Barbarians at the Gate

by Bryan Burrough

  Cohen’s little speech sent shivers through Kravis. So this is what it’s come to, he thought. Every investment banker with an extra nickel in his pocket thinks he ought to go into LBOs. After five years of steadily mounting competition, Kravis was sick of it. Morgan Stanley, Merrill Lynch, firms he had never heard of, all wanted a piece of his business. Now it was Shearson Lehman. The entire idea behind Kohlberg Kravis’s 1987 fund was doing deals too large for anyone else to handle. Once and for all, Kravis had hoped, his firm could leave the competition behind. Now, just as they had carved out a territory for themselves, here came Peter Cohen, a man who probably didn’t know the difference between LBO and BO, claiming he had a right to do an $18 billion deal! Kravis couldn’t believe the ingratitude, the gall. One part of him wanted to teach all of them, particularly Peter Cohen, a very rough lesson.

  “I regard Shearson as a firm we’ve given business to,” Kravis repeated. “I have a relationship with you. This would have been the perfect deal to bring to us.”

  “But we’ve raised this money,” Cohen repeated. “We have a responsibility to investors in the fund to put that money to work.”

  “This deal is so visible, so big,” Kravis warned. “It has all the right cash flow characteristics, I can’t lay off. We have to be in on this deal. And we will be in this deal.” *

  Tom Hill, watching and listening, thought Cohen’s notion a bit strange. Did Peter really think Henry Kravis would stay out of a $20 billion deal because of a conversation on a ski slope? He could see, in any case, that neither Cohen nor Kravis was going to budge. Each man seemed to believe it was his blood right to own Ross Johnson’s company. Hill tried to play the peacemaker, occasionally throwing in a “What can we do?” or a “How can we work that out?” He was getting nowhere. These two were just building up steam.

  “I’d be very surprised if you end up buying this at seventy-five,” Kravis said.

  “Why?” Cohen asked.

  “We’ve been looking at this company for a long time, and we know it well. This bid is just cheap. It’s really very cheap.”

  “This is really Ross’s deal,” Cohen said defensively. “We’re just financing it.”

  “Well, you’re his partners now.”

  “It’s Ross’s deal, and he’s very close to the board.”

  Kravis didn’t miss Cohen’s message: Johnson had his board in his back pocket.

  “What do you intend to do?” Kravis asked.

  “What do you intend to do?” Cohen shot back.

  “I don’t know what I’m going to do.”

  “Well,” Cohen said, “what do we do about it?”

  “Well,” Kravis said finally, “maybe there’s a role for both of us.” Kravis had anticipated this confrontation. There were, he suggested, three options. “We can compete,” he said. It was a notion neither Kravis nor Cohen relished. A drawn-out bidding battle could send the price of the company skyrocketing and, because higher purchase prices inevitably meant higher debt levels, would all but guarantee the winner a Pyrrhic victory.

  Or, Kravis continued, Shearson and Kohlberg Kravis could team up in a joint bid for the company. Neither Kravis nor Cohen, their egos fully intact, relished that idea either. For his part, Cohen regarded a partnership with Kravis—or anyone else, for that matter—as an admission that Shearson couldn’t manage the deal itself. Selling off a piece of equity to an investor was one thing; he expected to do that. A fifty-fifty deal was another thing altogether. A partnership, at least between these two men, seemed unlikely.

  Or, Kravis concluded, Shearson could sell RJR’s food businesses to Kohlberg Kravis, taking tobacco for itself.

  Cohen was noncommittal. He would have to check with Johnson and others before seriously talking about any joint venture with Kohlberg Kravis. “It may make sense for us to do something together, Henry. But what does that say about the future? I don’t know the answer to that. What does it all mean? I can’t tell you that now.”

  The meeting was winding down. Maybe, Cohen suggested as he got up to leave, they should talk more next week.

  Afterward Cohen and Hill retreated to Hill’s Upper East Side apartment. There they called Johnson and relayed the news. Cohen played down the confrontation, insisting that he planned to meet again with Kravis on Monday.

  When they finished, there was a long silence.

  “What do you think it means?” Johnson asked.

  “One way or another,” Tom Hill said, “Henry is coming.”

  Cohen also relayed news of the meeting to his boss at American Express, Jim Robinson, who was at his Connecticut farm.

  Robinson listened with interest. As Cohen laid out the confrontation with Kravis, his interest turned to worry. Henry Kravis was not someone to be trifled with.

  Maybe, Robinson suggested, he should call and reason with Kravis himself. “Maybe we can work together on this thing,” he said.

  Cohen discouraged that idea, explaining that he believed it would be interpreted as a sign of weakness.

  Robinson wasn’t so sure. But he decided to bow to Cohen’s on-the-scene expertise. No good second-guessing the executives you place in charge of day-to-day matters, he told himself. He knew how much this deal meant to Cohen and to Shearson’s future. Cohen wasn’t giving up a single piece of RJR Nabisco without a fight.

  Still, Robinson reasoned, talking with Kravis only made sense. The man was simply too powerful to needlessly provoke.

  “Give me one more shot at Henry,” Cohen asked. “Give him a chance to do his homework, and I’ll get back to you Monday morning after I talk to him.” Jim Robinson agreed.

  Kravis wasn’t waiting around for Peter Cohen.

  By Friday evening he had assembled a team of investment banks to advise and finance a competing offer for RJR Nabisco. Heading the list was Drexel Burnham, Jeff Beck’s employer. Drexel’s powerful junk-bond network was still remarkably intact despite being the focus of a two-year federal investigation stemming from the Ivan Boesky insider-trading probe. Still, Drexel’s future was a question; an indictment was rumored to be near. And if it hit in the middle of the coming contest, it could have catastrophic consequences for Kravis. To cover himself, he decided to hire Merrill Lynch as a backup fund-raiser.

  Morgan Stanley, the bank of Steve Waters and Eric Gleacher, was a natural choice for the routine number-crunching and advisory work Kohlberg Kravis would need. Waters was a Kravis favorite, and Kravis knew the banker’s career could use a boost after his abrupt fall from power at Shearson.

  Three investment banks made for a cumbersome, not to mention expensive, team. It would be the largest array of advisers ever assembled on a Kohlberg Kravis deal. Even so, Kravis decided to hire a fourth: the red-hot merger boutique, Wasserstein Perella. Wasserstein, arguably Wall Street’s most brilliant takeover tactician, would be invaluable in any major deal. But advice was not what Kravis needed from him. Hiring him was purely a defensive move: He wanted Wasserstein out of circulation. Left out of the deal, Wasserstein could prove a dangerous agitator. Better to hire the roly-poly deal maker and lock him in a closet than allow him to run loose and perhaps assemble a competing bidding group.

  Hiring the investment banks had gone smoothly. But Kravis had encountered a rude surprise when he began assembling the team of commercial banks he would need to raise the $10 billion or more of permanent financing. On Thursday he had called Ronald Badie, the head of West Coast operations for Bankers Trust, the big New York bank that was a leading source of takeover financing. Badie, Kravis’s longtime banker, promised to start work the next day after clearing the assignment with his bosses in New York. But when Badie called back on Friday he sounded strangely calm.

  “Henry, there’s a problem,” the banker said. “I’ve got to be honest. Right now I don’t have clear-cut permission to go forward with you. But I’ll try to work something out over the weekend.”

  Kravis was floored. Nothing like this—certainly not on this scale—had ever happened before. The on
ly possible reason Badie couldn’t commit, Kravis knew, was that Peter Cohen had already hired Bankers Trust on an exclusive basis, an exceedingly rare and cutthroat move. This was a crisis of the first order. Cut off from its regular source of bank money, Kravis’s army had no bullets.

  “You can’t be exclusive with someone else!” Kravis exploded. “You can’t be!”

  All day Saturday Kravis pondered what to do about RJR Nabisco. The more he stewed, the more worried he became. Cohen and Hill, although no veterans of buyouts, weren’t stupid. Unless he heard otherwise, Kravis had to assume they had bank financing in place and were on the brink of sewing up the deal. The way Cohen sounded the night before, the board of directors must surely have been in Ross Johnson’s pocket.

  The situation with Bankers Trust was an unexpected crisis. It not only threatened to cut Kravis off from his most reliable source of funding, but was regarded by him as clear evidence Shearson was trying to prevent the major banks from funding a competing bid for Johnson’s company. On top of that, Kravis had learned that the American Express board was scheduled to meet on Monday. That could mean only one thing: Shearson needed its corporate parent’s approval for the massive bridge loan it required to fund the buyout.

  Everything pointed to Shearson and Johnson’s wrapping up this deal quickly. And if they signed a merger agreement, Kravis knew, it would be difficult to break. On Saturday night Kravis consulted with Bruce Wasserstein. Wasserstein, known for his aggressive tactics, counseled a blitzkrieg approach. If Kravis was seriously worried about Johnson’s locking up the deal, he said, the only way to proceed was to attack—and fast. Any delay gave Johnson time to sign a merger agreement with a board of directors apparently packed with his cronies.

  Wasserstein, also trained as a lawyer, paraphrased former Supreme Court justice Louis D. Brandeis. “Sunlight is the best of all disinfectants,” he told Kravis. If Kravis was worried about Johnson stealing this deal in some darkened back room, Wasserstein argued, he should shed some sunlight on the process. And the best of all illuminations, he continued, was an immediate tender offer.

  A meeting of the entire Kravis team was set for the next day.

  Fast, fast, fast, Kravis thought. Everything had to move fast.

  Around the world there are thousands of commercial banks. In the takeover world, only three count.

  Citibank, Manufacturers Hanover Trust Co., and Bankers Trust formed a powerful triumvirate with loose control over the spigots through which flowed the billions of dollars in money necessary to fuel Wall Street’s takeover machine. Junk bonds sold by Drexel Burnham and others were important means of supplementary financing, but without the Big Three banks, the takeover world would come to a screeching halt.

  So powerful was this trio, and so eager were they to lend money for takeovers, that by the late 1980s all three were acting as “common carriers” for merger money. That is, they saw nothing wrong with lending simultaneously to any number of bidders seeking the same prey. Like their distant cousins the investment banks, the commercial banks erected “Chinese Walls” of secrecy to maintain the confidences of each bidder.

  From time to time, of course, this notion angered the banks’ longtime clients. Gillette, the Boston-based razor-blade maker, cut its long-standing ties to Citibank when an arm of the bank agreed to back a hostile bid for control of the company. Other examples abounded. All in all, the banks found lucrative takeover fees more than outweighed the lost business of a few churlish clients. As much as Corporate America disliked the practice, the fact remained that the banks’ power and influence were simply too pervasive to be challenged.

  It was possible, although rare, to hire one of the Big Three on an exclusive basis for a major takeover. It was also expensive. Henry Kravis’s suspicions to the contrary, Shearson hadn’t in fact demanded an exclusive arrangement with either Bankers Trust or Citibank. Not foreseeing competition, Peter Cohen hadn’t thought they would need exclusives. Jim Stern, Shearson’s liaison to its banks, had brought the matter up informally with Bob O’Brien of Bankers Trust, but O’Brien had allowed the matter to be left vague. O’Brien would later acknowledge, however, that he had allowed Shearson to operate under the impression that his bank wouldn’t lead a competing bank group. There remained an implicit understanding that Bankers Trust was working for Ross Johnson alone.

  Thus when Ron Badie had asked for clearance to back Kravis, O’Brien’s New York superiors, caught off guard, had blocked it until the matter could be cleared up. All weekend Badie tried in vain to secure approval to work with his largest client. The snag wouldn’t be untangled until the following week, well after it had already had an effect on Kravis’s actions.

  Until Saturday evening, the Kravis camp hadn’t been in touch with the other two members of the banking triumvirate. Dick Beattie, Kravis’s attorney and confidant, was relaxing in his Manhattan apartment Saturday night when he took a call from Mark Solow. Solow, head of acquisition finance at Manufacturers Hanover, was a canny banker, well respected among Wall Street’s takeover set.

  Solow explained that he was trying to reach Peter Solomon at Shearson. He knew Beattie was also one of Shearson’s closest outside advisers. Did Beattie have Solomon’s home number?

  “What do you want to talk to Peter about?” Beattie asked.

  “I probably shouldn’t tell you,” Solow responded. “But I need to talk to someone at Shearson Lehman right away.” What Solow didn’t say was that he had been contacted by Bob O’Brien of Bankers Trust about joining the Shearson bank group, and wanted to talk to someone at Shearson before accepting.

  Nevertheless, Beattie realized the call had to be about RJR Nabisco. Solow obviously didn’t know about Kravis’s interest and certainly wasn’t aware that Beattie was representing Kravis in a brewing fight with Shearson.

  Beattie thought fast. The developing situation with Ron Badie made him especially sensitive toward bank matters. He had to cut Solow off before he got to Shearson.

  “It’s funny you should call, Mark, because Henry Kravis wants to talk to you. Can I have him call you?”

  “Sure.”

  Beattie told Solow he couldn’t find Peter Solomon’s number and hung up. He immediately dialed Kravis and explained the situation.

  Kravis reached Solow early the next morning. “Is Manny Hanny working on an exclusive basis for Shearson?” he asked.

  “No, we’re not working on an exclusive basis with Shearson or anyone else,” Solow said.

  Kravis was relieved to hear Solow was available. In that case, he told the banker, Kohlberg Kravis wants to hire Manufacturers Hanover on an exclusive basis for a bid on RJR Nabisco.

  Solow was surprised. “Jeez,” he said. “We’ve never done that before.”

  “Well, you’re going to do it this time,” Kravis said. “We’ll make it worth your while.”

  For Kravis it was a rare piece of good news. Manny Hanny was one bank Peter Cohen wouldn’t get his hands on.

  It was during that weekend that the first boxes of financial data began arriving at Lazard Freres and Dillon Read, the vanguard of a wave of numbers the bankers would receive in coming weeks to help them determine RJR Nabisco’s fair price. Inside they also found a half-dozen financial studies authored by outsiders, most sent in attempts to cajole Johnson into some type of restructuring.

  At Lazard, Luis Rinaldini hustled into a colleague’s office that Saturday with a handful of studies. “Have you seen these?” the Argentinian asked in amazement. At his Chicago apartment, Ira Harris received the documents Saturday morning and was shocked by what he read.

  Not a single valuation put RJR Nabisco’s value below $80 a share. Most were closer to $90. Dillon Read’s Project Tara put a price tag on RJR Nabisco of $81 to $87 a share, an average of $2 billion more than Johnson’s $75 suggestion. Ruben Gutoff’s Project Reo noted that private market valuations of the company went as high as $96 a share. All the bankers knew RJR Nabisco had fat to cut—Johnson’s RJR Air Force was notori
ous on Wall Street—but they hadn’t expected to see valuations like this.

  While the bankers sifted through Johnson’s data, a curious package was delivered anonymously to Charlie Hugel in Connecticut. Inside Hugel found an RJR Nabisco planning document, apparently generated by Dean Posvar’s people. Titled “Corporate Strategy Update” and stamped CONFIDENTIAL, it was dated September 29, just three weeks before Johnson addressed the board.

  Hugel read the document carefully. It gave an overview of the stock problem, outlined ways to fight Philip Morris, and suggested tobacco liability concerns probably made the company an unlikely takeover candidate. But what drew his attention were the valuations put on the company. Step-by-step, the document built a case for placing a price tag on RJR Nabisco of as low as $82 a share and as high as $111 a share. “A strong case,” it concluded, “could be made for RJR Nabisco refusing to accept any offer below one hundred and eleven dollars per share.”

  Hugel was confused. As low as eighty-two? If Johnson’s own people said the company was worth $82 to $111, what the hell was he doing bidding at $75?

  Equally curious was the source of the document. There was no note attached, no clue to the sender’s identity. But one thing was clear: Someone, almost certainly a high-level RJR Nabisco executive with access to confidential documents, was out to get Ross Johnson.

  “We’re interested in a tobacco company,” Kravis began, eyeing Bruce Wasserstein, “but I’m not sure I want to tell you which one yet.”

  Kravis smiled. Everyone in the crowded boardroom knew Wasserstein was waist-deep in the Philip Morris bid for Kraft.

  On Sunday afternoon the investment bankers had trickled in in pairs, driving in from weekend homes or strolling through the leaf-strewn paths of Central Park to convene in Kohlberg Kravis’s boardroom at four o’clock. Kravis and his people had arrived by noon and had spent much of the afternoon studying various analyses of the values locked inside RJR Nabisco.

  From his seat at the side of the great table, Kravis surveyed the troops he had assembled for his assault. To his left, in his customary position, sat Dick Beattie, pale blue eyes steady, jaw firmly set. To Beattie’s left was Casey Cogut, the lawyer’s boyish second in command. Cogut supervised much of Kohlberg Kravis’s legal work at Beattie’s direction. The two lawyers had driven in together that morning from their Connecticut homes.