Barbarians at the Gate

by Bryan Burrough

  Hired by Ross Johnson within hours of his initial LBO announcement, Linda Robinson found her old friend’s p.r. effort in disarray. It had no theme, no rhyme, no reason. The first week on the assignment she spent keeping up with the avalanche of hostile phone calls. As the chief spokesperson for Johnson’s management group, she was constantly on the phone, ladling out inside details to reporters.

  Her activist style quickly alienated Bob Baker, a genteel South Carolinian who was Salomon Brothers’ senior public relations specialist. Baker thought Linda Robinson talked too much. He had argued against a New York Times piece Robinson had helped arrange that profiled Cohen and other Wall Street figures involved in the RJR and Philip Morris deals. “That’s what you do when the deal is over,” Baker insisted. “Linda, it’s going to look like a bunch of silly fucking yuppies.”

  Matters came to a head when Baker suspected Robinson was plotting to put Cohen on a Sunday morning news show, “This Week with David Brinkley.” The Salomon spokesman, trying to conjure a high profile for his own firm’s deal makers, had arranged for Salomon’s Ron Freeman to appear alongside Ted Forstmann, and didn’t want his man replaced by Cohen.

  “Linda, we at Salomon are deferring to you because you work for management,” Baker said. “Far be it from me to suggest that because you sleep with the chairman of American Express you would tilt to Shearson’s interest. On the surface, there would appear to be a conflict of interest here. I’m not suggesting that. This is not a threat. Just remember, there is life after this deal.”

  Although she nearly lost her temper with Baker, Linda Robinson tried to avoid wasting time on bureaucratic squabbling. She had bigger fish to fry. The Robinsons led a busy social life, packed with formal galas of one sort or another; she joked that they tried to spend a night and a half at home together every two weeks. Among the Robinsons’ closer friends were the Henry Kravises. The two couples’ Connecticut spreads were only twenty minutes apart, and Linda had managed to get Kravis interested in the thoroughbred business. The two had just bought their first horse together. They had named it Trillion, although in the weeks to come Kravis would give it a nickname: Cookie Crumbles.

  Since Kravis first announced his bid, Linda Robinson had been quietly lobbying him to team up with Johnson. “Linda has always cuddled up to Henry,” says one of Kravis’s aides. “You have to understand these people. They all want to be friends with each other. So Henry starts getting calls from Linda every day. And he starts talking to her. She was playing matchmaker.”

  Linda Robinson’s conversations with Kravis were a closely guarded secret. Other than her husband and Johnson, only Steve Goldstone knew of them. Goldstone grew worried: Of all the Wall Street firepower at their disposal, was it wise to have a public relations person as the primary conduit to Kravis?

  “Linda, you ought to be careful here,” Goldstone ventured at one point. “You don’t want to be saying anything that the group hasn’t agreed upon in advance.”

  Linda Robinson told the lawyer not to worry. She knew what she was doing.

  Salomon’s Ron Freeman, a veteran investment banker but no expert on LBOs, appeared pasty faced and nervous as Sam Donaldson bore in for the kill on Sunday morning television.

  “Talk about the morality, if you will, of what’s going on with these LBOs,” Donaldson urged. “In the old days, companies were built to prosper and hire people, and make a profit for the stockholders…. Now a lot of people get into this business simply to break up companies, to make the maximum money, and to leave town. Is that moral?”

  “I think that’s not the only description of the LBO phenomenon,” Freeman replied. “Corporate restructurings occur to vast degrees of difference. For example, some of the largest and best known corporations in the United States have restructured themselves with amazing success. Atlantic Richfield would be a good example of that. AT&T would be another. The extreme cases are only one small part of this overall restructuring movement.”

  “I grant you it’s not the only description,” Donaldson said. “But there certainly are cases where people say in advance, ‘We’re going to get in there, we’re going to break up the company, it’s worth more in its separate parts than it is together, we’re going to get the money and we’re going to run.’ Mr. Forstmann, is that a good thing?”

  Forstmann’s only condition before appearing on the Brinkley show was that he wouldn’t discuss the RJR Nabisco deal. Although his interest had been reported in the newspapers, no one outside the talks knew how deeply involved he was.

  “Well, sometimes that’s a good thing to do,” Forstmann said. “It’s not always a bad thing to do.”

  “What about the workers, Mr. Forstmann?”

  “Well, they—”

  “Who are they, anyway? I mean, if they’re out of a job.”

  “No, that’s not the point at all,” Forstmann said. “Again, in my article, I said that without discipline, workers are one of the groups that may suffer. Discipline is the—investment discipline is the phrase that’s got to come back and be talked about. In the beginning the innovators of this idea, of whom I was one, had a great deal of discipline…. What has happened is imitators by the hundreds have gotten into this business and as imitators flocked in, discipline has eroded, and as a result, breakups that didn’t make sense have occurred.”

  “I’m not pointing the finger at you,” Donaldson said a moment later. “I guess I’m pointing the finger at the people you yourself brought up, these so-called imitators. Now, why should they have a free ride with no regulation?”

  “Well, I don’t think it’s a free ride. And if we had more time and we could get into it…. What’s gone wrong here is that people have created a new source of money which is commonly called junk bonds…”

  After the taping, Forstmann asked Freeman back to his apartment, and the pair watched themselves on television. Freeman called his mother-in-law. “That other man on with you was so cute,” she told the Salomon banker. “Is he Jewish?”

  Over coffee, Forstmann brought up RJR Nabisco. His enthusiasm of the night before was beginning to wane. “Ron, I don’t know if we can get together. You guys are doing this all wrong. All these junk bonds, PIKs and Zeros, this and that. It’s crazy. And what is this deal with Johnson?”

  “I just don’t know,” Freeman said. “We’re really not in control here. We’re kind of silent partners.”

  “Well, here it is, the biggest deal of all time. And Kravis is going to take it.”

  Thanks to a pileup on FDR Drive, Forstmann was running an hour late when he arrived at Shearson that afternoon, accompanied by his brother Nick and Steve Fraidin. The trio was escorted through milling groups of investment bankers to the boardroom, where they were joined by Peter Cohen and John Gutfreund. Forstmann had tactfully left Boisi behind.

  As they gathered, Forstmann didn’t know whether the day’s talks would end with a joint agreement to fight Kravis or a one-way ticket out of the deal. Within minutes the picture cleared.

  “First, I want to say I misspoke last night,” Cohen began the meeting. “I was a bit confused. Let me give you the correct terms now.”

  Cohen laid out Shearson’s proposed capital structure. It was nothing like what he had suggested the night before. Among other things, Forstmann Little was to be junior debt rather than senior. The changes were enormous. Forstmann didn’t believe Cohen had intentionally misled him—no one would do that—and chalked it up to inexperience.

  “Well, Peter, this is quite different from what we talked about last night,” Forstmann said when Cohen finished. “Not that I hold it against you. It’s just different.”

  “Yeah, I know.”

  Ted Forstmann was the picture of accommodation, but inside he suspected this was the last straw. Still, Forstmann found himself listening as Cohen for the first time went through specific details of the management agreement. As Cohen explained it, each side seemed to have veto power over everything the other sides did. If he heard correct
ly, Johnson and his management team could practically veto their own firing.

  This is insane, Forstmann thought. The absolute amateurs of all time are playing in the World Series. They’re putting up billions of dollars and they can’t even get rid of the management. And they actually think I’ll do the same.

  When Cohen finished, there was a moment of silence. “We think we can do a lot better,” Gutfreund said. “This is just where we are now.”

  Salomon’s chairman turned to Fraidin. “What do you think, Steve?”

  Fraidin thought Gutfreund and Cohen had no idea how their arrangement with Johnson would look to outsiders. They were missing the big picture. “Because of the size of this transaction,” Fraidin said, “I think there’s going to be a tremendous amount of political and congressional scrutiny. I think that reaction is going to affect every institution in this room. And I think we ought to keep that in mind.”

  He continued. “By my calculation, this management contract is worth about two billion dollars. Is that right?”

  “No, no, no,” Forstmann interrupted. “That’s not right.” What he meant was: That can’t be right.

  “I think it is,” Fraidin said.

  Gutfreund looked around the room. “Is that right?”

  They totted up the numbers. If all the incentives were met, the deal could be worth as much as $1.9 billion.

  “That certainly is a very big profit for management,” Fraidin observed.

  Yes, they agreed, it was. Cohen emphasized again that the agreement would need to be reworked.

  “Tell me about the fees,” Ted Forstmann said.

  Gutfreund chuckled. “Oh, we knew Teddy would get to that.”

  Cohen began reading. First came a success fee. Shearson and Salomon would receive $120 million if the takeover was successful. Next came a 5 percent fee paid to everyone who put up equity.

  “What’s that for?” Forstmann asked.

  “Oh, you get part of that,” Cohen said.

  “Oh,” Forstmann said.

  Shearson was projecting an estimated $103 million in fees for auctioning off RJR Nabisco assets after the LBO. There was a fee—$23 million—for committing to the mezzanine debt. Forstmann Little would receive a $30 million fee for its share of the mezzanine debt.

  Forstmann thought the list would go on forever. He asked questions but only pretended to write down the answers. At his side, Fraidin had some questions for Cohen.

  “Are you going to be getting a spread when you do the junk bonds to take out the bridge?” the lawyer asked.

  “Oh, yes,” Cohen said, “we get a three and a half percent fee on that.” That came to about $425 million.

  Fraidin saw the Forstmann brothers exchanging bewildered glances. “Is there a bridge fee?” Fraidin asked. Multibillion-dollar bridge loans, he knew, don’t come free.

  Cohen nodded.

  “What the hell is that for?” Forstmann asked.

  Jim Stern was standing in the corner. Shearson’s junk-bond chief looked as if he hadn’t slept in a week. “If you would like to take the risk on a billion five,” he said, “we’d be delighted to let you take it.”

  Forstmann didn’t miss the sarcasm. He glared at Stern.

  “I don’t know who you are, but—Peter, who is this guy?” Forstmann was so mad he felt the blood drain from his face. “Maybe you don’t know who I am,” he said to Stern. “But you’re talking about taking the underwriting risk on one point five billion. I’m talking about putting in three billion forever.” Forstmann’s anger was rising, and no one in the room wanted to get him started on The Spiel.

  Cohen intervened. Pointing to Stern, he said to Forstmann, “You want him outta here? You want him to leave the room?”

  Forstmann thought Cohen sounded like a Mafia don. “No, no,” he said. “He can stay.”

  The fee discussion resumed. “Well,” Fraidin asked, “what about the bank fees?”

  “Yes, of course,” Cohen said. “There’s bank fees.” Shearson was assuming payment of a 2.5 percent fee to its commercial banks—about $375 million.

  “Two-and-a-half percent, huh?” It was Nick Forstmann, rolling his eyes at his brother.

  “Two-and-a-half percent,” Fraidin repeated. It sounded like a lot of money.

  Cohen wasn’t through. “And we’ve estimated seventy-five million dollars for legal fees.” He turned to Fraidin. “So I guess you really want this deal to go through.”

  “Well,” Fraidin said, “that’s not how I operate.”

  At one point, Nick Forstmann halted the proceedings. “Hold it, hold it. Wait a minute,” he said. “Peter, what are we paying for this company? I don’t understand this. If I’m calculating right, it seems to me you’re borrowing too much money.”

  When Nick Forstmann ran the numbers, they didn’t add up. If he heard right, Shearson proposed raising $19 billion after their downpayment. But it seemed to need only $16.5 billion to buy RJR Nabisco. “It looks like we’re raising two and half billion too much,” Nick Forstmann said. “Why are we doing that?”

  “Is that right?” John Gutfreund asked.

  Nick Forstmann glanced over at Steve Fraidin. He didn’t need to say anything. Do these guys know what they’re doing?

  They took a break. Nick Forstmann retreated to a conference room to hash out the arithmetic with a dozen Shearson and Salomon bankers. His brother and Fraidin caucused in a hall outside the conference room. To Fraidin it was obvious that Cohen’s presentation left little room for agreement.

  Fraidin returned to the room alone. “Look, Teddy may want to reconsider some aspects, including the fees, the capital structure, the Ross Johnson situation, and the governance issues.”

  In short, everything.

  “I’m also concerned that the preferred is a PIK preferred, which you may know he’s never used.”

  “Okay,” Cohen said.

  Later, after Cohen and Tom Hill reviewed more of their strategy, the Forstmanns walked outside to their waiting car. Fraidin wondered aloud what their next step was.

  “Well,” Ted Forstmann said, “let’s go uptown and call Boisi and tell him where we are.”

  “Where are we?” Fraidin asked.

  “You know where we are, Steve,” Forstmann said. “We’re out.”

  Chapter

  12

  In one way, an LBO is a lot like buying a used car.

  A target company’s annual report and public filings can be compared to a classified ad. Like an advertisement, they contain useful information, although a savvy buyer knows the numbers can convey anything a clever accountant needs them to.

  The car buyer wants to know more than just what’s in the ad. He wants to talk to the owner, check under the hood, go for a ride around the block. For LBO buyers, a thorough inspection is equally crucial. More so than any takeover artist, the LBO buyer must know his prey. His success depends on determining exactly how much debt the target company can take on, and figuring precisely what budgets can be cut and what businesses sold to pay down that debt quickly. To take the used car analogy a step further, the LBO buyer must estimate, in precise detail, how many miles the car has left, how many spare parts he will need, and how much maintenance will be required. His margin of error is so thin that a worn crank shaft or a blown gasket could prompt the bank to call his loan. Similarly, in an LBO, a wrong calculation or an inaccurate projection can bring both buyer and seller down in an avalanche of debt.

  But what if you’re Henry Kravis, and the fellows driving the car won’t even let you kick the tires?

  This was the dilemma Kravis now faced. In a bidding contest, Johnson and Cohen would hold all the cards. Not only did they have access to every piece of confidential information, they had a management team to analyze it. They knew where every last dollar was stored, which budgets could be slashed without hurting the business, which plants could be mothballed without slowing production. Information was the key to success, and Kravis was on the outside looking in.

>   One of the special committee’s most important duties was helping Kravis learn about RJR Nabisco. The bankers of Lazard and Dillon were the referees charged with creating “a level playing field” on which Kravis, at least theoretically, could compete equally with Johnson. In practice, this proved a difficult task.

  The process by which LBO buyers inspect a target company is known as due diligence. When Kravis worked with a management group, due diligence was a breeze. Confidential documents were instantly produced, and executives were always available to brainstorm on the best ways to improve cash flows and reduce overhead. Kravis had teams of accountants, lawyers, and investment bankers crawl all over a target company until he was satisfied they knew its every nook and cranny and had earmarked every asset to be jettisoned, pared, or retained. It was a methodical, unexciting chore, but in many ways it was the key to Kohlberg Kravis’s success in the LBO business.

  On Thursday, October 27, Kravis and Roberts had met with Charlie Hugel and received assurances they could promptly begin due diligence. RJR Nabisco executives, including members of Johnson’s group, would be produced for interviews. Like many public corporations RJR was chartered in Delaware, and under Delaware case law the board was compelled to produce its executives for Kravis’s scrutiny. But, as Kravis would find out, there was no law saying they had to be cooperative.

  The special committee had arranged for Kravis to begin interviewing RJR executives at New York’s Plaza Hotel Monday morning, October 31. The interviews would go on for two days. Johnson wouldn’t be called—fruitless, Kravis figured. And Ed Horrigan had refused. Kravis’s team spent all weekend preparing.

  Johnson’s executives were to run an unusual gauntlet. Kravis planned to greet each man in a sitting room, brief him on his firm’s operating philosophy, and encourage him to stay on if Kravis won. Afterward he would escort each executive to a separate room, where he would be grilled by Paul Raether and a handful of Kohlberg Kravis associates. Raether was in a foul mood even before the interviews began. The first boxes of RJR financial data had arrived from the special committee only that morning, giving him no time to prepare intelligent questions.