Barbarians at the Gate: The Fall of RJR Nabisco

The summary

The RJR Nabisco takeover was not a crime, and that is what makes it useful. In Bryan Burrough and John Helyar’s account nobody breaks a law. The chief executive, the buyout firms, the investment banks and the directors all behave rationally given what each personally stood to gain — and the company still ends up sold at a record price paid with borrowed money, its chief executive gone, its new owners holding a deal they would later say they would not repeat. The argument underneath the storytelling is structural. When the people making a decision are paid on a different basis from the people who own the asset, the decision stops being about the asset.

Burrough and Helyar covered the fight as Wall Street Journal reporters and built the book out of that reporting; Harper & Row published it in 1990. Its publisher now describes it as “a book that created a genre of its own,” and the claim holds up — the fly-on-the-wall deal narrative, reconstructed from the participants themselves, starts here.

A leveraged buyout is a bet placed with the target’s own balance sheet

The mechanism at the centre of the story is simple enough to state in one sentence, which is why so few people notice how strange it is. In a leveraged buyout, an investor buys a company using debt secured against that company’s own assets and future profits. The company, in effect, pays for its own purchase.

The RJR numbers make this vivid. When KKR filed its financing plan with the SEC in December 1988, the documents showed a $24.8 billion purchase in which the firm would supply about $2 billion — $1.5 billion in cash from a pool bankrolled largely by institutional investors, the rest raised from debt securities — and borrow roughly 87 percent, some $21.7 billion, against RJR Nabisco itself. Of that, $16.7 billion was bank loans and $5 billion short-term subordinated loans destined to become junk bonds. A KKR spokeswoman told UPI at the time that this was “the most conservatively structured leveraged buyout Kohlberg Kravis has ever done.”

That was the conservative version. The ratio is the whole point: a thin slice of real equity controls an enormous asset, so modest gains multiply and modest losses are fatal. It also explains why so many people wanted in. Reviewing the book in 1990, the Christian Science Monitor noted that hundreds of millions of dollars in fees for investment bankers, lawyers and advisers rode on the outcome.

The trigger was a man bidding for his own company

The auction did not begin with a raider at the gate. It began inside. On 20 October 1988, RJR Nabisco president F. Ross Johnson and his management team offered to take the company private at $75 a share. A chief executive bidding for the company he runs sits on both sides of the table at once: he helps set the price he pays, and he owes a duty to the shareholders he pays it to.

The terms made the conflict concrete. Johnson’s original proposal, UPI reported, contained provisions to enrich him and other senior managers by as much as $100 million. On 5 December 1988, Time put Johnson on its cover under the headline “A Game of Greed.” Whatever else the coverage achieved, it hardened the board.

The board took the lower offer

Once the company was in play the directors ran an auction, and after six weeks it produced a result that only makes sense if you stop treating price as the only variable. On 30 November 1988 the board awarded RJR Nabisco to KKR at $109 a share, roughly $25 billion — UPI reported the winning bid at $25.07 billion — over a management bid of $112 a share, about $25.4 billion.

Time reported that the directors preferred KKR’s sounder financial structure, its plan to sell fewer businesses, and stronger protections for employees. Johnson left as agreed. “Ross will step down after the transaction is complete,” Kravis told the Winston-Salem Journal the following week. It is the book’s sharpest lesson in governance: a board is entitled to weigh what a bid does to the company rather than only what it pays per share — though this board began doing so only after the bidding had already run for six weeks.

Almost nobody won

The deal closed in 1989 and the debt arrived on schedule. RJR was soon swapping stock for debt with its bondholders, and a share issue in April 1991 raised $1.125 billion in fresh capital and brought a Standard & Poor’s upgrade. KKR started unwinding its stake in 1994 and sold the last of it in 1995.

Perry Golkin, a KKR partner, was later asked at Wharton whether the firm would buy RJR Nabisco again. He said no. The high-yield market shut down after Drexel Burnham Lambert collapsed, forcing quick sales of securities. Philip Morris cut Marlboro prices. Tobacco litigation, which the industry had been winning, turned against it. Parts of the plan worked — assets sold for more than expected, profitability improved — but the largest buyout in history was not, by its own buyer’s account, a good investment.

The bottom line

Structure beats character. The RJR Nabisco fight was settled by who got paid for what, not by who was clever or greedy, and the winning price reflected an auction’s momentum more than a business’s worth. That is why “barbarians at the gate” — a phrase Ted Forstmann aimed at Kravis’s junk-bond financing before it became this book’s title — has outlasted the deal itself.

Read it if you want private equity explained from the inside, or if you want the best argument in print that incentives, not villains, account for most corporate disasters.