“Barbarians at the Gates” is the story of the world’s largest Leveraged Buy Out (LBO) deal in 1988. The story encompasses all the biggest investment banks, Commercial banks, RJR – Nabisco management and bidders for the deal. Infact in 2002, 14 years after this incident, RJR story was simulated as a documentary film on History Channel.
Ross Johnson, CEO of RJR-Nabisco, is shown as an opportunistic guy, always looking to consolidate his power and augment his wealth without caring the impact of his actions on company and its employees. He was more concerned to pump up RJR-Nabisco stock rather than managing the company . Unfortunately, he never understood that it was he and his management team that always holded the stock down.
The investment bankers well known for their luxurious life styles are shown hungry to get a piece of action in the LBO deal irrespective of whether they can add any value to the tranaction.This novel changes the image of Investment bankers. As portrayed in the novel, the investment banks are constantly in the look out of merging, acquiring and restructuring companies for their personal purpose. The worst part in this bidding war was abysmal politics for money and power that kept creeping again and again.
The rise of Ross Johnson from Standard Brands to Nabisco (National Biscuits Association) to RJR- Nabisco is portrayed very effectively. He is shown as highly capable for twisting and turning things in his favor, neglecting the responsibilities of his position. He likes flying in jets, staying in royal suits and leading a luxury life.
The Bidding war for the control of RJR-Nabisco resulted in stock price souring from $ 40-45 to $108 that shows quite clearly that the prey on Wall Street is rewqrded the best.
Among the Bidders, Frostman-Little along with Goldman Sachs also tried to participate in the bid but backed out owing to skyrocketing valuation and Frostman unwillingness on using Junk bonds.
First Boston brought another twist in the story. The group tried convincing board that with Tax incentives that it could bring in, RJR-Nabisco shares are as valuable as $118. In fact, due to their bid, the Special Committee decided to have second round of bidding. But with insufficient background work( strong commitment from banks for financing) they were rejected in the second round of bidding.
Shearson and Salomon do tried their best but failed eventually to KKR. Their desperation for the deal was evident from the management contract they agreed to with Ross Johnson where apart from $2 Billion incentives, Ross was given complete veto power on the new entity.
The decision of Special Committee fetches a important point to note . Even though Shearsen group bid was a bit better than KKR, the special committee awarded the deal to KKR. The committee had already made up their mind. All they wanted was to rationalize their decision.This incidence shows the importance of impression that one has for others. The committee perceived Ross Johnson as a greedy man ready to torn the company for personal motives and that impression factored in awarding the deal to KKR.
Your financial voculabary will improve drastically while going through the novel. You will hear many new terms like Bridge loan, PIK (Pay in Kind) Securities,Mezzanine Debt,Golden Parachute , ”Gun to the head” Strategy, Junk bonds, White Knights, Merchant banking etc.
Basics of Leveraged Buy Out (LBO)
In an LBO, The management proposes a buyout of the firm using a lot of debt and a special committee of the board members is formed to consider its feasibility. Once the board approves the proposal, it is made public and other investors are free to top the offer.This exercise converts a public firm to a private firm and the new group that has taken over the company is free to restructure the firm.
The success of any LBO relies on the industry the company operates in. With huge debts that mount up after LBO – the management, the products and the earnings have to be highly reliable to generate the cash flows and pay the debt. Cost cutting and selling unwanted businesses are the major activities that follow after LBO.
Of the money raised for any LBO, about 60%, the secured debt comes from commercial debt. Only about 10% comes from the buyer itself. The rest of 30% comes from major insurance companies whose commitments sometimes took months to obtain. Then in mid 80’s Drexal Burnham began using high risk junk bonds to replace the insurance company funds. The company soon proved its ability to raise enormous amount of these securities on a moments notice to for hostile take over. These bonds thus served as high octane fuel that transformed LBO industry.
The hardest hit in a LBO deal are the Bond holders as they find their bonds losing value overnight because of excess debt born by the company.Typically after 5 to 8 years of an LBO, the company is sold or taken back to public which often gives 3 to 10 times returns to the original investment.
About KKR
KKR was the first firm entirely dedicated to sell LBO deals. Initially, because of their small size and low profile they faced immense difficulty in convincing clients the Modus Operandi of an LBO. Clients used to wonder “How can these guys along with few other can borrow enough money to buy entire company?” But slowly KKR flourished and in 1981, for the first time they were noticed for brief press coverage. Today, KKR is a revered name among Private Equity groups.
Filed under: Book Reviews | Tagged: Bid, KKR, LBO, Nabisco, RJR, Wall Street
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