Introduction
"Barbarians at the Gate" is a gripping account of one of the most infamous business deals of the 1980s. Written by Bryan Burrough, this book takes readers on a wild ride through the world of high finance, corporate greed, and leveraged buyouts. At its core, it's the story of RJR Nabisco, a giant in the food and tobacco industries, and the fierce battle for its control that captivated Wall Street and the entire business world.
The book's title refers to the corporate raiders and financiers who were seen as barbarians storming the gates of established companies, using aggressive tactics to take them over. This metaphor perfectly captures the atmosphere of the 1980s business world, where traditional corporate values were being upended by a new breed of ruthless dealmakers.
The Rise of Leveraged Buyouts
A Tax Loophole Becomes a Business Strategy
The story begins with an explanation of how leveraged buyouts (LBOs) came to be. Originally, LBOs were a clever solution to a tax problem. In the late 1960s, wealthy business owners were looking for ways to pass their companies on to their heirs without paying massive estate taxes. They had three unappealing options: pay the taxes in full, sell the company outright, or go public and lose control.
Enter Jerry Kohlberg, a lawyer who devised a fourth option. His solution was to create a shell company that would buy out the original business using mostly borrowed money. This allowed the original owner to keep some control while avoiding hefty taxes. It seemed like a win-win situation.
From Tax Dodge to Money-Making Machine
In the 1980s, LBOs transformed from a slow, careful process into a rapid-fire money-making machine. The catalyst for this change was the emergence of junk bonds, high-risk, high-yield securities that could quickly raise large sums of money. This development, combined with tax laws that favored debt over equity, made LBOs incredibly attractive to investors.
The potential for profit was staggering. In 1982, Gibson Greetings was bought for $80 million in an LBO, with investors putting up just $1 million of their own money. A year and a half later, the company went public and sold for $290 million. The primary investor turned $330,000 into $66 million. This kind of return sparked a frenzy, and by 1983, there were ten times more LBOs than just four years earlier.
The Debate Over LBOs
As LBOs became more common, they also became more controversial. Supporters argued that they made companies leaner and more valuable. The massive debt taken on during an LBO forced management to streamline operations and cut costs, often leading to increased efficiency.
However, critics pointed out the dark side of this practice. Government officials warned that today's leveraged takeover could become tomorrow's bankruptcy. Employees often bore the brunt of cost-cutting measures, losing their jobs in the process. Original shareholders also suffered as their investments lost value due to the company's new debt burden.
The Rise of Ross Johnson
A New Breed of Businessman
At the center of this story is Ross Johnson, a man who embodied the excesses and ambition of the 1980s business world. Johnson started his career in Canada in the 1950s at the bottom of the corporate ladder. Unlike previous generations of businessmen who pledged loyalty to a single company, Johnson was part of a new breed that moved from firm to firm, always chasing the next big opportunity.
Johnson was driven by a love of luxury and an insatiable appetite for change. He reveled in buying new properties, dining at world-class restaurants, and rubbing elbows with celebrities. In fact, he often kept celebrities on his company's payroll to promote whatever business he was running at the time.
Johnson's Business Philosophy
Johnson's approach to business was ruthless and focused on constant change. He would liquidate entire departments on a whim or relocate whole sectors to different cities if he thought it would give him a tactical advantage. This philosophy was instilled in him by his mentor, Tony Peskett, who believed in keeping business and management in perpetual flux.
While critics saw this as change for the sake of change, leaving chaos in its wake, Johnson thrived in this environment. He used the frequent shakeups to climb the corporate ladder, always positioning himself to benefit from the next big move.
Johnson's Rise to Power
Johnson's big break came in 1976 when he became CEO of Standard Brands, a Canadian packaged goods company. From this position, he set his sights on merging with Nabisco, a much larger company known for iconic brands like Ritz crackers and Oreo cookies.
The merger was technically a takeover by Nabisco, but in practice, Johnson and his team from Standard Brands took control. They brought their aggressive, idea-driven style to the conservative Nabisco, shaking up the company's staid culture.
This pattern repeated when Nabisco later merged with RJR Reynolds, one of the world's largest tobacco companies. The clash between Nabisco's flashy Northern US style and RJR's traditional Southern values was stark, but Johnson's approach ultimately prevailed.
The LBO Revolution
Henry Kravis and the Birth of KKR
While Ross Johnson was making waves in the corporate world, a young Wall Street upstart named Henry Kravis was revolutionizing the world of LBOs. Unlike other traders who closed deals in hours or days, Kravis took a slower, more methodical approach that could take years to complete.
This approach wasn't appreciated by his superiors at Bear Stearns, so Kravis left to form his own company. Along with his cousin George Roberts and LBO pioneer Jerry Kohlberg, he founded Kohlberg Kravis Roberts & Co. (KKR) in 1976.
KKR's Approach to LBOs
Under Kravis's leadership, KKR transformed LBOs from tax workarounds into powerful tools for corporate takeovers. Kravis and Roberts were interested in cutting huge deals, knowing that a $10 billion deal took about as much work as a $100 million one.
By 1987, KKR had set itself apart from other players in the LBO world. They created a massive investment fund, raising $5.6 billion – twice as much as their competition. This war chest positioned KKR to take on the biggest deals in the market.
The RJR Nabisco LBO
Johnson's Ill-Fated LBO Attempt
Despite his success in the corporate world, Ross Johnson was a novice when it came to LBOs. However, with so much money to be made in these deals, he felt compelled to attempt one with RJR Nabisco. Knowing that established players like KKR wouldn't work with him due to his reputation for greed, Johnson partnered with Shearson, an investment banking company eager to get into the LBO game.
Johnson's deal with Shearson included outrageous terms that would have jeopardized the austerity measures typically required in an LBO. These included a massive cut of the total deal for Johnson himself and guarantees to maintain certain departmental budgets and retirement packages.
The Bidding War Begins
Johnson and Shearson initially planned to offer $75 per share for RJR Nabisco, totaling $17.6 billion – an unprecedented amount for an LBO. However, their lack of experience and discretion allowed information about the deal to leak prematurely.
When the RJR Nabisco board heard about Johnson's offer, they insisted on opening up the process to other bidders. This decision sparked a bidding war that would captivate Wall Street and the business world.
Multiple Bidders Enter the Fray
As news of the potential LBO spread, offers began pouring in. A special committee was formed to evaluate the bids and get the best deal for shareholders. Two offers stood out:
- KKR offered $94 per share
- First Boston, using a tax loophole, offered between $105 and $118 per share
When Shearson got wind that KKR was entering the bidding, they quickly raised their offer to $100 per share. However, this wasn't enough to end the competition.
The Final Showdown
The outlandishly large offer from First Boston prompted a second round of bidding. All parties were asked to submit new bids, and First Boston was required to prove they could secure the necessary financing.
In the end, both Shearson and KKR increased their bids to between $108 and $109 per share, while First Boston failed to secure the required funding. This left the board with a difficult decision: choose Johnson and Shearson's offer or go with the experienced LBO specialists at KKR.
The Fall of Ross Johnson
Johnson's Reputation Catches Up to Him
Throughout his career, Ross Johnson had been known for his extravagant lifestyle and his disregard for anyone outside his inner circle. These traits, which had helped him climb the corporate ladder, now worked against him in the final stages of the LBO battle.
Johnson's management deal, which would have given him and his team an enormous payout, became a symbol of corporate greed. A New York Times article exposing the details of this deal sparked nationwide criticism, further damaging RJR Nabisco's already tarnished reputation.
The Board's Decision
Faced with the choice between Johnson's team and KKR, the special committee ultimately chose KKR. Their decision was influenced by several factors:
- KKR's experience in acquiring companies without dismantling them
- Their promise to put the company and its employees first
- The negative publicity surrounding Johnson's management deal
- The general dissatisfaction with Johnson's leadership style among board members and employees
The Aftermath
With KKR's victory, Ross Johnson's time at RJR Nabisco came to an end. The decision was met with relief from all levels of the company, from factory workers to board members. KKR promised to bring much-needed order to the company, applying their experience in acquiring and managing large corporations.
While the RJR Nabisco deal wasn't the financial windfall that some had anticipated, it also didn't break KKR, despite its unprecedented scale. The deal would go down in history as one of the largest and most dramatic LBOs of the era.
Johnson's Life After RJR Nabisco
Despite the setback, Ross Johnson's career didn't end with the loss of RJR Nabisco. His talents as a salesman and his lack of ethical constraints allowed him to continue thriving in the business world throughout the 1980s.
Johnson entered a state of semi-retirement, forming a consulting firm with an old friend. While neither of them needed the money, they enjoyed the work and continued to offer advice to friends in the business world.
The Legacy of the RJR Nabisco LBO
Impact on Wall Street
The RJR Nabisco LBO had a profound impact on Wall Street and the broader business world. It marked the peak of the LBO craze and showcased both the potential and the pitfalls of these complex financial maneuvers.
The deal's sheer size – $25 billion when all was said and done – set a new benchmark for what was possible in the world of corporate finance. It also highlighted the immense power that had been accumulated by firms like KKR, which were able to raise and deploy billions of dollars in a matter of weeks.
Changes in Corporate Governance
The RJR Nabisco affair also led to changes in corporate governance practices. The spectacle of a CEO attempting to buy out his own company, potentially to the detriment of shareholders, raised serious questions about conflicts of interest and the responsibilities of corporate leaders.
In the wake of the deal, many companies implemented stronger oversight measures and clearer guidelines for management behavior. The role of independent directors was also strengthened, as the importance of having truly impartial voices on corporate boards became evident.
The End of an Era
In many ways, the RJR Nabisco LBO marked the end of an era. The excesses of the 1980s – the corporate raiders, the junk bonds, the lavish lifestyles of executives like Ross Johnson – had reached their zenith. The deal's aftermath, which included years of struggle as RJR Nabisco attempted to manage its massive debt load, served as a cautionary tale about the dangers of unchecked financial engineering.
The 1990s would see a shift away from the aggressive, debt-fueled takeovers that had characterized the previous decade. While LBOs continued to occur, they were generally smaller in scale and subject to greater scrutiny.
Lessons Learned
The RJR Nabisco saga offered several important lessons for the business world:
The dangers of excessive debt: The deal highlighted how too much leverage could cripple even a strong, profitable company.
The importance of corporate culture: The clash between RJR's traditional Southern values and the aggressive, change-driven culture brought in by Johnson and his team illustrated the challenges of merging disparate corporate cultures.
The power of public perception: Johnson's lavish lifestyle and generous management deal became major liabilities once they were exposed to public scrutiny, demonstrating the importance of maintaining a positive public image.
The value of experience in complex financial transactions: KKR's victory over Johnson and Shearson showed that when it came to LBOs, expertise and a track record of success were crucial.
The potential conflicts of interest in management-led buyouts: The spectacle of a CEO trying to buy his own company raised serious ethical questions and led to changes in how such deals were viewed and regulated.
Conclusion
"Barbarians at the Gate" is more than just the story of a single business deal, no matter how large or dramatic. It's a window into a transformative period in American business history, a time when the old rules were being rewritten and immense fortunes could be made (or lost) overnight.
The book vividly portrays the key players in this drama – the ambitious Ross Johnson, the shrewd Henry Kravis, and the countless bankers, lawyers, and executives who were drawn into their orbit. Through their stories, we see the human side of high finance, with all its ambition, greed, and occasional moments of doubt and regret.
But beyond the personalities, "Barbarians at the Gate" is a story about the evolution of American capitalism. It traces the development of leveraged buyouts from a niche tax strategy to a dominant force in corporate America. It shows how changes in tax law, financial innovation, and shifts in corporate culture combined to create an environment where such massive deals were not only possible but encouraged.
The RJR Nabisco deal, in many ways, represented both the pinnacle and the turning point of this era. Its unprecedented size and the drama surrounding it captured the public's imagination and brought the world of LBOs into the spotlight. But it also exposed the potential downsides of this approach to business, setting the stage for a reevaluation of corporate priorities in the years to come.
In the end, "Barbarians at the Gate" is a cautionary tale about the dangers of unchecked greed and the importance of responsible corporate governance. It reminds us that while financial innovation can create tremendous value, it can also lead to excess and abuse if not properly managed.
The lessons of the RJR Nabisco affair continue to resonate today, as businesses and regulators grapple with new financial instruments and evolving corporate structures. By understanding this pivotal moment in business history, we can better navigate the challenges and opportunities of the modern economic landscape.
As we reflect on the events described in "Barbarians at the Gate," we're left with a deeper appreciation for the complexities of corporate finance and the profound impact that business decisions can have on individuals, companies, and society as a whole. It's a reminder that in the world of high finance, the stakes are always high, and the line between success and failure can be razor-thin.