The New Tycoons

by Jason Kelly

  Elements like the breakdown between consumables and non-consumables—along with same-store sales growth, expansion plans, and potential acquisitions—are the things that Wall Street obsesses over, better to build their models with and therefore make predictions about the company’s earnings and ultimately their stock price. When I visited, Dollar General was in the midst of meeting analysts from brokerage houses (known as the sell side) and institutional investors (the buy side). Dollar General caught the attention of some of the world’s foremost investors, including Warren Buffett, who was among the 10 biggest shareholders of Dollar General as of late 2011. He more than doubled his stake during the third quarter of that year. His interest is especially interesting given that he’s been a vocal critic of private equity, with which he’s sometimes gone head to head in buying companies. In a 2010 speech that was pre-recorded and played at corporate governance conference, he said Berkshire Hathaway had avoided buying companies outright from buyout firms in part because they “don’t love the business” in the same way long-time owners do. His preference is to keep owners after the acquisition to take advantage of their “passion” for the company.5

  Part of the attraction for Wall Street about the Dollar General story is the relative outperformance of the company versus Family Dollar, which fended off its own takeover in 2011. That approach, from activist shareholder Nelson Peltz, spurred more interest from other hedge funds. Bill Ackman bought shares of Family Dollar in 2011 and told an investment conference in New York that year he believed he could make money if Family Dollar could replicate Dollar General’s success.6

  I asked Dreiling whether he worried he’d given his competitors a blueprint they could use to beat him. “There are no secrets in retail,” he said. “It’s not about the plan. Everybody’s got an idea. This is about executing the plan.”

  For some of the execution, Calbert and later Dreiling turned to KKR’s in-house operations squad known as Capstone. The group had advised Calbert during due diligence and was responsible for helping the deal team write a 100-day plan for Dollar General. Within weeks of the deal being announced, a small group landed in Goodlettesville. Three Capstone executives were there for 100 weeks. Dean Nelson, the head of Capstone, also sat on Dollar General’s board for a period. Like their counterparts at other private-equity firms, the KKR operations experts had to walk a fine line. Like Dreiling’s analysis of the blueprint, Nelson said his team has to essentially cajole and enable: “These are things the companies have thought of. You have to figure out how to help them do it.”

  In Dollar General’s case, Capstone went about ruthlessly figuring out a plan to “remerchandise” the stores. No SKU was sacred and each one had to be analyzed in terms of profit per square foot. The stores were carrying four brands of batteries. That was deemed too many. Solution: Cut it to two and let the manufacturers duke it out.

  Fixing the private-label offerings was a crucial part of merchandising and the quality challenges there quickly came into sharp focus when a rat had been found in a Dollar General private-label package of green beans.

  Nelson put the entire private-label project in the hands of Rebecca McKillickan, who spent two years reassembling the business. Dreiling, an avid diet soda drinker, took a special interest in private-label colas after he sampled the product and practically spit it out. It turned out the supplier had altered the formula—the “brix” in cola-speak—in order to save money. “He reformulated that product himself,” Nelson said of Dreiling.

  Hundreds of miles from headquarters, there is evidence that Dollar General is a sprawling work in progress. A few days after Christmas, I wandered into the Dollar General in my wife’s hometown, a town called Walton tucked in the Catskills in upstate New York (population 6,596). It’s a classic rural location for a discount retailer, so much so that there’s a Family Dollar a quarter-mile away, just a couple blocks up Delaware Street.

  On this quiet December morning, the store was in the process of shifting out of Christmas mode, with deep discounts on holiday items, from labels to ornaments. Many of them were already gone, and one set of shelves had a sheet faxed from a central location laying out how to properly display Valentine’s Day candy and gifts. On my way out, I spotted a local touch: bright orange t-shirts to support the local high school sports team, the Walton Warriors.

  This particular Dollar General is far from the gleaming palace a few blocks from Dreiling’s office, but there were signs it could get there. While it’s not the town’s most unusual store, it’s got the potential to be a new generation of general store in towns like this.

  By the spring of 2009, a handful of executives inside Dollar General and at KKR realized they were far ahead of where they’d planned to be and that a public offering was possible, maybe even that year. In May, Dreiling held an offsite strategy meeting with his direct reports and invited Calbert in for part of the day. Calbert broached the idea of an IPO with the managers, who greeted the idea enthusiastically.

  A key element behind Calbert and KKR’s thesis about Dollar General in 2006 and 2007 was that the economy had crested and would soon turn their way—that is, people were going to be looking for places to save money. They were right, and startlingly so, Calbert and Dreiling said. “What the economy did was the trial that made everything happen faster,” Dreiling said. A spooked U.S. consumer started looking for ways to save money through the recession, and then held on to some of those habits in the fragile recovery.

  The typical Dollar General customer lives in a household that makes about $40,000 a year. Dreiling’s job is to make sure she’s happy, while also wooing a couple of other sets of customers. Dollar General categorizes these shoppers as “trade-downs” and “trade-ins.” Trade-downs are folks who are coming to Dollar General out of personal economic necessity, who’ve decided they can’t afford to buy what they need at Target anymore. They typically make higher than the average customer, up to about $70,000 a year, but are looking for every place they can to save money. Trade-ins are the relatively wealthy customers who shop for food at a traditional or even high-end grocery store, but save on, say, household cleaners at Dollar General.

  The IPO provided another interesting test case. It would be the first time that KKR Capital Markets would underwrite a stock offering. For Dollar General CFO Tehle, that made a big difference. “Any other firm, they are looking to sell you something, that’s their job,” he said. “With KCM, you feel like they’re a partner to the business.” The IPO filings outlined how much KKR and the other investors stood to gain, after only a couple of years work. The equity investors paid an average of $8.76 for each share of Dollar General they owned. At the IPO price of $21 apiece, the paper gain was more than double. In May 2012, Dollar General was trading above $46 a share.

  KKR sold only a small amount in the IPO, and the firm has sold down its position in secondary offerings, five of them as of April 2012, each at a higher stock price, including $45.25 in 2012. In December 2011, Dollar General opted to use some of its excess cash to buy some of KKR’s shares back, reducing the number of shares outstanding, a key for the debt ratings agencies.

  For KKR, Dollar General was a much-needed win from its LBO boom buying spree. TXU and First Data continue to struggle and are unlikely to be sold for much more than what KKR and its investors paid for them.

  For Tehle, a friendly but serious man, standing above the NYSE that November morning resonated on a personal level. He’d been at the company at its depths, staring down the barrel of a corporate existential crisis. He hadn’t known whether he’d be part of the new, KKR-led regime. He’d sat on the phone and wondered whether the deal that he’d believed in and helped navigate would even get done, in the teeth of those ugly credit markets in 2007.

  “It was elation,” Tehle told me during the headquarters visit. He was wearing a pink shirt with French cuffs. The cufflinks are a square that says “DG” with “NYSE” underneath it, a token from the IPO celebration; Dreiling has a pair of his own. “N
o one thought it would happen that quick. This is what we were all working for.”

  Notes

  1. Debbie Howell, “Dollar General’s Cal Turner Sr. Dead at 85,” DSN Retailing Today, December 11, 2000.

  2. Steve Matthews and Rachel Katz, “Dollar General to Pay $10 Million to Settle SEC Probe,” Bloomberg News, March 15, 2004.

  3. Simon Clark and Randy Whitestone, “KKR Seeks Repeat of Past Supermarket Profits with Safeway Bid,” Bloomberg News, January 19, 2003.

  4. Dollar General Proxy Statement filed with the U.S. Securities and Exchange Commission, filed May 21, 2007. http://sec.gov/Archives/edgar/data/29534/000104746907004478/a2178068zdefm14a.htm

  5. Dakin Campbell and Andrew Frye, “Buffett Says Buyout Funds ‘Don’t Love the Business,’” Bloomberg News, November 12, 2010.

  6. Whitney Kisling and Joshua Fineman, “Ackman Buys Family Dollar Stake, Says It’s an LBO Candidate,” Bloomberg News, May 25, 2011.

  Chapter 5

  Modern Art

  Inside KKR

  Ten thousand bucks.

  Henry Kravis and his cousin George Roberts each scribbled out a check in that amount, smaller companions to the $100,000 draft their more established colleague, former boss and partner Jerome Kohlberg, had written.

  That formed the entirety of the start-up capital for what became Kohlberg Kravis Roberts & Co., known then unofficially, and now officially, as KKR. None of the three men would ever need to put any more money in. The two cousins would become billionaires several times over. Kohlberg would go on to create his own firm the following decade after disagreeing with the cousins on the strategy of the firm. Kohlberg & Co., based in suburban Mt. Kisco, New York, has invested in the likes of sporting goods maker Bauer, Christian publisher Thomas Nelson, and Central Parking. He also personally owns the Vineyard Gazette, a newspaper on Martha’s Vineyard.

  Today, the original bank documents hang framed near Kravis’s corner office on the 42nd floor of KKR’s headquarters at 9 West. A gift from JPMorgan’s Jimmy Lee, the matting features logos of companies KKR has bought in the intervening years, from Safeway to Motel 6. Since Lee tracked down the documents, KKR has gone on to buy everything from Del Monte to Oriental Brewery. At three different points, it’s held the title of pulling off the biggest leveraged buyout in history.

  By dint of one of those deals, the $30 billion purchase of RJR Nabisco in 1989, KKR is the most famous of all the leveraged buyout firms, at least by the measure of asking a random passerby or a relative over Thanksgiving dinner. The extraordinary details of that hotly contested deal gave rise to Barbarians at the Gate, one of the most compelling business stories of all time. The book, by Bryan Burrough and John Helyar, captured vividly the backroom dealings, outsized egos, and gamesmanship that people on Wall Street recognized as being all too accurate and everyone else reacted to with some combination of admiration and horror.

  Just as Barbarians stood the test of time, so did the RJR deal in terms of its stature in the industry’s history. Despite talk at the time that it was representative of a wave of megadeals, none came close. For almost two decades, no firm was able to top it in sheer dollar volume, and that may be part of the reason the deal, and the epic account of it, remain so closely associated with KKR and inform its public image to this day.

  KKR’s New York headquarters are majestic. Security is tight, with a guard posted behind glass before a visitor can pull open the wooden doors that open onto a view of Central Park. The carpeted halls are lined with art from Kravis’s own collection, which tends toward the modern. His wife, Marie-Josée Kravis, curated what’s on display around KKR headquarters, picking from the Kravises’ wide-ranging art collection. While the corridors have mostly understated modern art, some of the meeting rooms feature more provocative pieces. There’s a small meeting room down the hall from Kravis’s office with two massive Cindy Sherman photographs hanging on opposite walls, from a series the artist did featuring what can only be described as creepy clowns.

  Vestiges of the earliest days are sprinkled throughout the offices of KKR, beyond the bank paperwork framed in the anteroom to Kravis’s office. In the small library adjacent to his office, where he holds most meetings, there’s a picture of Joe and Rose’s, the restaurant in midtown Manhattan where Kravis and Roberts had dinner right after they left Bear Stearns. The site of the restaurant is now a Dress Barn.

  Any conversation with someone who works or has worked at the firm, including the cousins, makes it clear that Henry and George together are running the show. There are no other major investment firms today beyond theirs whose figurative DNA is linked to actual shared DNA.

  Henry and George have known each other for 66 years, dating back to a family vacation the Tulsa Kravises and the Houston Robertses took to Marblehead, Massachusetts. Not surprisingly, neither remembers the trip, though as the two grew older, and closer, both their parents reminded them of that first meeting. As children, they saw each other frequently, and Kravis is fond of saying their last major disagreement was over a bicycle when they were seven years old.

  George was visiting Henry, who’d just gotten a new bike. George wanted to ride it. Henry didn’t want him too. Scolded for not being a better host, Henry got chased into the house, where he promptly ran smack into a wall, injuring his face to the point where he had to go to the hospital. Argument over.

  Beyond middle school and summer camp, use of the term “best friend” is limited, and yet Kravis uses it frequently to describe Roberts. For decades, they spoke one-on-one every day by phone or in person. In the modern era, they typically are involved in some sort of meeting or group communication on a daily basis, though they’ve fallen out of the daily check-in habit.

  Still, the ethos was set. The two men, known as “HRK” and “GRR” in firm correspondence, are by all accounts inseparable philosophically. “It’s very clear they have a pact, and it’s very strong,” said Craig Farr, who runs the firm’s capital markets business. This partnership pervades every aspect of the firm. While each man speaks for himself, it is clear they’re also comfortable speaking for the other. Any statement to the press or investors of any magnitude comes from both of them. During our conversations, Kravis constantly referenced “George and I” when describing decisions large and small.

  “We’re two people, with one voice,” Kravis said. “If we disagree, we talk it out. If one of is totally against it, it’s not happening.” In another conversation, he referred to KKR as a football team “with a two-headed quarterback.” When I asked Roberts how it trickles down through the firm, he compared it to a healthy relationship between parents that models behavior for their children. “There’s no agenda between Henry and me,” he said. “That reinforces everything we’re trying to do at the firm.”

  With two long-standing founders so in synch, and still firmly in control of their creation, the culture is thus undoubtedly a reflection of them. And that culture is a serious, driven one, with 9 West, Menlo Park, and every KKR office living shrines to overachievement. They preach discipline, and “relentless” is a word I heard over and over again.

  While the RJR deal turned out to be an outlier in terms of size for that period, the notion of Doing The Big Deal is quintessential KKR. The firm has underscored that in the decades hence by buying big-ticket, high-profile companies. Its partners are at times painfully methodical, but ultimately hyper-confident in their strategy. The line between rigor and mania is a thin one, and there’s a drive to be the best that seems to exist in slightly sharper relief in the halls of KKR. Maybe it’s the art on the walls, maybe it’s that everyone is impeccably dressed. Maybe it’s the lack of irony and sense of absolute focus that pervades every single conversation. It manifests itself mostly in the way KKR chooses who ends up working at the firm. I heard stories of rounds of interviews stretching over months, with meetings that numbered in the thirties or forties. Up until a decade ago, when it became logistically impossible, any candidate of significance met every single pa
rtner. Recalling his hiring in 1993, chief administrative officer Todd Fisher said, “The process was shocking in terms of its intensity.”

  As is the case at other firms who haven’t gone through any sort of CEO succession (Carlyle being the other prime example), the chemistry between the founders is seen as a crucial asset. The power of that partnership and the underlying personalities, too, make a multibillion-dollar question mark for all of KKR’s investors, both public and private. Kravis told his public shareholders in 2011 that he and Roberts are keenly aware of succession planning. “You have to be assured that George and I think about this every day,” he said at the March investor meeting at New York’s Pierre Hotel. “We talk about what will be the future at KKR and you can’t run any company, in our view, unless you build a very deep bench of people.”

  The best-known face of the firm beyond the founders is Scott Nuttall, whose title, Head of Global Capital and Asset Management gives him a broad portfolio overseeing all of the firm’s money-raising activities and newer lines of business. In addition to sitting on the management committee, he’s also the firm’s primary senior executive voice to public shareholders through the quarterly conference calls with Wall Street analysts and investors.

  Nuttall captures the firm’s relentless discipline and Kravis’s and Roberts’s insistence that KKR wasn’t about one or two men. During one conversation, he parried any attempt to talk about himself, constantly pushing the discussion to the firm. Yet he has quietly gained more and more responsibility since his arrival at KKR in the early 1990s after working for a short stint as an analyst at Blackstone. His current role makes him among a handful of people who could potentially run the firm, especially since he’s been a deal guy as well as worked in management overseeing some of the newer initiatives as well as an expanded fund-raising effort.