KKR’s $34 Billion Acquisition of RJR Nabisco
Deal overview
· Acquirer: Kohlberg Kravis Roberts & Co. (KKR)
· Target: RJR Nabisco
· Total transaction size: $34 billion ($25 billion cash price and debt assumed by KKR)
· Closed date: 24th April 1989
This deal is a notable example of a leveraged buyout (LBO). An LBO entails a highly leveraged company takeover within the framework of a structured financing, where debt finances the takeover due to its lower cost of capital as compared to equity. RJR was an attractive LBO candidate for KKR due to its steady and moderate growth but also because of its low capital investment requirements given the nature of the tobacco business at the time. Although RJR presented a declining return on assets and a falling inventory turnover, this was viewed by KKR as remediable. Indeed, within private equity, many funds favour companies and businesses that present ‘fixable’ problems as it enables greater potential after the transaction for value creation via operational improvements.
After the 1987 crash, RJR’s stock stalled at $55 per share. CEO Ross Johnson, seeking to take the company private, partnered with Shearson Lehman Hutton to propose a $75 per share management buyout, reserving 20% ownership for himself and his team. The board rejected the offer, labelling Johnson a "black knight," triggering a public bidding war. KKR entered with a $20.43 billion bid, outbidding Shearson and rejecting a joint deal. The chaotic auction drew multiple bidders and failed agreements. Final offers came from KKR ($24B), First Boston ($23.38–26.11B), and RJR’s management ($22.9B). KKR claimed victory as its offer strongly chimed with the RJR board’s more non-quantifiable objectives, notably stakeholder profit and welfare. However, this came at the cost of considerable ensuing litigation. Although this didn’t hinder the acquisition itself, it posed a considerable hurdle amongst many others post-LBO.
Company Details: Acquirer – Kohlberg Kravis Roberts & Co. (KKR)
KKR was established in 1976 by three former partners from Bear Stearns and was a pioneer of the 1980s LBO model. In that era, their primary goal was to acquire underperforming companies, restructure them, and then sell them for profit, with the 1989 RJR LBO solidifying their reputation during the sector's boom. Today, KKR operates as a publicly traded global investment firm, managing hundreds of billions in assets across a diverse portfolio that includes private equity, credit, infrastructure, real estate, insurance, capital markets, and growth equity. The firm has expanded significantly beyond its 1980s focus on aggressive LBOs, now running 28 offices and pursuing broader alternative asset strategies.
Company Details: Target – RJR Nabisco
Before the 1989 acquisition, RJR Nabisco was formed in 1985 through the merger of RJR Tobacco and Nabisco Brands, establishing itself as one of the largest US consumer products conglomerates. At that time, Nabisco alone generated over $19 billion in sales, with RJR recording total global sales of $12.9 billion. Since the acquisition, KKR quickly divested major snack and food divisions to mitigate debt, alongside implementing cost reductions and restructuring. By the late 1990s, the food and tobacco segments were separated due to the legal risks associated with tobacco sales, particularly the potential for class action lawsuits to deter buyers. The food business subsequently became Nabisco Group Holdings, which was acquired by Kraft in 2000 and is currently a subsidiary of Mondelez International.
Legal Contentions and Impact
A pivotal legal contention originated from the bidding war before the LBO. The Schneider v. Lazard Freres & Co. case was part of an onslaught of shareholder lawsuits against Nabisco when the Management’s bid was dismissed in favour of KKR’s bid. RJR’s shareholders sued the investment advisors, alleging that they had given faulty advice in claiming that the two bids were equivalent in value, while the shareholders alleged that the Management Group’s bid was superior. This alleged valuation mistake, if proven correct, would have cost the RJR shareholders more than $1 billion. The Schneider court broke new legal ground by permitting this direct shareholder action against the Special Committee's investment bankers.
Unlike prior Delaware law, which required proof of directors breaching their fiduciary as well as of the advisor aiding and abetting that breach, the Schneider court held shareholders only needed to prove that the auctioneers had acted negligently Contrary to prior corporate law principles. This reasoning entailed finding that investment advisors were direct agents of the shareholders and hence directly liable for negligence. The Schneider decision strongly fixated on how any loss through such sales would be sustained by shareholders.
Although initially the Delaware Courts found that there had ‘probably’ been no breach of Delaware law in the RJR shareholder litigation, this decision was subsequently departed from by the New York Appellate Court’s finding of liability, resulting in Delaware courts’ previous ‘aid and abet’ standard being supplanted by the Schneider standard. Although this litigation presented a hurdle to the success of the LBO itself in achieving its economic and financial purposes, it strongly expanded liability of investment advisors to shareholders, which was an especially welcome legal impact given the sentiment at the time of little regard for shareholders and for ethics in the Wall Street.
Nonetheless, the judgement’s long-term impact has presented some difficulties. The new standard means increased indemnification of financial advisors by corporations, leading to the financial burden of any potential Schneider liability being retained by the selling corporation. This consequently, incentivising rational bidders for a corporation to lower their bids, could result in a negative net effect on selling shareholders. The lower acquisition price more than offsets any expected proceeds from legal suits. Furthermore, the heightened liability, particularly concerning the valuation of non-cash bids which was central to the RJR Nabisco case, incentivises an increased use of pure cash as the means of payment in sales of corporations. This has meant that auctioneers are more cautious, preferring all-cash bids due to their inherent simplicity in valuation, even though complex non-cash bids can sometimes yield higher prices or facilitate more transactions by resolving differences in buyer-seller beliefs.
Future Implications
This deal epitomised the excessive leverage and high-risk strategies of the 1980s LBOs. However, in hindsight, it appears not as ‘golden’. Indeed, this transaction was heavily regarded as having been unsuccessful, primarily due to post-LBO events which diverged dramatically from the pre-LBO assumptions and conclusions upon which KKR’s bid heavily rested. After the buyout, the tobacco business proved not to be as good a cash cow due to price wars among cigarette companies and tobacco litigations. RJR was left particularly vulnerable to the market disruption due to its lack of financial flexibility; it was unable to invest in promoting its products and was instead forced to cut back on promotional spending. Notably, RJR Nabisco was left with a debt burden of about $25 billion, five times its pre-LBO debt obligations. Although KKR made an additional $1.7 billion equity infusion in 1990 and secured an additional $2.25 billion in new bank loans, the competitive strategy of a prominent market player, Philip Morris, in cutting the price of Marlboro cigarettes by 40 cents, posed a further hurdle to RJR and KKR.
Nonetheless, the deal wasn’t a complete failure: around $22 billion was returned to banks, junk bond investors, and preferred shareholders, while KKR, its advisors, and loan syndicates earned nearly $1 billion in fees. KKR’s aggressive recruitment drive for a new CEO in 1989 which culminated in the hiring of Louis Gerstner, the highly regarded president of American Express, was one of several strategies which led to the sale of fringe assets at premium prices, ultimately enabling corporate overhead costs could be cut by almost $50 million. However, arguably, this is demonstrative of how during the LBO-boom priorities surrounding long-term management were being superseded by a growing desire for making short-term profits. Indeed, even with this deal, much of the 'success' was left confined to a select group of Wall Street insiders through hefty fees.
Moreover, any profit and growth achieved post-LBO came because of the multiple complex concessions and sales KKR made. This included operational cut downs, spinning the international tobacco business off to Japan Tobacco and prominently separating and then recombining the domestic tobacco and food parts of the company in a shuffle featuring almost as many participants as the bid war preceding the deal. The massive debt load, market disruption, and costly settlements ultimately discredited LBOs of this scale, highlighting their vulnerability to downturns and prompting tighter leverage rules and hurdle rates. As such, the magnitude of the deal and its aftermath has left a notable impact within private equity. There has been a shift toward fund-level compensation to better align incentives and curb excessive risk-taking. Exemplified by the fallout from RJR Nabisco, this compensation model and a growing institutional investor base in the 1990s encouraged more cautious investing. Consequently, high-risk deals declined, as reflected in the drop in bankrupt investments from 11% in 1985–1989 to 3% in 2006–2007.
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