Mergers & Acquistions

RJR Nabisco Case

Academic Group 4
Girish Shenoy I Meghna Saluja I Nikunj Daruka I
Saloni Solanki I Vasvika Jain
 Summary
RJR Nabisco began in 1875 as a tobacco company. As of 1987, it had two business segments: Tobacco & Food

Auction Bids:
Management Group Strategy
1987
KKR: $75 cash; $11 pay-in-kind
October 20, 1988 preferred stock; $6 Pay-in-kind
Sell food assets & take the
Food Products KKR Bid: $ 20.7 bn
tobacco business private convertible debt
Sales: $ 9.4 bn The Management Group (Ross Financing: $1.5 bn Equity; $3.5
Operating Income: $ 915 mn Johnson, CEO of RJR Nabisco, Strategy: Retain all of the
Rationale: The market bn subordinated debt; $12.4 bn
Assets: $ 10 bn Edward Horrigan (vice chairman tobacco business &
undervalued company’s bank debt
of RJR Nabisco), Shearson continue their presence;
tobacco business and food
Tobacco Business: Lehman Hutton (IB firm) Retain significant portion
business due to its association Management Group: $90 cash;
Sales: $ 6.3 bn proposed to buy the company of food operations
with tobacco $6 Pay-in-kind preferred stock;
Operating Income: $ 1.8 bn for $17 bn ($75 piece) $4 convertible preferred stock
Assets: $ 5.2 bn Pre-Offer Share Price: $ 55.875
Selling of assets will eliminate Financing: $2.5 bn Equity; $3 bn
Revised Bid: $21.1 bn ($92 subordinated debt; $15 bn Bank
undervaluation & generate
share) Debt
substantial gains
 Why was RJR Nabisco a great LBO
candidate?
Consistent and Steady Growth
RJR Nabisco was an attractive LBO candidate because it exhibited a
steady & consistent growth in the long run. It consisted of two main
businesses of Tobacco and Food, both being unaffected by business
cycles and insensitive to market wide fluctuations.

Low Capital Expenditure Requirements

RJR Nabisco had low capital expenditures in both the businesses
(though high working capital requirements which were supposed to be
funded by regular cashflows). In the 3 years following Nabisco’s brand
purchase, it had spent less than 7% of its revenues towards capital
expenditure.

Low Debt
RJR Nabisco also had a low level of debt. It had a long-term debt to
assets ratio of just 30% which was quite attractive for being an LBO
candidate. There was a great scope for debt expansion for the
company and this turned out to be most attractive basis for an LBO.

The above points of attraction overshadowed the problems of declining ROA and falling
inventory turnover of RJR Nabisco. These problems seemed to be fixable.
Approach to valuation followed by different bidders

KKR
• Retained tobacco business and discontinued the food
business to an extent of $6.2 bn
• $5.6 bn was raised for financing the deal, along with
other partners to finance the deal
• Assumed $5.2 bn of pre-existing debt

Management Group
• Value derived only by eliminating food business and
taking the Tobacco business private
• Food business sold at $ 12.7 bn
03
• Outstanding debt of $5.2 bn was assumed

First Boston Group 02

• Planned to derive value from tobacco business and
proceeds from sale of Food business
• Food business to be sold at the tune of $13 bn
• Value of shareholders varied from $98 to $110 bn 01
 Why did KKR win?
Operational
KKR planned to lean the
Cost
operations and identify the
potential savings from there
in operations
Growth of
KKR assured continued
Business
support to the Food Business
of the RJR and also was in
support of the growth
Detailed Bid
The initial bid was
comprehensive and detailed of
funding; not just a approximate
value on future potential
Convertible
Offered
Debtconvertible debt to
existing shareholders so that the
shareholders could participate in
upside of the company
 Risks associated with LBOs
Lower Equity Levels
The LBO process tends to use most
of the equity funds of the company.
On an average, equity levels stand
at ten percent or even less, this
makes it extremely difficult to get
sufficient credit for new projects.
Poor Gross Margins
Considering the higher debt
ratios and interest rates, the
gross margins are bound to fall in
near future. The firm doesn’t
have the equity to borrow
additional money and might
even miss multiple profitable
opportunities.
 LBO has always been
Excessive Debt Proportions considered lucrative and a
recipe for success.
Most of the investors in LBOs use
massive amounts of debts to
overtake the company. The debt  However, leveraged buyouts
face several risks and the
ratio may go as high as 70 percent
in some cases. chances of their failure are
comparatively higher.
“High Leverage is unsafe, not
just for a company but the
entire economy. LBOs are
reducing the safety.
Management loses the power
to do many things. It has no
High Debt Servicing Demands margin for error and less
margin for additional risk”
These debts are expensive and come - Franco Modigliani
with high servicing demands directly
impacting the profitability and the
ability to take up new ventures.
 The US senate was closely monitoring
this deal as it was $20+ Billion deal
Negotiations Stakeholder
Confidence vote from the Board of
Directors Management

 Management Group focused their Regulatory Hurdles  Management Group was

attention on the internal working and standing together as a bidder
stakeholder management
 Ross Johnson used his position
 KKR: Structured financing, voter to his advantage till he lost
appeasement in terms of business
valuation
Thank You!