The 1980s was an interesting time period for many reasons. One of these reasons was the development of some rather interesting business practices. Business owners were a different kind of flashy then. They loved a life of luxury and looked to all ways to preserve this. This was where the leveraged buyout came in.
As much as the leveraged buyout was practised by many, there is no story quite like the one provided by Ross Johnson – the CEO of RJR Nabisco in the 80s. Johnson was a man on a mission and he didn’t worry about who stood in his way. This attitude saw one of the most infamous leveraged buyouts turn sour.
In this book summary readers will discover:
- What is a leveraged buyout?
- The rise of Ross Johnson
- The story of KKR
- When greed gets the best of you
Key lesson one: What is a leveraged buyout?
The leveraged buyout or LBO first originated in the 1960s. It was developed as a way for business owners ready to retire to work around estate taxes and forward the money to their heirs. Estate taxes often amounted to huge sums of money leaving business owners with three ways of dealing with them. The first was to pay the estate taxes in full when passing the company to their heir. The second was to just sell the company leaving them with no further control of it and lastly, they could go public. The last option was a bit risky as the success of the business was then dependent on the market.
This was why Jerry Kohlberg, a lawyer, came up with the idea of a leveraged buyout. To give you an example of how it works, consider a business owner who is ready to retire. He would ask his lawyers to found a shell company consisting of a number of investors. These investors would all take out loans in order to buy out the business owner’s company. Investors only paid about 10 per cent of the cost with the rest of the money coming from bank loans and insurance bonds. In this manner, the investors get the company not using much of their own money and therefore at a fraction of the cost that they would have paid in a bidding war with competitors. In addition, the business owner still has a stake in his company and some control. The shell company took on an incredible amount of debt, but in the long run, it was a situation that greatly paid off.
Take for example a company called Gibson Greetings. In 1982, the company was sold for $80 million to an investment group. The group used only about $1 million of their own money to make the purchase. About 18 months later, the company went public and was resold for $290 million! This buyout paid off for the primary individual investor. At the start, they had put down just $330 000 and this was converted to $66 million. As much as the LBO had been around for decades, it boomed during the 80s because of deals like this. It was further prompted for two reasons. The first was the US Internal Revenue Code which allowed deductions of interest tax but not dividends. They encouraged companies to rather be in debt and pay interest rather than taxes on profits. The second reason was junk bonds that made it easy to get huge amounts of money in a short time.
LBOs accelerated, occurring ten times more than in previous decades. However, because of how they operated, they were also frowned upon. When LBOs occurred, the massive debt which the company incurred led to cost-cutting and refining the business. This brought about big changes and many people lost their jobs due to cutbacks. Government officials warned businesses against LBOs because this debt burden could lead to their downfall if they were not careful.
Key lesson two: The rise of Ross Johnson
Ross Johnson started out as a salesman in Canada in the 1950s. He quickly worked his way up the corporate ladder. This ascent began when he started working at a Canadian department store called T. Eaton. It was here that he worked under Tony Peskett who had an interesting business strategy. Peskett liked to keep the business and its management in a constant state of flux which kept other companies and the market always in a lurch. This strategy of Peskett’s benefited Johnson greatly and he quickly climbed the corporate ladder with each one of Peskett’s changes.
Johnson saw Peskett as a mentor and when he finally left T. Eaton to become CEO of Standard Brands, he saw his opportunity to shine brightly on his own. Using what he had learned from Peskett, Johnson enjoyed a life filled with luxury but what he had attained was never enough. It was during this time that he decided to pursue a merger with a bigger company – Nabisco. In the 80s, Nabisco was already a successful, conservative company. They valued their employees as well with no one working past 5 pm or having any fear of losing their jobs. This quickly changed after the merger.
Johnson’s practices were against everything that Nabisco believed in. Even meetings turned into somewhat of a circus with staff from Standard Brands shouting and heckling. What made matters worse is that Johnson encouraged this behaviour seeing nothing wrong with it. Johnson’s love of money and power only grew and it spread rapidly through Nabisco. He later went on to seek a merger with one of the biggest tobacco companies in the world, RJR Reynolds. This opened up growth opportunities for both Nabisco and RJR Reynolds making it a win-win situation even though there were stark contrasts between the two. They all had a common goal, the same as Johnson from the very start – to make more money.
Key lesson three: The story of KKR
Whilst Johnson was shaking up the business world with his tactics, on Wall Street a young banker named Henry Kravis was also turning things around. He worked for the investment bank Bear Stearns who was not always fond of the way Kravis worked on his many LBOs. It wasn’t long before he left to start a firm alongside his cousin George Roberts and LBO creator, Jerry Kohlberg. This saw the beginning of the private equity company Kohlberg Kravis Roberts or KKR.
Just like how Johnson got the opportunity to thrive at Standard Brands, so too did Kravis at KKR. He started changing LBOs from a way to avoid tax to a way to take over companies. Kravis and his cousin set their sights on the big leagues knowing they could make millions in the process. Their goal was to form an incredibly massive investment fund, one that would guarantee them more deals in the future. They sought to bring in new investors, even waiving their management fees for a few years. By the time they met Johnson, KKR had managed to accumulate $5.6 billion which was much more than their competitors.
Key lesson four: When greed gets the best of you
Johnson knew that even though he didn’t need one, LBOs were a lucrative option. He didn’t want to look back and see that he had lost his opportunity since LBOs were practically booming at the time. So, Johnson came up with a plan. He wanted the most money he could possibly get and that meant that he would have to stay away from those experienced with handling LBOs like KKR. He, therefore, turned to Shearson, an investment banking company that was a relative outsider in the LBO world.
Shearson, of course, was attracted by the large company and the opportunity it afforded them to get a piece of the LBO action. They immediately agreed to all Johnson’s requests which included the maintenance of particular departmental budgets, retirement packages and a huge cut of the total deal. Understanding how LBOs work, these requests jeopardized the company’s ability to recover in future when they had to make cuts to pay off the debt resulting from the deal. This was their first slip up due to inexperience. Their second was their lack of discretion. LBOs work so well because they are concluded before anyone else on the outside knows what’s happening within the company. This did not happen with Shearson.
In the beginning, Johnson and Shearson set a price of $75 per share for RJR Nabisco. This was $4 more than it had ever been. If all went according to plan, the company would sell for $17.6 billion which at the time would be the highest amount ever asked of a bank to loan. When the board heard about this, they decided a press release was needed to see if any other offers would come in. The board were never really fans of Johnson and saw this as an opportunity to get rid of him from the company once and for all. As expected, offers came flying in. KKR came in with $94 per share, First Boston offered between $105 to $118 per share and Shearson upped its offer to $100 to outbid KKR.
This led to a bidding war with KKR and Shearson raising their offers to compete with First Boston. In the end, they both offered the same amount and the board had to decide. It was either go with KKR or basically give Johnson a victory. The New York Times even wrote an article describing Johnson’s greed and his attempted LBO. With all this swirling around in the media, the board went with KKR effectively ending Johnson’s career at RJR Nabisco. KKR won the bid by further emphasizing that they would make the company and its employees top priority again.
Everyone was happy to see Johnson go. However, Johnson did not have any regrets about his actions. He moved on to semiretirement before starting a consulting company with a friend. Johnson said he didn’t start working again for the money but he liked to keep himself entertained by handing out business advice.
The key takeaway from Barbarians at the Gate is:
Leveraged buyouts were all the rage in the 80s. They had evolved from tax workarounds for retiring business owners to a takeover strategy. The story of Ross Johnson and RJR Nabisco has become somewhat of a cautionary tale. One that everyone can learn from.
How can I implement the lessons learned in Barbarians at the Gate:
Don’t be blinded by greed. Ross Johnson put his money and lifestyle above everything else. He did not think twice about the consequences of his actions. During his reign at both Super Brands and RJR Nabisco, he used people as pawns to achieve his goals. This never works out. This was the very reason why the board did not hesitate to go against him. If you mistreat people, success will never last long as they would be happy to jump ship when a better offer arises.
