Johnson and Horrigan are the classic stereotypical examples of men who made massive profits at a huge corporation by producing a deadly product, cigarettes, and diverted much of the corporate wealth to fund their wildly ostentatious and luxurious lifestyle. They would rank even lower except that, mainly by luck and incompetence, the sale of the company hugely increased the wealth of their shareholders.
In 1988 several investment groups battled to buy RJR Nabisco, the huge tobacco and food company. It was, at the time, far and away the largest privatization of a publicly traded company in history. The authors finish their excellent (and best-selling) account of the fierce competition by asking: “What did all this have to do with doing business?” Our response: very little, in the conventional sense, but everything in the world with keeping score.
On the surface, the leveraged buy out (LBO) was a case study in financial engineering; how to obtain the greatest financial value without, in fact, creating any value. Huge amounts of money were made by various parties; over $500 million in fees were paid to various Wall Street investment banks and law firms. And although LBOs often benefit the buyer at the expense of the selling company’s shareholders, in this case the value of RJR shares almost doubled as a result of the bidding war that developed for the company. On the surface, the battle for control of RJR was about nothing but money. But if you look a little deeper you’ll find that money was just a way of keeping score between the competing players in an intense game.
Most LBOs during the late 80s were engineered by a company’s existing management, and/or outside firms that specialized in LBOs. They worked with investment banks, who arranged to pay off existing shareholders, often through the sale of high yield bonds, known as “junk” bonds because of their risky nature. (Drexel Burnham Lambert’s notorious Michael Milken to a large extent created, then dominated, the market for high yield bonds.) As soon as a company was purchased, various parts, sometimes all the parts, were sold to third parties to pay off the bonds. Remaining parts of the company were then subjected to rigorous cost cutting, and operated to generate as much cash flow as possible. If all went well, cash flow from the remaining operations were used to make the interest payments on the outstanding junk bonds, with residual cash flow returned to the new owners. After this restructuring and cost cutting was complete, and the now streamlined, often much smaller company was showing healthy profits and cash flow, it could be resold, often for very large profits. Massive layoffs were often an integral part of the cost-cutting process, creating a process where a few Wall Street firms and LBO players massively profited, often at the expense of displaced low-level workers.
At the heart of the RJR story is Ross Johnson, the genial Canadian born CEO of RJR. Ross ascended to the top of America’s 18th largest company by cultivating directors of the various companies with which he was associated, his gregarious personality, and sharp elbows, when needed, to remove those who competed with him for corporate power. But although he could be ruthless when occasion required, Johnson was, at heart, the consummate good old boy who enjoyed nothing more than eating, drinking, playing golf and smoking cigars with his corporate cronies. Unfortunately, Johnson wasn’t nearly as good at operating businesses as he was at corporate politics – most managers are talented at one or the other, but not both. With no clear plan, he engaged in continual restructuring and movement, often just to avoid boredom. RJR’s major product innovation during his reign was Premier, a smokeless cigarette, dubbed “one of the great new product fiascoes of all time”
Johnson loved the luxe corporate life, and he enjoyed dispensing corporate largesse to those around him. RJR’s tobacco operations generated huge cash flow, about $1.2 billion a year, which supplied Johnson with plenty of cash to lead the good life, at shareholders’ expense. He and his buddies loved flying in corporate jets so much that RJR built a fleet, known as the RJR Air Force, of 8 of the most expensive corporate jets, housed in a custom built hangar that was so grandiose it later proved unsaleable. Johnson and other RJR executives lived in expensive Manhattan apartments and resort homes paid for by the company. Johnson had the company pay for his 12 different country club memberships. And limos, oh yes, there were limos. In fact, Ed Horrigan, the head of RJR’s tobacco operations, would go ballistic if he was met by anything other than a white stretch.
Not surprisingly, given Johnson’s lax, unfocused, and self-interested management, the company’s stock price was stagnant. Combined with the huge cash flows from RJR’s tobacco operations and the attractiveness of the company’s Nabisco brands, such as Oreos, the company was ripe for a takeover.
Johnson and his top managers were part of one group bidding to take RJR private. But the corporate playthings were actually more important to Johnson than having a huge bank account. In fact, Johnson never wanted to win the bidding contest for RJR, and possibly become a billionaire, if it meant he would have to live a Spartan lifestyle. “I’m telling you, we’re not going to start running a pushcart operation here. I don’t want a bunch of your guys coming around saying we should have five jets instead of six…I don’t want my lifestyle to change” he told his financial backers during the LBO battle.Lifestyle, for Johnson, meant hanging out with famous athletes, golfing and partying with his business buddies, shaking up the corporate status quo, throwing out new ideas to his subordinates, all in an atmosphere of supreme luxury.
Ted Forstmann, another player in the drama, also lived the good life, Manhattan style. Forstman was an LBO pioneer who prided himself on using real money, rather than junk bonds, to finance his friendly buyouts. A 49-year-old bachelor at the time, he traveled in chauffeured Mercedes, private jets, and helicopters to cut through that nasty Manhattan traffic, and had vacation homes in Southampton and Aspen. His hobbies included financing an Afghan rebel group and an excellent tennis game.
Despite his wealth, health, and professional prominence, Forstmann was an angry man. In his mind there were certain rules to the game, and the new wave of leveraged buyouts, dominated by Kohlberg, Kravis, Roberts, and Co., known as KKR, broke those rules. Forstmann often righteously – and correctly – prophesied that buyouts financed with junk bonds would crash and burn, singing the economy and Wall Street along the way. He would preach on the subject to anyone who would listen, and was very proud of an editorial he wrote for the Wall Street Journal about the evils of junk bond financing. Yet, as much as he believed his own sermons, Forstmann was probably also motivated by envy. He believed that he was the best at what he did, yet this little guy Henry Kravis, the diminutive lead partner at KKR, was now getting all the attention – and all the best deals, thanks to funny money junk bond financing. Forstmann and his firm would enter the fray to acquire RJR, but his motivation was only in small part financial – Forstmann wanted to be seen as the white knight who rode into town to save RJR Nabisco, and the world at large, from the evil junk bond forces of KKR. In the process, he hoped to return his industry to its traditional rules and objectives: join forces with the managements of troubled businesses, turn them around, and sell them after 5-7 years of ownership, relying on the sale of an improved company, rather than huge management fees, for the bulk of the profits.
Another player in the drama was Jim Robinson, chairman of American Express, which owned Shearson, the investment bank which was, in alliance with Ross Johnson and management, making one of the bids for RJR. But the buyout was so big that even the combined forces of American Express and Shearson were not enough, and all the players were forced to make alliances. When explaining to Forstmann that Amex/Shearson was considering partnering with KKR, and thus using junk bonds, he said “Teddy, what we’ve done is the best thing, not the right thing. It’s the smart business thing to do”. But Forstmann was sure that junks bonds were neither right nor, in the long run, smart. At one point his investment banker at Goldman Sachs, Geoff Boisi, asked Forstmann “what are you, a priest? Have you got some kind of religious conviction about this stuff?” Whether Forstmann knew it or not, the answer was yes; business as sport has all the passion of religion. As a retired stockbroker in Winston Salem said, “Reynolds wasn’t a stock. It was a religion”.
The battle over status for the bond underwriting was the perfect example of the childish way in which these wealthy financiers kept score. In a major bond offering – and none could be more major than RJR – multiple firms are involved, with one firm leading and supervising the offering. Bond firms publish ads known as “tombstones” in financial publications to showcase their work. In the tombstone ads, the leading firm in the syndicate is listed on the left, with the other firms involved being listed on the right. Solomon Brothers came very close to tearing the $25 billion dollar deal apart because they would not be listed on the right if one of their most detested competitors, Drexel, was listed on the left. According to the authors of Barbarians at the Gate, “It all came down to this: John Gutfriend and Tom Strauss (of Salomon) were prepared to scrap the largest takeover of all time because their firm’s name would go on the right side, not the left side, of a tombstone advertisement buried among the stock tables at the back of the Wall Street Journal and the New York Times.”
Much of the fight for status was institutional – based on the team, rather than the individual player. Peter Cohen was so determined to make the RJR deal for Shearson that he was willing to do things that really weren’t economically viable, such as giving huge equity stakes, at no cost, to Ross Johnson and his management team. The goal was to establish Shearson as a serious player in the takeover game. John Gutfriend of Salomon Brothers needed this deal to erase several years of embarrassing failures in the financing of takeovers. Being seen as “top dog” by their peers, both institutionally and personally, was what really drove these dealmakers.
As Johnson and the various investors, investment banks, and lawyers fought over who would control RJR Nabisco, some insiders fought back. John Greeniaus ran the Nabisco portion of RJR Nabisco, but wasn’t included in the management group that was attempting to buy the company. Partly out of spite, and partly because he hated what was being done to the company he ran, Greeniaus began sabotaging Johnson and Horrigan’s efforts to buy the company. He supplied competing buyers with critical information about ways in which Nabisco could be more profitably run, and the many areas of fat which could be cut from a post-Johnson company. “It wasn’t money that made John Greeniaus tick; it was making Nabisco a well oiled machine. Now Johnson wanted to take his machine and sell it for spare parts.”
Ego, personal and institutional prestige, revenge, accomplishment; these were the factors that drove the takeover of RJR. Almost everyone involved – Kravis, Johnson, Horrigan, Ed and Linda Robinson, Peter Cohen – was already rich, by conventional standards. Although huge amounts of money changed hands in the deal, there may not have been a single person actively involved in the deal whose standard of living changed as a result of winning, or losing, this deal.
In the end, Henry Kravis and KKR, financed with junk bonds, beat out Johnson and Horrigan and others to buy the company. But Johnson and Horrigan walked away with a over $100 million in combined golden parachute payments, despite the fact that it was their inept management that made the company such an attractive target for the takeover in the first place. Not surprisingly, despite the rising stock price, the takeover battle did not go over well in RJR’s hometown of Winston Salem North Carolina, where many employees were also lifelong shareholders. Excerpts from letters to the RJR Nabisco board of directors during the takeover battle:
“This group of insiders was entrusted with the management of the RJR tobacco company. In return we are lied to, cheated and used by a small group of insiders for their own gain. I fail to see the difference between what Johnson is doing and armed robbery, except that you will let Johnson get away with it…”
– Veteran RJR tobacco worker
“Somehow, there ought to be a greater value in the world than a stock price.”
– Winston Salem businessman.
Barbarians at the Gate: The Fall of RJR Nabisco by Bryan Burrough and John Helyar.