Barbarians at the Gate

by Bryan Burrough

  Fennebresque got excited. He phoned Maher, who walked down from his office. Fennebresque laid out their plan. Did Maher think it could work?

  Maher pondered the idea for a moment. “I wouldn’t object to that,” he said.

  Fennebresque found the response, so typical of Maher, maddening. I wouldn’t object to that? What kind of reaction is that? This is a great idea! It was exactly the facet of Maher’s personality his friend found so exasperating. How many times had Fennebresque pleaded with Maher to stand on a desktop and give a stirring speech? The enthusiasm just wasn’t in him.

  Fennebresque roped together a group and began telephoning LBO buyers who might be interested in forming a consortium to bid for RJR Nabisco.

  Maher, a man badly in need of good news, finally got some the following week. To his surprise, his pursuit of Philip Morris paid off. The company, although still locked in a fight for Kraft, hired First Boston to analyze a possible bid for RJR Nabisco. Maher knew chances were small that Philip Morris would acquire RJR. But maybe, Maher thought, it might drop its Kraft bid if it cut a friendly deal with Ross Johnson. If so, First Boston could use Philip Morris as the centerpiece of a consortium to buy the company.*

  For Maher’s closest advisers, the Philip Morris assignment was especially sweet. It held out the prospect of spoiling Wasserstein’s coup on the Kraft bid while gaining a share of the RJR Nabisco battle, all in one fell swoop. “This is great!” enthused Fennebresque. “It fucks Bruce on Kraft. It fucks Bruce on RJR. It preserves our relationship with Philip Morris. And it gets us into the RJR deal. Beautiful!”

  Fennebresque’s group, meanwhile, was having little luck assembling the consortium Maher envisioned building around Philip Morris. Fennebresque had met several times with aides of billionaire investor John Kluge, but the talks went nowhere: Disclosure of Johnson’s management contract had lent the deal a patina of greed from which Kluge recoiled.

  Several days later, Maher learned that Philip Morris was about to strike a friendly deal with Kraft and thus wasn’t likely to chase RJR Nabisco any further. Coming on the heels of the failed Kluge talks, the news struck Maher like a blow to the stomach. His worst fear now seemed unavoidable: First Boston was to be the only major Wall Street firm left out of the deal of the century.

  For several days, First Boston’s RJR team fell into a funk. Greg Malcolm, the firm’s junk-bond chief, jokingly captured the mood. “We’re just a dog chasing a bus,” he told colleagues. The inference was clear: First Boston, in attempting to join the battle for RJR, was out of its league.

  As the bankers’ minds idled, doubts about First Boston’s direction returned. Fennebresque, plagued with dire visions, flew off to Minnesota to scout a minor acquisition candidate. Can we ever be the same again? he found himself wondering. Bruce made us all feel so special. You couldn’t help but bask in his reflected glory. Can we ever regain that feeling that we were special?

  Unlike Fennebresque, few witnessed Maher’s demons. To outsiders he remained impassive, steady as ever. Inside, Maher was scared. He had tried every way he knew to get a piece of the RJR Nabisco deal and had gotten nowhere. He knew what people were whispering behind his back. First Boston has lost it. They’ll never be the same again without Wasserstein. “Our franchise was on the line,” Maher recalled. “It was crucial we get involved in this deal.”

  Maher wasn’t totally without options. One idea particularly intrigued him. Late one Friday afternoon, Brian Finn had burst into his office with another of his schemes. In his excitement, Finn had ordered Maher’s secretary to hold all calls.

  “If you fucking pick up the phone, I’ll kick your ass,” a smiling Finn told his boss. “Now shut up and pay attention to me.”

  Maher harbored a special affection for Finn, one of First Boston’s brightest young stars. Finn was Wall Street’s version of a computer hacker, a brash numbers cruncher who spent hours alone ruminating about takeover tactics. A fervent New York Mets fan, he developed his love for numbers as a kid computing batting averages. As First Boston’s specialist on antitakeover restructurings, Finn patrolled the outer edges of accepted merger strategies, twisting and reshaping corporate balance sheets to mount creative defenses to hostile takeovers. His boyish face, unruly brown hair and rumpled suits, not to mention his lightning-fast mind, reminded some of a young Bruce Wasserstein. In fact, Finn had been a Wasserstein favorite and became the subject of an intense tug-of-war between his departing mentor and Maher. Maher won out after a long evening’s talk in which he and Finn drained a bottle of gin. “In the end I just couldn’t kick Jimmy when he was down,” Finn said.

  Finn brought Maher’s attention to a two-page memo lying unread on his desk. Finn had sent it that morning after being hit with an idea during the hour-long drive to his new Long Island home. The strategy laid out in the memo was, Maher could see, complex, incomplete, and an incredible long shot.

  It turned on an esoteric tax law loophole set to expire December 31, just two months away. In its first step, Finn’s plan called for First Boston to acquire RJR’s food businesses for a bundle of securities known as installment notes. In theory at least, First Boston could take those notes to a major bank and receive money for them, a process known as “monetization.” The beauty of the idea was that, using the loophole, taxes on the notes could be deferred for ten or twenty years, creating a tax savings of as much as $4 billion. In the plan’s second step, First Boston would auction off Nabisco, passing on 80 percent of the profits to RJR shareholders and keeping the remainder. RJR’s board could save billions of dollars and pass on its windfall to shareholders on a tax-free basis. First Boston would then acquire RJR’s remaining tobacco businesses in a conventional $15 billion leveraged buyout.

  The installment note loophole, discovered by Wall Street tax counsel in reaction to tax law restrictions in 1986 and 1987, had first been used in the sale of several businesses in the wake of Campeau Corporation’s 1988 takeover of Federated Department Stores. So successful was it in saving taxes that Congress eliminated it in September. But legislators made the move effective at year-end, giving First Boston and other corporate buyers a brief window of opportunity. Finn proposed to drive the largest takeover in history right through that window.

  Maher was skeptical. To himself he wondered if the idea wasn’t just a little too flaky, a little too outlandish for such a high-profile deal. Installment notes had never been tried on such a scale. Hundreds of questions, Maher knew, would have to be resolved before the sketchy plan could be considered a viable alternative.

  “There’s a lot left to resolve,” Finn acknowledged.

  “So,” Maher had said, “go resolve.”

  First Boston’s search for a bidding partner had stalled after talks fell through with the Kluge group. Then, on November 9, after a week of inactivity, Leon Kalvaria walked into Dave Batten’s glass-walled office. Kalvaria was a cigar-chewing Rhodesian who had aided the unsuccessful search for a partner.

  “Goddamn it,” Kalvaria groused, “let’s not just give up.” He and Batten hauled out the lists of potential partners and looked at them once more. Had they forgotten to call anyone? The two bankers threw out name after name until they came to one Batten didn’t recognize: Resource Holdings.

  “What about them?” Kalvaria asked.

  “Who is it?”

  “It’s Jay Pritzker.”

  Batten wasn’t heartened. Pritzker, the respected Chicago investor who owned Hyatt Hotels, had a reputation as being unwilling to pay top dollar for acquisitions. First Boston hadn’t even bothered to contact his people. But time was running out. Bids were due in nine days. “Why not?” Batten said. “Make the call.”

  Later that day Kalvaria reached Jerry Seslowe, Resource Holdings’s chief executive. At forty-two, Seslowe, a roly-poly former accountant with Groucho Marx eyebrows, kept a low profile on Wall Street. After eleven years at the Big Eight accounting firm Peat, Marwick, Mitchell & Co., where he worked with Pritzker and other big-name inves
tors, he had begun his own small investment firm. Resource Holdings spent much of its time considering investment options for Pritzker and Denver billionaire Philip Anschutz, the rest for a stable of other investors: Indianapolis shopping mall king Melvin Simon and Cincinnati investor Carl Lindner, among others. On Wall Street, Seslowe was considered a minor leaguer whose client list occasionally enabled him to hit a home run.

  Seslowe listened patiently as Kalvaria made his pitch. He liked the young Rhodesian, and he knew First Boston badly wanted a way into this deal. But to Seslowe, Kalvaria’s idea smacked of desperation.

  “You have to be crazy,” he told Kalvaria. “For us to come into this at this late date, it’s too little too late. Leon, go home.”

  Kalvaria persisted, but Seslowe would hear no more. “Forget it, Leon. Go home.”

  Only later was Kalvaria reminded of Brian Finn’s unusual strategy—“Finn’s tax thing” as it would come to be called. He tried Seslowe again the next day.

  “Jerry, we have an edge. We have a tax structure that could give shareholders eight to ten dollars in additional cash which can’t be done by KKR or Shearson. Can we come up and make a presentation?” Seslowe relented. “Okay, come on over.”

  The next morning Fennebresque and Kalvaria spent an hour going over their idea with Seslowe. The First Boston bankers hinted they had other major clients—they mentioned Pepsi—that might go along as well. Seslowe, impressed, said he would study the idea further. “I wish you guys had called us two weeks ago,” he said.

  Jay Pritzker listened closely as Seslowe’s voice crackled over the line from New York.

  At sixty-six, Pritzker headed a family acknowledged to be among America’s sharpest investors. He was a small, wiry man still energetic after triple- and quadruple-bypass heart surgery. Grandson of a Russian-born pharmacist who emigrated to Chicago from Kiev in 1881, Pritzker had built over four decades a business empire as notable for its diversity as its profitability. It centered on two businesses, the Hyatt Hotel chain, and Marmon Group, a secretive conglomerate with tentacles into more than sixty businesses, from ready-mix concrete to Ticketmaster. Low-key and headline shy, the Pritzkers made a rare splash in the mid-1980s with a bold attempt to resuscitate bankrupt Braniff Airlines, an effort that ultimately proved disappointing.

  That Friday, Jay Pritzker listened skeptically as Jerry Seslowe detailed First Boston’s unusual tax strategy. “Ah, Jerry, it’s too late,” Pritzker said. Formal bids were due in just seven days. But Seslowe persisted. As the two discussed their probable competitors, Shearson and Kravis, Seslowe detected a shift in Pritzker’s interest. Pritzker had long been an admirer of Henry Kravis and was impressed by his intense interest in RJR.*

  “If Henry is there,” Jay Pritzker said, “maybe there’s something to it…”

  Billionaires have a way of making friends.

  One of Jay Pritzker’s closest friends and advisers was Melvyn N. Klein, an amiable Corpus Christi, Texas, investor who, while working on Wall Street in the early 1970s, had become friends with Henry Kravis. In early 1988 Klein had formed an investment fund with Harry Gray, the former chairman of United Technologies. The fund’s third partner was a partnership headed by Jay Pritzker. By that spring Gray Klein, armed with $500 million in newly raised capital, had attempted to invest in a number of high-profile takeovers, including the battle for Federated Department Stores.

  In February, a Gray Klein limited partner named Daniel Lufkin proposed that Pritzker and Gray Klein investigate an LBO of RJR Nabisco; the plan was dubbed Project Smokescreen. Klein and the Pritzkers spent months analyzing the proposal. None knew Ross Johnson, so Klein had suggested they feel out Kravis about a joint approach. Klein pitched the idea to Kravis at a breakfast May 4. “There’s no way he’s going to do this,” Kravis had said, relating details of his earlier meeting with Johnson. “Just no way.” That was the end of Project Smokescreen.

  In October, after Johnson’s initial proposal was announced, Klein had called Kravis again and expressed interest in acquiring a minority stake in any Kravis buyout of the company. Kravis had said he would think about it.

  Friday afternoon Pritzker phoned Klein in Texas. “Mel, what is our obligation to Henry Kravis on RJR?” Klein said he knew of none, but would check. That afternoon, as Pritzker weighed whether to join forces with First Boston, Klein reached Kravis.

  “I just want to be up-front with you,” he said. “It looks like Jay Pritzker may team up with First Boston on a third-party bid for RJR Nabisco.”

  “Thanks, Mel,” Kravis said. “I appreciate that.”

  Hope was dwindling fast for First Boston when Maher convened a meeting in his office that Friday afternoon. His only chance of avoiding the ignominy of being left out of the RJR Nabisco deal was Finn’s flaky restructuring proposal. He called in Finn and a handful of others to figure out what to do. Outside the sun was setting. As a metaphor it seemed all too apt.

  Finn had drawn up a more detailed set of plans for the meeting. Using the installment note loophole to acquire RJR, he projected up to $4 billion in savings on taxes deferred beyond the year 2000. If everything clicked exactly right, Finn figured, First Boston might earn almost $300 million in fees—four times the largest merger-advisory fee ever. But Finn knew Maher was interested in more than fees. “Ancillary benefits,” he noted in his memo, included a “dramatic impact on M&A market share” and “immeasurable public relations/franchise benefits.” In short, Finn suggested, if they pulled this one off, they would never have to hear about Bruce Wasserstein again.

  There were, Finn admitted, some unique problems to be ironed out. For one thing, deferring $3.5 billion in taxes—a conservative scenario—was unprecedented. According to Finn’s calculations, this single transaction would boost the annual federal budget deficit by 2 percent. If First Boston proposed it, RJR Nabisco’s board would almost certainly have to take into account the political fallout. “It’s clear,” Finn said, “that Washington would go apeshit.”

  But the brash young banker argued that Congress was unlikely to intervene. Legislators had specifically extended the use of installment notes until year end. And Congress would be in recess during much of the approaching auction. What were the chances of a special session being called to trash an LBO? “They can’t do anything,” Finn stated.

  Still open was the question of whether First Boston needed partners to make Finn’s idea work. Some argued for flying solo. Maher wasn’t so sure. A respected partner would add legitimacy, something Maher was acutely aware his team might need.

  Maher’s wish was about to come true. As darkness fell outside his window, Leon Kalvaria stepped out to take a call. It was Jerry Seslowe. Jay Pritzker’s former accountant sounded excited. “Leon, we’ve talked it over with Jay. We’re there. Let’s move.”

  Finn sat in the dingy conference room overlooking Rockefeller Center and fumed. Why are these guys giving us so much grief? They ought to be happy we’re here.

  It was Tuesday morning, just three days before the Friday bid deadline, and Finn and three First Boston colleagues had come to Lazard’s offices to present their proposal in detail. Finn was always surprised how ratty Lazard’s suite seemed. The floors probably hadn’t been carpeted since 1932, he said to himself.

  First Boston had pitched its proposal as a restructuring rather than an acquisition. Maher was betting the board might instinctively wish to keep RJR Nabisco independent, and a restructuring, albeit a drastic one, might be an easier pill to swallow than those offered by Kravis or Cohen. First Boston and the Pritzkers were offering to work with the board to sell the food businesses, pass along proceeds to shareholders and leave the tobacco business intact.

  As the meeting progressed, Finn sized up the two bankers across the table. Luis Rinaldini of Lazard, Finn knew, was sharp, a good talker, like himself a rising star. John Mullin of Dillon Read impressed Finn as a relic of pre-1970 Wall Street, a stodgy, “white-shoe” banker playing way out of his league in the fast-moving
eighties.

  “We don’t see this board participating in this kind of complicated transaction,” Rinaldini was saying. “Not with all this risk from Washington.” The Lazard banker was shaking his head. “It’s too risky. It’s not their style. Of course, we don’t want to discourage you in any way.”

  The hell you don’t Finn thought. He realized what was happening. These guys are offended. They think we’re screwing up their process. They think we’re making a mockery of the whole thing. Finn suspected he knew what the real problem was. We’re doing their jobs for them. They should’ve thought of this themselves. They think we’re trying to steal their jobs.

  Far from welcoming First Boston’s interest, the special committee seemed to be snubbing it. Finn left the meeting fearing this was going to be far tougher than he had hoped.

  Maher read Peter Atkins’s letter in disgust.

  The board wasn’t going to allow First Boston a chance for due diligence. If First Boston wanted to bid, it would have to fly blind, its only guide an annual report and a stack of 10-Ks.

  It didn’t seem fair. “I don’t know what we’re going to do,” a disappointed Maher told Atkins on Wednesday, two days before the bidding deadline. “I expect we’ll give you something to think about on Friday, which may or may not make your life easier.”

  Atkins remained noncommittal. “Do what you want to do.”

  News of First Boston’s odd proposal surfaced in the press Thursday morning. Few details were available, but almost no one seemed to take it seriously. Bruce Wasserstein told anyone who would listen what a joke the First Boston approach was. On Friday an unnamed board adviser savaged the overture in The Wall Street Journal as “Mickey Mouse.”