Book Review of Barbarians at the Gate: The Fall of RJR Nabisco by Bryan Burrough and John Helyar

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This Book Review of Barbarians at the Gate: The Fall of RJR Nabisco by Bryan Burrough and John Helyar is brought to you from Dennis Hamilton from the Titans of Investing.

Genre: Management & Leadership
Author: Bryan Burrough and John Helyar
Title: Barbarians at the Gate: The Fall of RJR Nabisco (Buy the Book)


The leveraged buyout (LBO) of RJR Nabisco is undoubtedly one of the most significant transactions of all time. Its aggregate value, which amounted to approximately $31.1 billion, stood as the largest leveraged buyout transaction for nearly two decades.

The events surrounding six weeks in October and November of 1988, summarized in Barbarians at the Gate: the Fall of RJR Nabisco, tell the story of a different time in financial markets and history. However to this day, the story still represents a lucid example to the realities of corporate takeovers and what can happen when things get out of hand.

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In its prime, RJR Nabisco was once America’s nineteenth largest industrial company. The tobacco and food conglomerate owned hallmark brands such as RJ Reynolds cigarettes, Oreos, Ritz Crackers, Del Monte Foods and even a small stake of ESPN. Due to a market crash in 1987 and growing liability from pending tobacco lawsuits, RJR Nabisco’s stock stayed south of the highest price it had ever traded.

Over time, the continually low stock price left the company grossly undervalued and vulnerable to takeovers. Displeased with the market’s perceived discount, management undertook several initiatives to yield the company its rightful valuation; all of which were unsuccessful. After exercising virtually all alternatives, management finally resorted to taking the company private through a management buyout of the firm.

The public announcement of management’s buyout intentions precipitated perhaps the most publicized and memorable series of events surrounding an M&A transaction in modern history. Moreover, the action effectively hoisted RJR Nabisco on the auction block, leaving the company exposed to corporate raiders and other suitors looking to get a piece of an American institution.

Esteemed financial powers across Wall Street joined forces to pony up the cash required to take down a titan of industry. To each, the transaction represented the “poster child” of some varying form of supreme recognition: a miraculous comeback, a visible way to assert dominance, a financial crusade.

Regardless of the impetus, the events during those six weeks in 1988 continue to serve as an example of irrationality amongst acquisitors when gathering at the gates of a target company. Blinded by competition and the ultimate objective of winning, they often lose sight of the source of value to themselves.


Barbarians at the Gate: The Fall of RJR Nabisco is the tell-tale story of Wall Street and corporate greed at the peak of the leveraged buyout (LBO) boom of the 1980’s. At the core of the events that took place in October and November of 1988 was one of America’s greatest and most respected companies: RJR Nabisco.

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Once America’s nineteenth largest industrial company, the tobacco and food conglomerate owned hallmark brands such as RJ Reynolds, Nabisco, Del Monte Foods and even a small stake of ESPN. Feeling slighted due to its flat market performance, a small management group led by CEO F. Ross Johnson pursued alternatives to yield the company its righteous valuation.

After strategic thought and a helpful lead, the team pursued a management buyout of the company. As word of management’s intentions surfaced, the company, coveted by many, was unintentionally put into play, leaving it ripe for the taking to highest bidder and publicly exposing America to the realities of corporate takeovers.

A Blinding Glimpse of the Obvious, F. Ross Johnson

A native Canadian, Ross Johnson was the consummate people person. His wit, schmoozing tactics, and dominant personality gave him the upper hand in virtually all corporate battles. This characterized his unconventional ascension to CEO of a publicly traded company.

Riding a wave of mergers and playing the game of office politics all too well, Johnson eventually found himself in the position of President and Chief Executive of RJR Nabisco.

A deal-driven, yield-driven salesman that frequently got bored, Johnson was constantly looking to shake things up.

His organizational ADD came with a love for constant restructuring and reorganization. Wherever he went, he was never hesitant to spin-off divisions, scrap traditions, or ruffle the ranks of management. The best example of this was his highly controversial decision to relocate the headquarters of RJR Nabisco to Atlanta.

The headquarters was previously located in Winston-Salem, North Carolina, where it had been since the company’s founding in the late 1800s. The action made Johnson wildly unpopular with the RJR Nabisco community and devastated the town of Winston-Salem for many years.

Always breezy and never taking his business too seriously, Johnson prided himself on his ability to effortlessly switch directions, spin outlandish explanations, and most importantly, pad expense accounts. A sterling exemplar of out-of-control fringe benefits in the corporate world, Johnson had a knack for the finer things in life.

As CEO of a company that generated $1.2 billion in cash flow a year from tobacco alone, seemingly infinite resources were at his disposal: corporate apartments, limousine service, luxury cars, club memberships, and ten corporate jets known as RJR Air Force. All of the above were symbols of the increasingly fuzzy line between what constituted proper use of a corporate asset and what constituted abuse. Johnson walked a very thin line.

Johnson’s exuberance had trickle-down effects.

If somebody was not getting a “slice of the pie”, then there was no reason why they shouldn’t. He frequently combatted opposition in the boardroom by throwing money at his problems. Increasing director salaries and consulting contracts helped Johnson maintain control of the board.

While schmoozing and spending were his strong suits, Johnson’s eventual road to ruin was his obsession with the company’s stock price. The market crash of 1987 and increasing liability from pending tobacco lawsuits kept RJR Nabisco stock south of $70 dollars per share, the highest price it had ever traded.

Johnson undertook several strategies to boost the price: divestitures, introducing Premier, a smokeless cigarette, and even implementing a share buy-back program. Nothing he tried worked. The market continued to treat RJR Nabisco as a tobacco stock, in spite of the fact that 60 percent of the company’s sales were from its food division.

Being an executive strapped with “more cash than you know what to do with” brings a flurry of investment bankers constantly pitching ideas.

The prospect of a leveraged buyout was always within earshot of Johnson. Knowing little about their mechanics, other than the fact that they involved high levels of debt, Johnson shied away from leveraged buyouts. Leveraging up a company meant cutbacks, and anything hindering Johnson’s ability to run his company in lavish form was unacceptable.

However, the continually low stock price made RJR Nabisco vulnerable to a takeover. Knowing the market was never going to give the company its due, Johnson realized RJR Nabisco should be a private company.

The LBO Boom of the 1980s

A number of factors helped fan the LBO Boom of the 1980’s. First, the tax deductibility of interest, but not dividends, in the Internal Revenue Code effectively subsidized the trend. What helped the boom take off was the increased use of junk bonds.

Traditionally, 60 percent of the money raised in an LBO came from secured debt loaned by commercial banks. Only about 10 percent came from the buyer’s own pocket, and the remaining 30 percent came from major insurance companies, whose commitments often took time to obtain.

In the mid-eighties, Drexel Burnham Lambert, under the direction of bond czar Michael Milken, began using high-yield or “junk” bonds to replace insurance company funds. This significantly reduced the bureaucracy required to line up financing for deals.

Milken’s ability to raise enormous amounts of money at a moment’s notice revolutionized the LBO industry.

Once thought of as too slow to compete in takeover battles, now LBO firms could move swiftly using junk bond financing and launch split-second tender offers. Additionally, towards the end of the eighties, Wall Street was in a lingering slump.

Looking for better ways to deploy capital and bolster traditional brokerages’ sagging profits, banks increasingly relied on LBO funds, bridge loans, and M&A fees. This “perfect storm” of aligning interests perpetuated the frenzy of the LBO boom, as more players entered the market and financing became widely available.

KKR, What is That, a Delicatessen?

Throughout the 1980’s, Henry Kravis and his firm Kohlberg Kravis Roberts & Co. (KKR) were practically synonymous with LBOs. It all started in the 1960s and 70s at Bear Stearns, where Jerry Kohlberg, Henry Kravis, and George Roberts, corporate finance professionals by trade, began working on a profitable side business they called “bootstrap deals.”

The predecessor of an LBO, bootstrap deals were an aid to elderly business owners who were looking for a way to avoid estate taxes, yet allow their families to maintain control of their company. A shell company backed by a group of assembled investors would buy the family-held company using mostly borrowed money.

Over time, proceeds generated through the sale of stock publicly would pay down debt and generate significant returns for the family and the shell. Due to the operational aspect of the investments, returns were generally realized over three to five years.

Eventually, “bootstrap deals” became more profitable and more time-consuming.

As a result, Kohlberg, Kravis, and Roberts left Bear Sterns to form their own freestanding LBO group, KKR. After perfecting the craft they created, they rode Wall Street’s mid-eighties leveraged buyout wave to prominence. The collection of their names, once confused for a delicatessen, is now legendary on Wall Street.

In an LBO, a small group of senior executives, usually working with a Wall Street partner, proposes to buy the company from public shareholders, using massive amounts of borrowed money and a little of their own equity. The debt used to buy the shares is assumed by the company and is paid down over time, using cash flow from the company’s operations and, often, by selling pieces of the business.

In order to meet the steep debt payments, companies going through an LBO often grow lean and mean. This means deep cuts in spending and every other imaginable budget in order to have sufficient cash flow to service the debt. The Wall Street partner emphasizes frugality, as unnecessary spending eats away at cash flow, which has the potential to pay down debt.

Simplistically, LBO’s are financial arbitrage on the capital structure of a company. Through paying down debt, the equity portion of the company grows, and with it so too does the initial equity committed by management and its Wall Street partner.

Through the paying down of debt, changes in the capital structure become the source of returns. If done correctly, LBO’s have the potential to make those involved a lot of money. Typical LBO candidates are undervalued companies in relatively stable or mature industries, which generate consistent cash flow.

RJR Nabisco was the perfect candidate, as Warren Buffet popularly said, “I’ll tell you why I like the cigarette business…it costs a penny to make, a dollar to sell, it’s addictive, and there’s fantastic brand loyalty.”

Johnson’s first outward vote of confidence for an LBO came when he agreed to dinner with Henry Kravis.

At dinner, Kravis spoke ardently of the benefits of an LBO. How putting debt on a company, which naturally had a negative connotation, actually helped it tighten its operations and seek efficiencies. In addition, and much to Johnson’s liking, he discussed how executives could earn millions more from a little extra effort.

Johnson left the dinner more open to the idea of an LBO; however, he knew the two would not do business together. He knew Kravis would want complete control, and he would never resort to taking a subservient role.

Unfortunately, Johnson could never leave well enough alone. There were always things to be shaken up. A year after the dinner, Johnson would enter Kravis’s world with another, lesser firm. In the name of boosting the stock, he engaged Shearson Lehman to assess the viability of an LBO.

Everyone who could read a balance sheet could see that RJR Nabisco’s tobacco business was spewing out cash that had to go somewhere. Ross Johnson was ripe to do a deal, and everyone knew it. When he uncharacteristically stopped taking calls, the bankers knew something was going on. Their natural inclination was to get a piece of the action, and there was no one better than Henry Kravis to report their observations.

Shearson Lehman Hutton and American Express

When Ross Johnson changed course and began contemplating LBO scenarios, he was answering Peter Cohen’s prayers. Cohen, the CEO and Chairman of Shearson Lehman Hutton, was looking for a way to boost his firm’s lackluster performance in merchant banking and simultaneously debut its new LBO fund. Advising Ross Johnson on the largest LBO in history was just the opportunity he was looking for.

Backed by the tremendous financial power of American Express, Shearson Lehman was capable of doing the deal. However, this would be unchartered water. Like many other Wall Street investment banks looking to get a piece of the LBO boom action, Shearson Lehman had just recently rolled out their LBO fund, but had yet to complete a single successful deal. Nonetheless, Johnson and his management group were committed to Shearson, professing at one time, “We win with Shearson or we go out with Shearson.”

Central to the success of an LBO is secrecy. In secrecy, management works with its Wall Street partner in a quiet manner to assemble financing for the deal. Once everything is arranged and a bid price is agreed upon, the proposal is offered as a take-it-or-leave it proposition to the board. Hence, if done correctly, the bidding can end before it even begins. Peter Cohen and Tom Hill, Shearson’s merger chief, assumed Johnson was on board with their plan.

Without Johnson, Shearson had no deal and they knew that.

However, so did Johnson, and as a result, he and his management group of seven forced Shearson into countless cannibalizing concessions. The most important and controversial was the management agreement, which would be the source of tremendous headache for the deal team over the coming weeks.

In it, Shearson agreed to take only two of the seven board seats, pay the management group’s taxes, give Johnson veto power and virtual control over the new board, and give the management group up to 18.5 percent of post-LBO RJR Nabisco equity. In total, the package’s value could go as high as $2.5 billion.

Even though Shearson was putting up all the capital, management was getting the free ride. It was a document of “greed incarnate” and would have severely negative public relation implications if ever placed in the hands of a reporter. Over time, Shearson began to realize that if they wanted to do this deal, they would have to do it by Johnson’s rules.

Lifting the Veil of Secrecy

Johnson, known for running his mouth, had incidentally mentioned that he was having Shearson evaluate the merits of an LBO to Charlie Hugel, Chairman of the Special Committee for RJR Nabisco. Since that time, he had decided to move forward with the proposal and present it at the next board meeting.

A press release was to be issued the day following his proposal. Not putting much thought to the public announcement, Johnson and Shearson were convinced of the same fundamental fallacy: their bid would go unopposed due to the sheer size of RJR Nabisco. Moreover, no one, not even Kravis, would attempt a buyout this size without the help of a friendly management team.

The following morning at 9:35, the announcement crossed the Dow Jones News Service.

Management’s $75 a share bid, representing the largest corporate takeover in history, was public. Having lifted the veil of secrecy, management’s buyout intentions were now exposed. Once public, corporate raiders and other suitors were free to make a run at the company before management had a chance to assemble financing. RJR Nabisco was on the shelf, ripe for the taking to the highest bidder.

Surely, $75 a share would be topped. Everyone knew it, Kravis especially. It was excessively cheap. Even Johnson’s proprietary data, which would be exposed to the special committee by an anonymous source, said the company was worth anywhere from $82 to $111 a share. By bidding at $75, it was blatantly obvious Johnson was trying to steal the company from under the board’s nose.

Tom Hill was sitting in on another client’s strategy session that morning with Jeff Beck of Drexel and Bruce Wasserstein of Wasserstein Perella & Co. and couldn’t help but notice both of them constantly ducking in and out of the conference room.

He then reflected on a comment Beck made earlier about being way off on price. He scrambled and a moment later had Henry Kravis on the phone. His worst imagination was realized: Henry Kravis and KKR would not be sitting on the sidelines, especially after having given Johnson the idea a year earlier.

Knowing Kravis was too powerful to provoke, Hill organized a meeting with Cohen and Kravis that evening.

Together they discussed the prospect of Shearson and KKR working together. This proved to be wishful thinking, as the deal simply represented too much to each party. Kravis soon retained a team of advisors that would go head-to-head with Johnson and Shearson.

Heading the list was the largest piece of financial artillery on Wall Street: Drexel Burnham and its extensive junk bond network. In addition, Merrill Lynch was hired as a backup fundraiser. For tacticians, Kravis hired Morgan Stanley’s Steve Waters and Eric Gleacher.

Additionally, as a purely defensive move, Kravis hired Bruce Wasserstein of Wasserstein Perella & Co. Taking the behemoth dealmaker out of circulation meant less agitation and competition, a good thing for KKR.

Acting fast, Kravis and his advisors approximated a tender-offer of $90 a share to offer the board. Holding a few reservations, Kravis wasn’t entirely certain he would go through with it. However, a press leak ended up forcing his hand, pre-committing Kravis to move forward with the offer. The source of the leak was obvious: the bankers.

From that point forward, Kravis knew he would have to play things close to the chest. After KKR’s announcement, RJR Nabisco stock skyrocketed. Johnson and Shearson had blown their tactical advantage, and it was only a matter of time before things started spiraling out of their control.

A Few Billion Dollars Lost in the Sands of Time

The shock of Kravis’s bid was evident in the faces of the management group. The whole thing had become a bad dream. It was over as far as Johnson was concerned. They would either reach an agreement with Kravis, or raise the white flag.

To fight off Kravis and enter into a bidding war meant throwing out every financial and operating assumption that yielded the $75 bid. This meant more debt, which made Johnson cringe.

At this point, having Johnson and a friendly management did not matter.

Kravis stood ready to do the deal with or without Johnson. Upon the suggestion of Dick Beattie, Kravis’s counsel, Cohen and Kravis were set to meet for a second time. Both men were realists and knew a drawn out bidding battle would surely cost the winner billions.

The two revisited the idea of working alongside each other. Cohen suggested a fifty-fifty split, but Kravis would not have it. KKR had never done that in the past and was not about to start, especially in a deal of this magnitude.

Taking matters into his own hands, Johnson met with Kravis and his cousin George Roberts alone. Inquisitive and openly curious about working with KKR, Johnson did nothing but show his true colors. Asking poignant questions primarily on the subject of cost cutting, Johnson made his desire to run the company and live a Spartan life crystal clear.

It also became clear to both Kravis and Roberts that Johnson’s ability to wield the budgetary ax, in the event that they would pursue the LBO together, would be tougher than expected. Johnson wanted things done his way, and there was no way around it.

After the meeting, Kravis and Roberts made a proposal.

They would pay a one-time $125 million dollar fee to Shearson and grant them a 10 percent stake in the company if they agreed to let KKR acquire RJR Nabisco. To Cohen and Hill, this was nothing more than a “bribe” that infuriated them. There was no way they would take it.

Another meeting was called where all sides could openly talk. At midnight, the meeting was held with everyone present at RJR Nabisco’s offices. Cohen, still angry over the “bribe” emphasized that Shearson was still open to a partnership with KKR. Management had made clear their intentions to stay with Shearson.

Kravis was in a difficult position. He had never made a major takeover bid without the analytical help of the existing management team. Now, if he wanted to team up with management, he would inevitably have to team up with Peter Cohen and Shearson.

Shearson was “thrown for a loop” by Kravis’s $90 bid and was now badly outmatched in financial sophistication.

To temper the degree of financial power, Cohen brought in Salomon Brothers led by John Gutfreund and Tom Strauss with its $3 billion in capital. Salomon Brothers had gone through some rough years and was desperately looking to grow into the merchant banking business as well.

As the latest addition to the RJR Nabisco-Shearson deal team, their aspirations became more reality. Together, John Gutfreund and Tom Strauss would equally contribute to stirring the already complex pot.

Barbarians at the Gate and the White Knight, Theodore Forstmann

Central to the RJR Nabisco transaction was a clash between two conflicting schools of thought on Wall Street: the junk bond users versus the non-users. Among the most vocal and passionate for the non-users was Ted Forstmann, founder of Forstmann Little & Co., another extremely successful and reputable leveraged buyout firm. However, one firm always overshadowed the successes of Forstmann Little & Co.: KKR.

At the drop of Kravis’s name, Forstmann would launch into a fervent condemnation of his competitor. Kravis’s unbridled success over Forstmann was the main reason for his deep enmity. The other was his use of junk bonds. Forstmann believed that Wall Street had been taken over by a junk bond cartel, of which his archrival, Henry Kravis, belonged.

Moreover, he believed that their usage had contorted the buyout industry’s priorities. No longer did firms work alongside management to grow their businesses and sell out after a few years. Now, the industry seemed to be comprised of quick-buck artists looking to drive returns solely from leverage plays.

Forstmann was known for tangential rants, pontificating on the evils of junk bonds. He refused to use junk bonds in any of his deals, or work with anyone with ambivalence towards them. Comparing them to a steroid that enabled even the puniest acquisitors to take on the titans of the industry, Forstmann had multiple names for junk bonds: phony money, monopoly money, play dough, and his favorite, “wampum”.

His overwhelmingly strong opinion toward them had effectively turned maniacal. He knew the users had the upper hand in the RJR Nabisco transaction, and it was the perfect, visible forum to undertake his personal crusade to fend off Kravis and the junk bond scourge.

He would connect with Ross Johnson and Shearson when talks with Kravis fell through. The trio of Shearson, Salomon and Forstmann Little would review print outs of how their offer together looked. Repeatedly, they didn’t meet Ted Forstmann’s expectations for reasons including the egregious management agreement, the excessive fees, the capital structure, the governance issues, and the Ross Johnson issues. It didn’t “feel right” so Ted Forstmann and Forstmann Little & Co. were out.

Upon leaving the management group’s team, Forstmann would decide to form a third party bid group with a host of blue chip companies. With the hordes of users at the city gates, Forstmann believed he could stop them once and for all.

He would stand at the bridge and push the barbarians back, like the white knight he purported himself to be. There was just one problem – the only way to boost returns enough to justify a bid in the eventual bidding range was to use junk bonds.

The Drexel Problem

Looking to circumvent a public circus and get both sides to come together, Linda Robinson, Johnson’s PR agent, managed to organize one last meeting with Henry Kravis. The secret summit was meant to hash out the main points of contention.

First, Kravis wanted majority control of the equity and the board. He later consented on splitting everything evenly. However, on another issue he refused to compromise. Drexel had to run the books on the bond offerings.

Within minutes, they had the beginnings of an agreement. Control of RJR Nabisco would be split fifty- fifty, neither side would have outright control, and the stock would be split down the middle with Johnson and the management’s portion coming out of Shearson’s take.

When discussion of Drexel rolled around, things heated up. Everyone knew Drexel, with its extensive junk bond network, was the only one that could ensure a deal this size would get done. Cohen didn’t like the idea of selling bonds under Drexel. He knew they hogged deals.

Attempting to put the argument to rest, Kravis and Roberts assured Cohen that he would receive half the fees even if Shearson didn’t sell a single bond. This pacified Cohen but not Tom Strauss of Salomon Brothers.

All around Wall Street there are rivalries and sensitivities, but none more so strong as that of Salomon Brothers towards Drexel.

Salomon hated Drexel, and to lose the largest bond offering to an archrival would be a profound embarrassment to the firm. Tom Strauss wouldn’t have it. The obstacle was known as The Drexel Problem. Some would point to Drexel’s expected indictment.

Others, such as Tom Strauss and John Gutfreund, would cite their concerns over placing their own capital in the hands of another firm. Ironically, they had planned to do the same under the original agreement with Shearson.

As foolish as it may seem, focal to The Drexel Problem was an obsession over the sequence of firm names on a deal toy. In a bond underwriting where multiple banks are selected, only one bank can be chosen to run the books. This designation is known as “lead left” and has great significance on Wall Street. The lead bank places its name first, on the left side, of deal toys or advertisements, boasting its active role in a deal.

A deal such as RJR Nabisco had tremendous implications for the lead bank. Tom Strauss and John Gutfreund would do anything to avoid the perception that their firm was taking a back seat, denoted by placement to the right of its blood rival, Drexel. Thus, the two stood prepared to scrap the largest takeover of all time because their firm’s name would be to Drexel’s right.

Convinced they had a deal, Johnson retreated from the office wanting no part in trivial arguments centered on alignment of firm names or fees. In his absence, three from his team marched downstairs to notify Kravis and Roberts that negotiations were off.

This infuriated Kravis. As far as he was concerned, they were still going on. Exacerbating things, minutes later, news of the management group’s $92 bid crossed the Dow Jones News Service. Johnson was floored. His bankers had taken over and launched a counterbid without his consent. In that moment, Johnson realized he had lost all control of his fate. The great compromise had unraveled over pure greed.

The Management Agreement: A Symbol of Greed

Steven Goldstone was Johnson’s protection from himself. As counsel to the management group, he was charged with the responsibility of drafting and holding the management agreement. Fearful that it would eventually get out, Goldstone held it well. When the two groups tentatively reached an agreement contingent on the three points, Johnson encouraged Goldstone to slide the agreement across the table. He did so, however, he also failed to retrieve it.

Saturday morning, the New York Times headline read “Nabisco Executive to Take Huge Gains in Buyout.” Johnson, naturally oblivious, never viewed the management agreement to be the symbol of greed others did. He thought the story to be so beyond the truth that surely it wouldn’t have any credibility.

That weekend, Charlie Hugel read The Times story and began receiving angry calls from directors demanding an explanation. Johnson told Hugel not to believe it and explained that these compensation arrangements were typical of LBOs. He also mentioned that the equity received by the group would be spread amongst a large number of employees. This was the first time Hugel heard any mention of distributing stock. Regardless, he wasn’t buying Johnson’s story.

Of all the factual content in the article, one of the more surprising elements was an excerpt suggesting Salomon’s misgivings about the management agreement. Making matters worse, members of the management group would report to Johnson that his banks were not making any progress in assembling financing. Feelings of being overmatched crept over the management team, as Johnson began to realize the limitations of his partners.

Twenty-Plus Billion-Dollar Circus

Following the damaging release of the management agreement publicly, rising anti-Johnson sentiment began to fester. Among the most disgusted parties was the Board.

All the secrets of RJR Nabisco began to unravel as a steady outpouring of newspaper stories carried information on the millions in golden parachutes promised to management, the excessive amounts of restricted stock granted to the board and executives, and the substantial consulting contracts.

Worsening things, two insurance companies with large holdings of RJR Nabisco bonds sued because of the plunge in value as the stock had risen. Of all the members on the special committee, Charlie Hugel’s perception of Johnson changed the most. Everything was building up and contributing to the revised picture of Johnson developing in his mind.

Johnson began to grow despondent.

Until this point, nothing had gone according to plan. Most of all, it was the bidding level that bothered him. As bidding jacked the price up, more and more debt was to be assumed by RJR Nabisco, making the company virtually inoperable to Johnson’s golden standards. Henry Kravis also grew concerned as the headlines on LBOs mounted.

Headlines attracted Congressmen, which in turn attracted the possibility of anti-LBO legislation. Not only that, but Kravis, without a friendly management team now, was still searching for someone to provide guidance on the complexities of RJR Nabisco. He found that man in John Greeniaus.

John Greeniaus, the chief executive of Nabisco, was left out of the management group.

Seeing an opportunity to get back, he had previously slipped an anonymous package in the mail addressed to Charlie Hugel. Now, he was to join forces with Kravis and shed light on RJR Nabisco’s depths. The information Greeniaus provided KKR proved to be the gigantic “chink in the armor” of the management group.

Greeniaus would point out the sheer amount of waste in Nabisco from a cash standpoint. Spending money was forced on him, at the command of Johnson and corporate, in order to keep earnings and cash flow predictable. This was music to Kravis and KKR’s ears and served as the key toward unlocking a bid near $100 a share.

After bowing out on principle, Ted Forstmann and Forstmann Little & Co. left their third party responsibilities to another: First Boston. In the takeover flurry that spurred Wall Street’s growth in the 1980’s, First Boston initiated more takeovers than any other firm.

Its success was due in large part to two dealmakers: Bruce Wasserstein and Joe Perella.

After their resignations, First Boston seemed destined to fade away into obscurity. The responsibility of picking up the pieces was left to Jim Maher. Maher immediately convened a meeting to draw up an attack plan. Like every other investment bank on Wall Street, First Boston wanted a piece of the action.

The extent of First Boston’s involvement was based on a bid that took advantage of an obscure tax law loophole set to expire at year-end, just two months away. Under their plan, First Boston would acquire RJR’s food business for a bundle of securities known as installment notes.

The taxes on these notes could be deferred for ten to twenty years, creating a tax savings of as much as $4 billion. In the second step of the deal, First Boston would auction off Nabisco, passing 80 percent of the profits to RJR Shareholders and keeping the remainder. First Boston would then acquire RJR’s remaining tobacco business in a traditional $15 billion LBO.

The board could save billions of dollars and pass it all to shareholders on a tax-free basis. In theory, the structure seemed to work. However, deferring $3-4 billion in taxes was unprecedented and had significant political implications. Many believed this to be nothing but a gimmick, too outlandish for such a high-profile deal. Nonetheless, First Boston found bidding partners and proceeded with the structure.

Three realistic bids were considered. In last place was KKR’s bid of $94 a share, or $21.62 billion. In second with a bid of $100 a share, or $23 billion, was the management group. Taking first place was First Boston’s tax arbitrage strategy, which suggested a price between $105 and $118 a share. However, the proposal was only half-formed and lacked financing. As far as the special committee could see, it was no more than an idea.

Seeking an expert opinion on the matter, a tax lawyer was solicited for advice.

After reviewing it, the lawyer concluded that, though far-fetched, the proposal could work. The tax opinion simply meant the board could not throw out the First Boston proposal and its promise of a bid as high as $118 a share.

For not being afforded the opportunity of due diligence, Jim Maher and his team had caught the break of all breaks. In order to give them time to firm up their bid, a second round auction would be declared with a new deadline just eight days away. All bids would be thrown out, including management’s winning bid of $100 a share.

By all rights, Kravis and Robert’s should have lost, but the compelling yet incomplete nature of First Boston’s proposal gave them new life. Now they knew where the management group stood. Moreover, they knew how flimsy First Boston’s proposal really was.

If KKR was the biggest winner from the declaration of a second round, there is no doubt that the largest loser was Ross Johnson and the management group. Their tactical advantage was blown, once again, as their blockbuster bid of $100 a share had been overshadowed by First Boston’s “miracle bid”.

What is Henry Doing?

As all eyes on both Wall Street and Main Street turned to the RJR Nabisco circus, Kravis and Roberts had a plan: they were going to lay low. Rumors spread among investment bankers and lawyers: KKR didn’t know what it was going to do; it may not even bid at all.

Shearson and the management team heard the same thing. Without Kravis there, their only competition was First Boston, whose proposal was sure to fail.

The First Boston bid hung in limbo. Without bank backing, the intricate tax-loophole proposal was nothing more than an idea. Eventually, the board dismissed the miracle bid, as all key questions to the proposal – such as timing of antitrust approvals and its monetization scheme – remained unresolved.

However, it wasn’t without impact. First Boston’s proposal had changed the entire dynamic of the bidding process.

Hours before bids were due, Kravis and Roberts convened to discuss their plans. Kravis was prepared to lead the final charge, but Roberts was having second thoughts. Having founded the firm on the basis that the two would agree on everything or they wouldn’t do a transaction at all, KKR’s involvement in the largest corporate takeover at that time hung by a thread.

However, a single statement of optimism offered to Roberts by an associate changed the whole mood. Within minutes KKR was back to discussing how much they were going to bid. In spite of what everyone was led to believe, KKR was still in the running for RJR Nabisco.

The Final Stretch

Giving KKR little thought, Shearson was convinced they were on the verge of victory. After submitting its bid, the management group sat around impatiently awaiting the call. Hours passed and nothing came. Dick Beattie took a call. It was the special committee requesting the KKR team come to Skadden Arps’ offices.

Arriving soon after, Kravis was asked, “Is this your best offer?” by one of the board’s bankers. Kravis replied with a quick affirmation of the obvious. “Well, if we can work out the securities and get comfortable with the financing, we are prepared to recommend your bid to the board.” After six grueling weeks, Kravis and Roberts were on the brink of victory.

For the management group, “no news” was bad news.

Word surfaced that the special committee firm had summoned Kravis. Shearson and the management team could not believe it. Henry Kravis had managed to fly under the radar only to trump them, once again, in the final bid. With no rules governing the bidding process, they knew they would have an opportunity if they could keep the auction open. If the management group wanted to win, they had to bid now.

The KKR team was beginning to get impatient when a faxed copy of an early version of a story to be published in the next morning’s Wall Street Journal arrived. The article pinned the management group’s bid at $101 a share and speculated that the Kravis bid was around $103 or higher.

It was actually $106. It also suggested Johnson’s management group might bid again. The message was clear: somebody on the special committee was leaking the details of their bid in an effort to bid up the price. Having their bid shopped gave way to the realization that a management group counterattack was eminent.

The bidding had reached dream-like levels. In the final hours, the management group had groundlessly boosted their bid from $101 a share, to $108, and finally settled at $112 a share. Their uncorroborated acts of desperation characterized the outlandish antics surrounding the transaction over the past six weeks.

Coming down to a final price for KKR meant two things. One, a merger agreement must be drawn up and submitted. Two, Kravis and Roberts wanted the board’s promise that neither Johnson nor any member of management would be allowed into the final board meeting, mitigating the possibility of their bid being refuted and outbid, again. On those terms, a $109 a share bid stood.

As the special committee convened, one common theme was clear: Ross Johnson had become a national symbol of greed, and no one wanted to hand him RJR Nabisco. Weighing out the differences between the two suitors, the decision was unanimous: KKR would be awarded the deal.

With a winning bid of $109 a share, the aggregate deal value would be close to $31.1 billion, up significantly from the management group’s first proposal of $17.6 billion. Although Ross Johnson and his management team were out of jobs, they had served their constituents to the best of their ability; the shareholders were undoubtedly the ultimate victors.

RJR Nabisco walked away as the ultimate loser. Under a mountain of debt, the company’s decline accelerated. All available cash was used to pay off its junk bonds, while its rivals were able to reinvest all profits back into their businesses. The result was a wounded company that took 10 years to get over its LBO debt. Over that same time, its market share shrank and its market value shriveled.


The auctioning of America’s nineteenth largest industrial company became the source of grappling amongst the recesses of Wall Streeters for many reasons. First, it represented something; what it represented varied for each party involved. For Johnson, a “quick and dirty” way to get rich and live the high life with complete control.

For Kravis, a visible way to assert dominance over the mounting competition. For Peter Cohen and Shearson, a leap in the league tables. For Tom Strauss and John Gutfreund, the ultimate recognition to the left. For Jim Maher, a big comeback. For Ted Forstmann, a financial crusade of principle belief.

People do crazy things when they want something badly. Being caught up in the madness is a surefire way to avoid recognition of that. So much money was wasted obsessing over a price to pay. Few stepped back to think about the implications of snowballing debt on the company.

Likewise, few gave thought to how outlandish things looked from the outside looking in. From Wall Street to Main Street, the antics surrounding those six weeks in the Fall of 1988 were heavily publicized. Moreover, the summation of them, this book, continues to remind people what happens, especially in business, when individuals, or barbarians, primitive in their thought process, gather at the gates of a company.

Blinded by their objective, they lose sight of the source of value to themselves, endangering others and even multi-billion dollar companies. would like to thank the Titans of Investing for allowing us to publish this content. Titans is a student organization founded by Britt Harris. Learn more about the organization and the man behind it by clicking either of these links.

Britt always taught us Titans that Wisdom is Cheap, and principal can find treasure troves of the good stuff in books. We hope only will also express their thanks to the Titans if the book review brought wisdom into their lives.

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