Barbarians at the Gate: KKR's Rivals for RJR Nabisco

This article is an excerpt from the Shortform book guide to "Barbarians at the Gate" by Bryan Burrough and John Helyar. Shortform has the world's best summaries and analyses of books you should be reading.

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How did Kohlberg Kravis Roberts & Co. come to be the highest bidder in the RJR Nabisco LBO? How many competitors did KKR have to beat?

Although CEO Ross Johnson didn’t think many financial companies were interested in buying RJR Nabisco, many stepped up. According to Bryan Burrough and John Helyar’s book Barbarians at the Gate, KKR was the highest bidder in the contest for RJR Nabisco.

Keep reading to learn about all the companies who bid for RJR Nabisco, including KKR.

The LBO of RJR Nabisco

Burrough and Helyar recount how the assumption that no one else would try to buy RJR Nabisco proved to be horribly wrong. When the board gave Johnson the go-ahead to pursue an LBO, he and Shearson proposed to pay $75 per share based on their initial analysis. This was published in a press release. According to Barbarians at the Gate, KKR and a number of financial companies saw the press release and thought RJR Nabisco was worth a lot more than $75 per share.

(Shortform note: Lower-than-usual prices naturally attract attention from prospective customers. Sam Walton used this principle strategically to build Walmart into a retail empire, by selling some items at cost in order to draw in customers, and making a profit on other things they bought while they were there. But, in hindsight, Johnson and Shearson’s $75 bid was a strategic blunder: If they had offered a little more, the price might have not lured in other bidders and started a bidding war.)

Kravis

The Kohlberg Kravis Roberts company was a financial consulting firm that, according to Burrough and Helyar, had arguably invented LBOs and was unarguably the market leader in LBO consulting. They were among the first to react to the press release. After meeting with banks to discuss the value of RJR Nabisco and the availability of funding, they considered offering the board $90 per share.

Burrough and Helyar note that before Kravis reached a decision on how much to offer per share, someone leaked their meeting minutes to the press, and a newspaper ran a story announcing that they were offering $90 per share for RJR Nabisco. Upon seeing the story, Kravis felt obligated to make the offer official in order to avoid confusion or bad press.

Kravis was at a severe disadvantage when it came to determining how much RJR Nabisco was worth because no one at Kravis had inside knowledge of RJR Nabisco’s operations. This was in contrast to practically all the other LBOs they had done, where they worked closely with the company’s executives. Shearson and Kravis considered partnering up instead of bidding against each other but were unable to agree on the terms of the partnership.

The Strategic Importance of Information

In The Art of War, Sun Tzu argues that espionage and intelligence-gathering are among the most important elements of fighting a war because understanding your opponent is crucial for strategic planning. Kravis’s situation illustrates how this principle can be applicable to business strategy as well as military strategy:

First an intelligence leak forced Kravis’s hand in making a competitive offer to buy RJR Nabisco. Then, lack of inside information handicapped them when it came to determining how much was really safe to bid. When Kravis finally did find an insider who was willing to discuss RJR Nabisco’s operations with them, that new information was what enabled them to place the winning bid.

Salomon

Burrough and Helyar report that a finance company called Salomon Brothers also prepared to make an offer to buy RJR-Nabisco when they saw the press release stating that Shearson had offered $75 per share. When they saw Kravis’s competing bid of $90 per share, they backed off.

After the partnership negotiations between Kravis and Shearson broke down, Shearson started looking for other partners to augment their financial resources for competitive bidding. At that point, Salomon entered into a partnership with Shearson. With Salomon’s backing, Shearson increased their offer from $75 per share to $92 per share.

Strategic Partnerships

In Crossing the Chasm, Geoffrey Moore discusses the importance of partnering with other companies so you can take advantage of each other’s capabilities. If you’re trying to bring an innovative product to market (which is the focus of Moore’s book), your corporate partners may be able to deliver supporting services or just establish your credibility in the marketplace in ways that you couldn’t on your own. In the case of the Shearson-Salomon partnership, the primary capability that each company contributed was their credit, since one of the biggest challenges of pulling off an LBO is raising enough borrowed money for the buyout.

Forstmann

Forstmann Little, the second-leading LBO company after Kravis, was also interested in owning RJR Nabisco. Shearson and Salomon offered to partner with Forstmann, but after reviewing their financial analysis and proposal in detail, Forstmann declined.

According to Burrough and Helyar, Forstmann thought Shearson’s fees were excessive and their analysis wasn’t very good. Also, unlike most other LBO consultants, Forstmann eschewed junk bonds and thus objected to taking on partners who would sell junk bonds to raise money for the LBO.

Forstmann later partnered with Goldman Sachs, and they prepared to put in their own bid. But after doing their financial analysis, they decided they couldn’t safely bid more than $85 to $90 per share without resorting to junk bonds. Since they couldn’t top the highest bid that had already been placed, they withdrew from the contest without making a formal bid.

The Wisdom of Doing Nothing
The way Forstmann handled the RJR Nabisco LBO, or rather declined to handle it, demonstrates an important business principle that can be easy to overlook: Sometimes the best strategy is to do nothing.

Books about building up your business often focus on the necessity of taking risks in order to reap rewards. They offer advice on overcoming your aversion to risk because excessive risk aversion can cause you to miss important opportunities. But it’s also possible to make the opposite mistake. In any given situation, you need to evaluate whether the opportunity is actually good enough to be worth the risk.

Furthermore, in the highly dynamic world of business and finance, you often encounter situations that seem to demand immediate action, whether it’s a natural disaster that disrupts shipping and causes certain stocks in your portfolio to plummet, or a chance to get in on a huge business deal (as in Forstmann’s case), or something else. The adrenaline rush that these situations elicit makes you feel like you need to do something, but in many cases the best thing you can do is actually to do nothing, riding out market fluctuations and passing up business deals that would be exciting and glamorous but not actually profitable.

First Boston

As Burrough and Helyar recount, the final interested party was the First Boston financial consulting firm. First Boston had been a market leader in mergers and hostile takeovers, until two of their executives and a number of their employees left to form a competing company.

They were still struggling to recover from the split when the RJR Nabisco LBO was announced, and they wanted to participate in the LBO mostly to save face: Since the RJR LBO was the largest LBO in history, and since it seemed like every other major financial firm on Wall Street was getting involved in one way or another, sitting on the sidelines would have made it look like the corporate schism had completely ruined them.

Burrough and Helyar note that First Boston got a late start assessing RJR Nabisco’s value, but found a clever way to save about $4 billion by taking advantage of an obscure financial mechanism to defer some taxes.

Moving on and Thinking Big

First Boston’s entry into the RJR Nabisco LBO could be seen as an application of David Schwartz’s advice on dealing with setbacks. In The Magic of Thinking Big, he asserts that to overcome a setback you should experiment boldly with new approaches until you find a path to success, instead of beating yourself up over it or assigning blame to factors beyond your control.

First Boston’s staff certainly demonstrated boldness and perseverance when they decided to tackle the biggest LBO in history at a time when their company was in turmoil. And in spite of the upheaval, they found a creative way to save money (the tax deferrals) on the LBO that would enable them to bid higher. As Burrough and Helyar remark later in the book, the way First Boston tackled the RJR Nabisco LBO did help them to restore their reputation and shape up their company after the split, even though their bid ultimately didn’t win.

Barbarians at the Gate: KKR’s Rivals for RJR Nabisco