How Rjr Nabisco Was Bought Out in the 1980s Case Study

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RJR Nabisco LBO

The players in the RJR Nabisco leveraged buyout were the management group led by CEO Ross Johnson (supported by Shearson Lehman Hutton and Salomon Brothers), whose low-ball bid on the company was viewed as something of a conflict of interest, since his role as CEO was to achieve maximum shareholder value while his role as bidder was to get control of the company at the best price possible. The bid brought out other investors, who saw the company as being undervalued. The board eventually went with the higher bid by Kohlberg Kravis and Roberts (KKR), backed by the investment banker Drexel Burnham Lambert. First Boston was also a bidder as was Forstmann Little.

What prompted the LBO was that RJR Nabisco had a stable cash flow that was not conditional to market volatility and neither RJR nor Nabisco "required major capital expenditures" (Leveraged Buyouts, p. 288). Additionally, RJR had little relative debt and its capacity to draw on more was appealing in terms of an LBO.

Thus, what prompted the buyout was CEO Johnson, first of all, who initiated a management buyout bid -- which opened the door to a bidding war (mainly because his offer of $75 per share was regarded as "embarrassing" (Leveraged Buyouts, p. 289). Soon other investors saw an opportunity to capitalize on a company that was deemed to be undervalued. Did Johnson set out with this purpose in mind in order to ultimately boost the price per share of the company by setting the ball in motion? Or did he truly believe that a lowball offer would get his team control of the company? One could speculate, of course, but what made the LBO feasible was the fact that RJR Nabisco had significant brand value even as its return on assets had been declining and that its worth had been estimated by Smith Barney at between $85-$92 per share, significantly greater than Johnson's buyout bid and much greater than the company's pre-buyout offer share price of $56.

The terms and conditions of the LBO pre- and post-buyout in terms of corporate structure were that the company was to be kept "intact and to still have some public ownership" which KKR promised to give in their LBO, whereas with the Johnson offer, the team intended to "sell off assets" in order to "pay down debt" (Leveraged Buyouts, p. 289).

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However, after the LBO, the return on investment that KKR anticipated did not manifest and KKR ended up liquidating its interest in the company following its underwhelming ROI. Thus, before the LBO the corporate structure was overseen by Johnson and the Board and after the LBO, KKR became the overseer until the time when it too saw fit to eliminate its position in the company. Perhaps Johnson's lowball offer, in retrospect, was not so lowball after all.

However, the story did not end there. As the offers grew, they quickly outshot even the Barney Smith estimate of the company's worth, with Johnson's management team attempting to outflank the opposition with an offer of $112 per share. KKR countered with a lower bid of $109 per share, which ended up being the offer accepted by the Board because it was "guaranteed" money, as opposed to the offer by Johnson, which was not (Greenwald, 1988).

Thus, the financial qualities of the LBO in terms of the stock value pre- and post-LBO were to cause the price per share to be inflated beyond anyone's expectations. KKR was definitely paying more than the Smith estimate deemed reasonable, by nearly $20 per share, or nearly 25% higher than the greatest value estimate. Johnson had successfully gotten KKR to up their ante, essentially, which….....

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