Bid Rekindles Leveraged Buyout Doubts
The announcement Thursday that RJR Nabisco’s managers may seek to take the giant consumer products company private in the nation’s largest takeover quickly rekindled a controversy over the merits of the deals called leveraged buyouts, which have steadily increased over the last decade.
Although advocates say these deals streamline American companies to meet overseas competition, opponents complain that they have burdened companies with dangerous loads of debt, exploited the tax code and thrown thousands out of work.
The huge size of the RJR Nabisco deal--far larger than the largest completed buyout, the $6.1-billion buyout of food maker Beatrice Cos. in 1986--suggests that a new wave of enormous deals may be ahead, some observers say. “We may now be in a totally new league,” said Evan Simonoff, managing editor of Mergers & Acquisitions Report, a New York trade letter. “This suggests that even the biggest companies in America aren’t out of range” of the leveraged buyout.
In such deals, the management of a company borrows the money to buy it, then pays back the debt by using profits from operations or from the sale of company assets. But, to meet those payments at what are typically high interest rates, the managers must squeeze out as much excess cost as they can.
And often that leads to major corporate restructurings and layoffs, as it has in the restructuring of Beatrice, the 1985 buyout of retailer R. H. Macy and the 1985 purchase of diversified media company Storer Communications, to name a few.
Those companies are not required to disclose information on employment after they are bought out, but analysts speculate that hundreds have been laid off as operations have been sold or shrunk.
Advocates of the deals argue that such steps are often beneficial to companies that have become overstaffed and spendthrift through years of heedless management. They say that, when the companies are owned by their managers, the managers feel they have more of a stake and will work harder to make them succeed.
Also debated is the way that such deals greatly reduce companies’ income tax burdens. Louis Lowenstein, a professor of finance and law at Columbia University, says that, based on RJR Nabisco’s profits of $1.2 billion, the company might have tax obligations of $500 million as a publicly owned company. But that would be greatly reduced if the newly private company deducts the huge interest expenses it will pay because of the debt it has taken on.
“Part of what’s going on is a saving of a huge amount of income taxes,” Lowenstein said.
A nagging criticism of leveraged buyouts has been that managers usually know the financial picture of the company much better than the shareholders from whom they buy it and offer an unfairly low price. “Managers clearly have more and better information than the outsiders--and they are the buyers,” said Baruch Lev, a professor of accounting at UC Berkeley School of Business. “You have to assume they’re getting a good deal.”
Indeed, some firms that specialize in arranging leveraged buyouts have clearly made very good deals. Mergers & Acquisition Report says Kohlberg Kravis & Roberts, perhaps the most active firm, stands to make a total of $1 billion in profits from its recent leveraged buyout of Oakland-based Safeway.
But others say that shareholders--and those who represent them--have become much more savvy in recent years as the number of leveraged buyouts has increased. “Management may have pulled the wool over people’s eyes in the early days, but, after all the criticism, the shareholders are a lot more careful,” one Wall Street takeover-stock speculator said.
Several stock analysts said Thursday they expect that RJR Nabisco will be forced to raise its bid from $75 a share to $100 a share, even if no other bidders make offers for the company, in order to satisfy shareholders.
Another issue is the risk that companies may fail because they cannot pay off their debts after they go private. So far in this decade, a very small percentage of companies that have undertaken leveraged buyouts have failed because they couldn’t pay their debts.
“The bankers who do these deals say they are very careful about which companies they choose, and, in fact, their record is so far very good,” said Martin Sikora, editor of Mergers & Acquisitions magazine.
But some economists and others have worried that an economic downturn could tip many such firms into bankruptcy. The biggest recent bankruptcy of a company that went private through a leveraged buyout was that of Revco, owner of a Midwestern drug chain. It went private in 1986 in a $1.3-billion deal; but, because of stiff competition and other problems, it sought bankruptcy court protection last June.
Some proposed deals have failed to be completed. The management of Santa Monica-based Wickes Cos., for example, recently withdrew its offer for the firm, amid speculation that it could not raise the needed funds. And a directors’ committee at Hospital Corp. of America rejected its management’s offer to buy that firm, Sikora said.
Several industry analysts said Thursday that many banks may be eager to make loans for the RJR Nabisco deal because the company’s huge cash flow makes it a safe bet to succeed. “This looks like a very bankable deal,” said Robert Thompson, analyst with the Prudential Bache Securities firm.
Indeed, some critics say too many banks and investment people are looking for buyouts to invest in. Although the exact number of leveraged-buyout investment funds is not publicly disclosed, dozens are believed to have been formed in this decade. Such funds are organized to attract money from investors specifically for leveraged buyouts, with an expectation of high returns.
The largest may be those of the big leveraged buyout firms, such as Kohlberg, Kravis, Roberts; Forstmann, Little & Co.; Clayton & Dubilier; and Gibbons, Green, Van Amerongen. Kohlberg, Kravis has $6 billion in its leveraged buyout fund, according to Mergers & Acquisition Report. Because buyout sponsors often put up 10% to 20% of the total financing, this means Kohlberg, Kravis could conceivably finance $60 billion in such transactions.
An additional 40% to 80% of the funds for such deals usually comes in the form of bank loans, according to Simonoff of Mergers & Acquisitions Report. The RJR Nabisco deal will probably involve loans from a syndication of dozens of banks from this country, Europe and Asia, analysts said.
Staff writer Jonathan Peterson in Los Angeles contributed to this story.