Barbarians at the Gate (53 page)

“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.”

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 correctly, 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.”

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.

At nine-thirty the first executive, John Polychron, president of Planters, appeared. When Kravis shook Polychron’s hand he noticed a second man behind him, one of Harold Henderson’s lawyers. Kravis, alert for signs of tampering or intimidation by Johnson, was immediately suspicious. Was the man a spy? Was he sent along to intimidate those interviewed and prevent them from spilling secrets? Kravis couldn’t tell, and after a few moments the man departed, leaving Polychron on his own.

The next pair, John Greeniaus, the Nabisco head, and Bill McKnight, an aide, arrived at one o’clock. Kravis went through his speech, trying to make the pair comfortable. He was surprised when Greeniaus remarked, “Look, you gotta understand, I’m not part of the Ross Johnson group. I’m not one of these seven guys.”

“Watch this guy,” Kravis told Raether as he escorted Greeniaus into the interviewing room. “Maybe there’s a wedge here we can use. He just might be helpful.”

Raether was hopeful as Greeniaus seated himself at the interview table. But just as they began, a young Lazard associate came in with a message. “When you’re finished,” he told Greeniaus, “you’re supposed to go across the street to the forty-eighth floor.” It broke the mood. Raether suspected that the message from Johnson was meant to intimidate Greeniaus. It was all a mind game. Greeniaus, like Polychron before him, went on to answer questions politely and appeared helpful—but not too helpful.

Harold Henderson was scheduled to be questioned at five o’clock. Henderson, with his detailed knowledge of tobacco litigation, could be especially useful. A few minutes before five, Kravis and Dick Beattie ran into him in the hall outside the interview room. The lawyer introduced himself and shook Kravis’s hand.

“Can I talk to you, Mr. Kravis, a minute?”

The two men stepped into a vacant suite while Beattie waited outside. Kravis emerged from the room a minute later and watched Henderson walk off down the hallway.

“That’s the damndest thing I’ve ever heard.”

“What?”

“The guy made it absolutely clear: I’m with Ross, win, lose, or draw. He won’t talk to us. That’s the first time that’s ever happened.”

By Monday evening Raether was growing irritated. Johnson’s men
seemed to be suffering from collective memory loss. The easy questions they answered. But when Raether probed for a judgment, an opinion on where a budget could be cut, they clammed up with an “I’ll get back to you on that.”

The parade of Johnson executives continued on Tuesday. That afternoon a trio of senior executives led by the domestic tobacco chief, Dolph von Arx, came in. Von Arx had been quoted in
The Wall Street Journal
the day before saying he would leave the company in the event of a Kravis takeover. As a result, Kravis had little use for the man.

“You’ve undoubtedly heard most of what I have to say in these speeches,” Kravis said. “And well, Mr. von Arx, there’s not a lot to talk about with you. You’re leaving, or so I read in the paper, along with your top eight guys.”

“Oh, no,” von Arx protested. “Reread that quote. I’m not speaking for them; they have to make their own assessment.”

“Are you gone if I buy this company?” Kravis asked.

“I’m loyal to management, as you would expect,” said von Arx. “But I would have to reassess my position.”

Interesting, Kravis thought, how quickly these people switched allegiances. As for the others, a few, such as Bob Carbonell of Del Monte, were pleasant and mildly cooperative. Others couldn’t seem to remember their names.

Ed Robinson was the worst. Johnson’s chief financial officer should have been a treasure trove of information. His intimate knowledge of the company’s European and offshore funding operations could have been invaluable.

Shown in on Tuesday at five o’clock, Robinson clearly wanted nothing to do with Kravis. Hostility radiated from the man like summer heat from a city street.

“Do you want to hear what I have to say?” Kravis asked.

“No,” Robinson said. “I know enough.”

In the interview room, Robinson was openly antagonistic. To most questions he either pleaded ignorance or said he would find the answer and send it on later. At one point, Raether asked about the company’s leasing subsidiary, whose existence he had learned of only through an unsolicited letter to Kravis offering to buy it.

“What leasing company?” Robinson said.

And so it went. After a series of particularly evasive answers, one of
Raether’s aides, Scott Stuart, threw up his hands. “Do we want to continue this charade,” he asked Raether, “or can we go home now?”

Robinson was issued out. The last to be questioned, Dean Posvar, the planning chief, was little better. It was like interrogating prisoners of war, Raether thought, and he half expected Posvar to give his name, rank, and serial number. When the last session ended, Raether stormed out.

“This is useless,” he muttered to Josh Gotbaum, a Lazard Freres banker monitoring the interviews. “These guys aren’t saying anything.”

Then Geoff Boisi called Boisi wasn’t about to give up on RJR Nabisco. He had three of Goldman’s best clients chomping at the bit to get a piece of this deal. Procter & Gamble badly wanted RJR’s biscuits business. Ralston Purina of St. Louis coveted a host of food brands. And David Murdock, the chief of Castle & Cooke, parent of Dole fruits, was dying to get his hands on Dole’s archrival, Del Monte. As seriously as his clients sought pieces of Johnson’s company, no one wanted this deal more than Boisi.

Much like Shearson, Goldman Sachs was about to unveil a multibillion-dollar investment fund. The Goldman fund, though, was to be earmarked for bridge loans. For the first time it would allow staid old Goldman to compete head-to-head with moneyed megafirms such as Shearson and Merrill Lynch. The fund was Boisi’s baby; an RJR Nabisco bid would be its debut.

The consortium Boisi envisioned would be a dream team. All he needed to complete it was someone interested in buying the tobacco operations. That someone was going to be Ted Forstmann. Forstmann just had to be convinced. And Boisi knew all the right buttons to push.

All that day he hammered at Forstmann, reminding him of the reasons they had attempted this deal in the first place. Kravis had to be stopped,
Boisi insisted, before he jeopardized every
Fortune
500 company. “If KKR wins this, there’ll be no stopping them,” he argued. “They’ll be bigger than Boone Pickens, Carl Icahn, and all the raiders wrapped into one.”

Corporate America would stand up and cheer a challenger to the junk-bond cartel, Boisi told Forstmann. Whoever beat Kravis would emerge the true hero of this mud-wrestling match. That hero, Boisi suggested, had to be Ted Forstmann. Only Forstmann had the right combination of skill and power to pull it off.

“You don’t realize how strong you are,” Boisi said. Forstmann Little’s “cheap” money gave it an edge over all other competitors. “You just don’t realize how powerful your money is. It’s the key to the whole deal.”

Soon Forstmann began to nibble at Boisi’s bait. The lure of striking a blow against Kravis and the junk-bond junkies was too strong. And no one could deny the appeal of working with blue-chip companies such as P&G. Forstmann allowed himself to think out loud.

“If we do our due diligence, and this really is economically viable, these guys you’ve rounded up are going to be aggressive participants,” he mused. “Everybody is a real money player. Nobody comes from the other world. No one’s part of the cartel. Boy…wouldn’t that be a wonderful thing?”

Yes, Boisi said, and it wouldn’t have to be risky. “I know you’re not going to do anything risky. I know your parameters. But think of this: If this deal could meet your standards, think of what we could accomplish. These junk-bond guys have had their way for three, four years. We could turn the tide.”

Forstmann found himself thinking of the Revlon deal. The junk-bond cartel had risen to power on Ron Perelman’s takeover of Revlon. He again felt a pang of responsibility for that loss and the damage the raiders had wrought. He had been defeated in that fight. But now…

An image began to form in Forstmann’s mind.
The junk-bond hoards are at the city gates,
Forstmann thought.
We could stop them, once and for all. This is where we could stand at the bridge and push the barbarians back. Wouldn’t that be phenomenal?