Bryan Burrough and John Helyar

A Book Review

Barbarians At The Gate

The Fall of RJR Nabisco

By

Bryan Burrough and John Helyar

Barbarians at the Gate has been called one of the most influential business books of all time - the definitive account of the frenzy that overtook Wall Street in October and November of 1988 from the leveraged buyout of RJR Nabisco, Inc. by Kohlberg Kravis Roberts & Co. for $24.9 billion. It was the largest takeover in Wall Street history. It was co-written by Bryan Burrough and John Helyar, both journalists for the Wall Street Journal. They wrote a series of articles about the takeover attempt. In 1989, they obtained additional information for the book by doing over 100 interviews. They interviewed all the major people -executives, lawyers, bankers and Wall Street traders - involved in the story, as well as many others. They provide a detailed account of the events in October and November of 1988 leading up to the buyout, as well as biographies of major players in the takeover attempt.

It is an insightful book, with respect to business, finance and corporate law and tells a complex, entertaining story--a drama, replete with a colorful ensemble of characters. Foremost of these characters, is Ross Johnson. It is also the story of his rise to the heights of corporate business. Johnson had come late to management at the age of forty in the early 1970s, but, in the next 15 years, he rose to be head of the nineteenth largest corporation in the United States - RJR Nabisco. At the time, RJR Nabisco was America's nineteenth largest industrial company, formed in 1985 after the merger of R.J. Reynolds Tobacco Company and Nabisco Brands, Inc. Its other major subsidiaries included Del Monte Corporation and Planters Life Savers Company. Johnson's methods were ruthless but effective. He worked for himself, for the extravagant perks which he valued, and for the ultimate power which he insisted on. He believed that a CEO can do anything. In the process, however, he also increased the value of his companies for the shareholders.

In the early 1980s, Ronald Reagan took office and cut income tax. When interest rates and inflation eventually started to come down, the US economy experienced a strong recovery. Share prices rose steadily, inflation remained low and unemployment fell. But despite all this good economic news, RJR-Nabisco's stock remained low. Ross Johnson became fixated on the stock price and tried every conceivable means to prop up the price. He was constantly approached by bankers and financial consultants and encouraged to take on more debt, by taking the company private, but Johnson abhorred debt.

Then on Black Monday, October 19, 1987, Wall Street fell dramatically. By the end of the day the Dow Jones Industrial Average had lost more than 22.5% in value. The crash ruined many individuals and came in the middle of Ross Johnson's problems with the share value of his company. In fact, the crash may have led to Johnson's decision to go for an LBO, a reversal of his previous position on the matter. As the term implies, a leveraged buyout involves the purchase of a publicly held corporation from its shareholders using funds raised by the issuance of debt securities.

Ross Johnson secretly formed an internal management group that would take RJR private by executing a management-led leveraged buyout. The management group would consist of Johnson; Harold Henderson, general counsel; Edward A. Horrigan, Jr., vice chairman and chairman of R JR Nabisco's tobacco division; John Martin, executive vice president; Edward J. Robinson, chief financial officer; Andrew G.C. Sage II, outside director and consultant; and James O. Welch, vice chairman and chairman of R JR Nabisco's food division. Steven Goldstone, of Davis, Polk & Wardwell, would serve as counsel to Johnson and the management group. James D. Robinson III, chairman and chief executive officer of American Express, would act as informal senior advisor to Johnson.

The management group's financing partner would be Shearson Lehman Hutton, led by its chairman and chief executive officer, Peter A. Cohen. The deal meant a lot to both Shearson Lehman and Peter Cohen. A successful leveraged buyout of R JR Nabisco would catapult Shearson Lehman into merchant banking, revive the firm's moribund junk bond department and generate up to $200 million in upfront fees alone (Burrough, 154).

In negotiating the LBO with the Shearson, Andrew Sage makes Cohen agree on a secret management agreement, principally negotiated for the seven members of the management group. The agreement, provides that Ross Johnson would have control of the new board of directors, an effective veto. The seven managers would have an initial 8.5% equity stake in the corporation, which would increase up to 18.5% as performance goals were met. Their purchase of this equity interest would be financed by tax-compensated loans from Shearson Lehman. The value of this agreement was estimated to be as high as $2.5 billion over time, with the initial 1% share allocated to both Johnson and Edward Horrigan alone worth $100 million within five years (Burrough, 169). This secret management agreement will eventually turn the tide against Ross Johnson.

On October 19, 1988, F. Ross Johnson, the president and chief executive officer of R JR Nabisco and his management group, worried by the fact that their stock is undervalued at $55 a share, proposed an LBO at $75 or $17.6 billion, in cash to the company's board of directors (Burrough, 1-9).

Johnson was a charismatic leader and courted the board of directors since he had come to RJR during the merger with Nabisco. He felt he had control over the board. Although his control of the leveraged buyout was quickly usurped by the investment bankers and lawyers, he remained a central figure throughout the story.

Shearson Lehman had pressed for the implementation of the normal "gun-to-the-head" strategy, offering the board of directors a complete, fully financed bid and giving the board little alternative but to accept it. Johnson, believing that he had the board under control, had refused and the eager Shearson Lehman had reluctantly agreed. Largely because of the unprecedented size of the proposed leveraged buyout, the management-Shearson Lehman group grossly underestimated the potential competition and assumed that it would be an uncontested takeover. The estimated $15.5 billion of bank financing