Barbarians at the Gate

by Bryan Burrough

  Jane Smith was a skinny, bright, energetic fashion student at Washington University in St. Louis, the kind of “good girl” who wore pearls and nice skirts to peace rallies and who once called her mother when she couldn’t find her way back to the sorority house. Upon graduation she journeyed to the fashion capital of the world, New York’s Seventh Avenue, only to quit her first job after two days when her supervisor suggested she clean the bathrooms. Moving on to another firm, she rode the subway each day and scraped by in a tiny apartment, always making sure to have plenty of fresh flowers and a bubble bath. “Beauty and glamour,” she liked to say, “are a state of mind.”

  After paying her dues in polyester for eleven months, Jane Smith got up the gumption to take her portfolio to her idol, Oscar de la Renta. De la Renta wasn’t terribly impressed, but she was persistent. She signed on as a design assistant, and soon twenty-four-year-old Jane Smith was playing Eliza Doolittle to the famed designer’s Henry Higgins. She took cooking and riding lessons, learned French, and tried hard to be a charming dinner partner. At the office she was sweet and innocent, a crier not a yeller, still the ideal prom date who talked about themes in gift wrapping.

  The earliest casualty of her self-transformation was her first name. She would introduce herself as Jane Smith and hard-bitten Seventh Avenue types would say, “Yeah, and I’m Tarzan.” A boyfriend suggested she go by her real first name, Carolyne, and it stuck.

  So, unfortunately, did the boyfriend. Axel Roehm, heir to a German chemical fortune, was tall, dark, handsome, European, and rich; in short, her fantasy of the ideal husband. They married and, as Carolyne Roehm, she moved to Darmstadt, Germany, to lead the life of a wealthy, lonely hausfrau. After a year of domestic boredom Roehm ran back to de la Renta in tears, the marriage a failure. De la Renta gave her responsibility for his lower priced. “Miss O” line and the traumatized young divorcée threw herself into the work with a vengeance.

  A year later, in 1979, she met Kravis at a party. It wasn’t love at first sight. Kravis was too short, for one thing, and he had a boring job on Wall Street. He was also married, although separated from his wife of nine years. After a Christmastime skiing date in Vail—Roehm’s mother chaperoned—they began seeing each other. Theirs was not a storybook love affair. Roehm, coming off a tough divorce, was a reluctant target. “It was a friendship,” Roehm recalled. “Being together with Henry was like putting a wonderful salve on a bad wound…. [My recollection] is not clouded by the romance of the beginning, because there wasn’t one. We were friends for a long time before I thought of him as a lover.”

  Kravis’s marriage had been on the wane for years. In 1970 he had wed Hedi Shulman, the daughter of a Brooklyn psychiatrist. The Kravises, with a Park Avenue apartment and rented summer homes in Greenwich or The Hamptons, had always been social climbers. But by most accounts, Kravis, his later riches still a dream, balked at his wife’s spending habits.

  “Hedi always wanted to buy the biggest and the best, the most,” recalled a family friend. “Henry didn’t like to spend money at that time. Hedi was driven by the dollar. It drove Henry crazy. It was personally embarrassing to him to have to explain to people out in North Carolina why his wife was going off to a summer home with their staff.”

  One summer evening Kravis stepped off the train in Greenwich to find Hedi waiting expectantly. “Henry, I’ve found the most wonderful house to buy!” she enthused. She drove Kravis out a lonely road where mansions lay a mile apart. Down a long, wooded lane she led him, emerging before a virtual castle. Kravis, unnerved, didn’t even want to get out of the car.

  Kravis attacked the courtship of Roehm with all the zest of a major takeover contest. On their way to a formal dinner one night, he insisted she test a pair of new tennis shoes; he despised the ratty old sneakers she had worn for years. Roehm, trying her damndest to slip into a red lace dress, finally relented and took a shoe. In its toe she found a diamond necklace.

  “As far as romance goes, Henry has fantasy,” Roehm says. “It’s not Oscar Wilde, but of all the business types I’ve gone out with, he’s by far the most romantic. Every anniversary, every Christmas, every birthday, he writes me these sweet, long letters about what he’s feeling. You know, ‘My faith, my love, my belief in you.’ They’re very touching letters. I’ve kept all of them.”

  They were partners in business before marriage. In 1984 Kravis agreed to invest several million dollars to bankroll Roehm in her own design business. She rented half a floor in the Seventh Avenue building that also housed Lauren, Beene, and Blass. Unveiled in a show seven months later, Roehm’s first collection of elegant evening wear and sprightly day wear was a triumph. When she strolled out for the standing ovation, a teary Roehm waved to the man who made it possible, Henry Kravis. He was crying, too.

  Roehm was ready for marriage, but Kravis, after finally getting a divorce in 1984, apparently was having second thoughts. One day, as she frantically prepared for her first showing, Roehm broke down in tears before her mentor. “I don’t think Henry will marry me,” she said. De la Renta, ever the father figure, called Kravis. “You’re going to tell me this is none of my business, and it is none of my business,” the designer said. “I understand that you’ve had a bad divorce and may not be in the mood to marry again. But I’ve got to tell you: I will be very disturbed if Carolyne becomes the mistress of an unmarried man. I think she’s better than that. I will use all my influence to break the relationship.”

  When Kravis finally asked for her hand, Roehm wavered. They were in Italy, where Roehm was shopping for new fabrics for her next collection. “I said I had to think about it,” she recalled. Crestfallen, Kravis pestered her about it all evening and into the next day. “He kept saying, ‘I can’t believe you said that, I can’t believe it.’ Every five minutes it was, ‘What’s your decision?’ He kept at me all the next day until finally, around three, I said, ‘Well, okay.’”

  Days before their wedding the couple moved into an apartment whose elaborate furnishings immediately became the talk of the town. English and French antiques from Louis XV to Empire filled the “public rooms,” where rich, silken draperies fell in puddles onto the floor. On the living room’s celadon walls hung a Renoir, across from a Monet landscape. In his library Kravis preferred English horse paintings. A drawing room held a Sisley, a second Renoir, and Dutch flower paintings. The apricot and yellow damask dining room, with its massive Sargent, conjured up visions of a grand English manor house. Coral damask lined the walls and silk festoon shades adorned the windows. To one side was a faux-marbre dining alcove, where Roehm would place a trio—two violinists and, say, a harpist—to play softly for dinner guests.

  Four years later GQ would enshrine the Kravis-Roehm wedding, along with that of Charles and Diana, as one of the “twenty weddings of the century since 1980.” Their vows, exchanged at the apartment, were followed by dinner for 101 and a toast by Kravis’s father. “Henry’s always been impatient,” said Ray Kravis. “He was born premature, and he’s been in a hurry ever since.”

  The newlyweds cut a wide swath through Manhattan society. Kravis, already on many of the “right” boards—New York City Ballet, Mount Sinai Hospital, the exclusive Spence School—leapt onto the coveted Metropolitan Museum board and had a museum wing named after him. Roehm, whose dresses cost up to $8,000 and are worn by the likes of Barbara Walters and Sigourney Weaver, attained the New York Public Library board of trustees and orchestrated memorable galas for the Metropolitan Opera and the New York Winter Antiques show. The Kravises added a beach home in The Hamptons, a ski chalet in Vail, and a pre-Revolutionary manor in Connecticut, where Roehm gardened and rode horses and Kravis sometimes raced around on a Honda four-wheeler. Despite his burgeoning fortune—variously estimated at between $200 million and $350 million—the Kravises continued to work grueling twelve-hour days, traveling constantly.

  When in New York they went out nightly, becoming mainstays of W and Women’s Wear Daily, in large part because Roehm, thr
eatened by up-and-coming designers like Donna Karan, made a conscious decision to seek the social limelight. Her clothes were intended for women like herself—tall, thin, and rich—and she saw the society pages as her best bet to stand out in a crowded field. W noted wryly that in her quest for publicity, Roehm appeared “on the cover of every imaginable publication, including real-estate listings.” It wondered: “Is Pravda next?”

  In many ways it was a storybook life. Summers in Salzburg. Holidays in Vail. Weekends hunting pheasant in Connecticut. Evenings at glittering charity balls. Mornings with Roehm strolling through the Renoirs, an aria on her lips. Their West Highland terrier, Pookie, walked each day by a liveried servant. Of all the stories, the one told most often was of the night Kravis surprised his wife in bed with an eye-popping emerald necklace. When she wore it to a Council of Fashion Designers cocktail party, it was the talk of the crowd.

  “Where did you get those?” asked a longtime friend.

  “I found them under my pillow,” Roehm replied.

  “And where have you been sleeping?”

  “In the right bed.”

  By 1987 the LBO industry, once the exclusive hunting ground of Kohlberg Kravis and a handful of other boutique firms, was getting crowded. Attracted by the tremendous returns seen in Gibson Greetings and Beatrice, institutional investors poured billions of dollars into scores of firms, hoping to get a piece of Kravis’s action. Two of Wall Street’s largest concerns, Morgan Stanley and Merrill Lynch, each raised more than $1 billion to do LBOs, and most other firms, including Shearson, planned similar thrusts. Kravis and Roberts hadn’t even finished spending their $2 billion 1986 fund—by far Wall Street’s largest—before one of their rivals, Forstmann Little & Co., unveiled a $2.7 billion fund. Suddenly the sound of footsteps Kravis had been hearing became a thundering posse, charging into his corral.

  Now deals where Kravis could once have quietly negotiated a buyout agreement became bidding contests. “Done deals” unraveled in the face of higher bids, sometimes wasting months of work. When Kravis did carry the day, prices were sky-high. “A lot of guys want to do deals just to do them,” complained Paul Raether. “They want to put scalps up on their walls. They say, ‘I gotta do this deal because it’ll make me a player. It’ll put me on the map.’”

  For Kravis, a startling case in point came during the fall 1986 bidding contest for Jim Walter, a Tampa construction firm. A Kohlberg Kravis bid was topped by PaineWebber, a firm with no track record in LBOs. When Kravis, alarmed, asked the firm’s chairman, Donald Marron, what he thought he was doing, Marron pointed out that his firm had a lot of money and talent committed to merchant banking and needed to put them to use. It wouldn’t be the last such conversation Kravis had.

  If Kohlberg Kravis were to reassert its dominance in LBOs, it somehow had to rise above the competition. The only place to go was up. In early 1987 Kravis and Roberts made a conscious decision to go after the megadeals, the $5 billion and $10 billion buyouts that few others could attempt. They had laid the groundwork by completing a string of mammoth LBOs: the $6.2 billion Beatrice deal, the $4.4 billion buyout of Safeway Stores, and the $2.1 billion buyout of Owens-Illinois in 1987. Now they would push into higher, uncharted territories.

  “‘Who else could do a ten-billion-dollar deal’ was the reasoning,” recalled Raether. “Nobody. The only possible competitor at those levels was corporations. And most likely you won’t get competition from corporations at that price level.”

  Erasing the competition wasn’t the only attraction of the megadeal. Kravis and Roberts knew from experience that it took little more work to complete a large LBO than it did a small one. Whatever the size of the transaction, however, their percentile fees remained the same. It didn’t take a genius to see they could make more money working on $10 billion deals than “puny” $100 million deals. On Beatrice they had taken a $45 million fee, plus $60 million apiece on Safeway and Owens-Illinois. That money went straight into the partners’ pockets.

  The vehicle to attain these new heights was a new fund, their largest ever. Even before spending the 1986 fund, Roberts began lobbying to raise another, bigger one. “We don’t have to finish the 1986 fund,” he argued. “The money is available now. Let’s get it while we can.” Recalled Raether: “By 1987 everyone had a pot of money. We wanted to have by far the biggest pot. That would differentiate us from everybody else. It would be clear we had more power than anyone else, and everyone would know it. Everyone would know the big deals were ours.”

  They began raising the new fund in June 1987, using publicity from the Beatrice deal to whip up interest. As an incentive to investors to re-up, Kravis offered to waive the management fee for all deals done before 1990. It worked. When the fund closed just four months later, Kravis and Roberts sat atop a $5.6 billion war chest, more than two times the size of its nearest competitor’s. Of the estimated $20 billion in equity poised for LBO investments worldwide, the two grandsons of a Russian immigrant controlled one dollar of every four. Fully leveraged, it gave them an unprecedented $45 billion in buying power, enough money, Fortune pointed out, to buy all ten Fortune 500 companies headquartered in Minneapolis, including Honeywell, General Mills, and Pillsbury. Wall Street had never seen anything like it before.

  Wall Street didn’t know the half of it. For the first time, Kravis and Roberts had sought and received permission from their investors to secretly accumulate stock in their targets. These so-called toehold investments, a mainstay of corporate raiders like Boone Pickens, would give Kravis negotiating advantage with chief executives and allow the firm to profit from the inevitable run-up in a target company’s stock. A reaction to its new competitive environment, this tactic, more than any other, took the firm away from Jerry Kohlberg’s fireside chats and institutionalized its new, more aggressive bent. Arm-twisting, rather than friendly discussion, would now lead to most of the firm’s deals.

  But this approach required Kravis to walk a fine line. Most pension funds, the major source of Kohlberg Kravis’s money, were either barred from, or leery of, hostile takeovers. Just a whiff of hostile action could scare off investors and irreparably damage their franchise in strictly friendly LBOs. If Kohlberg Kravis were branded a raider, what chief executive in his right mind would want to work with it? It made Kravis, thin-skinned by nature, acutely sensitive to public criticism.

  As stock prices plummeted in the crash of October 1987, Kravis and Roberts made their move, swooping in and secretly buying vast chunks of several major U.S. corporations. In 1988 they brought the LBO idea to one of those companies—its identity still secret—and were rejected. At the end of March, Kravis unveiled a 4.9 percent stake in Texaco, then under pressure from its largest shareholder, investor Carl Icahn. For two months Kravis and Roberts attempted to talk the oil company’s officials into a buyout or major restructuring. “We tried everything in the world to get them to do something with us,” Raether recalled, “and they wouldn’t.” The firm eventually sold its stock at a profit.

  The problem, it soon became clear, was that Kohlberg Kravis was all bite and no bark. With one eye trained on their pension-fund investors, Kravis and Roberts couldn’t bring themselves to make an outright hostile bid. And everyone knew it. In mid-September, the firm made an unsolicited, $4.64 billion bid to acquire Kroger, the Cincinnati-based grocery chain that had days before rejected a similar offer from the Haft family. Kroger twice rejected Kravis’s overtures, leaving him with a nice profit on his 9.9 percent stock position and egg on his face.

  It wasn’t just new deals that were turning sour. After shedding many of its businesses, Kravis was finding it impossible to sell the remainder of Beatrice. The problem was a nasty knot of liabilities that no buyer wanted to take on. After being perused by every food industry buyer from Ross Johnson to Heinz, Beatrice, for the moment, belonged to Kravis. By midyear, not only hadn’t the $3 billion profit they had hoped for materialized, Kravis and his investors were little better than break-even.

&nbs
p; It had been a rotten year. Rejected by his targets, competitors nipping at his heels, Kravis couldn’t be blamed for falling into a foul mood. When Jeff Beck mentioned approaching RJR Nabisco, Kravis hadn’t thought much of it. Kravis sent out dozens of similar feelers every month. On October 5, Kravis breakfasted with one of his favorite investment bankers, Steve Waters of Morgan Stanley.

  “What’s going on with RJR?” Kravis asked. He hadn’t talked with Johnson since their meeting a year before.

  Waters said he knew of nothing new. The last time the two had discussed RJR Nabisco, Kravis had been worried about the tobacco industry’s mounting legal problems. After the Cippollone case his worries had subsided. “I’ve rethought some of my objections about tobacco liability,” he told Waters. “Maybe we should see if Ross might want to talk.”

  Waters telephoned Johnson later that day. Jim Welch returned his call. “Henry has changed his mind about tobacco liability, Jim,” Waters said. “He’d really like to sit down with you guys.”

  “Well, that’s interesting,” Welch replied. “Ross is busy now. Let us think about it. We’ll crank through the numbers and get back to you.”

  Waters’s call should have been a warning. Johnson ignored it.

  Chapter

  6

  The history of merchant banking, with the exception of RJR Nabisco, is that I stayed out of it.

  —PETER A. COHEN

  As his sleak Gulfstream jet descended through the clouds over Atlanta that Friday evening, Peter Cohen pondered the weekend ahead. The following morning, October 8, Cohen was to meet with Ross Johnson for the first time in nearly a month. Tom Hill’s team had been assembling data for weeks, although Johnson still hadn’t signaled whether he would go through with an LBO. Cohen hoped they would find out in the morning.