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Why was RJR Nabisco such an interesting LBO Candidate?

RJR Nabisco (now known as Nabisco Brands Inc.) is the company that created the Oreo cookie. The Oreo cookie was first introduced in 1912 and has since become one of the most popular and well-known cookies in the world.

Why was RJR such an interesting Leveraged Buy Out (LBO) candidate?

  • Growth: RJR Nabisco experienced steady growth throughout the 1980s, with revenue increasing from $8.4 billion in 1980 to $18.6 billion in 1988.

  • Capital expenditure: In 1987, RJR Nabisco's capital expenditures were approximately $681 million.

  • Cash Flow from Operations: RJR Nabisco's cash flow from operations in 1987 was approximately $1.8 billion.

  • Debt Capacity: It had low debt levels and a relatively strong credit rating of a AAA credit rating from Standard & Poor's

  • Asset Base: It had undervalued assets that could be sold or spun off to reduce debt and increase value.

  • Room for improvement: It had operational inefficiencies that could be improved by cutting costs, increasing margins, and focusing on core businesses.

These factors made RJR Nabisco appealing to private equity firms and other investors who saw an opportunity to acquire the company using mostly debt financing and then restructure it to enhance its profitability and value.

Here is what happened in the LBO deal

  • The deal was initiated by RJR Nabisco’s CEO F. Ross Johnson who wanted to take the company private and avoid shareholder pressure and regulatory scrutiny.

  • The deal sparked a fierce bidding war between Johnson’s management group and several other parties, including Kohlberg Kravis Roberts & Co. (KKR), a leading private equity firm led by Henry Kravis.

  • The deal involved complex financial engineering, such as using junk bonds, bridge loans, asset sales, and multiple classes of securities to finance the acquisition.

  • The deal was influenced by various factors such as market conditions, tax laws, antitrust issues, political interventions, and media coverage.

  • The deal was ultimately won by KKR who paid $25 billion for RJR Nabisco, making it the largest LBO in history at that time.

Following the LBO, RJR Nabisco's debt levels increased to over $20 billion, which was a staggering amount of debt at the time. The company's credit rating was subsequently downgraded to junk status, with Standard & Poor's giving it a rating of BB+. Moody's downgraded RJR Nabisco's credit rating even further, to Ba1.

The high levels of debt taken on during the LBO led to significant financial challenges for the company, including a heavy interest burden and difficulty generating enough cash flow to service its debt obligations.

The company eventually restructured its debt and regained investment-grade credit ratings, but the LBO and its aftermath had a lasting impact on the company's financial performance.

The deal became a symbol of corporate greed and excess in the 1980s and inspired a best-selling book and a movie called Barbarians at the Gate.

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