Barbarians at the Gate: Drawing Lessons from 1980s Wall Street M&A Activity

In lieu of the recent announcement of Verizon's intention to buyout Vodafone's stake in Verizon Wireless, a brief discussion of the famed, business-school classic Barbarians at the Gate (written by Bryan Burrough and John Helyar) might help the non-MBA (myself included) understand M&A 101 and lessons learned.

("Amazon.com")

Background of Barbarians at the Gate

Barbarians is about the leveraged buyout (LBO) of RJR Nabisco, a former tobacco and food conglomerate that was eventually broken into separate units in 1999. Ross Johnson, the CEO of RJR Nabisco, had helped orchestrate the merger of R.J. Reynolds Tobacco and Nabisco Brands in 1985 for the tune of $4.9 billion. At the time, it was the largest merger ever to take place outside the oil industry (Barbarians P. 66).

Ed Horrigan, a longtime executive of R.J. Reynolds, became the CEO of RJR Nabisco after the merger. However, there were early signs that this the merger was not exactly peanut butter and jelly. To begin with, the pairing of a food and tobacco company was not the ideal mixture:

“Early on, Horrigan learned that one of Nabisco’s brands, Fleishmann’s Margarine, had developed a joint marketing campaign with the American Heart Association that, among other things, urged consumers not to smoke” (Barbarians P. 69).

Horrigan was eventually out-maneuvered by Johnson in 1986. Johnson had carefully packed his old friends from Standard Brands (which was bought by Nabisco) on the RJR Nabisco board. When Johnson threatened to resign, the board favored Johnson. Horrigan swallowed his pride and gave a speech announcing that he would accept a compensation package and allow Johnson to head the company (Barbarians P. 67).

Years after the merger, Johnson was satisfied with the steady influx of cash from popular products such as Winston cigarettes and Oreo cookies. In fact, he used the cash to on a whim on any project he felt compelled to throw money at. At one point, Johnson built a hangar for companies jets, according to the following article passage:

“RJR spent more than $12 million on a hangar at the Atlanta airport for its air force of 26 planes. The top 31 executives were paid $14.2 million. Buildings were redecorated and refitted simply because the money was available.”

If cash was not a problem, stock price certainly was. Johnson believed Wall Street was undervaluing his large company. He believed the stock price should be higher. Hence the LBO.

The theory behind the LBO is to pay-off the shareholders at a set price per share through debt. Johnson and the RJR Nabisco board would choose an financial services firm to finance the buyout. The buyout would be financed through company cash, stock, and bonds. In other words, the shareholders would be paid off, and the financial services firm would take over management of the company. The firm would then either downsize the company by selling of different portions or through lay-offs.

The majority of the narrative is devoted to the bidding battle between Ross Johnson and the management team (backed by Shearson Lehman Hutton (Shearson) and Salomon Brothers(Salomon), Kohlberg Kravis Roberts & Co. and First Boston. Other players were involved in this, such as Ted Forstmann, Senior Partner of Forstmann Little and Co., but Forstmann did not participate in the final rounds of bidding.

The bidding wars themselves provide a perspective into the egos and minds of some of the most powerful firms on Wall Street at the time, but instead of spending time on this discussion, please check out this great summary of the battle to learn more.

Relation to Verizon / Vodafone

In August of 2013, Verizon, the well-known cellphone service and cable provider, announced that it would buyout the share of Verizon ownership by Vodafone, a telecom company based in London, which currently has a 45% stake in Verizon.

(Verizon CEO Lowell McAdam: "nytimes.com")

Although the circumstances and business realities are different, below I’ve include a few thoughts that will be helpful to frame the large transaction as new breaks in the story are announced (Many of the stats involved were pulled from an article the Wall Street Journal):

• Billions of dollars are at stake: What effect will this have on the market? Is it ready to take on more corporate debt? According to the Wall Street Journal and numerous other publications, the price will be around $130 billion (RJR Nabisco’s takeover was $24 billion, which was the largest at the time). A little less than half ($60 billion) of it will be purchased in cash, the rest will be in bonds and stock.

• Verizon will be partnering with banks and other firms for financing: Guggenheim Partners, a former Morgan Stanley banker and executive, J.P. Morgan Chase & Co., and Morgan Stanley. RJR Nabisco did this as well, eventually settling with KKR. But do the projections of future subscriptions in Verizon (Given other providers like Sprint are putting more money into building cellphone towers) account for its ability to pay back the debt?

• What hurdles will Verizon face along the way? RJR Nabisco faced public leaks, backstabbing between the board and management, and bid after bid. Recent news, tor example, that shareholders of Verizon have already begun rounds of lawsuits against the company, seem to point to the fact that this might not be a smooth transition.
  
  
  
• Other questions to ponder: Is $130 billion the right price? What are the Vodafone executives receiving? Do they have incentive to put management interests before that of the shareholders? Will this deal downgrade Verizon’s bond rating.