Monday, August 09, 2004

Barbarians at the Gate 

Another thing I did this weekend was finish reading Barbarians at the Gate, by Bryan Burrough and John Helyar.

The book is the story of the strange and gargantuan buyout of RJR Nabisco. If this sounds boring, it's not, it's actually fascinating. In a leveraged buyout, or LBO, a company will be bought through some combination of cash and borrowed money (a combination of bank loans and bonds). The debt is then paid down over time through the cash flow of the acquired company, drastic cost-cutting, and the auctioning off of pieces of the company.

RJR Nabisco was a very rich company, with its tobacco operations bringing in billions of dollars a year in profits. The CEO, Ross Johnson, got interested in the idea of a leveraged buyout of the company. However, he also liked living the good life at the company's expense. He lived in expensive company-owned houses and apartments, kept a fleet of company limosines, and actually had a ridiculously luxurious airplane hangar built for the use of the company's executives. Actually, for their "Air Force" of private jets for the use of the top executives, all paid for by the company.

Not wanting to end this wonderful lifestyle with the aggressive costcutting necessary to pay down debt, Ross Johnson got together a group led by Shearson Lehman to perform an LBO. Shearson Lehman was trying desperately to get into the LBO business, and since RJR Nabisco would be the biggest LBO to date by an order of magnitude, it was willing to give Ross Johnson anything he wanted. This included giving an incredibly large share of the equity (approaching $2 billion) to Ross Johnson and 6 other top executives. Ross Johnson wanted it cheap, since keeping the debt low would make it easier for him to keep his perks. So Shearson Lehman bid around $75 a share, and tried to close the deal quickly, before anyone else had time to get a competing offer in. Since the stock was currently trading in the 40s, well off its highs, it was supposedly a good deal.

The problem was that since this was a public company, when the bid was made, the board of directors had to announce it publicly and hear any competing offers. And any cashflow-based valuation of the company made it obvious that $75 a share was way too low; the company was worth between $82 and $111 dollars a share, perhaps more. To date, all LBOs had been done with the cooperation of the company's management, since their detailed knowledge is required to understand where costs can be cut, and so forth. However, the announcement of Ross Johnson's LBO bid touched off a frenzy, as every major investment bank and LBO firm realized what was happening and tried to get a piece of the action, with the management group or without it. Since they were buying with borrowed money, the bidding price (and thus how much needed to be borrowed) was largely determined by the cash flows that the company could bring in. Well, the prices didn't stay anywhere near $75 a share.

The company eventually sold for around $25 billion dollars and went private. But the last couple hundred pages of the book are absolutely thrilling, as investment bankers desperately claw to outbid, outmanuever, and backstab each other, while throwing around dizzying amounts of money.

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