Leveraged BuyOuts LBOs

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Leveraged Buy-Outs (LBOs)

• RJR-Nabisco

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What is an LBO?

• A large fraction of the purchase price is
  debt-financed (thus leveraged)
  
• The LBO firm goes private, and its shares no
  longer trade on the open market
  
• The LBOs stock is held by a partnership
• When partnership consists primarily of management
  of the firm, it is known as a management buyout
  (MBO)
  

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RJR-Nabisco

• RJR started in 1875 as a tobacco company
• Winston, Salem, Camel Vantage
• Also had large food division
• Hawaiian Punch, Del Monte, Planters, Life Savers
• In 1985, RJR acquired Nabisco
• Oreos, Fig Newtons, Ritz Crackers

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What is RJRs Problem?

• Stagnant stock price
• Management believes that the market is
  undervaluing the strong cash flow from the
  tobacco business
  
• Also believe that the market is undervaluing food
  operations because of association with tobacco

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Barbarians at the Gate

• Key Players
• RJR Nabisco Management
• F. Ross Johnson, CEO James Garner
• Ed Horrigan, Head of RJR division
• John Greeniaus, Head of Nabisco division
• Charles Hugel, Chairman of the Board
• American Express / Shearson Lehman
• Jim Robinson, CEO of American Express Sen.
  Fred Thompson
  
• Peter Cohen, Shearson Lehman
• KKR Kohlberg, Kravis, Roberst Co.
• Henry Kravis
• George Roberts

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RJR-Nabisco

• RJR unable to move stock price (it had pinned its
  hope on Premier, and favorable court rulings)
  
• Everyone benefits when management takes over
• Debt can be an asset
• LBO game plan?

7
Who Leaked the Offer?

• What is to be gained (if anything) by leaking
  news of the offer?
  
• Who had the incentive to do this?

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Market Reaction to 75 LBO offer

• How did security prices respond to F. Ross
  Johnsons initial 75 offer (10/19/88)?
  
• Stock price rose from 56 to roughly 75
• Bond values fell 298M from 2.4B initial value
  (12 decline)

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Summary of Management Group Bids
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Summary of Bids by KKR
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Assessment of Bids

• Special Committee meeting on evening, Nov. 30
• Financial adviser assessed the two bids and found
  that the bids were substantially equivalent
  
• Financial adviser down-weighted value of non-cash
  securities
  
• Found both bids equal to approximately 108 per
  share
  
• Concern that further negotiations could result in
  withdraw of bid
  
• Management bid offers more cash / KKR would
  provide benefits for terminated employees
  
• Committee recommends KKR bid to Board, and merger
  agreement with KKR is executed

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What Was Source of Value?

• KKR paid 109 per share, for a stock that was
  trading previously at 56 per share. Where did
  they expect to make money?
  
• How about the Management Group?

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Differences in the Present Value of Cash Flows
Anticipated after LBO

• KKR Strategy (change in cash flows)
• Interest tax shield 1.83B
• Reduction in CAPX 2.59B
• Sales of assets 5.11B
• Loss in after-tax operating cash flows
  -0.289B
  
• TOTAL 9.241B
• Management Group Strategy (change in cash flows)
• Interest tax shield 1.161B
• Reduction in CAPX 4.121B
• Sales of assets 11.064B
• Loss in after-tax operating cash flows
  -6.251B
  
• TOTAL 10.095B

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What Happened Later?

• Year after LBO
• New management installed
• Sold many assets laid off workers
• Cut back operating expenses and capital
  expenditures
  
• Pre-tax earnings increased despite asset sales
• 1991 RJR-Nabisco went public again (sold 1.1
  billion in stock)
  
• 1995 KKR sold off last remaining stake in
  RJR-Nabisco (ultimately made about their original
  purchase price)

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The 1980s LBO Craze in Retrospect

• Some view RJR-Nabisco LBO as all that was wrong
  with corporate greed in the 1980s
  
• Carving up companies
• Individuals losing jobs
• Creating enormous debt burdens
• Alternative view is that LBOs generated enormous
  increases in market value and that most of the
  gains went to shareholders, not the raiders
  

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More Recent LBO Activity

• WSJ article a few years back Buyout Firms are
  Teaming Up to Spread Risk
  
• Buyout firms (like KKR) are often now teaming up
  in much same way that VC funds do
  
• Recent examples
• Burger King
• Tyco plastics
• Quest phone directories unit
• Problems Decision making corporate governance
  more complicated with more chefs

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More Recent RJR News

• RJR roughly one quarter of the U.S. cigarette
  market (Camel Salem)
  
• 1999-2003, margin per cigarette has fallen from
  2.2 cents to 0.6 cents (Philip Morris still 2.1
  cents)
  
• 9/17/03 RJR announces will cut workforce 40
• Stock price went up 14 on restructuring news
• 10/28/03 RJR acquires cigarette manufacturer
  Brown Williamson Tobacco (RJR owns 58 of new
  firm), merger completed July 2004
  
• RJR stock price rises 13 on merger announcement
• Why?

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