Barbarians at the Gate: The Fall of RJR Nabisco

Shearson remained concerned about competing bids after Johnson’s announcement. Henry Kravis expressed his disappointment to Tom Hill in a “venomous tone” (200). Because of Kravis’s power, Tom Hill and Peter Cohen met with him. Kravis announced that Shearson was now a competitor of KKR, while Cohen tried to convince him that Shearson had the right to pursue LBOs. Kravis, in turn, was fed up “[a]fter five years of steadily mounting competition” (202). His territory of “doing deals too large for anyone else to handle” was being challenged (202). Kravis suggested three options: competition, a joint bid, or a Shearson sale of RJR’s food business to KKR while keeping the tobacco business.

Cohen told Kravis to wait until after the weekend, while Kravis put together his team of investment banks, including Drexel Burnham, Morgan Stanley, Merrill Lynch, and Wasserstein Perella. He hired the latter strictly to keep the firm “out of circulation” (205). He tried to work fast to not miss the deal. Kravis was also concerned that Shearson might hire one of the “Big Three” (Bankers Trust, Manufacturers Hanover Trust Co., and Citibank)—who “had loose control over the spigots through which flowed the billions of dollars in money necessary to fuel Wall Street’s takeover machine”—on an exclusive basis (207). As a result, he exclusively hired Manufacturers Hanover himself.

KKR called his bid Project Peach. There were three possible plans. The first option was to send a “bear hug letter” to the company’s board signaling the intention to pay more than $75 per share without naming the exact price (212). The second option was to meet with Johnson and Shearson and pursue a joint bid. The final option was “the blitzkrieg approach”—a tender offer (212). All RJR Nabisco valuations ranged between $82 and $111 a share—much higher than Johnson’s $75. There was also a leaker on the inside of the company: “almost certainly a high-level RJR Nabisco executive with access to confidential documents” who “was out to get Ross Johnson” (210). For KKR, “This deal was three times larger than anything they had ever done before” (220). The bid would not be completely hostile because Kravis wanted to seek the approval of RJR Nabisco’s board.

At the same time, John Gutfreund of Salomon Brothers, “a newcomer to the takeover world,” also sought to pursue RJR Nabisco (213). Gutfreund also had to spend “much of his time suppressing internal revolts” in the firm (215). The company had a trading floor that dealt with a larger dollar amount of securities than the New York Stock Exchange daily. But Salomon wanted to move into merchant banking. Gutfreund worried that the massive amount of money necessary to pursue RJR Nabisco “would place an enormous burden on the firm” (215). The Salomon team decided to move aggressively and “quickly and secretly accumulate a large position in RJR Nabisco stock—a toehold—with an eye toward launching an unsolicited takeover bid” (217). Their goal was to spend $1 billion. Salomon director Warren Buffett confirmed the validity of this strategy.

Then the news of Kravis’s tender offer at $90 leaked to the media, including The Wall Street Journal, New York Times, and CBS Radio. Many were shocked. Johnson’s lawyer Steve Goldstone later said that the news “literally knocked my socks off” (224). The leak was “the worst breach of confidence” some Wall Street businessmen had ever seen (224). It also forced Kravis’s hand and made him act fast to announce the bid himself. He shocked Peter Cohen with this news, “Neither man could guess what had gone wrong” (228). Johnson called Kravis himself, surprising him “with an onslaught of cheerfulness” (227). Kravis then began an investigation into the identity of the leaker. At first, he believed him to be Drexel Burnham Lambert’s Jeff Beck, who was then “exiled from all strategy meetings” for weeks (228). Then Kravis’s aides thought that the leaks may have come from Bruce Wasserstein. In the end, “Kravis came to believe there were dual sources of the leaks, Beck and Wasserstein’ (228). Both denied responsibility. The rest of the time, KKR “largely worked alone” only seeking financial analysis from the bankers. Kravis’s announcement also put an end to Gutfreund’s bid.

49-year-old Theodore J. Forstmann of Forstmann Little Co. was “a man who had everything” (231). The grandson of a German immigrant who had amassed a fortune with a textile company called Forstmann Woolens, the young Ted had a privileged but unhappy childhood. His father was a violent alcoholic, and the children lived “in physical fear” of him (234). Ted grew up athletic, playing tennis and hockey. He then attended Columbia Law School. However, following his father’s death, the family money “began to dwindle,” as the company “had failed and was sold” (235). After graduating, Ted worked for such firms as Fahaerty & Swartwood, where he met Henry Kravis. Forstmann focused on investment banking, merger work, and underwriting. By 1974, Forstmann was out of work—“a Wall Street refugee” (236). Yet he was able to make $300,000 from the sale of Graham Magnetics where he was on the board of directors. In 1978, with the investment banker Brian Little, he founded Forstmann Little & Co., which became one of “the first LBO firms to raise money directly from giant pension funds, a practice pioneered by Kohlberg Kravis” (238).

Forstmann subscribed to an old way of operating with LBOs and was highly critical of Kravis’s methods, “The reason Kravis can pay these incredible sums is that his money isn’t real” (234). He specifically criticized the “mutant strains” of high-yield, high-risk junk bonds, such as “securities that paid interest only in other bonds” or “stocks that were crammed down shareholders’ throats” (233). By 1988, almost every major LBO firm or key investor relied on these types of junk bonds. Forstmann felt that these junk bonds were “laying waste to his business” since they allowed “corporate raiders to raise money cheaply and easily” (239). Forstmann compared the situation to a cartel. The leaders of this cartel, KKR, “now had the upper hand in the looming battle for RJR Nabisco” (232).

On October 25, 1988, Forstmann published an “anti-junk-bond diatribe” (241) in the opinion pages of The Wall Street Journal. Forstmann sought to reveal Kravis “as the fraud he was” because of the RJR Nabisco deal (241). The anti-junk-bond crusader had a generally positive personal experience with Johnson in the early 1980s and thought that he could work with him. Thus, even though Forstmann was opposed to “selling cancer,” he decided to pursue RJR Nabisco as well (242). The deal was attractive not only financially but also because “Ted Forstmann knew he wanted to hurt Henry Kravis” (243). The Human Factor in Business is very much in evidence here, as Forstmann’s personal vendetta against Kravis drives him into a financial battle that will have implications for the entire US economy.