The Deal That Changed The World

Greed, Glamour, and the Making of an ’80s Wall Street Legend.

It’s early 1988 in Midtown Manhattan, cherry trees start to blossom in Central Park, unfar where from Ross Johnson, CEO of RJR Nabisco, is having a working lunch with Peter Cohen, investment banker, to discuss making changes at RJR Nabisco. While lunching, Ross floats the idea to not only be the top manager of the firm but to fully align work and profits, to have “skin in the game” for the performance of the RJR Nabisco. Ross needs Peter’s advice because Peter represents a powerful investment bank – Shearson Lehman Hutton – which would structure the deal, find lenders and financiers, and have a legal team to seal the deal, a Leveraged Buyout, the largest in history.

The Lunch That Changed Wall Street

At lunch, in 21 Club, Ross’s favorite locale, they strategize the move to the Board of the company. RJR Nabisco is a cigarette and food manufacturing conglomerate. RJR Nabisco’s share price at the time was $56 and with around 230M shares outstanding the firm was valued at $13B. They agree that making a presentation around the theme of “conglomerate discount” is key to success. Ross would use his charm to tell the Board how he’d be offering a 33% premium to the existing shareholders, $75/share or $17B valuation, and let some join him in the new SPV, formed to take over 100% of the RJR Nabisco in a leveraged buyout.

A few months later, Ross presented the offer to the board. The way it works in the LBOs, the board has a fiduciary duty to achieve the highest price for the shareholders. Hence, Charles Hugel, the Board member and the chairman of the special committee spearheaded the process of getting other bidders by hiring the investment bank that prepared the investment memorandum and sent it to the potential investors. After the initial outreach by the Lazard (IB of RJR Nabisco), few to many non-binding offers are submitted – also known as letter of intent or “LOI” – and the investment bankers review and select investors for the second stage. Selection is based on the offer size, reputation and experience, and ability to put the financing together and sometimes proof of it.

The Bidding War

Enter KKR, the formidable private equity firm founded by Henry Kravis, Jerome Kohlberg, and George Roberts, Wall Street’s powerhouse. They had money, reputation, and network to put the type of money together that allowed KKR to outbid $17B put together by the CEO and his backers. The October of 1988 arrived with three bidders and potential owners of the RJR Nabisco. The third one was Forstmann Little, another investment firm. The board was in a good position, it had a minimum standing offer which was 1/3 more valuable than what the firm was worth a few months ago, but it also had two Wall Street players pushing value up, as so so-called “bidding war” ensued. After several bids, KKR submitted a modified binding offer for cash and debt-free RJR Nabisco for $109 per share, around $25B. Although Ross and his backers had placed another offer at $112, an equivalent of around $26B, the board decided the KKR was more likely to 1) follow through on the offer and put the financing together 2) succeed with a restructuring and create value for the stakeholders. Therefore, by the Christmas of 1988, KKR emerged as a winning Barbarian at the Gate that conquered the Empire which just like Rome, but 1,500 years before, would be divided into pieces.

The Aftermath

At last, KKR only was able to recover the costs that went into taking a stake in the RJR Nabisco deal, perhaps with a small IRR. Even KKR’s special press release on the 20th anniversary of the deal mentions that the KKR fund that invested in the RJR Nabisco would have had 2x higher IRR if it hadn’t invested in the conglomerate. Today, RJR Nabisco’s pieces are absorbed by other conglomerates. The tobacco business, which included Camel and Winston is absorbed by Reynolds American Inc., and the Food business unit which includes Oreo and Ritz is owned by Mondelez International. As it’s clear from the essay, the real reason why this deal made the headlines for the decades to come and books written about it, isn’t because of the success that KKR achieved with the portfolio firm, but instead, the deal is a reflection of times, 80’s Wall Street filled with ever larger deals, eventually making its way into a major motion picture Wolf of Wall Street, first portrayed by Michael Douglas (portraying Gordon Gekko) and later by Leo Di Caprio (portraying Jordan Belfort).

Written by George Chanturia, Founding Partner at Argo Advisory

Argo Advisory | Published: November 2024

Sources:

KKR Pioneered the Private-Equity Business. Here Are Its Hits and Misses & Buyout Blitz: How KKR Took Nabisco Private 20 Years Ago