Merger & Acquisition

Leverage Buyout Case let

on
RJR Nabisco and KKR

Submitted To: Prof. Vivek Sharma

Submitted By: Vikram K Thakur 02

Pooja Rane 18
Ankur Pagaria 17
Hemlata Gupta 26
 RJR Nabisco Leverage Buy Out
By
Kohlberg Kravis Roberts & Co.

RJR Nabisco, Inc. was an American conglomerate formed in 1985 by the

merger of Nabisco Brands and R.J. Reynolds Tobacco Company, a leading
producer of food products (Shredded Wheat, Oreo cookies, Ritz crackers, Planters
peanuts, Life Savers, Del Monte Fruit and Vegetables, and Snickers Chocolate) as
well as Winston, Camel and Salem cigarettes.

In 1999, due to concerns about tobacco lawsuit liabilities, the tobacco

business was spun off into a separate company, and RJR Nabisco was renamed as
Nabisco Holdings Corporation. Nabisco is currently owned by Kraft Foods.

KKR & Co. L.P. formerly known as Kohlberg Kravis Roberts & Co. was
founded in 1976 by Jerome Kohlberg and cousins Henry Kravis and George R.
Roberts, all of whom had previously worked together at Bear Stearns, where they
completed some of the earliest leveraged buyout transactions.

KKR & Co. sponsors and manages private equity investment funds and
famously specializing in leveraged buyouts, based in New York. Since its
inception, the firm has completed over $400 billion of private equity transactions
and was a pioneer in the leveraged buyout industry. KKR’s has completed a
number of landmark transactions including the 1989 leveraged buyout of RJR
Nabisco, which was the largest buyout in history to that point.

After 1987 resignation of Jerome Kohlberg at age 61, Henry Kravis as a

succeeded senior partner and George R. Robert were responsible for the 1988
leveraged buyout of RJR Nabisco.

In October 1988, F. Ross Johnson who was the President and CEO of
RJR Nabisco proposed a $17 billion - $75 per share Management Buyout
(MBO) of the company with the financial backing of investment bank Shearson
Lehman Hutton and its parent company, American Express.
 Later on, Kravis who had originally suggested the idea of the buyout to
Johnson, presented a new bid for $20.3 billion - $90 per share financed with an
aggressive debt package. KKR also had the support of significant equity co-
investments from leading pension funds and other institutional investors. KKR's
investors included Coca-Cola, Georgia-Pacific and United Technologies
corporate pension funds as well as the Massachusetts Institute of Technology
endowment, the Harvard University endowment and the New York State
Common Retirement Fund.

However, KKR also faced criticism from existing investors over the firm's
use of hostile tactics in the buyout of RJR Nabisco. KKR proposed to provide a
joint offer with Johnson and Shearson Lehman but was rejected and Johnson
attempted to block KKR's access to financial information from RJR.

KKR’s rival private equity firm, Forstmann Little & Co. was invited into
the process by Shearson Lehman who attempted to provide a bid for RJR with a
consortium of Goldman Sachs Capital Partners, Procter & Gamble, Ralston
Purina and Castle & Cooke. Ultimately the Forstmann consortium came apart
and did not provide a final bid for RJR.

In November 1988, RJR set guidelines for a final bid submission at the end
of the month. The RJR’s management and Shearson group submitted a final bid of
$112 per share, a figure they felt certain would enable them to bypass any response
by Kravis and KKR.

KKR's final bid of $109 per share, though a lower dollar figure, was
ultimately accepted by the board of directors of RJR Nabisco. KKR's offer was
guaranteed, whereas the management offer lacked a "reset", meaning that the final
share price might have been lower than their stated $112 per share. Additionally,
many in RJR's board of directors had grown concerned at recent disclosures of
Ross Johnson' unprecedented golden parachute deal. TIME magazine featured
Ross Johnson on the cover of their December 1988 issue along with the headline,
"A Game of Greed: This man could pocket $100 million from the largest
corporate takeover in history”.

KKR's offer was thus, welcomed by the board. F. Ross Johnson received
$53 million from the buyout. KKR collected a $75 million fee in the RJR takeover
at $31.1 billion of transaction value (including assumed debt).
 The RJR’s LBO benefited many of the parties involved. Investment bankers
and lawyers who advised KKR walked away with over $1 billion in fees, and
Henry Kravis and George Roberts attracted unprecedented amount of publicity that
turned the cousins into instant celebrities.

Unfortunately for KKR, size would not equate with success as the high
purchase price and debt load would burden the performance of the investment.
KKR was able to overcome the RJR Nabisco investment, raising a new investment
fund and continuing to invest throughout the 1990s.

Financial Characteristics of the LBO

There were several financial characteristics that made the RJR Nabisco an
attractive candidate for LBO –

a. RJR’s cash flow’s especially from the tobacco business was steady and
predictable.
b. Neither of the RJR’s business required major capital expenditure.
c. RJR had a low debt level; its long term debt was less than the shareholders
equity.
d. RJR’s tobacco and food business featured many well-known brands across
the world which gave the company a high breakup value of $85 - $92 per
share (as per Smith Barney) compared with its stock price of $56 prior to the
buyout.
Bidding Groups and their funding patters-
Bidding Party Bidding price per share Funding Pattern

$84 Cash

$112 per share $24 Preferred Stocks

$4 Convertible Stocks

$88 Cash
$101 per share $9 Preferred Stocks
$4 Other Securities
RJR Management
$90 Cash
$ 100 per share $6 Preferred Stocks
$4 New Common stocks

$84 Cash
$ 92 per share
$8 Debt Securities

$ 75 per share Bidders did not specify form of payment

$81Cash

$ 109 per share $18 Preferred Stock

$10 Convertible Bonds

$80 Cash

$ 106 per share $18 Preferred Stock

KKR Acquisition Group $8 Convertible Bonds

$75 Cash
$ 94 per share $11 Preferred Stock
$8 Convertible Bonds

$78 Cash
$ 90 per share
$12 Securities