Barbarians at the Gate (27 page)

Although its client ultimately won the battle, the Koppers deal had a profound effect on Shearson’s merchant-banking effort. Suddenly hostile deals, the backbone of its recent successes, were badly out of favor. That summer Cohen turned down the chance to back a pair of hostile takeover attempts, the Rales brothers’ raid on St. Louis-based Interco and underwear magnate Bill Farley’s run at a Georgia textile concern, West-Point Pepperell.

At the same time, Shearson’s earnings began to sag. The entire securities industry suffered in Black Monday’s wake, but few firms more so than Shearson, which had dramatically increased its overhead by acquiring a faltering brokerage, E. F. Hutton. Although there had been layoffs—and Cohen planned more—he badly needed a fresh stream of profits. Merchant banking had become Wall Street’s most active and profitable business; now more than ever, it was critical that Shearson plunge into it. And with hostile deals all but ruled out, that meant one thing: LBOs.

When Ross Johnson switched course and began contemplating LBO scenarios, it looked like the answer to Cohen’s prayers. An $18 billion buyout could wash away a lot of problems. The mere fact they had carried it off, the largest LBO in history, would instantly catapult Shearson into the top ranks of merchant banking firms. Afterward anyone considering a major LBO would have to consider working with Shearson. It would be a magnificent debut for the fund. The residual benefits for Hill’s merger business would be tremendous. The bonds Shearson would sell to finance the deal could, in one fell swoop, revive Cohen’s moribund junk-bond department. And all before they took a single fee.

Oh, the fees!
The upfront fees alone—for advising and money lending and a “success fee,” maybe $200 million in all—would be a gigantic boost
to Shearson’s flagging earnings. And it wouldn’t stop there. For years afterward the money would continue to stream in. There would be fees for refinancing, fees for advice, and fees for simply minding the shop. M&A alone could count on tens of millions in fees from the divestitures they planned as RJR Nabisco’s unwanted businesses were chopped up and sold to meet debt payments. And all before they even thought about returns on their investment: Hill was projecting an annual return of at least 40 percent. On a $500 million investment, that was $200 million a year—for five years or more!

It was enough to make Cohen’s head swim. Even though he had masterminded Shearson’s own acquisitions, Cohen had worked on only one LBO in his entire career, Sheller-Globe, which until RJR Nabisco remained Shearson’s largest. But Johnson’s friendship with Jim Robinson, combined with the deal’s potential impact on Shearson, compelled him to take an active interest in the current deliberations. Johnson was dangling before his eyes a dream deal, quite literally the deal of a lifetime. And as his plane touched down in Atlanta that evening, it was all within Peter Cohen’s grasp.

After breakfast, the Shearson team shuttled across the parking lot to headquarters in twos and threes to avoid arousing suspicion. Upstairs, they settled into Johnson’s office overlooking a sea of Georgia pines. Johnson, accompanied by Horrigan, Sage, and Henderson, had brought along the newest member of his team, Steven Goldstone of the Wall Street firm of Davis, Polk & Wardwell.

At forty-two, Goldstone was a curious choice to advise the RJR Nabisco
executives. Slight and balding, the New York-raised son of a lingerie merchant, he was a rarity among Wall Street lawyers. Most specialized in advising merger clients or litigating court cases, but Goldstone did both. As a tactician he was virtually unknown. For a decade he worked on the bread-and-butter underwriting and mid-size acquisitions on which the securities industry is built. He had met Johnson when Davis Polk helped install RJR Nabisco’s poison pill that summer.

As a litigator, Goldstone had gained notoriety for his role in what
American Lawyer
called “the most talked-about district court ruling” of 1987. Defending the Wall Street firm Donaldson Lufkin & Jenrette in a San Diego lawsuit, Goldstone inexplicably defied a court order to produce a key witness, prompting the judge to declare a default judgment against his client, a move that left Donaldson Lufkin vulnerable to a $100 million loss. Adding insult to injury, claims against three codefendants were thrown out four months later. Hiring Goldstone had been Henderson’s idea.

From the outset it was clear this would be no ordinary LBO. The talk in Johnson’s office that day was cordial and covered a variety of issues: price, profits, and plans of attack, among other things. Until then their discussions had been largely theoretical and over the phone: No one was sure Johnson would actually go through with it. “What do you think the chances are he’ll do it?” Nusbaum asked Goldstone at one point. Goldstone pondered the question a moment. “Less than fifty-fifty,” he said.

For all their uncertainty, Tom Hill was surprised to find how thoroughly Johnson’s people understood LBOs. The pupil, in fact, was about to tell the teacher how class would be run.

Central to the success of most LBOs is a ruse known as the “gun-to-the-head” strategy. In it, a group of senior corporate executives secretly works with a Wall Street firm such as Shearson to assemble financing. Once the financing is lined up and an offering price agreed on, the chief executive presents the bid as a take-it-or-leave-it proposition to his board. Hill had even drawn up a ten-week schedule the Johnson-Shearson group could follow in approaching its own buyout. It might have been called “Ten Steps to a Successful LBO”:

The idea is to keep the entire process secret until a deal has been cut, ending the bidding before it can begin. Placing a gun to the board’s head, in Wall Street parlance, is intended to leave directors with few options. Disclosing the overture prematurely tends to put the company “in play” for corporate raiders and risks frightening off a certain offer from management. For years boards capitulated and signed merger agreements with the “ambushing” management. Many still did. Wall Street strategists such as Hill consider it crucial to sneak up on a board with a fully financed offer ready to be launched. He naturally assumed Johnson felt the same way.

Johnson wouldn’t hear of it. He had seen this board exact its wrath on Tylee Wilson for lesser transgressions; hell hath no fury like this board scorned. Nor was he willing to let Shearson arrange financing or do anything else that, if leaked, would anger directors. Johnson had it good in Atlanta, and until he made up his mind to pursue the LBO, he wasn’t going to risk it all by letting Shearson get ahead of him. On the other hand, Johnson had supreme faith in his ability to make a pitch. If an LBO was the best approach, he knew he could sell it to the board—but only if it was an idea, not an ambush.

Diverting from accepted LBO strategy made Cohen and Hill uneasy, but they had no choice; without Johnson, they had no deal. If the board chose to publicly announce their overture, it would blow their tactical advantage. In a worst-case scenario, it would put them on equal footing with any party who might wish to top their bid. But no one—Cohen, Hill, or Johnson—was particularly worried about that happening. RJR Nabisco was simply too big for all but a handful of firms in the world to think about attacking. That day Hill ran down the possibilities:

All were dark horses. Everyone in the room knew the only one strong enough to put up real competition was Henry Kravis. Of all the world’s conglomerates and investors, only Kravis had the combination of power, confidence, and money to mount a serious counterbid. Johnson’s office was filled with opinions and purported intelligence. Someone mentioned they thought Kravis was on an African safari and might not be able to react fast enough. But it was when Johnson talked that Shearson Lehman Hutton listened. They all knew Kravis had courted him a year earlier.

“Henry won’t do anything,” Johnson said confidently. “I just don’t think he’s interested in tobacco.” Andy Sage echoed his boss’s feelings.

It was a critical assertion, one that Johnson repeated several times in coming days. He knew of Kravis’s overtures via Beck and Waters and didn’t take them at all seriously. He purposely avoided mentioning them to Shearson. “No reason to,” Johnson would later say. “They’d have just run around in a flap saying, ‘We’ve got to do this and we’ve got to do that.’ These are not cool people in this business. I didn’t want them to lose any objectivity.”

In fact, Johnson was lulled by the same fundamental fallacy embraced by the Shearson executives. For all the talk of possible competitors, most of them were convinced their bid, if launched, would be unopposed. They felt certain that no one, not even Kravis, would attempt a buyout this size without the help of a management team to identify the best ways to cut costs. Even if tempted, they believed, Kravis would no doubt be put off by the daunting complexities of tobacco litigation. Cohen and Hill, in effect, considered Johnson to be their shield against any competing bids. As the group’s primary strategist, Hill had ways to test Kravis’s appetite, but later said he felt handcuffed by Johnson’s insistence on secrecy.
Asking questions, he knew, could prompt interest in the wrong quarters.
*

Just as Shearson took it on faith that Johnson could handle his board, Johnson took it on faith that Shearson could raise enough money to buy the company. In fact, the firm had never attempted anything like it and had even discussed the possibility of bringing in a major junk-bond power such as Drexel or Merrill Lynch to help out. The idea was quickly dropped: Seeking help would be an admission that Shearson couldn’t do the deal itself. Cohen was confident that, with American Express behind it, Shearson could do the job.

Price was never a matter of serious debate. Both Hill and Johnson thought a bid around $75 a share made sense. It was higher than the stock had ever traded—around $71—although not by much. The $75 a share worked out to $17.6 billion, nearly three times the size of the Beatrice deal. The $15 billion or so they would need from commercial banks was more than twice the largest sum ever lent on a takeover; Shearson’s Jim Stern had spent hours calculating whether that much takeover money existed in the
world.
“Seventeen billion dollars,” Johnson said. “Fuck, I’ll be going around on my hands and knees like a monkey with an organ grinder to find seventeen billion dollars.”