9781439181966

Eighteen

The insistent ringing of the phone late at night is always disconcerting. It is a noise that immediately fills me with dread: someone is reaching out to me in the darkness with bad news. So it was with a measure of anxiety that, late one night in November 1987, I turned on the lamp on our bedroom table, leaned over toward the trilling phone, and picked up the receiver.

I was relieved to discover that the caller was my partner, Ira Harris. A gigantic man with an explosive temperament, Ira had dominated the investment banking business in Chicago as the resident partner of Salomon Brothers until I had succeeded in luring him to Lazard. The lateness of the hour, I knew, meant little to Ira; he was always doing business. I prepared myself for a report on some recent development that was too important to wait until morning.

“I’ve just spoken to Ross Johnson,” he announced without even a pretense of an apology for the lateness of his call. “They want to meet us tomorrow for lunch in Atlanta.”

I knew, of course, that Ross Johnson was the CEO of RJR Nabisco, the company that had been formed by the merger of R.J. Reynolds Tobacco, the world’s second-largest cigarette manufacturer, and Nabisco, a major international grocery products company. But Johnson was neither a business nor a social acquaintance. And I was tired.

“Listen,” I said with perhaps too much abruptness, “I don’t know him or his company. Do you really want me to do this?”

“Absolutely,” Ira nearly shouted. “The management wants to do an LBO. They want us and Dillon Read to advise the board. Can you meet me there?”

I just wanted to go back to sleep. “Ira—” I started.

“Let me know what flight you’re on,” he interrupted. “I’ll have you picked up in Atlanta.” Without waiting for me to respond, he hung up.

And so with that call I became one of the initial participants in a complex and hard-fought deal that would be the largest LBO ever. It would involve a crowd of Wall Street’s most renowned bankers, lawyers, and public relations specialists. It was also a transaction that would, notoriously, symbolize the extravagant greed that energized and shaped the financial marketplace in the 1980s. And by the time it was concluded, I would almost be regretting that I had ever reached across my bed to answer the phone that late November night.

RJR Nabisco had lavish headquarters—a sprawling campus of enormous buildings gleaming like what seemed to be acres of polished marble. It had all been designed, I suspected, with the purpose of impressing visitors, and as I arrived at the meeting the next day I must admit that all the extravagance had the desired effect. I was impressed. Clearly, this was a very rich company, a conglomerate that had its own fleet of airplanes and sponsored golf and tennis tournaments with millions of dollars in prize money. But my banker’s mind couldn’t help wondering, How rich? On the plane ride down to Atlanta, I had worked out that at its present price of $55 a share, RJR was valued at about $16 billion. Yet not very long ago the stock had been trading at $76. The real market value price per share, I felt certain without even doing any due diligence, would be significantly higher. For the right price, the purchase of RJR Nabisco would be a very good investment. No wonder the Johnson group wanted to make a deal.

No sooner had I arrived at the headquarters then I was led into a meeting room. Charles Hugel, the chairman of RJR’s executive committee, was sitting at the head of a long table. To his right, I recognized Peter Atkins, who was a senior partner at Skadden Arps, Meagher & Flom, and one of the profession’s leading M&A lawyers. He was, I was told, acting as counsel to the executive committee. Ira and our colleagues from Dillion Read were also already seated.

Once I joined them, the meeting moved forward with surprising quickness. Hugel explained that the management of RJR, led by Ross Johnson, planned to propose an LBO of the company to the board of directors. The price was set at $75 a share, and Shearson Lehman Hutton, the investment bank advising the management, was confident that the financing could be arranged. A committee of independent directors, headed by Hugel, had been formed to review the fairness of this proposal. Lazard and Dillion Read would be the financial advisers to this special committee of the board; we would, assisted by Peter Atkins’s legal advice, represent the shareholders’s concerns.

Management, Hugel continued, was operating on a very tight timetable. But these top executives believed that the entire transaction could be swiftly concluded. After all, he pointed out, they were offering a premium of almost 40 percent over the current $55 share price. Of course, he concluded, there was undoubtedly some room for improving this initial bid. But there was every reason to believe that the special committee should be able to come to a prompt decision that was in the shareholders’ best interest. Two weeks, he suggested breezily, and the deal should, largely, be concluded.

I listened to Hugel and grew increasingly uncomfortable as he spoke. This would be one of the largest corporate transactions in the history of American business; certainly, it would be the biggest LBO. It was a deal in which management presumably would reap huge profits: a situation, I knew from past experience, that inevitably led to lawsuits from shareholders. In addition, a deal of this size involving a company whose products were household names would also attract the attention and scrutiny of the press. My every instinct was to be deliberate. Hugel’s recitation struck me as too confident, too matter-of-fact. And the emphasis on speed made me extremely uneasy.

After conferring with Ira and the bankers from Dillon Read, I spoke. We would, I said, get to work immediately; a joint team was ready to begin doing due diligence. But, I emphasized, we would not guarantee that this process could be finished in the two weeks that had been suggested. Our responsibility was to see that the shareholders received the best price. Therefore, a thorough evaluation of the company and its components had to be done. And, since this was a transaction involving a potential purchase by insiders, we needed to provide sufficient opportunity for other bidders to step forward. Two weeks, I reiterated, was simply too little time.

Hugel seemed undisturbed by my reservations about his timetable. He just plowed on, showing us the press release describing management’s purchase offer. It would be released immediately following the scheduled meeting later that day of the entire board. Then, he led us into the boardroom to meet with the special committee.

The boardroom, like everything at RJR, was gigantic. Seated around a table that looked nearly as long as the flight deck of an aircraft carrier were the members of the special committee. I had met many of these directors before. Martin Davis, chairman of Paramount, was a client of Ira’s and mine; I knew him to be a tough, demanding, and difficult man. Bill Anderson, chairman of NCR; and John Macomber, chairman of Celanese, were close acquaintances of mine. Vernon Jordan was (and still is) everyone’s friend and counselor. Juanita Kreps, the only woman on the committee, had been secretary of commerce in the Carter administration. John Medlin was chairman of Wachovia Bank. This was a sophisticated group; and I was buoyed by the certainty that no matter what pressures were put on us by management and Charlie Hugel, the committee members would not be intimidated. They would insist on an open and fair bidding process—and, if it was necessary, they would not allow their deliberations to be restricted to the proposed two-week timetable.

The directness of their questions reinforced my confidence. They wanted to know in great detail how we proposed to go about our task, and how often we would report to them. And they, too, expressed skepticism about a swift conclusion to the transaction.

When the committee members had finished with their questions, Peter Atkins spoke. With great deliberateness, he outlined the many legal issues involved in the transaction and the specific fiduciary responsibilities of the directors. He made it clear that management’s participation in the equity of the new company would be disclosed not only to the board, but also to the public. In fact, he emphasized, to insulate the board members from litigation by stockholders, full disclosure in every aspect of this transaction was essential.

By the time I boarded the flight back to New York the next day, the press release detailing the management proposal led by Johnson had been distributed. When the plane landed, I called the office and learned that RJR stock had jumped nearly $17 in heavy volume. The company was now “in play.”

Leveraged buyouts—LBOs—were a popular financial strategy in the 1980s, and the theory behind them was quite simple. A publicly owned company with mediocre performance and a relatively low market value would prosper if it was privately owned, and management was part of the new ownership group. Only private ownership dominated by executives who knew the company, according to this financial logic, could take the necessary bold, long-term actions to improve business. There would be no pressure to report increased earnings each quarter, and costs could be cut by selectively selling or closing underperforming corporate units.

In a typical LBO, an investment group working with management would acquire the target company by providing its own capital and arranging for significant loans, often through junk bonds. The transaction would be highly leveraged; equity capital would generally be only 20 to 25 percent of the purchase price, and the large remaining portion would be debt. As assets were sold off, the proceeds would be used to pay down the debt to a more conventional amount. After two or three years, the company, now with a reduced debt and improved earnings, would return to the public markets at a significantly higher value for the underlying equity. And the LBO firm, the management-owners, and the holders of the junk bonds would stand to make a substantial profit on the relatively small sums they had invested.

The 1980s had seen an explosion in such transactions, with the deals steadily growing larger and larger. Beatrice Foods, General Instruments, Gulf Oil, Carnation, and Storer Broadcasting—all were acquired through LBOs. The two leading, and very competitive, companies engineering LBOs were KKR, a company formed by three former M&A executives at Bear Stearns—Henry Kravis, Jerome Kohlberg, and George Roberts—and Forstmann Little, an investment group headed by Ted Forstmann, his brother Tony, and Brian Little. Drexel, with its proven ability to sell junk bonds to institutional investors, would often provide the debt financing. But no transaction the size of RJR had ever been attempted.

If Shearson Lehman, the bankers working with the Ross Johnson group, could engineer this deal, it would be a tremendous coup for the firm. Not only would Shearson reap a huge payday for its efforts—the fees alone on a deal of this size could total $200 million or more—but it would also be a direct challenge to KKR’s and Forstmann’s dominance.

I wanted to believe that Henry Kravis was too competitive a businessman to be content simply to read about the biggest LBO in history in the Wall Street Journal. In fact, I wanted him to make a competing bid. It was my responsibility to get the shareholders the best price possible, and without KKR’s stepping into the fray I doubted that we could find another bidder.

Yet I also had genuine concerns about KKR’s participation. Drexel had traditionally provided the firm’s junk bond financing. However, Drexel was now in its death throes. The SEC and federal prosecutors were deep into their very public investigation of Drexel and Michael Milken for insider trading, stock manipulation, and fraud, among a variety of other violations of security law. The besieged firm was no longer capable of providing significant financing for Kravis, or, for that matter, anyone else.

Without KKR’s coming in with a competing bid, we, acting on behalf of the shareholders, would be left with two options: either a recapitalization of RJR, or selling the company in several pieces. But both of these approaches were full of uncertainties. I felt we could push the RJR management–Shearson group to about $80 per share. To do better, however, we would need another bidder, and KKR seemed the only logical choice. But since Drexel could not provide the necessary debt financing, it was doubtful that KKR would step up. I was starting to think that maybe I had been wrong. Since there was only one bid, this transaction would, in fact, proceed as swiftly as Hugel had confidently predicted.

But even as I speculated anxiously about other bidders, I also knew we needed to begin our due diligence. On Saturday morning, the day after Ira and I arrived back in New York, our joint team set up a data room. If we were going to provide the shareholders with a value that would exceed management’s bid of $75 per share, we needed to evaluate RJR on the basis of the sum of its parts. Would selling off some of the divisions and restructuring the company give the shareholders a combination of cash and stock that was worth more than $75? We also had to review all aspects of the RJR management bid, including, most important, the assurance that they could raise the necessary funds and the quality of their debt.

Lazard’s members of the team included some of our best senior professionals: Bob Lovejoy would oversee the legal and regulatory aspects, while Luis Rinaldini and Josh Gotbaum would analyze the RJR numbers and derive values. Fritz Hobbs headed the Dillon Read group.

As we all gathered for the first time on that Saturday morning, what had started as an organizational meeting quickly turned into a valuation session. After only a few preliminaries, we began to speculate on what RJR was worth.

We all agreed: Shearson’s $75 bid was a lowball offer. Ira and I, after just a cursory review of the numbers our people had gathered, believed that a valuation in the high $80s, or even as much as $90, could be achieved: that is, a sale price of $20 billion. Luis Rinaldini thought $100 per share was achievable, and possibly an even higher price.

Yet despite these lofty valuations, I remained discouraged. If there were no other suitors, the Johnson group would not be pressured to increase its initial offer. So, I considered corporate buyers. There were companies, such as NestlÉ, Unilever, Philip Morris, and Coca-Cola, that certainly had the capability. However, I decided they would either be inhibited by antitrust concerns—Philip Morris was already bidding for Kraft—or be put off by the very real health issues raised by RJR’s tobacco business. And once again, I thought about restructuring. But this still remained, I had to concede, a weak option. I doubted that the board would support such a risky plan.

Glumly, I began to imagine how all this would play out. We’d get the Johnson-Shearson team to improve its offer to perhaps $80 a share, and the board would have no choice but to accept that. Yet the shareholders would not get full value, and thousands of employees would be laid off as RJR subsidiary divisions were closed. It would be a terrific deal for the management; at that price they’d make a fortune. It would also be a terrific deal for Shearson, its banks, and its investment bankers; total fees would be about $500 million. And it was pretty much a done deal—unless there was another bidder.

I decided to call Henry Kravis.

Henry and I traveled in the same circles, and over the years we had done some business together. I respected him. He was bright, and he cultivated a careful, almost guarded reserve. I knew that trying to gauge his interest in bidding for RJR would be difficult; Henry was not a man to reveal his intentions. Yet I had no other choice. I made the call.

Henry, typically, did not give much away. With a tone of casual detachment, he disclaimed any interest in RJR. He was not ready, he said, to get into another bidding war, especially with a management group. He already had received, he complained, enough bad press. He did not want to be blamed once again for the employee layoffs that would be necessitated by an LBO.

Trying not to appear as if I were pressuring him, I responded with what I hoped sounded like cool reason. The best response to bad press, I suggested, was a successful deal—especially one that would fortify KKR’s position as the leader in its industry. And I tried to assuage his concerns about the disadvantages involved in competing with management. We were specifically charged by the RJR board to seek the best result for the shareholders. We were prepared to provide any information he might seek.

Kravis listened without making any argument. Yet before we ended the conversation he conceded that if KKR decided to bid, it would want its bid to be the winning one. That gave me hope—but only small hope. I felt that even if Kravis were inclined to become involved, his partners—especially Jerry Kohlberg—would not want to proceed. They were famously risk-adverse. Ira Harris made a follow-up call. He, too, found Kravis cool, polite, and unrevealing. In the end, both Ira and I doubted that KKR would make a bid.

But Kravis, we later learned, had been following a well-crafted script in his conversations with us. Despite his coolly detached performance, he was seething. He felt betrayed by both Shearson and RJR. He had done a great deal of business with the investment bank, and had even previously discussed the possibility with Johnson of management’s buying control of RJR. Their attempting to negotiate a deal behind his back left him outraged. But it was more than just a personal affront. Shearson was threatening his “franchise.” It would be bad business to allow an interloper like Shearson to make the signature transaction of the decade, a deal three times the size of any previous LBO.

On Monday morning, before the opening of the stock market, the NYSE tape announced: “KKR to make $90 tender offer for RJR Nabisco.”

Kravis was furious that KKR’s intentions had been leaked to the press. Even more consequential, the leak set off a flurry of activity in the financial community. We were approached by a group led by the Pritzker family of Chicago and represented by First Boston. And the Johnson group was stunned. Shearson Lehman was then a subsidiary of American Express, and Jim Robinson, the chairman of AmEx, did not relish the prospect of going to war against Kravis. Suddenly, there were efforts to have Shearson and KKR submit a joint bid. But it quickly became clear that there were too many egos involved and that too much was at stake for even a pretense of cooperation. Peter Cohen, the CEO of Shearson, did not want to relinquish this opportunity to break into the LBO business in a spectacular way. Kravis, similarly, was unwilling to share leadership. And KKR’s investment bankers—a group including Drexel, Wasserstein, and Morgan Stanley—were openly contemptuous of their upstart rival Shearson. The talks involving a joint bid soon broke up.

But Peter Cohen now realized that the LBO would not go as smoothly—or as cheaply—as he and the Johnson group had previously anticipated. Shearson would need a financial partner if it hoped to meet the capital requirements necessitated by a bidding war. He turned to Salomon Brothers.

Along with Goldman Sachs, Salomon shared the position of the largest trading firm in the marketplace. And John Gutfreund was Salomon’s shrewd, autocratic boss. His photograph had recently been on the cover of BusinessWeek along with the headline “King of Wall Street.” In a best-selling book about Salomon Brothers written by a former trader, Gutfreund would famously be revealed to have calmly played a single hand of liar’s poker for $1 million. And in the aftermath of his recent marriage to a glamorous second wife, he had also became a well-publicized figure in New York society. I had known Gutfreund for many years and had a very high regard for his intelligence and integrity. By joining up with Salomon, Shearson had greatly increased its ability to make a winning bid. But I also had no doubt that Gutfreund’s participation in the negotiations would add more fuel to the already blazing media fire.

And then there was another unexpected development. Forstmann Little entered the bidding. Teddy Forstmann was Henry Kravis’s strongest rival and most severe critic. If they went head-to-head on RJR, I knew it would be an all-out war.

The two men, by both the nature of their personalities and the way they did business, were polar opposites. Henry Kravis was a small, slim, impeccably groomed man, a model of soft-spoken affability. Ted Forstmann was an athlete, a skilled tennis player, and defiantly outspoken. And while Kravis and his wife, Carolyne Roehm, like John and Susan Gutfreund and Jim and Linda Robinson, were what the newspapers called a “power couple,” Forstmann was a bachelor who rarely appeared at charity benefits and rarely received a mention in the society pages. Yet what most differentiated these two competitors was the way they engineered LBOs.

Ted Forstmann opposed junk bonds with an almost religious fervor. His financing apparatuses involved straight subordinated debt, and this resulted in a more conservative structure for his management and his investors. Nevertheless, Forstmann Little’s returns to its investors were remarkable, the equal of the KKR deals financed by Drexel and Milken’s junk bonds.

It was Forstmann’s distaste for junk bonds and for Drexel’s way of doing business that ultimately had persuaded him to enter the bidding war for RJR. He was determined to derail KKR’s deal. And he wanted to demonstrate that the Forstmann Little formula was a winning one, a strategy whereby enlightened investment bankers could prevail over rivals who, financed by junk bonds, cavalierly bought old-line companies with the intention of breaking them up and laying off workers.

After securing Goldman Sachs’s commitment to act as his investment bank, Forstmann then entered into discussions with the Shearson-Johnson group. He professed interest in joining their bid. Still, at the same time he was also negotiating with a consortium of large grocery companies. If his talks with the management team fell apart, Forstmann and the grocery companies would make their own competing offer.

The prospect of a bidding war—and a higher price for the shareholders—was, I was happily thinking, beginning to grow.

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Dealings : A Political and Financial Life

1439181969

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