Barbarians at the Gate: The Fall of RJR Nabisco (1989) by Bryan Burrough and John Helyar

The Reagan ‘80s were a giddy time for investment bankers. There were tens of millions of dollars in fees to be made in orchestrating corporate mergers (never mind if the end result benefited shareholders, let alone employees). The most innovative and potentially lucrative transaction was the leveraged buyout (LBO), an operation where a company’s management team, in partnership with a financial services firm, would acquire the company they operated, often using high yield corporate bonds (so-called junk bonds) to finance the deal. The management team would instantly transform themselves from ordinary executives into owner-operators with a huge equity stake worth tens of millions of dollars in the company they ran and now owned. The LBO of RJR Nabisco in the fall of 1988 would be by far the largest such operation ever undertaken. I suspect it’s a record that still stands.

There are lots of incredible things about “Barbarians at the Gate.” For starters, the authors, veteran Wall Street Journal reporters Bryan Burrough and John Helyar, completed all the research and writing for the 500-page book in less than ten months in 1989. I don’t see how that is possible, but evidently it is. Not only did the authors do a great job in compiling the information necessary to pull the complicated story together, they also put it all together in a narrative that is compulsively readable. Many nonfiction books claim to read like novels; “Barbarians at the Gate” actually does.

The star of the show, so to speak, is F. Ross Johnson, CEO of RJR Nabisco. The authors present Johnson as a breezy corporate playboy who was more enamored in living the highlife of a Fortune 500 CEO than in actually running a business. I’m not sure that is fair or accurate. Johnson’s resume is impressive, to say the least. Growing up lower middle class in Winnipeg, Manitoba, Johnson spent the first couple decades of his career bouncing around mid-level jobs in Ontario. In the late 1970s he found himself an executive at the Canadian arm of Standard Brands, which produced Planters Peanuts and Life Savers, among other consumer packaged goods. So began what must still stand as one of the greatest and most improbable runs in American corporate history. Johnson eventually ousted the long serving, tight-fisted CEO of Standard Brands. Shortly thereafter Standard Brands was acquired by Nabisco. Johnson then took over as CEO of Nabisco when their CEO stepped down two years after the merger. Next, the tobacco giant RJ Reynold acquired Nabisco. Johnson pulled off the miracle a second time, becoming CEO of the combined RJR Nabisco less then two years after the merger.

I’ve worked in corporate America for nearly two decades (albeit in technology companies and not consumer products) and I’ve found that people who are able to maneuver themselves to the top and stay there are universally talented individuals. Luck certainly plays a role here and there, but it is talent and hard work that matters most. Thus, I had a hard time swallowing the authors’ depiction of Johnson as something of a lightweight who was in it mostly to play golf and have drinks with celebrities. I just can’t believe that anyone who was able to pull off what Johnson did at Standard Brands and then Nabisco and then RJR Nabisco is anything other than a top tier executive.

By the late 1980s RJR Nabisco was a cash cow that was dramatically undervalued by the market. The company was a diversified conglomerate that sold everything from peanuts and Oreos to cigarettes and canned pineapples, and even owned a 20% stake in ESPN. However, Wall Street valued the combined operations as one big tobacco company. Because of the looming threats of lawsuits and government regulation tobacco stocks only traded at about nine times earnings. RJR Nabisco stock was stuck in the low $40s. The combined value of all the company’s parts was worth at least twice that.

RJR Nabisco was an ideal target for an LBO. The tobacco business virtually printed money, raking in over a billion dollars a year in profit. The rest of the company came pre-packaged in stand-alone business units that could be easily sold off. The founding father of the LBO trade, Henry Kravis of Kohlberg Kravis Roberts (KKR), pitched the idea of an LBO to Johnson in early 1988. Johnson liked the idea, but not Kravis, who had a reputation for running a tight ship and keeping the companies he bought on a tight leash. Johnson maintained a fleet of eight private jets at the lavish RJR Nabisco hangar in Atlanta (the so-called RJR Air Force) along with 20 fulltime pilots on the payroll. The jets flew Johnson and his top executives all over the country to attend Nabisco-sponsored golf tournaments at the best clubs in the country where they could hobnob with top sports celebrities like Jack Nicklaus and Reggie Jackson, which Nabisco paid millions to keep on retainer. Johnson knew that all of this was certain to full under the axe after an LBO with Kravis

Johnson saw an opportunity to have his cake and eat it too. Why not partner with another financial services firm less experienced with LBOs that might be willing to bend over backward to the management team to secure the business? Enter Peter Cohen at Shearson Lehman. In exchange for giving Shearson the chance to lead the biggest buyout in history, Cohen conceded to a management agreement that would leave Johnson in virtually uncontested control of RJR Nabisco (in addition to remaining as CEO he was granted a veto right over the board of directors) and a personal equity stake worth over $100 million. Shearson even agreed to pay the management team’s taxes. Despite the excesses of the deal, Johnson and Cohen were confident they could make it happen because the deal was just too big for anyone else to pull off. It would prove to be a fatal assumption.

Johnson’s management agreement was so outrageous it would ultimately prove to be his undoing. KKR refused to stay on the sidelines and watch the largest LBO deal in history unfold without them. After the Johnson and Shearson team made an initial bid of $75/share, KKR responded with $90/share, valuing the deal at roughly $20 billion. The unprecedented size of the operation stretched the global financial services industry to the limit. The RJR Nabisco board chairman Charlie Hugel, CEO of Combustion Engineering, conducted the auction process over six tortured weeks in late 1988. The competing players were able to go back and forth several times outbidding each other. The whole process was so scatterbrained and unfair, I can’t believe it didn’t generate lawsuits after it was all over. In the end, KKR emerged victorious with a bid of a whopping $110/share. Johnson’s management agreement had leaked to the press during the bidding process and led to Johnson’s picture on the cover of Time magazine under a headline about corporate greed. After that it was almost impossible for the board to give him the company. Johnson was especially reviled in Winston-Salem, the home of RJ Reynolds tobacco.

Henry Kravis eventually lured Lou Gerstner away from American Express to run RJR Nabisco for him. After five years at the helm, Gerstner left to run IBM and Kravis brought in Steven Goldstone, who ironically was part of Johnson’s management team at Nabisco. What is not clear to me is how the deal is viewed by KKR today. All else being equal, if they could go back in time to 1988 would they do it again? If not at $110/share, then what? I’d also be interested in reading a post mortem on what happened to the various brands and the employees who supported them. All told, though, “Barbarians at the Gate” may be the best business book I’ve ever read. It has aged incredibly well over the decades and may well establish itself as the greatest business book of the twentieth century.