers are
supposed to invest in the American economy.''
While that may be true, even the U.S. tax code is a strong ally of LBO artists. Since the interest
on junk bonds and bank loans is tax deductible, companies like RJR Nabisco can borrow at
Government expense. Some -- but not all -- of the Treasury's loss can be recouped from capitalgains taxes on the profits of shareholders who sell their stock.
The way the tax code treats stock profits is another plus for LBOs. Corporate earnings are taxed
twice: they are first paid to stockholders out of a company's after-tax profits, and the shareholder
then pays taxes on the dividends. ''There is no question that our tax laws have a bias toward debt
that must be rectified,'' says a top congressional aide.
The buyout binge produces some big-time losers as well, particularly investors who owned a
company's top-quality bonds when the same firm's junk bonds hit the market. Since the new
IOUs would saddle the company with a riskier load of debt, the old bonds get clobbered. No
sooner had Johnson disclosed that he wanted to buy RJR Nabisco, for example, than the
company's $5 billion of outstanding bonds lost 20% of their value. Furious bondholders,
including Metropolitan Life and ITT, immediately sued for damages. Declared Metropolitan Life
chairman Creedon: ''No one in his right mind wants to invest in corporate bonds anymore.'' In
fact, the LBO binge has created a financial innovation called the ''poison put,'' which guarantees
bondholders against the risk of buyouts and other unexpected deals that might depress their
holdings.

Shareholders can lose out in LBOs even when they sell their stock for a profit. That is because
stockholders usually receive far less than executives make when they break up a company and
then put it back on the market. LBO critics argue that managers who fatten their wallets in this
way are really profiting at the expense of other stockholders. So far, shareholders have brought
eleven class-action suits against RJR Nabisco charging executives with acts ranging from ''unfair
self- dealing'' to ''not acting in the best interests of the stockholders.''
The RJR deal also raises the salary competition among executives to absurd levels. Says John
Swearingen, former chairman of Standard Oil of Indiana: ''There is a limit to what managers
ought to be paid for managing other people's money.'' Adds a top executive involved in a current
takeover: ''The yardstick for compensation has just gotten twelve inches longer. The chief
executive who's doing a first-class job running a major U.S. corporation for $890,000 a year is
going to start thinking he's some kind of a fool.''
Washington lawmakers readily recognize the populist sentiments aroused by the spectacle.
''What's going on is corporate cannibalism,'' says Congressman Edward Markey. ''We have to ask
whether it is in the national interest to allow companies to go so heavily into debt.'' As chairman
of a House subcommittee that covers finance, the Massachusetts Democrat will play a key role in
drafting any legislation to curb LBO excesses when Congress reconvenes next year. But
lawmakers are uncertain how to limit buyouts, or even if they should.
Washington's reformers concede that the stock market is still edgy after its collapse. Wall Street
showed just how nervous it was when stocks dropped nearly 79 points in the week that George
Bush was elected President. ''Nobody wants to be blamed for setting off another stock market
crash,'' says a brokerage-house lobbyist. Legislators are still haunted by charges that proposals to
restrain takeovers last year helped cause Black Monday. Many Wall Street insiders are now
convinced that buyouts and mergers are among the market's few remaining props.
Yet Congress cannot ignore growing public fears that greed, debt and buyouts are all spiraling
out of control. ''The dealmakers have gone too far,'' says Samuel Hayes, professor of finance at
Harvard Business School. ''They have defied that tolerance that allowed them their freedom.''
Federal Reserve chairman Greenspan urged the Senate in October to consider tax-law changes to
curb the debt buildup. Said he: ''The laws still provide substantial incentives to borrow.''
House Speaker Jim Wright last week urged steps to slow the pace of buyouts, which he said were
having a damaging ''psychological and economic impact.'' Meanwhile, members of the Senate
Finance Committee have been quietly pondering measures that would reduce the tax loopholes
for interest payments and give a break to dividends. To cushion the Wall Street impact of such
provisions, they might be included as part of a general tax bill that would seek to narrow the
budget deficit.
LBOs do have some strong defenders, and not just among the executives who grow rich from
them. Some financiers and economists argue that increased leverage can be a benefit to
companies, especially those in mature industries like tobacco. Reason: these businesses produce
a lot of cash but call for relatively little research or development. For them, one efficient way to
distribute profits to shareholders is simply by buying up stock.

Proponents say many companies have become stronger than ever after being taken over and
reorganized. The point is driven home in a study by Abbie Smith, a University of Chicago
economist who surveyed 58 acquired companies -- among them, R.H. Macy, Mary Kay
Cosmetics and Uniroyal -- most of which had been bought out since 1984. The findings indicated
that the firms were generally more profitable and productive after they were bought.
Even so, the results underscored a common criticism of the motives for buyouts. Richard
Thevenet, vice president of Stern Stewart & Co., a Manhattan-based management efficiency
consultant, put it bluntly: ''Managers have an incentive to underperform before a buyout. Records
of dramatic turnarounds after an LBO raise a troubling question. Why were these managers
unable to accomplish these feats before the LBO? Shareholders bear all the costs, but not the
rewards of the turnaround.''
American business is built on a rock of lawfulness and trust between companies and those who
hold a stake in them. But when avarice grows out of proportion, cracks start to appear in the
foundation. ''Greed can be good,'' says M.I.T.'s Modigliani, when it spurs profitable and
productive growth. ''But it can also be bad,'' he warns, when it outpaces all other considerations.
In the fight for RJR Nabisco, that seems to have happened in spectacular fashion. No matter how
the battle turns out, the unseemly scramble for riches has, for the moment at least, given
overreaching a bad name. In the end, the RJR brouhaha may turn out to be a useful testing of the
limits: of greed, of debt, of dealmaking. The resulting outcry may prove an effective regulating
device. ''In its own way, the deal has been typically American, where nothing is in moderation,
including the enormous selfishness of management,'' notes James Bere, chairman of BorgWarner. ''It's touched a nerve. Sometimes we have to do things in extremes before we can put the
total in perspective.'' Without that perspective, the wages of greed may be a less productive and
ever more debt-ridden economy.
ONE PLAYERS GAIN IS ANOTHERS
In a buyout as gigantic as RJR Nabisco's, which could cost from $21 billion to $27 billion, even
the smallest pieces of the action will translate into tidy fortunes. The deal may generate some
hefty losses as well. WINNERS SHAREHOLDERS. $8 BILLION TO $14 BILLION IN
PROFITS. Before Oct. 20, when the public first learned that the food-and-tobacco company was
in play, RJR's 225 million shares traded at $56 each. RJR's new owners will pay from $94 to
$118 a share to buy the conglomerate. NEW OWNERS. $2 BILLION OR MORE. The new
stakeholders, a group that may range in size from a small core of investors to a large number of
employees, will have a slice of equity that could grow from $200 million to more than $2 billion
if the restructured company is successful. LBO INVESTORS. A 40% ANNUAL YIELD.
Returns on leveraged-buyout funds managed by firms like Kohlberg Kravis Roberts have been
astronomical, compared with other investments. Their performance has attracted money from
sources including the Coca-Cola pension fund and the Hartford insurance company.
INVESTMENT BANKERS. $300 MILLION TO $350 MILLION. Firms such as Shearson
Lehman Hutton and Drexel Burnham Lambert receive substantial fees for helping bidders put
their proposals together and financing their deals. An individual partner might earn $1 million to
$2 million. COMMERCIAL BANKS. $170 MILLION OR MORE. Whatever cannot be financed

through junk bonds must be borrowed from banks, which impose an up-front fee of 1.4% on
such risky loans in addition to substantial interest charges. LAWYERS. $100 MILLION TO
$200 MILLION. A battery of merger-and-acquisition experts are paid for their advice on how
contracts should be worded and whether the deals are legal. JUNK-BOND HOLDERS. A 14.5%
ANNUAL RETURN. These investors assume the greatest risk. If the newly acquired company
goes bankrupt, they are the last to be repaid. LOSERS CORPORATE-BOND HOLDERS. (-$1
BILLION.) RJR's $5 billion in highly rated corporate bonds became far riskier as soon as
management announced its plans to borrow $16 billion more for an LBO. Their market value
dropped 20%. U.S. TAXPAYERS. (-$2 BILLION TO -$5 BILLION.) At first the Government
will reap a windfall as RJR shareholders pay capital-gains taxes on their stock-sale profits.
However, the Government is likely to lose money in the long run because interest payments on
corporate debt -- and an RJR buyout will create a whopping pile of it -- are tax deductible.

U.S. News & World Report, Dec 12, 1988 v105 n23 p12(1)
Will RJR Nabisco's cookie crumble? (Kohlberg Kravis Roberts and Co.
takeover)
Full Text: COPYRIGHT U.S. News and World Report Inc. 1988
The frenetic six-week, leapfrog bidding battle for RJR Nabisco may at last be over. But it could
be a long time before Wall Street is able to answer a key question: Just who won? RJR
stockholders will be the clearest gainers. They will receive $109 per share, almost twice the
stock's recent value, if the buyout becomes final. Bankers and lawyers will collect some $500
million in fees for assisting in the $25 billion deal, the biggest takeover ever. An RJR
management group led by Chief Executive Officer F. Ross Johnson was a clear loser. Even
though key members stand to gain millions from golden-parachute provisions, they lost their bid
to own the company and are likely out of their jobs. Yet can anyone really say that the successful
bidder, Kohlberg Kravis Roberts & Company, is a clear winner?
To clinch the deal, the new entity created by KKR, the investment community's leading buyout
firm, agreed to go into hock up to its pin-striped lapels. KKR and its investors will put up only
$1.5 billion of their own funds. They will borrow $18 billion-$5 billion through the sale of junk
bonds and $13 billion from banksand cover the rest of the price by issuing RJR preferred stock
and convertible bonds. KKR, in taking RJR private by borrowing against its future cash flow,
will use the standard principle of the leveraged buyout. But the sale price the resulting debt are
so mammoth that turning a profit will not be easy. Interest rates have been rising and stock prices
declining in recent weeks. The new company could easily face $2 billion in annual interest
payments. A drop in the stock market could meanwhile reduce what KKR might realize from any
sale of RJR Nabisco assets needed to pare debts.
The rancorous takeover fight, coming on top of other huge leveraged buyouts, quickened
demands in Congress for changes designed to discourage risky levels of LBO debt. Still, the
success or failure of the RJR deal could have a greater impact on future LBO's than any
contemplated legislation. The financial markets themselves may begin setting limits on such
buyouts. Some recent junk-bond offerings, such as the Campeau Corporation's financing for its
buyout of Federated Department Stores, have run into trouble. Investors in past LBO's have
earned returns of 80 percent a year. But such bonanzas may be disappearing. KKR's $6.2 billion
buyout of Beatrice, another foods company, was expected to yield over $3 billion in profits. The
2-year-old deal so far has earned $380 million for investors, a far cry from the megaprofits of
earlier LBO's.

Time, Dec 12, 1988 v132 n24 p56(2)


$25,000,000,000: buyout barons KKR outfox Ross Johnson's group
and walk off with RJR Nabisco, but the price comes with a colossal
debt load. (Kohlberg, Kravis, Roberts and Co.) John Greenwald.
Full Text: COPYRIGHT Time Inc. 1988
Ross Johnson had suspected he was heading for a fall. ''They are not going to approve our bid,''
the RJR Nabisco president told TIME in an interview five days before his board of directors
decided the giant company's fate. His foreboding was on target. On the night of Nov. 30, some
30 sleepless hours after the official bidding deadline had passed, the RJR directors named the
winner in the biggest takeover wrangle in history. It was not the company's president.
In a stunning rebuff to Johnson, the board awarded the food-and-tobacco giant to Kohlberg
Kravis Roberts, the leveraged-buyout specialists. Underdog KKR won even though the firm's
final bid of about $25 billion in cash and securities, or $109 a share, was a bit less than the $25.4
billion, or $112 a share, that Johnson and his handful of top RJR managers had offered as their
last stab. (The largest previous deal was Chevron's $13.3 billion takeover of Gulf in 1984.) ''It
was destined to happen this way,'' said a source close to the bidding. ''The board could not appear
to favor management in a buyout.'' Members of the losing side felt that the board had in fact
discriminated against them. Declared an aide to the RJR officers: ''We were cheated.''
The outcome, which will need shareholder approval, was a startling upset of Johnson, 56, and his
top managers, who put the company into play on Oct. 19 and at first seemed to have the inside
track. But they were outfoxed and outclassed in a bidding war in which prices soared so high that
they were no longer the ultimate measures of value. The KKR team surpassed Johnson's group in
demonstrating to RJR's board that it intended to give a fair shake to stockholders and employees,
that it had the financial experience to raise the huge sum involved and that it would try to keep
most of the company in one piece. After being named the winner, KKR partner Henry Kravis,
44, declared, ''We want everything to settle down and everyone to get back to work.'' He added,
''Oreos will still be in children's lunch boxes.''
Much of Wall Street and corporate America saw the board's choice of KKR as a repudiation of
Johnson, who had become a symbol of executive greed after first proposing to buy out RJR
(1987 sales: $15.8 billion) for $75 a share. Company directors were outraged when they read
accounts, leaked by insiders, of how much Johnson and his seven colleagues planned to rake in
from the deal: as much as $2.6 billion. Though Johnson later insisted he had planned to share the
potential gains with 15,000 RJR employees, the battle lines were clearly drawn -- not just
between Johnson and KKR but between Johnson and his board of directors.
Board members first showed their unhappiness in October when Johnson and KKR began
publicly brawling over a possible joint bid. Angered by the spectacle, the directors called for
outside offers. KKR, headed by Kravis and his cousin George Roberts, 45, made its own bid, and
so did a team composed of the First Boston investment firm and Chicago's billionaire Pritzker
family. The Pritzkers topped the first round of bidding with a preliminary offer of $27 billion, or

about $118 a share for RJR stock that had traded for just $56 on the eve of the battle. The
Johnson group boosted its offer to $100 a share while KKR bid $94, a price that seemed to
indicate that the firm might drop out. The RJR board then extended the contest until 5 p.m., Nov.
29.
KKR's seeming weakness turned out to be a trap. The company's officers even let it be known
that Kravis was heading to Vail, Colo., for a skiing weekend and that Roberts was flying back to
his home in San Francisco. But Kravis and Roberts stayed in close touch with their team in New
York City as it prepared the final attack. When the directors met last week on the 35th floor of a
midtown Manhattan skyscraper to open the final bids, they found that Kravis and Roberts had
pumped their offer up to $106 a share, while the apparently complacent Johnson group bid only
$101. A board adviser also noted that ''KKR had the sounder financial structure.'' The First
Boston team, meanwhile, withdrew from the competition after failing to demonstrate that it
could finance its bid.
Persuaded that KKR was the winner, directors summoned Kravis to a conference room at about 9
p.m. to complete the deal. The real brawl, however, was just beginning. ''This game is not played
by Marquis of Queensberry rules,'' said a Johnson adviser. ''There really are no rules for this kind
of auction.''
At RJR Nabisco offices a few blocks away, Johnson was furious when he learned that the board
was ready to sell the company to KKR. His legal advisers swiftly drafted a letter to RJR
chairman Charles Hugel, who heads the board but holds no managerial post in the company,
declaring they were ''astounded'' that the directors ''would go off into the middle of the night to
negotiate.'' Hugel explained that the KKR bid simply was much higher. By 2 a.m., however,
Johnson's advisers persuaded him that his chances were still alive. Armed with a new bid for
$108 a share, Johnson arrived the next morning at the East Side law offices where the special,
bid-selecting panel of five directors was meeting. He demanded to present his proposal.
Lawyers for the board gave Johnson and his small coterie of advisers 15 minutes to sweeten the
latest offer. At about 1:15 p.m. on Nov. 30, Johnson, chain smoking, submitted a bid of $112 a
share and then settled into a tiny office to await the verdict. The directors still favored Kravis.
''KKR was going to have to sell fewer businesses,'' a source close to the board said, ''and there
was more protection for RJR employees under the KKR offer.'' Moreover, the informant added,
while the Johnson group said it would reduce its initial stake in RJR after the takeover from 8.5%
to 4%, ''they were still trying to steal the company.''
Board advisers then asked KKR to make a final offer. The intense Kravis agreed, submitting a
document offering some $25 billion for the company, but warned, ''If we don't get it back in 30
minutes, we are going away.'' Thirty-four minutes later, at about 8 p.m., board representatives
ushered Kravis into a conference room where investment banker Felix Rohatyn, a board adviser,
handed him the signed merger agreement.
Accepting defeat, Johnson issued a concession. Said he: ''I am proud of the fact that we put the
best bid on the table the first time and this time.'' He then returned with an attorney to RJR's

48th-floor New York offices in seemingly good spirits. As city lights glittered around them, the
two men sipped drinks and munched Oreo cookies while reflecting on the day's ordeal.
Johnson could afford to be philosophical: he can now pull the rip cord on a ''golden parachute''
worth at least $30 million. Besides a lucrative severance package, Johnson will reap large profits
from the sale of his more than 235,500 shares of RJR stock.
Kravis, meanwhile, could afford to be generous in victory. Though he may have to spin off some
$6 billion worth of RJR food brands to reduce the leveraged company's swollen debt, he talked
of shifting RJR headquarters from Atlanta, where Johnson moved it last year, back to its
traditional h
ome in Winston-Salem, N.C. Kravis said he will install retired RJR chairman J. Paul
Sticht, 71, in the top job again for several months to smooth the transition.
At week's end Johnson and Kravis sent a letter to RJR Nabisco's 125,000 employees to announce
the end of their struggle. ''It is now most important,'' the letter stated, ''that we return immediately
and actively to running our business.'' For Johnson, that business will probably mean finding
another job.

Fortune, April 24, 1989 v119 n9 p296(12)


How Ross Johnson blew the buyout. (RJR Nabisco Inc. ) Bill Saporito.
Full Text: COPYRIGHT Time Inc. 1989
THE AIR at the Castle Pines golf club, about 25 miles south of Denver, is so thin even a smallish
CEO can smack a ball halfway into the next quarter. Which is exactly what a group of friends
and customers of RJR Nabisco boss F. Ross Johnson were trying to do late last August. Johnson
had more on his mind than his long game, though. Market tests of Premier, the smokeless
cigarette that was supposed to puff up RJR's stock on Wall Street, were not promising. A man
who prefers gut instinct over research, Johnson sought some straight dope on the product from
trusted clients on the course. Those who lit up confirmed what the market researchers had told
him: Premier tasted like a smoldering Hefty Bag.
That revelation crystallized Johnson's decision to embark on a leveraged buyout of RJR Nabisco
-- a deal that ultimately led to the largest, looniest auction in the history of capitalism. Johnson
judged his own record by RJR's stock price, and he figured that with Premier flagging, an LBO
was now his best chance of increasing shareholder value.
If you think you have read all you want to read about what happened from there on out in this
thoroughly chronicled saga, think again -- you may have missed something. Did you know, for
instance, that before Johnson strolled down LBO lane, he tried to negotiate a merger of RJR's
Nabisco food business with that of archrival Philip Morris? Or that in the heat of the bidding
contest, Johnson came within an eyelash of reaching an agreement with a new archrival -- the
leveraged-buyout firm of Kohlberg Kravis Roberts -- under which the two could have bought
RJR Nabisco together for $4 billion less than KKR ultimately paid for it?
In the end, of course, Ross Johnson blew his big chance. But how? And why? Though the RJR
buyout played in the press like a two-reel cliffhanger, the critical issues that shaped the outcome
have been overlooked. A sometimes pathetic tale, it is full of insight about how business really
works when good intentions struggle with pride, ambition, and a thousand other human frailties
in the red-hot crucible of competition.
The lessons for management begin with the dangers of faulty assumptions. Johnson went into the
LBO with the deluded notion that it was his deal, and that all his investment bankers had to do
was find the money to finance it. He thought that RJR's directors would give him the deference
due a chief executive, never realizing that the board would have no choice legally or morally but
to treat him like an outsider.
The execution of the buyout strategy was as flawed as the assumptions that went into it.
Johnson's primary partner in the deal, the investment banking firm of Shearson Lehman Hutton,
suggested an offering price of $75 a share. This low-ball bid made Johnson and his management
group seem a bunch of quick-buck artists trying to grab the company cheap. Had either Johnson
or his bankers rummaged through RJR's files -- as the investment banking advisers to the board
of directors later did -- they would have found some analyses that could justify the directors in

rejecting as insufficient any bid less than $100. This was just one piece of evidence that led the
board to wonder whether Johnson had something more than the shareholders' interests at heart.
The greed issue grew even more obvious in the contract Johnson negotiated with his partners at
Shearson Lehman. The bankers knew that the management contract was incendiary, and they
told him so. Unfortunately for him and for them, they did not tell him no. The management
group was originally going to put up a mere $20 million for 8.5% of the company. Its members
stood to make $100 million in five years and come away with 18.5% of the equity, potentially
worth billions if they could meet an ambitious set of operating targets.
But who was the management group? Though Johnson insisted that the 8.5% in equity would be
divided among some 15,000 RJR workers -- and that insistence is consistent with his past
practice -- only six names emerged besides his own: Edward A. Horrigan Jr., the head of R.J.
Reynolds Tobacco; James O. Welch Jr., chairman of Nabisco Brands; Edward Robinson, the
parent company's chief financial officer; Harold Henderson, chief counsel; John Martin, an
executive VP; and Andrew Sage II, a former investment banker and an outside director. Too
much for too few, it seemed to the shocked directors.
The biggest deal attracted egos to match. Peter Cohen, 42, the chairman of Shearson, had a $1
billion LBO fund to play with and the drive to plant Shearson's name at the top of the merchant
banking heap. He was working under the watchful eye of his boss, American Express Chairman
James D. Robinson III, 53, a friend of Johnson's who frequently advised the RJR chief about
strategy. Competitiveness contributed to Cohen's failure to reach an agreement with his chief
rivals, KKR principals Henry Kravis, 45, and his cousin George Roberts, also 45, to pursue the
LBO jointly. One of the sticking points was the reluctance of Salomon Brothers, the powerful
bond house that was allied with Cohen, to work with KKR's bankers, the scandal-racked junk
bond firm of Drexel Burnham Lambert.
Although the competing sides were friends, they did not trust one another when it came to
business. Conflict between the bidding groups left the buyers in disarray and the sellers with the
whip hand. The dynamics of distrust sent the ultimate price spiraling ever higher -- in an auction
where a single dollar per share added about $225 million to the final price. Ultimately there was
barely a nickel to choose between the final bids, leaving a special committee of RJR directors
ample discretion to pick a winner.
If, by the end of the process, Johnson had any friends among the directors -- a group he had
taken pains to treat royally -- they did nothing to help him. Says a member of the special
committee, Gulf & Western Chairman Martin S. Davis: "You either play with the managers or
you play with the shareholders. We chose to play for the shareholders." Out of this tumultuous
fray RJR Nabisco's stockholders emerged as the only unambiguous winners.
A SELLER, NOT A BUYER
It would be hard to think of any chief executive less temperamentally attuned to orchestrating
and running a leveraged buyout than F. Ross Johnson, 57. For one thing, his whole career was
built on being a seller of companies, not a buyer. In that capacity he always seemed to come out

on top. As CEO, he peddled Standard Brands to Nabisco in 1981; then he later took over the top
job from Nabisco's Robert Schaeberle. He merged Nabisco with R.J. Reynolds in 1985, and the
board obligingly anointed him successor to Chief Executive J. Tylee Wilson.
An accountant by training who hails from Winnipeg in Manitoba, Canada, Johnson abhorred
debt. He didn't come across to his investment bankers as a free spender either. Says a Shearson
executive: "Ross told us categorically that there was a price at which he didn't want to own RJR."
Johnson didn't say what that price was, but his Shearson friends pegged it in the low-80s per
share.
That fiscal prudence is at odds with his public image as a corporate jet-setter who runs with a
pack of sports and celebrity buddies. A stylish dresser who towers well over six feet, Johnson has
a golf handicap of nine, which underscores his belief that there's no sense in running a business if
you can't have fun. He did all he could to make sure RJR executives joined the party; they had
generous expense accounts and referred to the company as "first-class."
Johnson's plan for RJR would have allowed him to preserve that odd combination of hard-eyed
number crunching and flamboyant style. He planned to sell the food companies quickly to pay
down the debt and avoid making about $2 billion in capital expenditures over the next three
years. The average Nabisco bakery is 30 to 35 years old. The tobacco company that he would
hold on to was already highly automated, but he planned to spend $900 million on development,
principally for Premier, which he wanted to continue despite the discouraging reviews.
Unfortunately for Johnson, the board of directors of RJR Nabisco has not always been a group of
happy campers. His predecessor, J. Tylee Wilson, had built a rocky relationship with the board
and was barely on speaking terms with some members by the time he was ousted. Johnson
alienated old Reynolds hands by moving the headquarters to Atlanta from tradition-steeped
Winston-Salem, North Carolina, where it is still the leading employer and has thrived for more
than 100 years.
As his ambassador to the board, Johnson recruited his friend Charles Hugel, 60, chief executive
of Combustion Engineering, and placed him in the curious role of "nonexecutive" chairman in
the fall of 1987. As both men understood it, Hugel's role was to run the board meetings and work
with Johnson and the board. In the best of times this could not have been an easy role to perform
diligently while running your own $3.5-billion-a-year corporation.
STIRRINGS OF AN LBO
The idea of a leveraged buyout had been brought to Johnson many times. For example, Donald
Kelly, who had done a highly successful leveraged buyout of Beatrice Foods with Henry Kravis,
urged Johnson to meet with Kravis. The two had dinner at Kravis's East Side Manhattan
apartment in September 1987. Kravis explained why an LBO would make sense for RJR, but
with RJR's stock near $70 in the pre-crash market, Johnson didn't believe there would be a big
enough premium to stockholders to justify the deal. Kravis didn't give up. A number of
investment banking firms approached Johnson on his behalf, to no avail.

RJR retained a consultant named Frank A. Benevento II in November 1986 to investigate a


variety of capital structures and reorganizations for the company. Drexel Burnham Lambert also
made a number of proposals that were kept in a file code named Sadim, or Midas spelled
backwards.
Johnson was working on something much more ambitious to raise the stock price: the joint
venture with Philip Morris. In the summer of 1988, he tried to entice his rival chief executive,
Hamish Maxwell, into marrying Philip Morris's limping General Foods division to RJR's
muscular Nabisco Brands and Del Monte. The two tobacco companies would each own 40% of
the new entity, which would have revenues of $18 billion, and the remainder would be sold to
the public in a stock offering. In this way, Johnson reasoned, RJR shareholders would benefit
from the P/E multiple that attaches to food companies, which runs about half again as high as the
tobacco multiple. True to form, Johnson volunteered to head the combined concern.
Maxwell wasn't about to be enticed. He doubted that a joint venture of such magnitude could
succeed, and he was not wholly convinced that Philip Morris's stock price would benefit.
Johnson then floated preliminary proposals past Pillsbury and Quaker Oats, but got no nibbles.
PUTTING RJR IN PLAY
Coming on top of these refusals, Johnson's disappointment with Premier convinced him that RJR
Nabisco's stock would remain irretrievably undervalued unless an LBO freed it to soar. But his
plans to embark on that course were derailed by terrible news: His son Bruce, 26, had sustained
severe head injuries when his car drove off the road in Westchester County, New York, on
September 7. Johnson spent two weeks in New York until his son's condition stabilized and then
flew back to Atlanta to rededicate himself to making a decision. (Bruce Johnson later lapsed into
what doctors describe as an irreversible coma.)
On October 7, Shearson Chairman Peter Cohen and J. Tomilson Hill, the mergers and
acquisitions chief, made a full presentation on an LBO to Johnson and other members of the
management group. Johnson asked that Hill and some of his colleagues join him at a dinner in
Atlanta with the directors on October 19, the night before the scheduled board meeting. At this
dinner Johnson planned to discuss his idea for an LBO.
A week before the dinner Johnson advised Hugel to put together a special committee of outside
directors to consider the LBO question. Hugel tapped Davis of Gulf & Western; John Macomber,
the former CEO of Celanese, who had sold his company to West Germany's Hoechst AG in
1987; William Anderson, the recently retired chairman of the executive committee of NCR
Corp.; and Albert L. Butler Jr., who owns a real estate company called Arista in Winston-Salem.
Hugel also phoned Peter Atkins, 45, a poker-faced partner at the law firm of Skadden Arps Slate
Meagher & Flom, who had just piloted the Fort Howard paper company through a litigious LBO.
Atkins agreed to become the legal adviser to the special committee.
When the fateful night of October 19 arrived, the outside directors along with Horrigan and
Johnson gathered at the Stouffer Waverly Hotel close by corporate headquarters. During dinner
Johnson talked about his various schemes to enhance shareholder value and why they hadn't

worked. Dividend hikes, outstanding earnings growth, and stock buybacks failed to get the stock
moving. In his estimation the only road was a leveraged buyout. As the directors digested their
dinner and his words, he added, "If you don't want to go ahead with this, just say so -- and no
hard feelings." Somewhat disbelievingly, one director said, "You're putting this company into
play." Replied Johnson: "It should be in play."
Several members of the special committee were shocked at the way things unfolded. They had
expected to discuss the LBO concept generally -- and had no idea Johnson would come loaded
for bear, with a lawyer and an investment banker in tow. Says one of the committee members:
"There's no substitute for trust and no excuse for surprises between management and the board."
Johnson was surprised too. Neither he nor Shearson was prepared to put the company in play that
night. But soon he and the other directors, who were now potential buyers, were asked to leave
the room. The remaining directors immediately focused their attention on what price the
company could command. After about 45 minutes Johnson was called back. "We want to make
sure that the number you were thinking about was not frivolous," Hugel said. "Define `frivolous'
for me," said Johnson. Hugel told him that anything short of the highest price at which the stock
had ever traded -- $71 a share -- was unacceptable.
Johnson left the room to confer with his advisers under the impression that he needed to name a
price. "It was not our intention to generate a number," says Peter Cohen. Tom Hill, on hand for
Shearson, told Johnson the firm was comfortable with $75 a share in cash, about 35% more than
the stock was selling for that day. Cohen still contends that $75 was a logical place to start.
Shearson predicated its work on buying the company entirely for cash, and based on
conversations with commercial bankers a week before, Cohen felt certain he could find $75 a
share -- a total of $17 billion.
When he reentered the room, Johnson told the board his group was prepared to put up a
minimum of $75 a share, but that he couldn't say exactly what price they would offer. One
director, civil rights leader Vernon E. Jordan Jr., a partner in the law firm Akin Gump Strauss
Hauer & Feld, raised the possibility of a higher bidder. "Suppose it goes to $82 or $84?" he
asked. "So be it," Johnson replied. "It proves what I've been saying."
"All the criteria indicated it was a responsible price," says lawyer Peter Atkins. Perhaps. But it
was remarkably cheap in light of the mushrooming amounts commanded by food companies in
the fall of 1988. Shearson's $75 a share was tied to selling the Nabisco businesses for $13 billion,
a figure that turned out to be low compared with the market rate for food companies. Grand
Metropolitan's offer for Pillsbury on October 4 came to $60 a share, or 27 times earnings, and
should have sent Shearson a message. And Philip Morris's astonishing initial bid of $11 billion
for Kraft, 22 times earnings, occurred on the eve of the RJR board meeting.
That night Johnson lost control of his destiny forever, essentially becoming a junior partner in
the latest Wall Street deal rather than the dealmaker himself. From there on he played a
diminishing role in the negotiations. The board chose to announce the next morning that the
company was entertaining the idea of a management buyout at the suggested retail price of $75 a
share. Enough information had been discussed to compel the board to make the announcement.

HIT FROM BEHIND WITH A BASEBALL BAT


Henry Kravis had been discussing other deals with Shearson and was upset to discover that
Shearson was not cutting his firm in on the huge new buyout. That Friday, October 21, Tom Hill,
Shearson's mergers and acquisitions chief, called and asked for a meeting to discuss deals that
the two were already involved in. Kravis did not disguise his annoyance. "I see you guys are now
our competitors," he told Hill. Hill called him back later, asking for a meeting to talk about RJR.
That evening Kravis, Hill, and Cohen convened at Kravis's office. The Shearson bankers wanted
to know whether Kravis had plans regarding RJR. Kravis said he hadn't made up his mind,
adding, "All I can tell you is that I'd be surprised if you buy this company for $75."
The press has reported that Kravis demanded to be let into the deal, alluding to the LBO business
as his "franchise." He gets testy about that: "There was no franchise discussion. I never said I've
got to be in this deal." But RJR was one of 20 or so names KKR kept tabs on as potential targets
even after Johnson had rebuffed them.
Late Sunday night the phone rang at Jim and Linda Robinson's New York apartment. Both
Robinson, the American Express chairman, and his wife, a public relations strategist, were
advising Johnson. As it happens, Linda Robinson is also a good friend of Henry Kravis and his
wife, Carolyne Roehm, a fashion designer. The caller, a reporter, told Mrs. Robinson that KKR
was going to launch a $90-a-share bid in the morning. Did she want to comment?
No, she didn't. She was staggered. She called Peter Cohen. It's a bluff, he told her. A bid didn't
make any sense to Cohen. He had planned to meet with Kravis the next day, although Kravis
says there was nothing in his appointment book. Neither Cohen nor the Robinsons called him.
Cohen woke up that Monday, October 24, to find a $90 offer, $78 of it cash, the rest in securities,
on the table from KKR. Kravis had just hit him from behind with a baseball bat. What made
Henry jump? He was afraid that Shearson was about to beat him to the punch with the first
official offer. Over the weekend he had tried unsuccessfully to reach one of his bankers and
learned he was tied up in discussions with Shearson. He also discovered that Shearson had a
board meeting scheduled for Tuesday, followed by the parent American Express Co.'s meeting.
The boards were ready, he thought, to approve the offer. "I know what you were doing," he
yelled at Cohen over the phone on Monday. Cohen told Kravis that the board meetings had been
scheduled for months. The two agreed to meet again, but trust had been shattered.
Although Cohen met with Kravis on Tuesday, October 25, to discuss the possibility of a joint
offer, the friction between the two was increasing. Later, Kravis offered Shearson a 10% cut in
the equity and up to $125 million to go away and let KKR pursue the buyout alone. The proposal
turned the atmosphere from chilly to frigid. But Cohen nonetheless told Johnson that Shearson
would step aside if he wanted it to. Johnson said no. Argues Cohen: "If management's game was
to max out for themselves, they had a number of ways to do it. This was one."
Around midnight Cohen called Kravis at his home and told -- not asked, told -- him to come to
RJR's Manhattan offices on the 48th floor of 9 West 57th Street, the building where KKR
happens to be headquartered. Why now? Kravis asked him. "Because if we want to work

something out, now is the time," Cohen snapped. Kravis, with his partner George Roberts and
KKR's outside counsel Richard Beattie, met with Cohen, Hill, Johnson, Jim Robinson, and
Steven Goldstone, a lawyer who was representing Johnson.
While Shearson and KKR continued their dance, every house on Wall Street was looking for
some way to cut in. Salomon Brothers figured RJR was worth $100 a share and within two days
lined up a major European company as a partner. When KKR announced its $90 bid, however,
the Europeans vanished. Salomon Brothers' President Thomas Strauss, 46, realized that Shearson
would need to raise more money if it were going to match KKR's bid. So he called Cohen, a
friend and safari partner, and told him: Peter, you've got a problem.
Salomon was the solution Cohen was looking for. With Salomon's banking and bond-selling
ability, he could make a fully financed offer for more than $90, without slicing the pie with
KKR.
AN AGREEMENT BLOWS UP
By the week of October 31, Shearson and the management group were ready to strike back with
their first firm offer: $92 a share, $2 better and richer in cash than KKR's $90 bid. Although
Kravis had blind-sided him a week earlier, one-upmanship didn't seem a smart idea to Cohen
now. He called Kravis to see if he was still interested in talking. "I think we should meet again,"
said Kravis. Cohen held back on the bid.
The second, critical set of meetings between the Johnson and KKR factions began at around six
on the evening of November 2 in a deluxe suite at the Plaza Hotel. What started on a premise of
compromise ended some 15 hours later in a virtual spitting match. The players were deeply
suspicious of one another, and no leader emerged to knock heads together. Even today neither
side can agree on what they were really disagreeing about.
The meeting began with just Kravis and Roberts for KKR, Cohen and Jim Robinson for
Shearson, and Johnson. The five met from 6 to 7 P.M. and made enough progress so that the
group decided to bring in the lawyers. They resumed talks, minus Johnson, around 9 P.M., joined
by KKR lawyers Beattie and Casey Cogut; Jack Nusbaum, Shearson's outside counsel;
Goldstone; and Salomon's Tom Strauss and his firm's outside counsel Peter Darrow. Some major
issues, such as control of the board and ownership of the equity, were broadly resolved fairly
early on. Beattie began to draft an agreement that KKR and the Shearson group would pursue
RJR jointly as equal partners in the deal. This was a major concession from KKR.
The management contract that Johnson had cooked up with Shearson was also aired. KKR had
no quarrel with Johnson and his management team receiving 8.5% of the equity in the new
company -- as long as it didn't come out of KKR's pocket. Shearson agreed to include Johnson's
piece in its half of the equity.
The group broke up at 11 P.M. so each side could huddle and then reconvene at RJR's offices
around the corner on West 57th Street. Alas, this was a vastly different scene from the plush,
quiet surroundings of the Plaza. Lawyers, bankers, advisers, principals, and assorted staff, as

many as 50 wheeler-dealers of various pin stripe, swam through the 48th floor office overlooking
Central Park.
Kravis and Cohen tussled over who would manage the junk bond underwriting that would
provide the financing: Drexel Burnham, KKR's longtime investment banker, or Cohen's partners
at Salomon. The quarrel had that noxious mixture of money -- some $200 million in fees were at
stake -- and turf. Drexel was the object of a criminal investigation and needed the prestige of
leading the deal. Salomon had clashed repeatedly with its upstart competitor as Drexel's junk
bond business flourished in the Eighties. Salomon and Shearson thought the financing that KKR
proposed required more junk securities than was prudent and wanted more bank debt. Tom
Strauss insisted that Salomon, along with Shearson, play a significant role in the financing.
Gradually the distrust that pervaded earlier meetings resurfaced.
Kravis had spotted John Gutfreund, Salomon's chairman, wandering around, but Gutfreund was
not at the meetings. At times Strauss disappeared, leaving Cohen to carry on alone. Says Kravis:
"We had no idea who was running the show. One minute there's John Gutfreund, then there's
Tom Strauss, then we didn't see either of them anymore and Peter Cohen is going back and forth
talking on their behalf." Exasperated, Kravis and Roberts asked to talk to Gutfreund. He was
strolling along 57th Street when Johnson found him.
Cohen was having a hard time keeping his aggression holstered. But he hammered away at
Salomon all night and finally persuaded Strauss to soften his position -- co-management with
Drexel was possible. But Cohen, too, was disturbed by men who weren't there, notably Leon
Black, Drexel's mergers and acquisitions chief, and Peter Ackerman, one of its leading
dealmakers. He had the same doubts Kravis did. Just who was calling the shots?
At 5 A.M., with each side confused about who was saying what for whom, the group stopped
talking. For the next several hours various emissaries tried to reconcile differences, but finally
around 9 A.M. Jim Robinson and Shearson lawyer Jack Nusbaum took the elevator six floors
down to KKR's offices. "We've made a good-faith effort and we came a long way, but we just
can't agree," Robinson told Kravis. "We are announcing a bid of $92 for the company."
THE ROBBER BARON
It had taken plenty of cajoling before Steven Goldstone, Johnson's lawyer, was willing to show
KKR the management group's contract. The document was complicated and still not specific as
to whom it covered. Beattie, KKR's lawyer, argued that his client needed to see it, and Goldstone
finally relented. Before he handed it over, he said to Beattie: "I must have your word that you
won't reveal any of this or make any copies."
Beattie agreed, but KKR's staff learned some of the details. Then three days later, on Saturday,
November 5, the contents of the contract appeared on the lead business page in the New York
Times under the headline "Nabisco Executives to Take Huge Gains in Their Buyouts." The
course of business history was about to change. Beattie denies discussing the contract with the
Times. However the newspaper got the scoop, Johnson became the biggest symbol of corporate
greed since the robber barons.

Charles Hugel, the chairman of RJR's special directors committee, couldn't quite believe what he
was reading when he picked up his Times that Saturday morning. The board did not know that
the contract existed. As the day wore on, directors kept calling Hugel. All were concerned and
some were angry: Was Johnson trying to make fools of them? Hugel telephoned Johnson. Why
wasn't the board aware of the contract? he demanded. Johnson explained that the agreement had
never been finished and that he didn't have a complete version to give to the board. He also
denied trying to walk away with $100 million for himself and he promised to send a letter to
Hugel immediately to clarify the details.
THE AUCTION BEGINS
The contract controversy obscured the momentous benefit that the fight between KKR and
Shearson was bestowing on RJR Nabisco's shareholders. The auction that was now under way
would be a true one, no collusion, no holds barred. On November 7, the committee sent all
bidders a letter outlining the rules. In particular, the committee asked prospective purchasers to
provide "a substantial common stock-related interest" in their offers for current shareholders. The
committee's advisers, the investment banking firms of Lazard Freres and Dillon Read, believed
that the RJR shareholders should have an opportunity to reap what could be considerable longterm gain down the line, so they recommended that the board solicit offers that combined cash
and securities that could be converted to stock at a future date. The rules also said that the
committee could change the rules.
The investment bankers at Shearson plotted their strategy around three words: Cash is king. By
this they meant that they believed the special committee analyzing the bids would consider cash
a superior form of payment than securities. To Johnson, historically a seller, the three little words
made a lot of sense. And he heard them from none other than Charlie Hugel, chairman of the
special committee.
Hugel confirms taking this position with Johnson, but points out that he did so before the
committee promulgated the bidding rules. Unfortunately, Johnson served as the only link
between Shearson and the committee, and he kept missing the importance of "continuing
equity."
The bids were due at 5 P.M., Friday, November 18, in the law offices of Skadden Arps Slate
Meagher & Flom on Third Avenue. Shearson and Johnson were going to put their best foot
forward. The management group, believing that it had been hurt by security leaks, deputized
Duncan Stewart, an outside lawyer, as its messenger. What Stewart delivered to Skadden Arps
was a bid of $100 a share -- $90 in cash, $6 in preferred stock, and $4 in preferreds convertible to
15% of the new company. The bid topped KKR's $94 offer -- $75 in cash and $19 in securities
convertible to 25% of the company. But there were two important differences: KKR had more
"continuing equity." And KKR said that it would keep as many of the food businesses as it
could. Shearson and the management group planned to sell them all off and so became tagged as
bust-up artists.
By this time another noted merchant banker, First Boston Corp., had also joined the fray, adding
a twist of its own. First Boston was teamed with Resource Holdings, a merchant banking outfit

headquartered in New York City and partially bankrolled by the Pritzker family of Chicago and
Philip Anschutz, a Denver businessman. The First Boston plan had one catch. It depended on a
tax loophole that was closing at the end of the year.
Both KKR and Shearson were aware that a bid from Resource Holdings and First Boston was
likely to come in. Earlier in the week the First Boston group tantalized the special committee of
the board by asserting that its offer could be as much as $118 a share. But, unhappily, the
financing was incomplete. Hugel was worried about extending the auction deadline to
accommodate the third bidder, fearing that KKR might drop out. For KKR there was always the
next deal. But for Hugel, KKR's exit would leave only the management bid on the table and the
iffy proposition from First Boston.
Directors Davis and Macomber wanted an extension, convinced that a board-led restructuring
might produce even higher values, or at least force a better price. The directors still had no firm
idea of the breakup value of the company and were afraid of selling it too cheaply. Says
Macomber: "I pushed hard on the restructuring issue. It had to be considered. We had to be ready
to move." Atkins informed the committee on Sunday that prudence dictated an extension to
consider the First Boston bid fully.
Then the special committee got a jolt from KKR: a letter, written by lawyer Beattie, that said the
information the firm was receiving from RJR managers was inaccurate and misleading. Based on
that information, KKR said, it may have underbid.
Throughout the previous week KKR had been reviewing RJR's businesses with the operating
executives. The food company managers, furious with Johnson for selling them down the river
so he could keep the tobacco works, were open with his opponents. The alleged information
shortage centered on the tobacco business. Digging in behind their boss, Edward Horrigan, a
member of the management group, tobacco executives gave KKR the cold shoulder. Says a KKR
source: "We were meeting with some people who seemed to have amnesia. They remembered
their names and their positions."
Initially Kravis and Roberts decided to say nothing to the committee about their difficulties. But
on Saturday, November 19, after discussing their bid with one of the committee's investment
advisers, KKR got the "distinct impression," says a participant, that it was behind in the bidding.
That's when it lobbed in the letter. The committee voted to extend the auction ten days.
The management group and Shearson believe the special committee's investment bankers used
the First Boston bid as a stalking horse to set up the second, more expensive round of bidding.
Their ire centered on one of the committee's financial advisers, J. Ira Harris, 51, a partner at
Lazard Freres and a onetime Salomon Brothers executive who allegedly left that firm on bad
terms with John Gutfreund. They believe he had a hand in bringing in the Pritzker family.
Jay Pritzker, the top financier of the clan, denies the allegation, as do First Boston and Harris. He
also denied leaving on bad terms with Gutfreund. Harris told FORTUNE: "It's ludicrous. This is
a flagrant attempt by the management group and its advisers to cover up the consistent mistakes
they made in handling this transaction."

As the high bidder in the first round, the Shearson-Johnson team was in a serious bind going into
the second. First Boston, deciding it couldn't get the deal done fast enough to take advantage of
the tax loophole, folded its tent. The management group did not want to bid against itself in the
event KKR decided to drop out. Furthermore, the group was still committed to pushing the cash
part of the deal as high as it could. Shearson's Tom Hill thought this maneuver would thrust the
sword at his rival's weakness: "We knew KKR could not make a deal having a huge cash level
and keep the food companies." Besides, Johnson still believed the committee would find cash
more compelling than junk.
Having received KKR's letter of complaint, the special committee directed the offending RJR
executives to be more voluble. KKR immediately set out to put the pedal to the metal,
challenging its staff to find a price it could go to the wire with -- one that would let KKR keep
the food assets and still satisfy the lenders that the firm would have the ability to service its debt.
The staff debated the pricetag in interminable meetings on Tuesday and Wednesday. Kravis
wanted the management group to think KKR was less than serious, so he went skiing in Vail,
Colorado.
Johnson went to Hell, media version. From the day he put his company in play, he had refused to
talk to the press. Even after the management contract hit the papers, he kept his mouth shut. But
a few days before Thanksgiving, Time magazine (owned by Time Inc., the publisher of
FORTUNE) persuaded Johnson to be interviewed for a cover story on the buyout.
Although he was coached before the interview, Johnson at once reverted to form: glib and
outrageously candid, a reporter's dream and a publicist's nightmare. The interview made him
look only slightly less sensitive to the welfare of his employees than Vlad the Impaler.
Discussing potential layoffs in the Atlanta headquarters, he said with seeming nonchalance that
those workers had "portable" jobs and could find employment elsewhere.
THE FINAL ROUND
While Johnson was wiping the egg off his face, KKR was hatching ideas. On Tuesday,
November 29, the day the new bids were to be submitted, KKR's staff gathered for a final
meeting: Kravis and Roberts went around the room of associates asking each for a price. The
agreed-upon figure: $106 a share, $80 in cash. KKR had already told the committee that if its bid
were accepted, it would dump Johnson. No hard feelings, just one of those things. Says Kravis:
"It became clear he was going his way, and we said fine. We'll go our way, but if we end up
buying this company, the best thing to do is to find a new CEO."
The Shearson-Johnson team assumed, with catastrophic consequences, that it did not have to be
the highest bidder in the second round. Since the special committee changed the rules the first
time, the Shearson bankers reasoned, it might do so again, and they didn't want to lead with their
chins. Says Tom Hill: "We just wanted a place at the table." Peter Cohen played safe, raising his
price one dollar to $101 share, and sending a message to the committee that his group was
willing to negotiate "any and all" provisions of its bid.

The bids were submitted again at Skadden Arps at 5 P.M. and the Shearson-Johnson contingent
retreated to Nusbaum's office at Willkie Farr & Gallagher at Manhattan's Citicorp Center. There
they waited for an opportunity to negotiate their price. And wait they did. At 8 P.M. Johnson left
for dinner, telling his colleagues they were losers "no matter what we do." He believed the board
was a captive of its investment banker advisers, and that his group's bid would have to win by a
wide margin before the committee would award him the deal. Cohen went home to celebrate his
20th wedding anniversary.
Around 10 P.M. Nusbaum found out from a reporter that the committee's advisers were
negotiating with KKR. "We were really astounded," he says. He sent a letter to the committee
demanding to see KKR's bid and insisting on the right to negotiate. Johnson called Hugel, who
told him "it wasn't close," but Hugel wouldn't tell him the difference. Cohen came tearing back
from dinner and initiated a series of computer runs to evaluate the variety of combinations of
cash and debt he could offer to raise the nominal value of Shearson's bid.
Johnson showed up at Skadden Arps's offices the next day, November 30, wanting to address the
committee. By now the special committee was reviewing with its investment bankers the KKR
offer as it had been completed the night before. The committee also asked KKR to discuss its
plans for running the company should it acquire RJR. Hugel, aware that the management group
wanted to make another bid, then asked George Roberts to extend the 1 P.M. deadline he had put
on the offer the night before. Roberts said no.
Cohen reached Johnson and Nusbaum as they cooled their heels. Full of vinegar, he had a new
number to play, $108 a share, and a new way to play it. "We'll use a stick," he told Nusbaum.
"We just called the bid in to Dow Jones." It was noon.
The committee now had a new $108 offer from management and a $106 offer from KKR that
was ticking away. Says Hugel: "We felt KKR was serious about the deadline, but we had a fully
negotiated agreement with them. You don't dismiss that out of hand." Hugel went back to KKR
and asked again for an extension. Roberts relented. He would delay one hour, but at a price: 20
cents a share reimbursement for expenses the firm figured it would incur during the contest.
Hugel agreed.
For 60 minutes the special committee had KKR in hand, but it was uncertain about the ShearsonJohnson group: Was it still playing the game and willing to bid higher? Around 1:30 P.M.
Atkins, the committee's lawyer, told the management group to "sharpen your pencils and put
your best bid on the table." Cohen was ready. He offered $112: It broke down into $84 in cash;
$24 in payment-in-kind (PIK) securities, which accrue interest but don't pay cash for a period of
years. The additional $4 was in preferred stock.
Atkins appeared in the KKR caucus room and tried to buy more time. He asked if the firm would
enter into a merger agreement at $106 a share under the condition that if the offer was topped
within seven days KKR would receive a $1-a-share kill fee. Kravis said no, but surprised Hugel
with a new bid of $108, upping the PIK securities in his package. No fuse was attached to this
offer because Kravis believed there would be no more bidding and that the committee was
beginning its final deliberations.

WITH KKR on ice, the committee had the leisure of spending the rest of the afternoon with the
Shearson crew, negotiating the terms of the securities included in its bid. Some five hours later
Hugel approached Kravis and Roberts and asked if the firm would like to make its "best and
final" offer. Kravis and Roberts agreed to up the ante by $1 in cash to $109. But Roberts didn't
make the same mistake twice. Thirty minutes, he told Hugel, or KKR was voting with its feet.
"Every time we went into that room we could see George clench," Hugel recalls. "We had to get
out before we froze to death."
With the score standing at $112 a share to $109, the committee had to make a choice. It was
easy: $109.
In the end KKR bested its rival because the firm was more flexible in negotiating with the
special committee than were its opponents. At the committee's request, for example, KKR
changed the conversion provision of the debentures in its package. At first it offered to convert
the debentures into RJR equity after two years, but the committee talked KKR up to four years.
The longer conversion period ensures shareholders a greater possibility of future bounty.
Lazard Freres and Dillon Read, the advisers to the committee, figured the convertibles would
trade at par or above it. If the securities trade at par they are as good as cash. The king was dead.
The management group refused to entertain modifications the committee's investment bankers
wanted -- or at least the investment bankers felt that way. The committee's advisers discounted
the management group's securities more heavily.
Including discounts, KKR's bid was calculated to be worth $108 to $108.50 a share, and
management's $108.50 to $109. The committee's investment bankers threw their hands up,
declaring the bids "substantially equivalent." It was now the special committee's turn. After 12
hours of deliberating the committee called the board to order. After another 15 minutes of
discussion, Martin Davis of Gulf & Western made a motion to sell the company to KKR.
The oft-pronounced verdict on the directors' decision is that they awarded KKR the company to
avoid charges of inside dealings with a management group that would reap a fortune in the
buyout. But by then Johnson's management contract was a shadow of its original. In the last-gasp
effort to make their offer more attractive, Shearson and Johnson agreed to slice the management
equity down to less than half its initial size. "If this goes on any longer," Johnson joked with
Cohen, "I'm going to be paying you guys." Of his committee's deliberations, Hugel says sternly:
"Nobody said, `Let's screw Ross Johnson.' "
ULTIMATELY the directors bet on the come. The returns from the surviving food and tobacco
company -- if the various projections are correct -- might create an enormous profit for
shareholders who hold on to their convertible securities. Hugel, for one, says he is hanging on to
his.
For a fellow $22 billion in debt, Henry Kravis is sanguine. He is confident that the 3-to-1 debtto-equity level he structured for RJR has quite a margin of safety to it, even if the tobacco
business doesn't. To replace Ross Johnson and call the shots at RJR, Kravis has hired -- no small
irony -- Louis V. Gerstner Jr., the president of Shearson's parent, American Express, and Jim

Robinson's right-hand man. His reported $2.3 million starting salary and $10 million to $15
million signing bonus makes Johnson, who was earning $1.8 million, look underpaid.
At Shearson, Peter Cohen is not talking like a loser. The RJR contest, he says, demonstrated his
firm's ability to raise huge amounts of cash and has led directly to three or four other big deals.
As for Ross Johnson, he watched horrified -- as if numbed -- as the numbers kept going up and
up and up. At the end, he admits: "I was a spectator at a tennis match." But don't feel too sorry
for him -- he floated away on a golden parachute of at least $23 million. And don't expect any
regrets either. Johnson says he would do it again: "The thing that makes me so comfortable is
that I did what I was paid to do -- get value for shareholders." The shareholders of RJR Nabisco
are the ones who really made out like bandits.

U.S. News & World Report, May 7, 1990 v108 n18 p50(2)
King of the biggest LBO of them all: RJR Nabisco's new chief is one
touch cookie. (leveraged buyout; Louis V. Gerstner)
Full Text: COPYRIGHT U.S. News and World Report Inc. 1990
RJR Nabisco's new chief is one tough cookie
As president of American Express and heir apparent to the chairmanship, Louis V. Gerstner, Jr.,
48, enjoyed the kind of position that most of his fellow Harvard Business School graduates only
dream about. But when KKR approached him last March with a contract worth up to $25 million
over five years, Gerstner did not think twice about jumping ship to head the biggest leveraged
buyout ever.
By opting out of the clubby corporate establishment, Gerstner in effect joined the enemy: The
upstart league of financial restructurers who have been shaking up the nation's largest concerns.
Such apostasy is not taken lightly by his former Fortune 500 colleagues. While American
Express's courtly chief executive, James D. Robinson Ill, wished him well in his new endeavor,
friends say the two have hardly spoken since their parting of the ways.
Gerstner, a marketing whiz who built American Express's Travel Related Services division into
the money machine it is today, has proven himself equally adept at stripping down and toning up
the lucrative but wasteful RJR Nabisco. The monstrous debt taken on to buy the company left
him little choice. "There's a lot of cash flow in this business, but historically this company didn't
have to worry about it," he explains. "Now we do." Gerstner cut the corporate staff in half,
moved headquarters from Atlanta to the company's Manhattan offices and sold off a fleet of
aircraft. "This company didn't need I I airplanes," he says. "We're down to four now and we'll see
if we need four."
Free hand. Critics of LBO'S contend that buyout firms sacrifice long-term investments for shortterm gains. But so far, Gerstner has been proving the opposite at RJR Nabisco. As chief
executive of a private company, he no longer has to worry about public shareholders and
quarterly earnings growth-an obsession with most heads of publicly traded corporations; he thus
has a freer hand to make tough decisions. Early on, for instance, Gerstner decided to take a $360
million hit against earnings at R. J. Reynolds by eliminating "trade loading," a widespread
practice in the tobacco industry of shipping more cigarettes at the end of the year than retailers
could sell. While the ploy artificially boosts earnings in the near term, unsold returns can bog
down future results.
The gregarious, cigar-smoking Gerstner has no intention of hiding behind the veil of privacy
afforded him by RJR Nabisco's new status. He releases earnings reports as if the company were
public, pops in frequently on factory hands, makes himself readily accessible to the press and
continues to advocate that business should play a greater role in public education. When I come
to work here, I have two uniforms to wear," he says, "that of the CEO who is running an exciting
global company with lots of opportunities and challenges, and my LBO uniform, which deals

with the financial structure of this transaction. The two don't meet that often." Admitting to being
an LBO rookie, he makes it clear he feels more comfortable in his CEO duds. "When I got out of
business school, conglomerates were all the rage," he reflects. "The facts are that some were bad
and some were good, just like LBO'S today. Neither is the savior or the curse of American
industry."

Financial Analysts Journal, Sept-Oct 1991 v47 n5 p15(13)


RJR Nabisco: a case study of a complex leveraged buyout. Allen
Michel; Israel Shaked.
Abstract: RJR Nabisco's moderate but steady growth, its low debt levels and significant breakup value made it an attractive takeover candidate. As the bids came in, RJR's board played a
substantial role in setting the bidding rules; it thus minimized the possibility of collusion and
increased potential gains to both shareholders and the firm's other stakeholders. While an
evaluation of RJR's equity at the time of the LBO is obviously dependent on the assumed longterm growth rate, the figures suggest that, even with a high, 5 per cent level of steady-state
growth, RJR's cash flows would have to grow at a rate of at least 18 per cent per year to justify
KKR's winning bid of $109 per share. (Reprinted by permission of the publisher.)

Bsiness Week, April 3, 1995 n3418 p46(2)


'Barbarians' revisited: KKR's buyout of RJR Nabisco was a major
fizzle - for investors. (Kohlberg Kravis Roberts and Co.; includes related
article) Elizabeth Lesly.
Abstract: Those who invested in KKR's leveraged buyout of RJR Nabisco in 1988 did not earn
money on the deal, but no equity was lost. KKR, however made almost half a billion dollars in
management and other fees. A history of the deal is presented.

Mergers & Acquisitions, July-August 1989 24 n1 p61(3)


The epic leveraged buyout of RJR Nabisco: a daring megadeal and
its daunting challenges.