Barbarians at the Gate

by Bryan Burrough

  The backbone of any successful LBO is a set of projections: profits, sales, and, most important, cash flow. Because they dictate the amount of debt a company can safely repay, projections are the key to formulating a bid. And the right bid means everything to an LBO: The higher the price, the higher the debt. Too much debt can crush the healthiest companies.

  Kravis had hoped to emerge from his due diligence sessions at The Plaza with a set of reliable projections. Stonewalled, his people had fallen further and further into a quagmire of confusion. By Monday, just four days before bids were due, Kravis knew something about Del Monte, a little about Nabisco, and next to nothing about Horrigan’s tobacco business.

  The job of assembling Kravis’s projections had fallen to a thirty-year-old associate, Scott Stuart, a handsome bachelor with a sadly neglected apartment on Manhattan’s Upper West Side. Often working eighteen-hour days, Stuart had developed four separate sets of projections for RJR Nabisco, each, at least in theory, more accurate than the last.

  He began with numbers obtained from RJR Nabisco via the special committee. Coming straight from Johnson, they were suspect. Normally, Stuart would spend weeks brainstorming with management to refine these numbers and identify areas where savings could be found. But with no management on board, Stuart turned to tobacco-industry analysts at Drexel and Merrill Lynch. Work with the bankers at Morgan Stanley and Wasserstein Perella yielded further revisions. Bit by bit, Stuart had compiled a nice, neat set of white computer runs. He wanted to believe they were reliable, but he feared they were no better than guesswork.

  Gaping holes yawned in Stuart’s analysis, the result of key figures he hadn’t been able to obtain. In a perfect world, Stuart wouldn’t have even attempted projections without gathering all the relevant figures. But he had no choice: Time constraints dictated he come up with something. For three weeks Stuart had pestered the bankers at Dillon and Lazard for the figures, but to no avail. At first he thought they, too, were stonewalling him. Later he would realize the problems lay within RJR Nabisco. No one below its highest levels knew the whole picture. Those that did, like Ed Robinson, were giving only name, rank, and serial number.

  By Monday, Stuart was growing panicky. Every day he searched for the missing numbers, shouting at Dillon Read, shouting at Lazard, shouting at his own accountants and lawyers crawling through the data room in Atlanta. Data room, hah! The concept made Stuart laugh. They got data all right: reams and reams of raw numbers that would take weeks if not months to fathom. It might as well have been Chinese.

  The numbers he needed weren’t complicated: an estimate of RJR Nabisco’s available cash reserves, a total debt number, an estimate of payments due Johnson’s management group under its golden parachute severance packages. Basic stuff, Stuart thought, yet they formed the foundation from which Kravis and Roberts would determine their bid. Both his bosses, Stuart was uncomfortably aware, were growing impatient with his inability to put finished projections on their desks.

  If missing figures weren’t bad enough, Stuart didn’t completely understand the ones he had. One number in particular puzzled them all. On the initial projections they had obtained from RJR Nabisco was a heading “Other Uses of Cash.” Beside it was a row of figures stretching out ten years, each year ranging from $300 million to $500 million. Stuart had no idea what the numbers meant. What the hell was “other uses”? Was it cash flowing in or out? Should he add it? Subtract it? Ignore it? Five hundred million dollars wasn’t the kind of sum Kravis liked his people to ignore. The swing between adding and subtracting it was nearly $1 billion, roughly the difference between a bid of $96 a share and $92 a share. For three weeks the figures lay like a row of mysterious coals glowing white on the darkened screen of Stuart’s IBM personal computer, a category no one could explain. When they asked Ed Robinson about it at The Plaza, he had pleaded ignorance. No one at the special committee knew what it was, either. The “Other Uses of Cash” now headed the list of mysteries Stuart had four days to solve.

  Then, on Monday, Stuart took a call from a Dillon Read associate, Blair Effron. Would you be interested in spending any more time with John Greeniaus? Effron asked. Greeniaus had just finished speaking with the special committee. “I think,” Effron said, “this guy wants to give you the real story.”

  Stuart took the offer to Paul Raether. “Sure, why not?” Raether replied. “They were the only guys who were helpful the first time around.”

  A meeting was arranged that afternoon at a midtown hotel, the Carlton House. Raether led Stuart and another associate into the meeting room, where they took seats at a round table. Greeniaus was already there, Larry Kleinberg in tow.

  “Before we start,” Greeniaus began, “I’ve got a few things I’d like to ask you.”

  “Fire away,” Raether said.

  “Are you guys still having conversations with the management group?”

  “No.”

  “With Ross Johnson?”

  “No.”

  “Do you have any plans to have any more conversations?”

  “Not as far as I know.”

  “Good,” Greeniaus said. The coast was clear. “I’ve got a few things I’d like to tell you.”

  The two-and-one-half-hour speech John Greeniaus embarked on was among the most startling Raether had heard in a decade of LBO work. In one fell swoop Greeniaus laid bare Nabisco operating secrets and strategies, its vulnerabilities and follies.

  “Look,” he said, “nobody’s ever asked us how we’d run this business for cash. Let me tell you, there are a whole lot of things that can be done.”

  Nabisco, Greeniaus stated confidently, could increase its operating income 40 percent in a single year if necessary. Profit margins could be taken to 15 percent from 11. Cash flow, he said, could be taken to $1.1 billion a year from $816 million.

  “Come on—” Raether said in disbelief.

  “No, you don’t understand,” Greeniaus replied. “Our charter is to run this company on a steady basis. There was really no good reason for the earnings in this group to go up fifteen or twenty percent. In fact, I’d get in trouble if they did. Twelve percent is about what I’m supposed to give every quarter. The biggest problem I’ll have next quarter is disposing of all the additional cash these businesses generate. The earnings are going to be too big. Christ, I’ve got to spend money to keep them down.” It was all done, Greeniaus explained, because Wall Street craved predictability.

  Raether was dumbfounded. “What are you going to spend it on?”

  “Product promotion, marketing.”

  “Is that money well spent?”

  Greeniaus chuckled. “No, not really.”

  He mentioned Johnson’s $4 billion plan to modernize Nabisco’s bakeries. “Technology for technology’s sake,” Greeniaus scoffed—an outlet for the tobacco cash Johnson didn’t know what to do with. “You don’t need to spend all this money,” he emphasized. “You’re just spending it for nothing.”

  Greeniaus trotted out Johnson’s sacred cows and slaughtered them one by one. Team Nabisco: a waste. The golf tournaments: a travesty. “Should I spend ten million dollars each year on the Dinah Shore? Does that sell crackers? No. But it’s forced on me by corporate. It’s built into my overhead.”

  Raether’s head was spinning as he left the meeting. This was the break they had been waiting for. “You guys better believe those numbers,” he told Greeniaus as they left, “because you may have to deliver them.” The implication was clear: If Kravis won, Nabisco would be managed, not sold. Greeniaus left the meeting on cloud nine.

  Raether hustled back and reported the meeting to Kravis. “I assume we’re not being set up,” Kravis said. It crossed his mind that Greeniaus might be a Johnson plant.

  “No, I think the guy’s real,” Raether said.

  Kravis thought about what type of man Greeniaus must be. Traitor or hero? “I gotta give this guy a lot of credit,” he said. “This is the first chink in their armor.”

  It was the
first piece of good news the pair had heard in nearly two weeks. Raether wasted no time plugging Greeniaus’s assumptions into their buyout models. By the next day their impact was clear. If everything Greeniaus said was true, Kohlberg Kravis could boost its bid from the low nineties to nearly $100 a share.

  On Tuesday, Johnson flew to Washington for a meeting with the president. Actually, he was one of several executives scheduled to see Ronald Reagan that day, all members of the commission commemorating the bicentennial of the U.S. Constitution. Johnson was vice chairman. Ushered into the office after lunch, he shook Reagan’s hand.

  “Ross,” the president said, “I can’t help but notice you seem to be getting some publicity lately.”

  Johnson smiled. For once he didn’t have a ready quip. After posing for pictures, his group met with Kenneth Duberstein, the president’s chief of staff, and Colin Powell, the national security adviser. Both men asked about the buyout. Johnson told some jokes about the ways of Wall Street.

  But even schmoozing with the president failed to lift Johnson from his growing pessimism. Later, leaving for the plane to New York, he turned to Dwayne Andreas, chairman of Archer Daniels Midland and chairman of the committee. Andreas was a friend; Johnson said he wished they saw each other more often. “Well, Dwayne,” he said, “I might have a lot more free time in a couple of weeks.”

  The computer runs on Ted Forstmann’s desk told the grim story. At $85 a share, Forstmann was comfortable bidding for RJR Nabisco. The deal could be financed the Forstmann Little way, with cash and no junk bonds. At ninety, it was still doable, though the returns to his investors fell sharply. Institutions put their money with Forstmann Little to get the 35 percent minimum return it promised. To pay much above ninety, Forstmann could see, he could give investors no more than 20 percent. Hell, he joked, T-bills paid 11 percent. It was mortifying.

  There was only one way to boost the returns enough to justify a bid. North of ninety, Forstmann could see, they could bid with the aid of a Goldman Sachs bridge loan, which would be refinanced through the sale of junk bonds. Forstmann cringed at the thought, but Geoff Boisi was pushing the idea hard. All week Forstmann, at Boisi’s behest, had suffered a crash course in junk bonds. Half the time he couldn’t understand what the young Goldman bankers were telling him. “I’m speaking English, and it’s like they’re speaking Turkish,” he complained.

  But Forstmann understood enough to realize the risks such a loan entailed. For each quarter Goldman couldn’t sell the bonds to refinance the loan, the loan’s interest rate rose. And rose. If everything went well, Forstmann could repay the loan through RJR Nabisco’s cash flow. But if for any reason Goldman couldn’t sell the bonds, Forstmann Little was liable for the entire amount. In effect, Forstmann was forced to bet the entire deal on whether Goldman could unload the bonds, a risky wager given the firm’s spotty track record.

  Boisi was practically feverish, he wanted the bridge so bad. He assured Forstmann it was safe. There was no more than a one in a thousand chance that Goldman couldn’t sell the bonds.

  “Sure,” Forstmann said, “so write that in there,” meaning, in the contract.

  “No, Teddy,” Boisi explained. “We have to have the right to get out of this thing in the event of an emergency.”

  It was the worst part of a process with which Forstmann had become increasingly uncomfortable. Discussing tobacco left him feeling slimy. Debating future demand in the teen market made him feel like a drug pusher. At least the bank talks were going well. Sunday afternoon Forstmann had stood before a packed auditorium at Manufacturers Hanover in his blue jeans and exhorted a crowd of gray-suited bankers to put forward the $10 billion or more he would need. From all appearances, they would.

  In the end, it always came back to junk bonds. They went round and round and round. At one point, Boisi threw up his hands.

  “What are you, a priest?” he asked Forstmann. “Have you got some kind of religious conviction about this stuff?”

  Forstmann tried to explain. “Geoff, there’s no place to go. I’m a fighter, but I just can’t do this stuff.” He pulled a copy of the article he had written for The Wall Street Journal and shook it at Boisi. “I really believe this stuff, you know.”

  They were in the thick of debate Tuesday afternoon when Brian Little took Forstmann aside. “I think you and Nicky and I ought to talk.” The two men collared the younger Forstmann and retreated to Little’s office.

  The three partners knew their position was bleak. The returns simply weren’t adequate unless they used junk bonds. None of them wanted to do that. But the simple truth was that, even if they had, they couldn’t. Forstmann’s antijunk diatribes had painted them into a corner. To go with a junk-bond–financed bridge loan at this point would invite public ridicule. “The reality is, it can’t be done without junk,” Little said.

  Their mood was somber. “I guess we should just end this,” Ted Forstmann said.

  He broke the news to Boisi and his three corporate partners. After the initial furor subsided, he wrote out a long press release citing in detail Forstmann Little’s reasons for backing out of the deal. It amounted to an attack on the auction process and on junk bonds; he planned to issue it the following morning. That evening he called Peter Atkins and read it to him.

  Atkins immediately realized he couldn’t let Forstmann issue the release. It sent the wrong message to junk-bond buyers and to a banking industry already jittery about LBO debt and the possibility of anti-LBO legislation. With just three days until the bidding deadline, this was no time to scare the banks. Forstmann could bow out, but Atkins simply couldn’t allow his departure to hinder the remaining two bidders.

  Forstmann stuck to his guns, insisting that he had to let the world know he was bowing out on principle. Frustrated, Atkins pulled Hugel from a Combustion Engineering board meeting at the Intercontinental Hotel. “We have to get them to change this press release,” the lawyer said. “It looks really bad.”

  Hugel felt he had bent the rules to allow Forstmann into the bidding in the first place, and, like Atkins, was embarrassed to find him withdrawing. “Our horse was dying,” Hugel would say later. “And,” Atkins added, “it was dying in public.”

  Now Hugel himself locked horns with Forstmann. For hours they argued about the release. “I have to put it out,” Forstmann kept insisting. Forstmann Little had a reputation to protect, he repeated. Hugel laid down the gauntlet. If Forstmann wouldn’t bend to persuasion, maybe blackmail would work.

  “What if I put out my own press release?” Hugel suggested.

  “What do you mean? What would it say?”

  “It’ll say you acted in a hostile and unethical way.”

  “You wouldn’t do that.”

  “Try me,” Hugel said. “I guarantee it’ll be in the newspapers the next day.”

  The next morning Forstmann Little & Co. issued a terse, one-sentence press release, bowing out of the bidding for RJR Nabisco with nary a peep of explanation.

  Chapter

  14

  On Monday morning, in an upstairs conference room at Skadden Arps, Peter Atkins was steering the special committee through its paces. Around him, the auction framework Atkins had erected was humming smoothly. The three investor groups—Forstmann Little wouldn’t drop out till the next day—were moving swiftly toward the Friday deadline, and Atkins was confident their bids would satisfy both the board as well as its increasingly restive shareholders. Confidentiality agreements were in place. Due diligence was marching forward. Everything seemed under control, just the way Atkins liked it, when a letter was carried into the meeting and placed in front of him.

  He scanned the document impassively. He could see the proposal was desperate, almost certainly too little, too late. “Vague” and “ephemeral” were words that leapt to his mind.

  Atkins had hoped to avoid something like this. The five-page letter beneath the First Boston letterhead was a monkey wrench aimed squarely at the gears of his machine. With any
luck, Atkins thought, it could be brushed aside. He had no way of knowing, of course, how difficult that would prove.

  Setting the letter down, Atkins faced the assembled directors. “There’s something else we have to deal with here,” he announced.

  As the shotgun marriages of America’s largest companies spurred Wall Street’s growth through the 1980s, one Wall Street firm initiated more major takeovers and created more tactical innovations than any other. First Boston, founded in 1934 and until the late 1970s a sleepy, second-tier underwriter, rocketed to the fore of major investment banks thanks largely to the brains and chutzpah of Bruce Wasserstein and Joe Perella.

  From a warren of cluttered offices inside First Boston’s glass-sheathed Park Avenue headquarters, Wasserstein—paunchy, disheveled, shirttails flying—and the tall, erudite Perella became the takeover era’s first superstars. In virtually every major takeover battle of the 1980s—at Getty, DuPont, Gulf—their footprints could be found. The two men helped transform investment banking from a sleepy gentleman’s trade by introducing the hustling, cutthroat ethic flourishing on Wall Street today.

  On a chilly Groundhog Day in 1988, after months of clandestine maneuvering, Wasserstein and Perella strode into First Boston’s executive offices and, reading from notes prepared by their lawyers, announced their resignations. As the pair walked out that morning, they left Wall Street’s largest and best-known merger department in disarray. More than twenty top First Boston deal makers—the cream of Wasserstein’s hand-picked crop—soon flocked to join the pair’s new start-up firm, Wasserstein Perella & Co. Many of First Boston’s best clients followed suit.

  When Henry Kravis launched his unprecedented tender offer for RJR Nabisco, Bruce Wasserstein was seated firmly at his right hand. By then, every major Wall Street investment bank and a host of minor ones were noisily feeding at the trough of RJR Nabisco. Every firm, that is, except First Boston. Without Wasserstein, First Boston seemed destined to sink into obscurity. King Arthur had left Camelot, it appeared, and the Round Table was no more.