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Ross Johnson, a Canadian-born executive with an all-American charm, embodied the spirit of the roaring 80s. With his ready smile, quick wit, and an eye for the good life, Johnson was a new breed of corporate leader – deal-driven, yield-driven, and always on the move.
As the book describes him, Johnson cut the biggest deals, had the biggest mouth, and enjoyed the biggest perks that came to symbolize the era. Born in 1931 in Winnipeg, Canada, Frederick Ross Johnson, always called Ross, was never the top student but consistently ranked in the upper quarter of his class without much effort. His easygoing nature, sharp wit, and natural leadership ability helped him hold sway over his peers.
Johnson's first job was with Canadian General Electric, where he honed his sales skills by schmoozing and entertaining clients on and off the golf course. He could easily drink scotch until the early hours and arrive at work the next day fresh as a daisy.
While his rise through the ranks was not meteoric, Johnson developed a unique philosophy about organizational evolution. He believed that creative chaos was essential for a business's long-term success, or as the book puts it, "The minute you establish an organization, it starts to decay." This belief would later drive Johnson to orchestrate the biggest buyout in history at the time.
It wasn't until the early 1970s, when Johnson was 40 years old, that he finally got the chance to run his own show. He was offered the position of President at the Canadian arm of the US food company Standard Brands. The company was outdated and stodgy – even its name failed to evoke an image of a modern, exciting food company.
Johnson quickly made his mark, replacing 21 of the 23 top executives with young men who shared his business approach. As the book describes, they were "dedicated to shaking up Standard Brands Canada by day and draining bottles of spirits by night."
Johnson's success led to his promotion to head of Standard Brands' international operations, which required a move to New York. At 42, Johnson was hitting his stride, proving himself to be a late bloomer.
His ability to connect with people, particularly board members at Standard Brands, helped him secure the CEO position within three years. He increased the CEO's salary from $200,000 to $480,000 and doubled the salaries of many top executives. Johnson also splurged on company apartments, a private box at Madison Square Gardens, and country club memberships. One of the most telling anecdotes from the book that captures Johnson's personality is when, shortly before Christmas, he was overheard telling his secretary, "Get me an inch thick of fifties, will you?"
After four years at the helm of Standard Brands, Johnson began to grow restless. The company was performing adequately, but not exceptionally. He had kept things lively by constantly shuffling people into different roles and introducing new products, some of which succeeded while many others failed.
Seeking a new adventure, Johnson found it in a $1.9 billion stock swap merger with Nabisco in 1981. Nabisco, boasting iconic brands like Oreo cookies and Ritz crackers, was the dominant partner, so Johnson assumed the role of president and chief operating officer.
One of the book's strengths is its deep dive into the history of each major company involved, providing a comprehensive account of Nabisco's founding and evolution. Although there isn't enough time to delve into those details here, it's a compelling reason to recommend the book.
Despite being COO rather than CEO, Johnson gradually gained control at Nabisco by ingratiating himself with the CEO and replacing key executives with members of his Standard Brands team, whom the authors refer to as "Johnson's Merry Men."
As his influence grew, Johnson began divesting brands where Nabisco wasn't the market leader. It quickly became evident that Johnson excelled at selling businesses, leveraging his charm and highlighting how poorly previous Nabisco management had run these divisions to potential buyers.
Johnson's success in a cookie war against P&G (another story the book covers in greater detail) and his strategic divestitures propelled him to the CEO position at Nabisco.
However, as with his time at Standard Brands, Johnson soon grew bored with Nabisco. He did, however, leverage his status as CEO of one of America's largest and most recognizable food companies to climb the social ladder, rubbing shoulders with world leaders, celebrities, and sports stars, many of whom he placed on Nabisco's payroll for substantial sums.
Johnson's leadership style was characterized by his belief that "ultimate success comes from opportunistic bold moves which by definition cannot be planned." This philosophy would soon be put to the test when an unexpected opportunity came knocking in 1985.
The CEO of RJ Reynolds, the North Carolina tobacco giant, reached out to Johnson with a proposal. At the time, RJ Reynolds still sold more cigarettes than any other tobacco company, although Philip Morris's Marlboro had surpassed Winston as the best-selling cigarette brand. The book does an excellent job of tracing Philip Morris's transformation into a more agile, savvy, and modern company from the 1970s onward.
The authors also provide a captivating account of RJ Reynolds' history, from its founding to its positive impact on the town of Winston-Salem, where signs once read "Thank you for smoking." The book delves into the company's evolution, boardroom battles, and the challenges it faced as public awareness of the health risks associated with smoking grew.
Tylee Wilson, RJ Reynolds' CEO, met with Johnson to discuss a major acquisition that would help the company diversify and reduce its reliance on tobacco, given the industry's increasing headwinds in the 70s and 80s.
In 1985, RJ Reynolds acquired Nabisco for $4.9 billion, with Johnson driving a hard bargain to retain his perks and secure the position of president and COO, second only to the CEO.
As he had done at Standard Brands, Johnson recognized the importance of cultivating strong relationships with the Reynolds board, something that Wilson had failed to do. This came to a head during a board meeting in 1986 when it was revealed that RJ Reynolds had been developing a smokeless cigarette for years without the board's knowledge. Wilson had kept the project, called Premier, under wraps, fearing that the information might leak.
The board, already not fond of Wilson, felt betrayed and expressed their anger during a lengthy meeting. Sensing an opportunity, Johnson called several board members after the meeting, claiming that he planned to leave the company for a position at the British food company Beecham.
The authors suggest that this was a calculated move by Johnson, who sat back and watched as the board members conspired to oust Wilson within weeks of that fateful meeting. Johnson was then voted in as Wilson's successor, and as he had done before, he replaced many top executives with his own team from Nabisco and Standard Brands.
With RJ Reynolds generating over $1.2 billion in annual cash sales, Johnson had even more resources to indulge his whims. He paid golfers Fuzzy Zoeller $300,000, Ben Crenshaw $400,000, and Jack Nicklaus $1 million per year for occasional tournament appearances. As a football fan, he also had OJ Simpson on the payroll, earning $250,000 annually.
Despite RJ Reynolds already owning six corporate jets, Johnson ordered two more top-of-the-line Gulfstreams, each costing $21 million, and built a state-of-the-art hangar for over $12 million to house them.
Johnson also rewarded board members with donations to their alma maters and generous consulting fees while reducing the number of annual board meetings. He increased their annual fees to $50,000 and allowed them to use company jets for personal travel.
Dissatisfied with the small-town atmosphere of Winston-Salem, Johnson convinced the board to move the corporate headquarters to Atlanta, despite the predictable backlash from employees and residents.
It was during this era that Wall Street began to take notice of RJ Reynolds. The 1980s saw a surge in corporate takeovers through leveraged buyouts (LBOs), fueled by cheap money in the form of junk bonds. LBOs, the precursor to modern private equity, involved borrowing vast sums to acquire companies.
The main issue with LBOs was that the newly acquired company was left with a massive debt burden, often forcing it to sell off assets to make payments. As a result, companies that had invested in innovation and expansion were now using their hard-earned profits to pay down debt, while the LBO investors reaped significant returns at the expense of corporate America.
RJ Reynolds, with its cash-rich business and valuable food brands under Nabisco and Standard Brands, was seen as a prime target by Wall Street. Johnson received numerous calls from investment bankers daily, with the authors noting that more than half of his 40 or so daily messages were from them.
Despite the persistent calls from investment bankers and the potential for a massive payday, Johnson was initially reluctant to pursue an LBO for RJR Nabisco. He understood that taking the company private through an LBO would mean assuming an enormous debt burden, which would likely put an end to the lavish perks he enjoyed, such as the company's six corporate jets, luxury apartments, and celebrity-filled golf pro-ams. Johnson was simply having too much fun to seriously consider the idea at first.
However, the pressure continued to mount. One of Johnson's friends, the CEO of Beatrice, a Chicago-based food giant, had recently been part of a $6.9 billion LBO orchestrated by KKR (Kohlberg, Kravis, Roberts), the largest such deal at the time. The Beatrice CEO was estimated to have earned over $400 million from the transaction, and both he and other investment bankers were urging Johnson to meet with KKR.
Despite his initial resistance, Johnson eventually agreed to meet with Henry Kravis, one of the key players in this story, at Kravis' opulent Park Avenue apartment, adorned with Renoirs and Monets. The book describes Kravis as a small, intense man with silvery hair, who was 43 years old at the time.
Kravis' father had made his first fortune in the booming stock markets of the 1920s, only to lose it all in the 1929 crash. He spent years paying off his margin calls before rebuilding his wealth as a petroleum engineer, estimating oil reserves for Wall Street firms.
The book provides a fascinating account of how Kravis gained experience on Wall Street before joining his cousin George Roberts at Bear Stearns, where they worked under the guidance of Jerry Kohlberg.
It was Kohlberg who developed the precursor to the LBO, known as the "bootstrap deal." Initially, this model was used to assist large family companies where the aging owner sought to avoid estate taxes. These companies had three options: remain privately held, sell shares to the public, or sell out to a larger company. Each approach had its drawbacks – remaining private ignored the problem, going public exposed the founder to a fickle market, and selling out often meant losing operational control.
Kohlberg's bootstrap deal provided a solution. He formed a shell company backed by a group of investors who only put up a partial amount of the total, with the majority of the funding coming from borrowed money. The family business retained a stake in the company and continued to run it. A year or so later, Kohlberg would sell some shares to pay down the debt while using the remaining debt to acquire complementary businesses, significantly increasing the company's value. When the original investors cashed out a few years later, they received a substantial return on investment. This model laid the foundation for the LBO business, which in turn evolved into private equity.
Kohlberg, Kravis, and Roberts refined the model while at Bear Stearns. When the firm refused to allow them to set up an LBO group internally, the trio left and established KKR. However, by the time Johnson met with Kravis, Kohlberg was no longer involved in the firm, and it was very much driven by Kravis and Roberts, who were extremely close and never made a buyout decision unless both agreed to it.
KKR grew their business gradually, raising increasingly larger funds, starting with $30 million and then securing $1 billion just six years later in 1983. As KKR and their deals gained attention, the number of LBOs increased tenfold between 1979 and 1983. In 1985 alone, there were 18 separate LBOs valued at over $1 billion each, with total LBO activity reaching $182 billion compared to just $11 billion six years earlier.
Kravis is more central to this story because he lived in New York, while Roberts, who disliked the city, resided in San Francisco. Despite maintaining a lower profile, Roberts was crucial to every move they made. Based on the book, Roberts comes across as more measured and analytical, less prone to letting his emotions cloud his judgment.
Another reason Kravis became the public face of KKR was his second wife, the socialite fashion designer Carolyne Roehm.
Although Johnson got along well with Kravis during their dinner and recognized him as a serious operator, he still didn't take the bait. He simply wasn't interested.
However, as British Prime Minister Harold Macmillan once said when asked about the greatest challenge for a statesman, "Events, dear boy, events." The same holds true for everyone, whether running a family or a national corporation. For Ross Johnson, it was the stock market crash of October 1987 that prompted a change of heart and, in the authors' words, marked the beginning of his road to ruin.
The October 1987 stock market crash had a significant impact on RJR Nabisco's share price, which had been trading in the mid-sixties before the crash and was now languishing in the low forties. Even though the company posted a 25% profit increase in December and generated 60% of its sales from non-tobacco products, Wall Street seemed to ignore these positive indicators, and the share price remained stagnant.
Johnson, like many CEOs, viewed the share price as a report card and felt that the company was being treated unfairly, primarily due to its association with tobacco.
He tried various strategies to boost the share price, including a $1.1 billion buyback of 20 million shares, but to no avail – the share price actually dropped further.
Johnson even explored a potential merger with rival Philip Morris, which owned both the Marlboro brand and food giant General Mills. He proposed combining Nabisco and General Mills to create an $18 billion company, with RJ Reynolds and Philip Morris each owning 37.5% and the remaining 25% being publicly traded. However, Philip Morris declined the offer.
In the aftermath of the October 1987 crash, trading volumes on Wall Street remained low, prompting investment banks to turn to a reliable source of income: takeovers. Mergers and acquisitions were highly profitable for Wall Street, generating substantial fees for advising, lending, and selling non-core businesses.
Although LBOs had been popular throughout the late 70s and 80s, Wall Street's increased focus on companies like RJR Nabisco was driven by the potential to earn massive fees from facilitating such deals with Ross Johnson.
The combination of the company's persistently low share price, Wall Street's incessant promotion of LBOs as a solution to unlock shareholder value, and Johnson's guiding principle of creating chaos made it increasingly likely that he would eventually take significant action. As the book puts it, "He could never leave well enough alone – there was shit to be stirred."
However, Johnson had one last hope for lifting the share price: the launch of Premier, RJ Reynolds' smokeless cigarette, which the former CEO had been ousted for failing to disclose to the board.
Premier looked like a normal cigarette but contained only a small amount of tobacco. The smoker would light the carbon tip, heating rather than burning the tobacco and flavor beads inside. The process produced almost no smoke and no tar.
Johnson hoped that Premier's launch would boost the share price, but repeated market research and taste tests yielded very negative reviews. Consumers found it too hard to draw on, complained about the terrible smell when lit with a match (like burning lettuce), and, most importantly, disliked the taste. Johnson realized that Premier was unlikely to lift the share price and might even have the opposite effect.
Running out of ideas and enthusiasm, Johnson began to seriously consider an LBO.
Johnson had previously asked his executives to explore the numbers and ideas related to an LBO, and they had engaged Shearson Lehman & Hutton to prepare proposals. Johnson reached out to Peter Cohen, the CEO of Shearson, but this time with genuine intent rather than just kicking the tires.
One might wonder why Johnson didn't approach Henry Kravis, given KKR's dominance in the LBO space. Although Johnson had met and been impressed by Kravis, he knew that KKR would insist on having control. KKR's business model was predicated on providing the majority of the money and, in return, controlling the board and management. While they often retained existing management after a takeover, they were subject to strict budgets and targets set by KKR, with the risk of removal if they failed to meet those targets.
In contrast, Shearson was in a different position. As they were not perceived as LBO experts, they were eager to be the lead player in the largest LBO of all time. Consequently, they were willing to structure a deal that would leave Johnson in control, with a full veto over all major decisions regarding the business's operation – the exact opposite of KKR's approach to managing their assets.
Another key aspect of the deal that Shearson agreed to, which would later come back to haunt Johnson, was the management deal. It specified that if Johnson and his team met all post-LBO targets, their stake could be as high as 18.5%, potentially earning them up to $2.5 billion, which Johnson could distribute as he saw fit. These terms were extraordinarily generous, and KKR would never have agreed to them.
When Peter Cohen, the cigar-chomping, headstrong, and aggressive dealmaker known for driving a hard bargain, agreed to the generous terms, it was because the prize was so big and Shearson was so desperate to become a player in the burgeoning LBO market. Cohen knew that if Shearson pulled off this deal, not only would the money be astronomical, but they would also be in pole position to do more and even bigger LBOs. The overall potential reward was immense.
Another factor that likely influenced Johnson's decision to go with Shearson was their ownership by American Express. One of Johnson's closest friends, who features prominently in the book, was Jim Robinson, the CEO of AMEX.
By the mid-80s, the LBO business was thriving. While KKR was the number one firm in the sector, competition was increasing as big Wall Street firms recognized the earning potential. For example, in KKR's $6.5 billion Beatrice deal, they earned $45 million in fees alone, not including the profits they would make from growing and selling assets from the deal.
To underscore their prominent position, KKR raised $5.7 billion in a new fund in 1987, giving them an unprecedented $45 billion in buying power.
A central tactic in the success of most LBOs is known as the "gun to the head" strategy, where the company's management secretly works with their Wall Street LBO partner to assemble the financing and then presents the deal to the board as a take-it-or-leave-it proposition.
Shearson incorrectly assumed that Johnson would go along with this strategy, but he refused outright. He had seen how the board reacted to the former CEO springing the Premier cigarette development on them and had spent a great deal of time building open relationships with the board members. The "gun to the head" tactic was not how he wanted to proceed, and at this early stage, Johnson was calling the shots.
The key to any successful LBO is having the management on board. They can provide the money men with all the company's facts, figures, cost-cutting strategies, and everything they need to know about how the company ticks, where savings can be made, and where investment will yield the best results. Without management's cooperation, any prospective LBO is flying blind.
The downside of not using the "gun to the head" strategy is that, as the board wasn't being forced to accept the first bid made by Johnson and Shearson, they would be obliged to publicize the fact that an offer had been made, putting the company in play.
However, both Johnson and Shearson believed that because the deal's value was so big, the biggest ever, there were no real competitors. They were aware that Kravis had expressed interest a year earlier but felt that he didn't want to get into the tobacco business. They naively believed that their bid would not face any competition, given the money, commissions, and fees that the deal would generate for all participants.
When the board eventually approved the LBO, it was based on an offer of $75 per share, valuing the deal at $17.6 billion – the largest corporate takeover in history. When the news broke, Henry Kravis was consumed by a mixture of emotions: anger that Johnson hadn't asked him to come on board despite his earlier LBO proposal, surprise that Johnson had gone with Shearson, who had never done an LBO, and astonishment that the bid was only $75 – he knew that was way too low.
This set the stage for one of the most enthralling and dramatic takeover bids ever. The book really shines in this regard, infusing the story with a pace and urgency that can't be done justice in a podcast. It delves into great detail about all the participants, their personalities, and their history with others involved in the deal.
What drives the deal and elevates the drama are the men involved, and for the most part, it is all men. While the book rightly points to how their machismo influenced and impaired their thought processes throughout the 42 days it took to complete the deal, it wasn't all down to testosterone. These men's decisions and behavior were also influenced by gossip, petty arguments, perceived slights, and cattiness that one would normally associate with low-brow reality TV like The Real Housewives of Beverly Hills.
That's what makes this story and the book so compelling. The authors get to talk to all the participants, and while they are involved in the biggest deal in corporate history, and we might initially have an elevated opinion of these Wall Street titans, the book reveals their frailties. Yes, they're high-achieving multi-millionaires, but in many ways, they're no different from anyone else.
As the story unfolds, all of Wall Street, and especially Henry Kravis, are taken by surprise when the RJR Nabisco LBO is announced. The stock market responds enthusiastically, with the share price skyrocketing and finishing the day at $77.25, up 21 points, already making the management bid look too low.
Peter Cohen of Shearson, who was funding the management bid, realized that KKR wouldn't simply sit this one out. The deal was too big, and even beyond the potential earnings, KKR couldn't let the big Wall Street firms muscle their way into the LBO business. Cohen knew that if they couldn't come to an arrangement with Kravis, KKR would make their own bid.
Cohen set up a meeting with Kravis on the Friday after the LBO was first announced. After a testy conversation, Kravis put forward three options:
- They could compete against each other, resulting in a bidding war that neither wanted. The end result could be a Pyrrhic victory, with the winner saddled with so much debt that it would be difficult for their investors to get a good return.
- They could partner together, which sounds like a good idea, except that neither man could countenance going into partnership. Kravis saw KKR as the top dog in LBOs, while for Cohen, who had RJR Nabisco management on his team, a partnership with KKR would be partly an admission of defeat, indicating that Shearson couldn't do the deal on their own.
- Shearson could sell RJR's food business to KKR. After all, KKR had just bought Beatrice, so this would be a nice fit.
Option 3 would seem like the most likely and favorable choice. Shearson would get to do the deal, and when the deal was done, they would invariably look at selling assets to pay down debt. In this scenario, KKR would buy a food business that complements their recent Beatrice purchase.
However, for whatever reason, this option was never explored beyond being briefly proposed again in another round of negotiations a few days later, but it was largely ignored.
Kravis didn't think that Cohen would consider any of the three options, so he wasted no time assembling a team consisting of his KKR colleagues and a string of outside advisers. Through a combination of rumor, mixed messages, and paranoia, as the weekend wore on, they became convinced that Shearson was going to try to get the committee that RJR had set up to monitor the LBO to agree to their offer on Monday.
The KKR meeting broke up on Sunday night, and although Henry Kravis and George Roberts hadn't officially agreed to go ahead with a bid, they had drawn some conclusions with their advisers but wanted to sleep on it. Kravis admitted to the authors that he was 75% sure he would make a bid on Monday for $90 a share.
Yet, on Sunday night, one or maybe even two of these outside advisers involved in that late-night session with KKR leaked to the press that Kravis was putting in a bid for $90. They did this to force Kravis's hand, ensuring that the bid would go in and that the adviser would be part of the biggest deal ever, reaping huge fees.
The news was on the front page of Monday's Wall Street Journal and New York Times, and Kravis understandably went ballistic. Not only was his hand forced, but he also had a leaker within his team. Bruce Wasserstein, a KKR advisor and one of Wall Street's most colorful characters, was a prime suspect, but Kravis couldn't prove it.
The news also caught Johnson, Peter Cohen of Shearson, and everyone else by complete surprise, as did the price of $90 per share, pushing the bid up to $20 billion.
Cohen and Johnson could see that unless some sort of truce could be made with Kravis, this was going to turn into a drawn-out and very expensive bidding war that might benefit shareholders but would ultimately saddle the company with too much debt.
Cohen met with Kravis again and proposed a 50/50 partnership. Kravis turned it down flatly; he didn't rate Cohen and didn't believe that Shearson brought much to the table. The meeting ended without any agreement, although Kravis did call back later with an offer: KKR would buy RJR Nabisco, and in return, Shearson would get a one-time fee of $125 million and an option to buy 10% of the company. Cohen was insulted by the offer.
Next up was Johnson. He met up with Kravis and Roberts. He had no ax to grind with Kravis and actually liked him. He thought Kravis had a sharp mind and respected the way he did business. While he was concerned about how the company might be managed if KKR were in charge, he was open to the idea of reaching some sort of compromise.
This is where the book comes into its own, describing the late-night calls between the main participants, the frantic toing and froing as each side realized that a compromise was in the best interests. However, their egos, reputations, petty arguments, combined with the pressure brought on by all the publicity, as well as the grueling hours they were putting into the deal, all complicated the issue.
Despite the progress made in the meeting facilitated by Linda Robinson, where Johnson, Jim Robinson, Peter Cohen, Kravis, and George Roberts agreed to the outline of a deal, the subsequent negotiations to iron out the details proved to be a shitshow.
The book does a fantastic job of describing how these negotiations played out. It seemed that there were too many cooks involved – far more progress would have been achieved had Ross Johnson, Peter Cohen, and Henry Kravis just sat down together and discussed their options.
However, many of these late-night negotiations involved too many lawyers, investment bankers, and advisers, each one wanting to make sure that their voice was heard and their opinion mattered. It was a mess.
One particular meeting broke up at 3:00 am with no agreement and a disillusioned and confused Johnson. He was open to reaching an agreement with Kravis and just couldn't understand why Cohen and his Shearson team were unable to do so.
The Shearson group went back to strategizing their response to KKR's $90 bid. The general consensus was that they needed to end KKR's involvement once and for all, and this could only be achieved by not simply improving upon Kravis's bid, but by raising the bid significantly. In the end, they felt that $100 per share could do it.
It's important to remember that all of this was also playing out in public. It was a corporate battle for the ages, and in Kravis and Roberts, the press had two very visible faces that they could hold up as the epitome of corporate and Wall Street greed. Kravis, with his beautiful socialite wife and extravagant parties, and Johnson, with his celebrity friends, corporate jets, and potential massive payoff, were easy targets, and the press didn't spare them.
Both Businessweek and Time wrote scathing stories on how the growth of LBOs was damaging corporate America, while Newsweek also reported gossipy details on Kravis's personal life.
Time also put Johnson's face on its cover with the headline "The Game of Greed," and the article contained all the details of the management deal, including the fact that Johnson stood to make $100 million from the deal.
While Shearson was working on their bid, Kravis was doing his utmost to do as much due diligence on the company as possible. The authors make a lovely analogy about how doing an LBO is a lot like buying a used car – you don't just buy off the ad, you need to go and meet the seller, get an idea of what type of operation he's running, and crucially, you also need to kick the tires, maybe bring a friend along who knows a thing or two about cars so that he can also take a look for you.
But Kravis wasn't even able to kick the tires. He didn't have the management on board with him to tell him all the ins and outs. The committee running the bids did allow Kravis to interview all the top executives in RJR Nabisco, but they were all Johnson's men, on Shearson's side, and were not going to reveal any vital numbers or plans.
So Kravis and Roberts once more came to the conclusion that they needed to reach a deal with Cohen and Shearson, that it was worth one more try. Linda Robinson, a high-powered owner of a PR business, who also happened to be the wife of Jim Robinson, the AMEX CEO, and the only woman centrally involved in this story, worked her magic to get Johnson, Jim Robinson, Peter Cohen, Kravis, and George Roberts to meet up one last time.
Within 30 minutes, they had agreed to the outline of a deal. Control of the RJR Nabisco board would be 50/50, and the stock would likewise be split down the middle, with Johnson's share coming out of Shearson's take.
KKR would take their customary 1% management fee, which would come to $200 million – more than three times the size of any previous merger fee on Wall Street. When they all realized how that might play out with the public, Kravis agreed that KKR would be willing, in theory, to reconsider the fee.
Other issues were discussed and agreed upon, such as who would sell the various businesses after the deal was done and what fees were to be paid to the various banks and advisers. Within an hour, they were done – all the major points had been agreed. Both parties left the meeting in high spirits, agreeing to get their various teams together to put the details into a formal agreement.
As you can imagine, in a deal of this size, there were numerous details that still had to be ironed out, and the book does a fantastic job of describing how the subsequent negotiations played out – and it was a shitshow.
The situation was becoming increasingly complex and chaotic. Shearson had partnered with Solomon to raise the money to finance the deal and underwrite the bond offering. In essence, a lead bank must be chosen to run the books, and this lead bank gets to have its name placed first on the tombstone advertisements that announce the deal. Being on the left of the tombstone signifies that you are the lead bank and has powerful symbolic significance on Wall Street.
KKR's part of the deal was being funded by Drexel, Solomon's arch-rival, and in all their negotiations, KKR had insisted that Drexel would be seen as the lead bank. This was agreed with Cohen – Drexel would appear on the left of the tombstone. However, Solomon wouldn't go for it, and Kravis wouldn't back down. As the authors rightly note, perception was the issue, and believe it or not, it was this tiny, stupid little detail that was sinking the deal between both parties.
Things then started to get a little bit crazy. Shearson put out a bid of $92 per share without even consulting Johnson, at a time when both Johnson and Kravis still believed that his side and KKR could still come to an agreement, even though negotiations had broken down. It was chaos.
Away from the Wall Street pressure cooker, the RJR board members were also feeling the heat. All the negative publicity that Johnson, Kravis, and the LBO industry were generating was coming back on them. While Johnson had always been mindful of the board and looked after them well, when the story broke in Time about how much Johnson stood to make, all bets were off.
The board was gradually more inclined to do a deal with KKR, which would have been inconceivable only a few weeks previously. They also realized that things had gotten out of hand, so after the last bid by Shearson was made, they decided to give all interested parties 11 days until 5:00 pm on November 18th to make their final bids.
As you can imagine, the next 11 days were frantic, with each group poring over the accounts, meeting industry experts and company insiders – anyone who could help them get the best insights into what the underlying value of the businesses was worth while also trying to second-guess what the other group would bid.
And then there was a dark horse. First Boston had quietly been working on their own bid using money from some wealthy investors, and their proposal also relied on a complex tax loophole that, if it was workable, would allow them to put in a very strong bid.
Again, the book really ratchets up the drama in detailing how each group arrived at their final price and even how their proposals were delivered, but the breakdown was as follows:
- KKR bid $94 a share
- Shearson and the management bid $100 a share
First Boston's bid was not what you could call a firm bid; it was more an explanation of what they believed they would pay if the board accepted their complex tax loophole proposal. If the board did accept it, then they estimated that their bid could be as high as $118 per share.
This bid really put the cat among the pigeons. It was considered by most to be pretty far-fetched, but the board, fearing litigation if they ignored what could potentially be the highest bid by a long shot, felt that they had to get expert advice.
The advice that came back was that First Boston's bid had potential, but that they would need to firm up on their proposal as there still wasn't enough in it to explain how all of their funding would be arranged. Because the board was giving First Boston a chance to rework their bid, a second round was declared – all bids were thrown out, and they were asked to submit a new bid within 8 days.
After all the weeks of work, the drama, the pressure, the publicity, everyone was drained, no one more so than Henry Kravis. Also, given that his best bid of $94 was so far below the other two bids, people speculated if KKR would drop out.
Roberts, who always comes across as less emotional and more calculating, convinced Kravis that they should feed that speculation – let everyone think that they'd had enough of this deal. The word subtly got out that Kravis was pretty depressed about the bid, and while it was never said that KKR was pulling out, Kravis went off skiing with his family for Thanksgiving, and Roberts went back to San Francisco for the holidays, while the other two interested parties worked on their proposals.
On the assumption that KKR was out of the bidding and also correctly surmising that the First Boston bid wasn't going to cut the mustard for a variety of reasons, Shearson and the management believed that they were in the driver's seat, and there was little incentive to bump up their bid by much if anything at all. In the end, they decided to increase it by just $1 to $101.
The First Boston bid hadn't advanced much since their first bid. It still left too many unanswered questions in relation to its funding, and while the tax loophole aspect was theoretically viable, it could potentially run into trouble politically.
But both bids were completely blindsided by KKR. Yes, Kravis and Roberts left New York for Thanksgiving and didn't do any work on the bid while they were away, but both men tacitly knew that when they got back, they'd look at it one more time. Reinvigorated after their break, they put in a bid for $106.
KKR won the bid, but not at $106. Because, as you'd come to expect from this story, the drama just kept coming. Shearson refused to accept that they lost. You see, there was nothing legally to say that they couldn't put in another bid. Sure, the committee had set a deadline, but it was unclear if that was legally binding, especially if another bid came in that gave shareholders more money. Shearson demanded that the committee accept another bid from them, a bid of $108, $25 billion, and to force the committee's hand, Shearson announced the bid publicly.
If the committee was going to accept another bid from Shearson, it was only fair that KKR were allowed to counter. In the end, the committee gave both sides an ultimatum: 15 minutes to submit your highest bid, and then it's game over.
KKR increased their bid to $108 in the belief that Shearson had already submitted their highest bid at $108. KKR rightly believed that the committee would favor their proposal if it was a tie. They had a better record in LBOs, and their proposal was more rounded and included good terms and conditions for the employees of RJR Nabisco.
However, unbeknownst to KKR, within the 15-minute timeframe, Shearson had increased their bid to $112, but there remained unresolved questions around employee benefits and also around Shearson's securities. In short, Shearson had no reset mechanisms that guaranteed a security would trade at a certain number over time. KKR's proposal had a reset for their securities. In essence, Shearson's junk bonds could float up or down, leaving the buyer open to the vagaries of the market.
This was a big negative. Actually, earlier in the bidding process, this issue was raised by Lazard, the prestigious Wall Street firm who were the advisors to the board, with both Shearson and KKR. KKR acted on it, but Shearson ignored it.
The board wanted KKR to win the deal, so they got back to them one more time and asked them for their very best bid. KKR came back with $109. Lazard judged both bids to be too close to call, but given the strength of the KKR proposal in terms of its securities and certain guarantees to employees, the board voted unanimously for the KKR deal, and so ended the biggest, most dramatic, and definitely most public corporate deal.
And what of the aftermath? Well, Ross Johnson resigned and got a golden parachute worth $53 million and sent each board member a dozen roses with a note: "Congratulations on a great job. The shareholders won."
Henry Kravis hired a young, dynamic executive named Louis Gerstner to become RJR Nabisco's CEO, who at that time was second in command to Jim Robinson at AMEX. Of course, Gerstner would cement his reputation by turning around IBM.
While all involved reaped huge fees from the LBO and the subsequent sale of assets, ultimately it would take KKR years to make any money from the actual business side of RJR Nabisco. Indeed, the RJR deal would prove to be the high point for the LBO sector.
By 1989, the junk bond market was in disarray. Michael Milken, the junk bond king, was jailed, as was financier Ivan Boesky. The story of Milken is told brilliantly in James B. Stewart's "Den of Thieves." We'll definitely cover it in one of our episodes.
And as you'd expect from the ever-opportunistic, parasitic Wall Street, the banks and institutions found a new way to make money: fixing the broken takeovers of the 80s. That's right, the very people who created the problem were now getting paid to clean up the mess they'd left behind. No wonder people have become so disillusioned with the financial markets and bankers.
In terms of where they are now:
- Ross Johnson set up a small consultancy but didn't do anything of major significance over the years.
- Peter Cohen was sacked by Shearson in 1990 with a $10 million payout and set up an asset management company that had some success.
- KKR is still going strong. It floated in 2009 and currently has a market cap of $53 billion. Henry Kravis and George Roberts are both worth between $8-9 billion and both stepped down from their positions as co-CEOs in 2021.
In conclusion, "Barbarians at the Gate" is a masterfully crafted story that captures the essence of the high-stakes, high-drama world of Wall Street in the 1980s. The book's strength lies in its meticulous detail, vivid characterization, and the authors' ability to weave together a complex narrative that is both informative and utterly engaging.
The story of the RJR Nabisco takeover is not just about the numbers and the financial intricacies; it's about the people, their motivations, their egos, and their relationships. Burrough and Helyar bring these characters to life, exposing their flaws, their brilliance, and their all-too-human qualities. From Ross Johnson's extravagance and charm to Henry Kravis's intensity and determination, each player is portrayed with depth and nuance.
Moreover, the book serves as a fascinating case study of the LBO phenomenon that defined the era. It provides a detailed look at the mechanics of these deals, the junk bond market that fueled them, and the personalities that drove them. The authors manage to make complex financial concepts accessible to the reader, without oversimplifying or losing sight of the bigger picture.
What sets "Barbarians at the Gate" apart is the way it captures the zeitgeist of the 1980s – the excess, the greed, and the sheer audacity of the players involved. It's a story that epitomizes the era, with its larger-than-life characters, high-stakes gambling, and the blurring of lines between business and personal ambition.
Yet, the book is more than just a time capsule. It raises timeless questions about the nature of capitalism, the responsibilities of corporations, and the human cost of unbridled ambition. It's a cautionary tale that remains relevant today, as we continue to grapple with the consequences of unchecked corporate power and the pursuit of wealth at all costs.
In the end, "Barbarians at the Gate" is a triumph of storytelling. It takes a complex, often technical subject matter and transforms it into a gripping, can't-put-it-down narrative. It's a book that educates as much as it entertains, offering a window into a world that is both fascinating and deeply troubling. It's no wonder that it has become a classic of business literature, a must-read for anyone seeking to understand the inner workings of Wall Street and the forces that shape our economy.
Sources
Barbarians at the Gate: The fall of RJR Nabisco By Bryan Burrough & John Helyar
https://www.youtube.com/watch?v=OtKizreanP0
https://www.youtube.com/watch?v=e6jdCSX3DY4&list=PLlm_ndk9SoTHgAvMUkIOJI_o4du3Cy2HF&index=3