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September 20, 2017 - August 22, 2018
Lifting the veil of secrecy was ordinarily enough to kill a developing buyout in its cradle:
Once disclosed, corporate raiders or other unwanted suitors were free to make a run at the company before management had a chance to prepare its own bid.
Weigl sicced a team of auditors on Johnson’s notoriously bloated expense accounts and collected tales of his former protégé’s extramarital affairs.
“An accountant,” Johnson would say during his bookkeeping days, “is a man who puts his head in the past and backs his ass into the future.”
Bob Dylan line of the time: “He who’s not busy being born is busy dying.”
“The minute you establish an organization, it starts to decay.”
“You learned that the guy who writes the ads for the bank isn’t the guy who loans the money. They break your balls.”
“All right,” Johnson liked to convene problem-solving meetings, “whose cock is on the anvil on this one?”
“That was a blinding glimpse of the obvious” (sometimes shortened to simply “a BGO”).
“Babies,” he said, “are only born at night.”
A former accountant, Johnson camouflaged the company’s poor results with an occasional bit of financial sleight of hand, sometimes stretching generally accepted accounting principles to their generally accepted limits.
Green made Nabisco a benevolent employer. Within three years of its founding, he installed a system for the company’s employees to buy stock on cut-rate terms, making them what he called “associate proprietors.” He refused to employ child labor in an era when it was common. And although he expected his workers to churn out America’s snacks from dawn to dusk, in brutally hot and often hazardous bakeries, he also felt responsible for providing them nutritious meals.
Then, in the midst of the Depression, Nabisco’s bakers came up with something novel. For years they had been trying to develop buttery crackers like those of some of their competitors. The result, covered with a thin coating of coconut oil and sprinkled with salt, was a completely new kind of cracker. They called it Ritz, and it became America’s most popular cracker almost overnight. Within a year, Nabisco had baked 5 million of them. Within three years, it was baking 29 million of them a day, and Ritz became the bestselling cracker in the world.
“Recognize that ultimate success comes from opportunistic, bold moves which, by definition, cannot be planned.”
He expanded aggressively, always keeping the capacity of his factory well ahead of current production, and he worked hard, for years living above the factory floor. He played hard, too, drinking deeply, gambling heavily, squiring around different women.
America’s love affair with tobacco went largely unopposed until 1964, when surgeon general Luther Terry issued his landmark report linking cigarette smoke with cancer. Cigarette sales, which had risen an average of 5 percent a year, fell sharply.
“It reminds me of the boxer who’s getting beat up something awful and going back to his corner at the end of the round saying, ‘He never laid a glove on me.’ The trainer says, ‘Well, keep an eye on the referee, because somebody’s kicking the shit out of you.’”
The basics of an LBO were relatively simple and familiar to all three men. A firm such as Kohlberg Kravis, working with a company’s management, buys the company using money raised from banks and the public sale of securities; the debt is paid down with cash from the company’s operations and, often, by selling pieces of the business.
Business, he felt, should be creating jobs and new products, things it couldn’t do if it was focused on paying back debt.
Kohlberg formed a shell company, backed by a group of investors he assembled, to buy Stern from its seventy-two-year-old family patriarch, using mostly borrowed money.
They found larger companies could be acquired as easily as small ones, for the simple reason that they had larger cash flows; by diverting that money to pay down its debt, Kohlberg Kravis was able to use a company’s own strengths to acquire it.
After a company was acquired, Kohlberg, Kravis, and Roberts kept a close watch on its budgets, but otherwise gave its management more or less free rein to streamline and meet its mountainous debts.
In 1982 an investment group headed by William Simon, a former treasury secretary, took private a Cincinnati company, Gibson Greetings, for $80 million, using only a million dollars of its own money. When Simon took Gibson public eighteen months later, it sold for $290 million. Simon’s $330,000 investment was suddenly worth $66 million in cash and securities.
A number of factors combined to fan the frenzy. The Internal Revenue Code, by making interest but not dividends deductible from taxable income, in effect subsidized the trend. That got LBOs off the ground. What made them soar was junk bonds.
Of the money raised for any LBO, about 60 percent, the secured debt, comes in the form of loans from commercial banks. Only about 10 percent comes from the buyer itself. For years the remaining 30 percent—the meat in the sandwich—came from a handful of major insurance companies whose commitments sometimes took months to obtain.
The firm’s bond czar, Michael Milken, had proven his ability to raise enormous amounts of these securities on a moment’s notice for hostile takeovers.
The only ones hurt were the company’s bondholders, whose holdings were devalued in the face of new debt, and employees, who often lost their jobs.
A top executive of Goodyear Tire & Rubber, for one, labeled the LBO “an idea that was created in hell by the Devil himself.”
But while the CEO remains nominal head, and often retains operating autonomy, there is no mistaking who calls the shots: firms such as Kohlberg Kravis and Forstmann Little control every board, approve every budget, and retain the power to remove senior executives at their whim. LBOs are not democracies: each executive in a Kohlberg Kravis-owned company answers to Kravis and Roberts.
A drawn-out bidding battle could send the price of the company skyrocketing and, because higher purchase prices inevitably meant higher debt levels, would all but guarantee the winner a Pyrrhic victory.
Go for it, Buffett advised. Once one of RJR’s largest shareholders, he knew tobacco and liked it. “I’ll tell you why I like the cigarette business,” he said. “It costs a penny to make. Sell it for a dollar. It’s addictive. And there’s fantastic brand loyalty.”
“I’m wealthy enough where I don’t need to own a tobacco company and deal with the consequences of public ownership,” he said.
Federal securities laws mandate that any target of a tender offer must formally reply to the offer within ten days. The board couldn’t ignore them then, Kravis said.
In 1985 Revlon, the international cosmetics giant, came under attack from little-known Philadelphia investor Ron Perelman. Perelman’s principal asset, a grocery store chain named Pantry Pride, was a fraction of Revlon’s size, but he was armed
with Drexel Burnham junk bonds.
Kraft put its Duracell battery unit up for sale. Forstmann had ardently and successfully wooed Duracell’s management. So close did he grow to Duracell’s president, C. Robert Kidder, that the executive took the extraordinary step of pleading with Kraft’s senior management not to sell Duracell to a junk-bond buyer such as Kohlberg Kravis.
A target company’s annual report and public filings can be compared to a classified ad. Like an advertisement, they contain useful information, although a savvy buyer knows the numbers can convey anything a clever accountant needs them to. The car buyer wants to know more than just what’s in the ad. He wants to talk to the owner, check under the hood, go for a ride around the block. For LBO buyers, a thorough inspection is equally crucial. More so than any takeover artist, the LBO buyer must know his prey. His success depends on determining exactly how much debt the target company can take on,
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Like many public corporations RJR was chartered in Delaware, and under Delaware case law the board was compelled to produce its executives for Kravis’s scrutiny. But, as Kravis would find out, there was no law saying they had to be cooperative.
“Our nation is blindly rushing toward the precipice,” warned Martin Lipton, the famed merger attorney, in a memo to clients. “As with tulip bulbs, South Sea bubbles, pyramid investment trusts,…Texas banks and all the other financial frenzies of the past, the denouement will be a crash.”
