In October 1988, RJR-Nabisco CEO F. Ross Johnson
felt that he had tried everything he could to boost the
price of the stock, and the market just wasn’t responding to
his efforts. He had been confident that a new “smokeless”
cigarette would boost the stock’s value, that is until the
spectacularly disastrous test marketing results.
Immediately, Johnson contacted Jim Robinson, CEO at Shearson
Lehman/American Express (the third largest securities firm
in the country), and authorized him to begin working on a
leveraged buyout of RJR. Under the supervision of Peter
Cohen, Shearson Lehmann put together the financing for a
takeover bid at $75 a share. The stock had previously
traded at $55, so the offer represented a 36% premium.
Although taken by surprise, Charles Hugel, RJR’s Chairman of
the Board, reacted quickly. He appointed a special
committee to consider the bid, and then publicly announced
Johnson’s proposal. Although previously he had not had any
intention of doing so, his actions effectively put the
company “in play.”
A few days later, Henry Kravis of KKR offered to
pay $90 a share in cash for the company. Kravis had earlier
discussed an LBO with Johnson and felt personally offended
by Johnson’s “theft” of his proposal. Kravis’ idea had been
simple: buy the company for less than it was worth, auction
it off in pieces at fair market values (a process called
“stripping”), and pocket the difference. However, Kravis
and Johnson had fallen out over technique: Kravis wanted to
keep the food division and sell the tobacco division;
Johnson wanted to keep the cigarettes and sell the food.
The Boards of Directors’ special committee
responded by asking for all final and highest bids to be
submitted by the following week. On the appointed day,
three bids were received: from KKR, the Johnson Group, and
a new group organized by Ted Forstmann of First Boston
Corporation. All the bids were quite different; with the
Johnson Group’s bid the highest at $100 a share. The
special committee met with each group to clarify features of
each bid, then decided . . . to ask each of the groups to
bid again.
First Boston dropped out of the running, and the last bids
received from the two remaining sides were effectively
tied--each had a face value of approximately $112 per share.
The Board of Directors made their final decision based on
their assessment of the intangibles, by no means the least
of which was the outraged reaction of the press to the
“greed” of the Johnson Group, which had deeply offended
public opinion by asking for a management “bonus” package
worth $3.5 billion.
With $16.6 billion in equity and $3.5 billion in
annual profits, the accepted bid from KKR was nearly double
the original price of RJR-Nabisco’s stock, and far above the
actual asset value of the company. The capital gains to the
pre-buyout shareholders would exceed $13.3 billion; the fees
to the bankers and lawyers involved would amount to over
$700 million. The entire leveraged buyout would involve a
grand total of $25.7 billion. Total debt would account for
80% of the corporate assets, and interest costs would just
be covered by the company’s annual cash flow. What was even
more stunning was that the entire deal had been put together
and concluded in less than three months.
