Saturday, September 02, 2006

Barbarians at the Gate: The Fall of RJR Nabisco by Bryan Burrough and John Helyar

This book provides blow-by-blow account of events related to LBO (Leveraged buy out) of RJ Reynolds Nabisco in 1989.

This should be a recommended reading for corporate finance students. There can hardly be better example of LBO than the one of RJR Nabisco.

Two WSJ journalists, with intimate understanding of the incident, reconstruct the entire story that spans only a couple of months. They use their extensive knowledge, contacts and access to key players  to provide ringside view of the event.

LBOs financed by junk bonds were a phenomenon of 90s. As dot coms became the in-thing later in the decade, doing LBOs using high risk bonds were the norm in 90s. As with anything, once the concept was found to be attractive, many unscrupulous people  entered the scenario which resulted in the convictions of legends such as junk-bond king Mike Milken among others.

LBO is a simple concept. It's the process by which a group of private investors take a public company private, retool the business, add some value and after some years sell the company as a whole or in parts for huge profits. So, where do they get money to buy these companies especially when the companies are bid in billions of dollars. The money comes thru high risk debts issues by the private investors. Naturally these loans have very high interest rates. How do these investors expect to repay the debt? Actually they do not. All they care is to be able to make interest payments on the billions of dollar debt they have raised for next 3-4 years. In that time, they will retool the company and sell it for much more value to be able to comfortably pay back the principal. How can they be sure about being able to make interest payments? One is from the cash on company's balance sheet and other is from the cash flow generated from the ongoing business. LBO is nothing more than putting down 5% to buy a house costing 100K. Fixing it up and selling it for 175K in a very short time and thus make nice profits without having to worry about the long term.

Another way to look at LBO and what happens to the company after LBO is akin to buying a used car. Sometimes people buy a used car not for the car as such but for the parts. This is because there is a huge demand for car parts all over the world. A 98 Honda civic (for example) is said be worth more when dismantled and sold as parts than for an intact car. Same with the business. A business as a whole may be valued less than the sum of its parts. So LBO investors sometimes sell the pieces  of business to make some quick money. It used to said that HP's printer business was so profitable that Wall Street had recommended spinning it off as a separate company. It's a different matter that it did not happen.

LBOs are done especially when stock is depressed. Astute investors know that the company is worth more than what market has priced it. So, even if they offer a small premium to the shareholders, they will only be happy to take the money and run. You can also create media hype, not-so-true news tidbits to create more panic to force people to sell out.

RJR stock was trading at around 60 after the 1987 crash which had depressed the economy. The management team led by Ross Johnson wanted to do the LBO at 75. Internal documents showed that company was valued anywhere between 85-115. So, if they could take the company private they were going to billionaires.

Once a public company comes to the market. Anyone can bid for it. Although the management team had liked to take it private with the investment bank of their choice, there were many others who found the opportunity irresistible. How different groups of investors played very hard and left no stones unturned to buy RJR Nabisco is the story in this book.

Basically it comes down to personalities, big egos, rash decisions, shortsightedness, greed and what not. So you will come across many colorful characters with their own idiosyncrasies. When they wheel and deal, their actions and behavior thru the time provides entertainment, and occasionally shocks you and nauseates you when you see the corporate filth.

All in all a great book to learn about one of the biggest LBOs in American corporate history. Authors have done  a  fabulous job of recreating the crime scene, accused and verdict. Audio book is also very good with a lot of dramatics to give  realistic feeling.

There are way too many characters and their side kicks. So it may be hard to remember all of them. Authors probably knew this. So they introduce characters often. It helps.

Great book.


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