Barbarians at the Gate

by Bryan Burrough

  From the outset it was clear this would be no ordinary LBO. The talk in Johnson’s office that day was cordial and covered a variety of issues: price, profits, and plans of attack, among other things. Until then their discussions had been largely theoretical and over the phone: No one was sure Johnson would actually go through with it. “What do you think the chances are he’ll do it?” Nusbaum asked Goldstone at one point. Goldstone pondered the question a moment. “Less than fifty-fifty,” he said.

  For all their uncertainty, Tom Hill was surprised to find how thoroughly Johnson’s people understood LBOs. The pupil, in fact, was about to tell the teacher how class would be run.

  Central to the success of most LBOs is a ruse known as the “gun-to-the-head” strategy. In it, a group of senior corporate executives secretly works with a Wall Street firm such as Shearson to assemble financing. Once the financing is lined up and an offering price agreed on, the chief executive presents the bid as a take-it-or-leave-it proposition to his board. Hill had even drawn up a ten-week schedule the Johnson-Shearson group could follow in approaching its own buyout. It might have been called “Ten Steps to a Successful LBO”:

  WEEKS ONE THROUGH THREE: Preliminary work on values and price discussions.

  WEEK FOUR: Meet with banks to discuss loans.

  WEEK FIVE: Banks work to refine a loan structure.

  WEEK SIX: Management decides whether to pursue LBO.

  WEEK SEVEN: Directors are quietly informed and asked to secretly form an “independent” committee to analyze any LBO proposal.

  WEEK EIGHT: Management prepares a merger agreement.

  WEEK NINE: Management makes an initial proposal to the board. Negotiations begin with the independent committee. A press release is issued stating the board is “considering a buyout proposal.”

  WEEK TEN: An acquisition agreement is executed and announced publicly.

  The idea is to keep the entire process secret until a deal has been cut, ending the bidding before it can begin. Placing a gun to the board’s head, in Wall Street parlance, is intended to leave directors with few options. Disclosing the overture prematurely tends to put the company “in play” for corporate raiders and risks frightening off a certain offer from management. For years boards capitulated and signed merger agreements with the “ambushing” management. Many still did. Wall Street strategists such as Hill consider it crucial to sneak up on a board with a fully financed offer ready to be launched. He naturally assumed Johnson felt the same way.

  Johnson wouldn’t hear of it. He had seen this board exact its wrath on Tylee Wilson for lesser transgressions; hell hath no fury like this board scorned. Nor was he willing to let Shearson arrange financing or do anything else that, if leaked, would anger directors. Johnson had it good in Atlanta, and until he made up his mind to pursue the LBO, he wasn’t going to risk it all by letting Shearson get ahead of him. On the other hand, Johnson had supreme faith in his ability to make a pitch. If an LBO was the best approach, he knew he could sell it to the board—but only if it was an idea, not an ambush.

  Diverting from accepted LBO strategy made Cohen and Hill uneasy, but they had no choice; without Johnson, they had no deal. If the board chose to publicly announce their overture, it would blow their tactical advantage. In a worst-case scenario, it would put them on equal footing with any party who might wish to top their bid. But no one—Cohen, Hill, or Johnson—was particularly worried about that happening. RJR Nabisco was simply too big for all but a handful of firms in the world to think about attacking. That day Hill ran down the possibilities:

  Hanson Trust PLC, a British conglomerate with a huge appetite for U.S. companies. Its chairman, Lord Hanson, had built its empire around a core tobacco company.

  American Brands, the Connecticut-based cigarette company whose brands included Pall Mall and Lucky Strike, had pulled off a daring defense against a hostile takeover raid earlier that year.

  Forstmann Little, Wall Street’s number-two LBO firm, had shown itself willing to charge into heated takeover battles with multibillion-dollar offers. But a $20 billion LBO, Hill suggested, was probably out of Forstmann Little’s reach.

  All were dark horses. Everyone in the room knew the only one strong enough to put up real competition was Henry Kravis. Of all the world’s conglomerates and investors, only Kravis had the combination of power, confidence, and money to mount a serious counterbid. Johnson’s office was filled with opinions and purported intelligence. Someone mentioned they thought Kravis was on an African safari and might not be able to react fast enough. But it was when Johnson talked that Shearson Lehman Hutton listened. They all knew Kravis had courted him a year earlier.

  “Henry won’t do anything,” Johnson said confidently. “I just don’t think he’s interested in tobacco.” Andy Sage echoed his boss’s feelings.

  It was a critical assertion, one that Johnson repeated several times in coming days. He knew of Kravis’s overtures via Beck and Waters and didn’t take them at all seriously. He purposely avoided mentioning them to Shearson. “No reason to,” Johnson would later say. “They’d have just run around in a flap saying, ‘We’ve got to do this and we’ve got to do that.’ These are not cool people in this business. I didn’t want them to lose any objectivity.”

  In fact, Johnson was lulled by the same fundamental fallacy embraced by the Shearson executives. For all the talk of possible competitors, most of them were convinced their bid, if launched, would be unopposed. They felt certain that no one, not even Kravis, would attempt a buyout this size without the help of a management team to identify the best ways to cut costs. Even if tempted, they believed, Kravis would no doubt be put off by the daunting complexities of tobacco litigation. Cohen and Hill, in effect, considered Johnson to be their shield against any competing bids. As the group’s primary strategist, Hill had ways to test Kravis’s appetite, but later said he felt handcuffed by Johnson’s insistence on secrecy. Asking questions, he knew, could prompt interest in the wrong quarters.*

  Just as Shearson took it on faith that Johnson could handle his board, Johnson took it on faith that Shearson could raise enough money to buy the company. In fact, the firm had never attempted anything like it and had even discussed the possibility of bringing in a major junk-bond power such as Drexel or Merrill Lynch to help out. The idea was quickly dropped: Seeking help would be an admission that Shearson couldn’t do the deal itself. Cohen was confident that, with American Express behind it, Shearson could do the job.

  Price was never a matter of serious debate. Both Hill and Johnson thought a bid around $75 a share made sense. It was higher than the stock had ever traded—around $71—although not by much. The $75 a share worked out to $17.6 billion, nearly three times the size of the Beatrice deal. The $15 billion or so they would need from commercial banks was more than twice the largest sum ever lent on a takeover; Shearson’s Jim Stern had spent hours calculating whether that much takeover money existed in the world. “Seventeen billion dollars,” Johnson said. “Fuck, I’ll be going around on my hands and knees like a monkey with an organ grinder to find seventeen billion dollars.”

  It could go higher, Hill warned. The board would try and negotiate a better price, perhaps as high as the low $80 range. It was all part of the elaborate stage play performed in most LBO situations. A management group bid low on purpose, knowing the board would want to coax a few dollars more. The ruse allowed directors to claim they had pushed for the best price. It was good public relations, but was even more useful in defending directors against the inevitable shareholder lawsuit.

  Johnson got visibly queasy when talk turned to paying more than $75. The higher the price, the more debt had to be piled on. The more debt, the more the corporate belt had to be tightened. Johnson was a man with absolutely no stomach for cost cutting, certainly not if it meant cutting back the RJR Air Force or other perks. He felt Shearson, like most lenders, was obsessed with what he called “nits and grunts” budget watching. Johnson insisted that, if the LBO went
forward, both Premier and the Atlanta headquarters be held sacrosanct from any budget cutting.

  “I’m telling you, we’re not going to start running a pushcart operation here,” Johnson declared. “I don’t want a bunch of your guys coming around saying we should have five jets instead of six, that sort of thing. I realize if we do this I’ll have to work my ass off a while. I don’t mind that. But I don’t want my life-style to change. I’ve got a great company, a nice life, I don’t want to change the way I live.”

  A more seasoned LBO player might have laughed at the idea of a painless LBO. Cohen and Hill went along, although privately Hill felt certain that both Premier and the headquarters would ultimately be sacrificed. Both men were bent on making the process of an LBO as easy for Johnson as possible; nothing would be done to spook their prize stallion from charging out of the gate at the board gathering the evening of October 19, just ten days hence. They readily acceded to each of Johnson’s “demands”; the future of Shearson’s LBO effort depended on keeping him happy.

  Steve Goldstone, hired to protect Johnson’s interests, sensed that Shearson might be painting an overly rosy picture for his client. “Look,” he told Nusbaum at one point, “are you guys telling Ross that he is going to have to pay top dollar here, and that he will have to make a competitive bid?” Both Nusbaum and Hill swore they were telling it straight.

  The last, and most important, point of discussion that day was a management agreement. As the central document defining Johnson’s relationship to Shearson, it would lay out how RJR Nabisco would be run, who would control it, and how the profits would be split.

  Within the LBO community, executives who throw in their lots with the likes of Henry Kravis have clearly defined roles. As leaders of publicly held companies, they were ardently wooed by LBO firms; a Kohlberg Kravis can knock on the door, but in most cases it can’t get in without being invited. In return, LBO firms typically permit them to put up their own money to buy 10 to 15 percent stakes in the companies they previously ran as professional managers. But while the CEO remains nominal head, and often retains operating autonomy, there is no mistaking who calls the shots: firms such as Kohlberg Kravis and Forstmann Little control every board, approve every budget, and retain the power to remove senior executives at their whim. LBOs are not democracies: each executive in a Kohlberg Kravis-owned company answers to Kravis and Roberts.

  Johnson didn’t care much for conventional wisdom. What he had in mind amounted to nothing less than a total reversal of the traditional roles of the executive and the LBO firm. Why, Johnson wondered, should Shearson control the board? After all, wasn’t he the one putting his job on the line? Why shouldn’t the managers, the men who knew this company best, call the shots? To Shearson’s amazement, he had demanded control of the board and a veto over major strategic decisions, both during and after the deal. He suspected correctly that Shearson would want to cut Premier, the headquarters, and the RJR Air Force. A veto was his insurance RJR Nabisco would be run his way, not Shearson’s.

  “For Christ’s sake, I’m not going to have a bunch of bloody investment bankers on my board telling me what I can do and what I can’t do,” he told Cohen. “You’ve got to have faith that I know how to do it. I don’t need a bunch of kids looking at screens all day trying to figure it out for me. That’s the way it’s got to be if I’m going through all this horseshit and put myself through five more goddamn years of agony instead of retiring.”

  Henry Kravis would have told Johnson to jump in a lake. But Cohen and Hill had already made up their minds to concede to his demand. Again they felt they had no choice. Johnson made it clear: No veto, no deal. “It was,” Hill would later acknowledge, “the price of admission” to a club Shearson badly wanted to join.

  But Cohen had so far balked at Johnson’s most outrageous demand. Andy Sage had determined that Shearson had promised the investors in its new fund a 40 percent return on their money. Fine, Sage said, Shearson could have 40 percent; he insisted Johnson and his people receive everything left over. That worked out to 20 percent or more of the stock in a post-LBO RJR Nabisco. Without arguing, Hill had let Sage know he considered the request excessive. As evidence, he had brought to Atlanta a sheaf of management agreements from other LBOs; in Beatrice, for example, Kelly and his people had bought a 12.5 percent share.

  But Johnson not only wanted a far larger percentage of the profits, he wanted it on a far larger deal. Hill had calculated a 20 percent share of the profits could be worth $2.5 billion to Johnson’s group in five years. In a September 30 memo to Cohen, Jim Stern had noted that Johnson’s suggested cut, or promote, “seems very large, particularly when one considers the size of this deal compared with [previous] ones. In absolute terms, the level of management’s promote dwarfs those in other deals.”

  The matter was discussed again Saturday. But when the group adjourned around three o’clock, little headway had been made. So much progress had been gained on other fronts it hardly seemed necessary to muddy the waters with a lengthy negotiation. Johnson assured Cohen the question of splitting the profits wouldn’t be a problem, and Cohen, thrilled with their progress, felt certain he was right. Sage agreed to discuss it with Hill the following week.

  Before returning to New York, the Shearson bankers tried once again to persuade Johnson to sit down with a group of commercial banks to discuss financing. Johnson refused. Shearson, he said, could approach only two banks, and then only for preliminary discussions. Find out if there’s enough money to do this deal, Johnson told Cohen, and limit it to that. They would have plenty of time to negotiate bank agreements in the weeks to come.

  Monday was Columbus Day. Cohen reached Charles Sanford, chairman of Bankers Trust, at his home. “Charlie, I have to talk to you about something that is of great importance to both of us. The sooner we can do this the better. Once we talk about it, you’ll understand why we can’t do this on the phone…” Cohen reached Citibank’s chairman, John Reed, the next day. “John, I’ve got a tremendous opportunity for you…”

  The following morning, Wednesday, October 12, a Shearson team led by Jim Stern met separately with senior representatives of Bankers Trust and Citibank. To ensure secrecy Stern demanded that both banks limit their credit analysis teams to no more than four bankers. Within two days he heard back that both were ready to commit to the transaction. This was going to be easier than anyone had hoped, Stern thought.

  Bob O’Brien, the head of takeover lending for Bankers Trust in New York, found analyzing Shearson’s proposal among the most fascinating exercises of his career. There was no question that any bank would jump at the opportunity to lend money for the LBO of a blue-chip company like RJR Nabisco. The central dilemma was this: Was there, as Jim Stern had already wondered, enough takeover money in the world to do it?

  In most large takeovers, loans are parceled out, or syndicated, to banks around the globe. O’Brien’s team canvassed each of his department’s fifty or so salespeople worldwide. Country by country, bank by bank, they totted up the dollars available for LBOs. The lending practices of banks in Ireland, Belgium, Denmark, and Greece were assessed. How would the Union Bank of Finland react to the buyout of an Atlanta conglomerate? How would the unpredictable Japanese banks feel about tobacco?

  In the end, O’Brien concluded there was a total of $21 billion worldwide that could be committed to a single buyout. From there he worked down. Not all the money, of course, would come. Some banks won’t like tobacco, he reasoned, because the chairman had smoke blown in his face one day. Of the $21 billion, O’Brien was willing to bet he could put his hands on $16 billion. It was an aggressive guess. In its calculations Shearson penciled in $15.5 billion—roughly three-quarters of all the LBO money in the world.

  For a man whose life had been one long party, there was a curious lack of merriment about Johnson in the days leading up to October 19. Andy Sage was struck by the fact he wasn’t getting the buoyant, late-night calls from Johnson that had accompanied all their
previous adventures. It struck more than a few amateur psychologists that Johnson might be doing the whole thing to fill the void caused by his son’s accident. Bruce Johnson remained in a coma.

  As the board meeting approached, Johnson seemed to grow ambivalent toward the whole idea of an LBO. Part of it, of course, was that so many of Johnson’s longtime pals wouldn’t be taking the trip with him. In a long, teary dinner, Johnson told Bob Carbonell he wouldn’t be part of the seven-man group making the bid; if they won, Del Monte was to be sold. Of those included, Ed Horrigan was the most enthusiastic. According to Johnson and others, Horrigan was positively giddy at the prospect of LBO riches. He scurried about, working and reworking a list of those to be included in the group on a yellow legal pad.*

  If Johnson was salivating over the millions he stood to make, no one saw it. Nor did he seem concerned by the inherent conflict of interest faced by executives engaged in LBOs. To Johnson, buying the company wasn’t a conflict of interest but a wondrous convergence of interests. In an LBO, he believed, everyone would win. The stock problem would be solved. Stockholders would get a $75 payout: “We wouldn’t hit that level for four or five years running the company the way it was,” he said, as if four or five years were an eternity. Shearson and his friend Jim Robinson would get a great feather in their caps. And Johnson and his friends would get rich beyond their wildest dreams.

  Monday-morning quarterbacks would attribute Johnson’s decision to proceed to greed. But it was more complicated than that. First and foremost the LBO seemed to satisfy Johnson’s cravings for action: He wasn’t letting this organization decay. If his justification—the stock problem—was overblown, Johnson had shown himself incapable of ignoring a dilemma other CEOs would dismiss as minor. And while Johnson liked the prospect of an instant fortune as much as any man, he loved giving as well as receiving. This would be the ultimate gift to everyone. “Ross,” his psychologist friend O. C. Adams observed, “created a situation where [he thought] there was a chicken in every pot.”