No Big Deal to KKR : Track Record Makes Nabisco Bid Logical for Buyout Pioneer

The record $20.3-billion bid for RJR Nabisco announced Monday by any standard would seem a shocking leap in the size of corporate buyouts. But for Kohlberg Kravis Roberts & Co., the leveraged buyout firm that made the bid, it is merely the logical next step in a succession of ever bigger deals, beginning back in the mid-1970s.

KKR is credited with inventing the big leveraged buyout, in which companies are taken private with borrowed funds and paid off from the acquired company’s own cash flow. Its record of success has persuaded investors that despite the staggering amounts of debt taken on in these deals, they are essentially sound and often extremely profitable investments.

“They have such a great track record that they have all of the financial institutions just standing in line to give them money,” said Richard J. Riordan, a prominent Los Angeles attorney and investor.

But the firm is drawing increasing criticism from labor unions and others who question whether leveraged buyouts are going too far.

Unions know all too well that as companies struggle to pay off debt they often lay off workers, and this has often made them outspoken opponents of these buyouts. And other critics assert that a quantum leap in the size of LBOs may trigger a backlash in Congress and the possibility of failure, even by KKR.

“The deals are so stretched,” said Louis Lowenstein, a professor of law and finance at Columbia University. “People think the game goes on forever,” he said, “but it’s like any speculative bubble.”

Industry experts view the RJR Nabisco bid as a kind of successor to KKR’s highly successful $6.1-billion buyout of Beatrice Cos. in 1986. Despite a cash flow that could barely cover the debt taken on at Beatrice, KKR succeeded in finding and selling off undervalued assets at the diversified food concern that in the end made the buyout extremely profitable. RJR Nabisco is a diversified food and tobacco concern.

“Their long-term pattern of success has made it easier to commit large sums of money to their funds,” said James George, investment manager for the Oregon state treasury. The Oregon public employees pension fund has put $600 million into KKR’s current war chest, making it the biggest single investor.

Pension fund managers and buyout experts say the increasing willingness of pension funds to commit ever-larger shares of their assets in buyouts is a measure both of their increasing confidence in that type of investment and the feeling that under current market conditions there are few other investments available with such potential high yields.

“They have been able to attract larger funds and that leads to doing larger companies,” George said. KKR currently has commitments of $5.5 billion from investors, which forms the equity base on top of which debt will be piled in successive buyouts.

Until recently, KKR refrained from making hostile bids for companies. The firm specialized in doing friendly deals with companies’ managements and steered clear of hostile deals for fear of alienating managements and making future friendly deals impossible. But the three founders split over this issue. The elder of the three, Jerome Kohlberg Jr., left the firm. It is now run by Henry R. Kravis and George R. Roberts, cousins who believed that the need to invest ever larger amounts of their backers’ funds made hostile deals a necessity. And in recent months there has been a flurry of such bids.

‘Matter of Money’

A KKR spokesman played down speculation that the firm leaped into the RJR Nabisco deal so as to preserve its reputation for doing the largest buyout deals. The KKR $90-a-share bid topped a $75-a-share, or $17-billion, offer by RJR Nabisco’s management, backed by Shearson Lehman Hutton. (In trading on Tuesday, RJR Nabisco’s stock price climbed $1 per share to close at $85.)

A senior investment banker with ties to KKR insisted that the firm’s bid makes financial sense on its own. “It’s not a matter of pride, it’s a matter of money,” he said.

But Riordan said that, based on past experience: “One of their priorities is to always have the biggest deal.”

In recent years, Kravis and Roberts have refused to give interviews and weren’t available for comment Tuesday. But Thomas M. Daly, an outside spokesman for the firm, said that aside from the willingness to make hostile bids, “Their strategy has not changed.” He added, “The only thing that’s changed here is the size.”

Aside from the simple availability of funds, the obvious attraction of going after very big companies is that they provide a proportionally larger return, buyout experts said. There are apt to be more hidden, under-valued assets that can be sold off at big profits. This reduces the debt and leaves the profits from the core businesses, which aren’t sold off. Big companies such as RJR Nabisco also have plenty of well-known brand name products that can command a big price if sold.

Larger Fees

Acquisition of big companies tend to generate much larger fees, which is how KKR makes most of its money. And the return to equity investors is equally rewarding, if earlier deals such as the buyouts of Beatrice and Safeway Stores are reliable indicators.

Also, “It’s easier to employ that capital they’ve amassed in one big deal than it is in 12 smaller deals,” said another investment banker.

The RJR Nabisco bid caps the evolution of financing techniques that began to be developed in the 1970s. Buyout sizes were limited initially by the fact that most of the financing came from banks and insurance companies. The use of high-yielding “junk bonds,” a technique pioneered by Drexel Burnham Lambert Inc., increased in acceptance, and now deals over $1 billion have become almost routine. An investment banker recalls that in the 1970s KKR did a $100-million buyout. “Nobody thought they could get the financing.”

THE DEALMAKERS’ BIGGEST DEALS

In billions

$6.1 . . . Beatrice Cos., 1986 $4.2 . . . Safeway Stores, 1986 $3.7 . . . Owens-Illinois, 1987 $2.5 . . . Storer Communications, 1987 $2.43 . . . Jim Walter Corp., 1987 $2.36 . . . Macmillan (in litigation) $1.8 . . . Duracell, 1988 $1.7 . . . 50% of Union Tex. Petro. unit, 1985 $1.25 . . . Rheem, World Color, Uarco, 1984 $1.23 . . . Stop & Shop, 1988 Source: Associated Press