Have you read Barbarians at the Gate?

For many individuals, the yuppie is an archetype that springs to mind when they think about the 1980s. These showy big spenders, who strived to preserve their glossy and lavish lifestyle at any costs, have come to symbolize the decade’s excesses.

Few stories better capture these characteristics and the broader climate of the 1980s than RJR Nabisco and its CEO Ross Johnson’s. But it’s not simply the tragedy of one company; it’s the narrative of how a once-benevolent corporate practice, the leveraged buyout, morphed into something far more evil, as told in Bryan Burrough and John Helyar’s book “Barbarians At the Gate.”

Have you heard of a leveraged buyout, often known as an LBO? By the 1980s, the LBO had become a nasty word, associated with corporate greed and Wall Street’s irrationality. The LBO, on the other hand, began as a strategy to preserve family wealth.

These arrangements were designed by astute lawyers seeking to assist affluent business owners in avoiding estate taxes and passing money to their heirs. LBOs initially appeared in the late 1960s, at a time when a generation of people, some of whom had built large corporate empires, were preparing to retire.

Because of the way inheritance taxes work, business owners who wished to retire and transfer their businesses on to their heirs would have had to pay astronomical taxes.

They had three options in these situations: first, they could pass the firm on to an heir and pay all of their taxes; second, they could sell the company, losing control; and third, they could go public, placing the business and its stock price at the mercy of the market.

None of these three options were really enticing. As a result, a lawyer named Jerry Kohlberg devised a remedy, although one that was slow-moving and lengthy.

Let’s pretend Mr. Big is retiring. His lawyers would set up a shell business and recruit a group of investors to buy out Mr. Big’s company with large loans. Mr. Big would retain a stake in his company, allowing him to preserve some control, while the investors would have gotten the target company at a considerably cheaper price than if they had bought it at the end of a bidding competition with other interested parties.

Bank loans, insurance bonds, and the investors’ personal monies would be used to support these buyouts. As a result, the investors only paid roughly 10% of the total cost, with the remaining 30% coming from insurance bonds and 60% coming from bank loans.

In other words, the investors got the target firm for nearly nothing, while the shell company took on a tremendous amount of debt, with the target company bearing the brunt of the load.

Investors realized how profitable this strategy was, and by 1983, there had been ten times as many LBOs as there had been just four years before. Now that you know what an LBO is, you’ll learn about a man who was responsible for one of the largest leveraged buyouts in history.

Ross Johnson began his career in the Canadian business world at the bottom of the corporate ladder in the 1950s. He would go on to become a prototypical example of a new breed of businessman, one that quickly moved from firm to firm, vowing allegiance to investors rather than a corporation. Playing the game this way proved to be fairly profitable, and Ross was no stranger to luxury – he was primarily motivated by a desire to travel, meet celebrities, and enjoy the finer things in life. He was never satisfied with the thrill of purchasing new properties, dining at world-famous restaurants, and meeting celebrities.

Ross didn’t pay much heed to the implications of his frequently unethical business practices while drinking up the good life. For example, in the guise of a tactical advantage, he would liquidate entire departments on the spur of the moment and shift entire sectors to different cities. To put it another way, Ross would gladly sacrifice many pawns to assist in the capture of a bishop.

So, how did he come to be so powerful? His first employment was in sales in Canada, where he was born and raised. He worked his way up the corporate ladder and, in 1963, landed a job at T. Eaton, an ancient Canadian department store, where he worked under the direction of Tony Peskett, a legendary head of personnel. Peskett urged all of his followers to keep business and management in a constant state of change, causing companies and the stock market to sway.

While critics of this approach said that such a tactic simply meant pursuing change for the sake of change, leaving behind a trail of chaos and destruction, Johnson personally benefited tremendously by adhering to it. He soon began making crafty moves and was able to climb the corporate hierarchy during the frequent shakeups.

Johnson benefitted from his friendship with Peskett, but it wasn’t long before he was putting his mentor’s advice into practice on a larger scale. Johnson’s big break came in 1976, when he was named CEO of Standard Brands, a Canadian packaged goods company. Finally, he was in a position to make decisions.

Johnson was already living the good life in this capacity, but his unquenchable need for bigger and better things led him to seek a merger with a far larger corporation: Nabisco. In the end, Nabisco technically acquired Standard Brands, but in effect, the situation was reversed.

Nabisco already owned some of the world’s most well-known crackers and biscuits, including Ritz and Oreo. Nabisco had settled into an efficient, conservative monolith of a firm by the 1980s, thanks to their phenomenally profitable products.

When Nabisco joined with Standard Brands, however, Johnson’s turmoil quickly clashed with Nabisco’s established processes. Rather than wasting time in tedious sessions with interminable presentations, the Standard Brands team flung out ideas, heckling everyone in their path. They even teased Johnson, who gleefully encouraged the rowdy behavior.

Johnson’s attitude quickly spread throughout Nabisco, and when the company merged with RJR Reynolds, one of the world’s largest cigarette businesses, the same transformation occurred. RJR Reynolds was one of America’s most popular cigarette brands at the time. The company dominated the market after its creator developed inventions such as the first pre-rolled cigarette and a well-known brand of pipe tobacco.

The firms amalgamated because of the potential for expansion it would provide for both of them. The flamboyant behavior of the northern US corporation Nabisco, on the other hand, clashed immediately with the ideals of its southern counterpart, RJR. Employees at the RJR factory, for example, had never seen a limousine, despite the fact that it was the favored form of transportation for Nabisco executives.

So, while Ross Johnson was known for shaking up enterprises, a newcomer to the scene would pose a threat to his growing authority. Henry Kravis was a Wall Street financier who made millions via leveraged buyouts. Ross used a unique approach to trading, and whereas most other traders closed deals in hours or days, it may take him years to complete an LBO.

Naturally, Kravis’s superiors at Bear Stearns, the investment bank, were not pleased with the lengthy timeline. For example, during an LBO, Kravis was appointed interim CEO of a stationery firm, triggering a frantic call from his Bear Stearns employer, who demanded to know what one of his senior traders was doing at the helm of a failing paper company.

Kravis’ vision was clearly misunderstood, and he and his cousin George Roberts soon left the firm to work with Jerry Kohlberg, the inventor of leveraged buyouts. Kohlberg Kravis Roberts, a well-known private equity firm, was founded by the triumvirate in 1976. (KKR).

Kravis played a crucial role in transforming LBOs from harmless tax workarounds to a formidable vehicle for company takeovers through this firm. Henry and George, on the other hand, were far more interested in making big deals than Jerry. The cousins were well aware that arranging a contract for $100 million required roughly the same amount of effort as cutting one worth $10 billion, and they weren’t going to waste any time.

By 1987, all of the major LBO participants had a pool of investor funds to use for LBOs. The Kravis cousins, on the other hand, have their sights set on a bigger prize. By founding a vast investment fund, the couple would demonstrate to everyone that they had the most authority and that they were the ones who got the best bargains.

Following a large purchase with Chicago-based Beatrice Foods, KKR began looking for money for a fresh war chest to achieve this goal. To attract more investors, the company even waived the fund’s management expenses for the first few years. They quickly raised $5.6 billion, more than doubling the amount raised by the competition.

LBOs were mostly refined by professionals such as the Kravis cousins, but with so much money to be earned, just about everyone wanted in on the action. While Johnson had no need for an LBO, he knew that if he didn’t, he would look back on the situation as a missed opportunity.

Johnson, on the other hand, recognized that his greed would deter any major players, including KKR, from touching RJR Nabisco. As a result, his sole alternative was to work with Shearson, an investment banking firm that specializes in leveraged buyouts.

This corporation was keen to acquire a piece of the LBO pie, so they gladly agreed to absurd terms like giving Johnson a huge percentage of the total deal and guaranteeing the continuation of particular departmental budgets and retirement packages.

Naturally, such concessions would threaten the austerity measures that any solid LBO is built on, such as department downsizing to repay the debt accrued via the transaction. But that wasn’t the only issue: the deal was managed without the delicacy and ruthlessness required to succeed due to the involvement of multiple LBO newbies. After all, a well-executed LBO is completed before anyone notices it has started.

To accomplish this, senior executives meet with investors and devise a buyout package. The executives present the proposal to a vote of the board once everything is in order and they have arrived at a share price offer. The agreement is already so far along that the board has no choice except to approve yes at this stage. Corporate raiders are waiting to step in and take the defenseless firm simply by buying enough of its shares on the stock market if the board says nay.

In the case of Johnson’s agreement, however, a lack of experience meant that information was leaked earlier than it should have been, culminating in terrible results. Johnson’s LBO attempt was doomed from the start. He and Shearson planned to sell RJR Nabisco for $75 per share, $4 more than the company had ever sold for before. After the statistics were tallied, the total cost came to $17.6 billion, which was more than double the amount any bank had ever loaned for a takeover. In fact, it wasn’t apparent at first whether there was that much money in the world.

Naturally, when the board heard about Johnson’s offer, they insisted on issuing a press statement and opening up an opportunity for other offers to come in. Frankly, the board didn’t care for Johnson or his management style and were happy to get rid of him if they could.

As word got out, offers started pouring in. Two bids stood out to a special committee entrusted with finding the best deal for shareholders. KKR offered $94 per share, but First Boston was willing to pay anything between $105 and $118 per share thanks to a tax loophole. But, before these proposals were made, Shearson learned that Kravis was planning to enter the fray, so it raised its bid to $100 per share in an attempt to beat him out.

It didn’t matter in the end; First Boston’s absurdly huge offer provoked a second round of bidding. All parties involved were requested to submit a new offer, and First Boston was asked to demonstrate how they would raise the monies.

Shearson and Kohlberg Kravis both raised their bids to between $108 and $109 million, but First Boston was unable to get the necessary finance. As a result, the battle between the two companies came down to a tie. The board had to choose between acquiescing to KKR’s iron hold and handing Johnson the victory.

Johnson’s management agreement became a symbol of corporate greed, which didn’t help matters. A single New York Times report exposing the lucrative contract Johnson’s team was pursuing was all it needed to set off a nationwide backlash. Of course, the board perceived this media incident as just another stain on RJR Nabisco’s already tattered reputation, so the special committee chose KKR, which vowed to prioritize the firm and its people.

Ross Johnson was fired from RJR Nabisco in a flash, and everyone was relieved to see him leave, from rural laborers to board members. By leveraging their experience of purchasing organizations without demolishing them, KKR would provide much-needed order to the company. So, while the deal wasn’t exactly the pot of gold that everyone had hoped for, it also didn’t break KKR because of its sheer size.

Leveraged buyouts started off as a cunning way for wealthy business owners to avoid paying estate taxes, but they quickly became a vehicle for hostile corporate takeovers. The story of these transactions is rich with compelling people and driven by distinct variances in approach that distinguished the winners from the losers.

Check out my related posts: What are my top business books?


Interesting reads:

https://www.goodreads.com/book/show/781182.Barbarians_at_the_Gate

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