Case Study: RJR Nabisco LBO Prescia 1

Case Study: RJR Nabisco LBO

Matt Prescia
RJR Nabisco LBO Prescia 2

The RJR Nabisco leveraged buyout was considered the largest LBO of all time, up until

2006. RJR Nabisco was formed in 1985 when Nabsico merged with RJ Reynolds (“Take a Look at

a Classic Private Equity Deal: RJR Nabisco Goes Private and the Street Goes Wild,” n.d.). RJR

Nabisco was appealing to other companies as a potential LBO, and there were many bidders

that were trying to pursue taking over this company because of the attractiveness RJR Nabisco

looked. In 1988, which is when the LBO took place, the CEO was F. Ross Johnson.

Johnson originally started to think about a LBO after RJR Nabisco took a big hit in the

1987 crash, which brought its stock from around $70, to the low $40s (Beattie, n.d.). He felt

that the bad publicity of tobacco was holding back from the foods division. In 1988, he

proposed a $17 billion LBO, in partnership with Shearson Lehman Hutton, in an effort to take

the company private (“History of the RJR Nabisco Takeover,” 1988). This bid was low to the

company, and it attracted other bidders. The players in this consisted of Drexel Burnham,

Merrill Lynch, Morgen Stanley, Wasserstein Perella, Salomon Brothers, First Boston, and

Goldman Sachs (Gaughan, 2015). When RJR Nabisco’s price continued to decrease, Johnson

started realizing that the low price of stock, will start to attract “corporate raiders.” (Beattie,

n.d.). This got Johnson to start talking to Shearson Lehman Hutton to try to complete a LBO,

which would avoid bringing Nabisco into play, where the company would be auctioned to the

highest bidder. However, as said before, he offered a buyout to the board of directors for

$17.6 billion, which actually the board of directors felt embarrassed by the low ball offer. After

this initial offer, other bidders were attracted, which then companies such as KKR (Kohlberg,

Kravis, Roberts & Company), First Boston, and Forstmann Little started to make offers.
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This was an attractive company to take over in the eyes of other bidders because RJR

Nabisco was a good candidate for an LBO. The companies cash flows were steady and

predictable. Both divisions, tobacco and food, did not vary with the ups and downs of the

business cycles of the economy. Also, neither of the divisions required major capital

expenditures. RJR Nabisco also had a low debt level, which means that it had unused debt

capacity (Gaughan, 2015). With these positives to the company, RJR Nabisco had a decline in

ROA from 15.5% to 11.5% from 1985 to 1988, as well as its inventory turnover going from 10 to

3.9 over the same period (Michel & Shaked, 1991). With that being said, management viewed

these problems as “fixable,” which means that when it comes to outside bidders, these

problems to not make or break a deal, however this is potential for value creation.

Prior to the LBO, “the salaries and perks of the management quickly grew to outsized

proportions,” (Beattie, n.d.). With the growing expenses, Johnson ran into trouble with the

board chairman. So, Johnson was able to get the chairman switched, and started appointing

friends of his to key positions. This was a way for Johnson to keep his perks, which he obviously

did not want to give up. According to Andrew Beattie, when a leveraged buyout was suggested,

Johnson did not like this idea. By Johnson taking Nabisco private, would mean there would be

money owed to a bank, ultimately forcing Johnson to cut back on his spending habits. After

meeting with KKR about a LBO, Johnson started to “warm up” to the idea. The reason he

started to think about it more, is because there would be benefits of an LBO, which what stuck

out to him was the increase of money. Johnson’s greed could be seen by his proposed terms

for the LBO, when Johnson offered $17.6 billion. His terms were that he would have control of

the board and 20% of the stock for himself (Beattie, n.d.). After KKR took over RJR Nabisco,
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they got ride of Johnson, however, still giving him a $30 million golden parachute. After the

deal was complete, RJR was still shaky. There were jobs that were cut, as well as divisions. The

international tobacco business went to Japan Tobacco. The domestic tobacco and food

divisions were separated and than later recombined. So even after the deal, the structure of

the company was being changed around a lot. Just prior to the initial buyout offer, RJR Nabisco

stock was as $56, and was sold to KKR for $109 a share. After the buyout, the company had a

lot of debt, and continued threat of lawsuits. This overall hurt the company, and the value of

the stock was decreasing. In 1991, KKR sold stock in the company back to the public, and in an

article written in 1999, “the company’s stock price has traded in a $10 range since 1993…’It’s

been dead money for six years,” (Mufson, 1999).

There are a couple reasons that this LBO was not successful for KKR. When the LBO was

complete, the deal was financed with very high interest rates. This left KKR with a great deal of

debt, (Hays, 1999). There were also lawsuits that were going against the tobacco industry,

which was constant, and was bringing the tobacco division down. Also, in 1999, the chairman

and chief executive of RJR Nabisco admitted that mixing the food and tobacco did not work out.

He said that they are two complete different businesses and should not be mixed. To add to

that, people should have the opportunity to invest in a tobacco or food company, not investing

in one company that has both. With this being said, the bad rap that tobacco has, hindered the

company’s stock.

RJR Nabisco was broken up, with the selling of the foreign tobacco business, the food

business became owned by Kraft, and the tobacco business renamed RJ Reynolds Tobacco

Holdings. When R.J Reynolds Tobacco was sold to stockholders, the parent company became
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Nabisco Group Holdings. After Nabisco Holdings was bought by Phillip Morris, RJ Reynolds

Tobacco Holdings acquired Nabisco Group Holdings again, and the deal was completed in 2000.

RJ Reynolds tobacco is currently the manufacturer of Newport (RJ Reynolds, 2015).

References

Beattie, A. (n.d.). “Corporate Kleptocracy at RJR Nabisco.” Retrieved from

http://www.investopedia.com/articles/stocks/09/corporate-kleptocracy-rjr-nabisco.asp.

Gaughan, P.A. (2015). Mergers, Acquisitions, and Corporate Restructurings. (6th). Hoboken,

NJ: John Wily & Songs, Inc.

Hays, C. (1999). “End of an Empire: The Overview; RJR Nabisco Splits Tobacco Ventures and

Food Business.” Retrieved from http://www.nytimes.com/1999/03/10/business/end-

empire-overview-rjr-nabisco-splits-tobacco-ventures-food-business.html

“History of the RJ Nabisco Takeover.” (1988). The New York Times. Retrieved from

http://www.nytimes.com/1988/12/02/business/history-of-the-rjr-nabisco-

takeover.html.

Michel, A & Shaked, I. (1991). RJR Nabisco: A Case Study of a Complex Leveraged Buyout.

Financial Analysts Journal, September-October 1991,15-26. Retrieved from

http://staff.bath.ac.uk/mnsrf/Teaching%202011/RJR%20case%20study.pdf

Mufson, S. (1999). “For R.J. Reynolds, a Topsy-Truvy History.” Retrieved from

https://www.washingtonpost.com/archive/business/1999/03/10/for-rj-reynolds-a-

topsy-turvy-history/1c78c094-a345-429e-a627-95024dcfe55b/.

“RJ Reynolds.” (2015). A Look Into Our Past. Retrieved from

http://www.rjrt.com/transforming-tobacco/history/

“Take a Look at a Classic Private Equity Deal: RJR Nabisco Goes Private and the Street Goes

Wild.” (n.d.). Business Insider. Retrieved from http://www.businessinsider.com/rjr-

nabisco-lbo-private-equity-deal-2012-1#rjr-nabisco-was-formed-in-1985-when-nabisco-

merged-with-rj-reynolds-tobacco-1.