TIME: Almanac 1993/TIME Almanac 1993.iso/time/caps/88/88capbus.1

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                Ä<                                                          December 5, 1988

BUSINESS

Where's the Limit?



The biggest takeover battle in history raises questions about
greed, debt and the well-being of American industry


The date was portentous:  on Oct. 19, precisely on year after
the stock market crashed, the chief executive of RJR Nabisco
was the host of a lavish meal at Atlanta's Waverly Hotel. Ross
Johnson's guests had come to expect such treatment. A brash
and hard-driving manager with a fondness for fine living, he
liked to treat RJR Nabisco's board members to an elegant evening
out before the next day's regular meeting.

On this night, however, Johnson's purpose was not just to be
convivial. Declaring that he had tried everything he could
during the past two years to boost RJR Nabisco's stock price,
Johnson said he had found a solution:  he and his fellow top
managers would take complete control of the company in a
leveraged buyout (LBO). Johnson would then sell off some of
the company's food brands and run the remaining divisions as a
private company. Surprised that a chief executive would
initiate a raid on his own company, the directors nonetheless
allowed him to mount what would be the largest takeover ever.

But the directors--and much of the public as well--were soon
shocked to read news accounts reporting that Johnson's plan
would enrich him and seven of his top executives beyond the
dreams of Midas. In exchange for $20 million they would put up
for an 8.5% stake in the new company, Johnson and the seven
other executives would see the value of their investment jump to
$200 million when the sale was completed. That was only the
beginning. By doing some simple arithmetic, critics of the
plan calculated that the eight men's holdings, which were
scheduled to grow to 18.5%, could be worth $2.6 billion within
five year if they turned RJR Nabisco into a leaner and more
profitable enterprise. Johnson's share alone would have been
worth $1 billion.

Swamped by a wave of resentment, Johnson rushed last week to
reassure the RJR board that he had intended all along to share
the newly created wealth with the 15,000 employees who would
remain after the breakup. "I wasn't going to take 18% of this
company for seven people," Johnson told TIME in his first
interview since the buyout offer. "If I'd known it was going to
be in the newspapers, I would have said, 'Look, there's going to
be 15,000.'"

Even as Johnson backed away from his huge initial stake, rival
bidders rushed in to get theirs. The competing offers turned
the fight for RJR Nabisco, whose brands range from Animals
Crackers to Winston cigarettes, into the brassiest and
potentially most damaging brawl in Wall Street history. By
last week three groups were locked in a titanic struggle for
the company (1987 revenues:  $15.8 billion), and the offering
price has climbed above $26 billion--more than the gross
national product of Peru or Portugal and twice the sum that
Chevron paid for Gulf Oil in 1984 in the largest previous
merger. The ordeal turned into a feeding frenzy for hangers-on
as well:  hundreds of lawyers and investment bankers involved
in the bidding stand to earn a total of as much as $1 billion
for their expertise.

The sums are so vast, and so apparently out of line with any
foreseeable benefits that the deal might bring to American
industry, that they raise deep and disturbing doubts about the
direction of U.S. business at a time when many firms lag badly
in foreign competition. Seldom since the age of the 19th
century robber barons has corporate behavior been so open to
question. The battle for RJR Nabisco seems to have crossed an
invisible line that separates reasonable conduct from anarchy.

Except for its scale, the proposed RJR breakup was like many of
the fruitless paper-shuffling deals that have proliferated in
the past decade. The management group is planning to take
apart a merger, between RJR and NAbisco, that they hailed only
three years ago as a brilliant strategic move. "What is being
done threatens the very basis of our capitalist system," said
John Creedon, president of Metropolitan Life Insurance company,
which is suing RJR because the potential buyout has undermined
the value of all bonds that the food and tobacco company sold
before the announcement. Not everyone was alarmed. Said Harry
D'Angelo, a finance professor at the University of Michigan: "I
don't see any major social dangers. The real challenges have
been to the conventional wisdom that large numbers of
shareholders provided the best means of financing industry.

The RJR battle has brought several U.S. business trends of the
past decade under greater scrutiny in Washington. Among the
political concerns:

-The relentless focus on dealmaking rather than on long-term
investment.

-The apparent disregard for company employees and the
communities in which firms are located.

-The rapid pileup of debt that has alarmed everyone from small
investors to Federal Reserve chairman Alan Greenspan, who
recently called for measures to curb borrowing.

-The cost to American taxpayers, who wind up underwriting the
buyouts to the tune of billions of dollars because interest
payments on the giant borrowings are deductible as a business
expense.

The RJR buyout aroused anxieties even in the investment
community, where some executives feared that the
Johnson-initiated scramble would swallow up too much of the
available money for deals and, moreover, give mergers and LBOs a
bad name. "This is the sort of excess that investment bankers
have worried about for years," said economist Robert Reich of
Harvard's John F. Kennedy School of Government, "because it so
clearly exposes the greed and rapaciousness of so many of these
takeovers."  Martin Weinstein, managing director of Kubera, a
Wall Street arbitrage firm, concurred: "Do I sense fear?  Yes.
At some point there is going to be a rebellion against greed."

The first sign of revolt, interestingly, came from the outside
directors who had come to dinner at the Waverly Hotel.
Appalled by the gall shown by Johnson, whom one director called
a "raider from the inside," a committee of five directors three
weeks ago opened the bidding to all comers. First to accept
the invitation were the most aggressive LBO artists of all, the
Wall Street firm of Kohlberg Kravis Roberts. Headed by Henry
Kravis, 44, and George Roberts, 45, KKR pioneered the leveraged
buyout in the 1970s and nurtured it into one of the
best-playing financial arrangements of the decade.

Many Wall Street insiders thought the KKR bid was as
self-serving and hasty as Johnson's offer had been. "They
broke the golden rule by injecting their egos into a business
decision," said one financier who knows KKR well. "They went
after RJR Nabisco to protect their franchise as the largest
dealmaker."

The directors' invitation attracted a third and scrappy new
bidder who helped turn the fight into a virtual Who's Who of
finance and industry. Assembled by the First Boston investment
firm, the group of newcomers included Jay Pritzker, the
Chicago-based chairman of Hyatt Corp., his wealthy family and
Philip Anschultz, a Denver oil billionaire. First Boston also
wooed Harry Gray, the retired chairman of United Technologies,
and several other high-rolling investors. The group came into
the bidding with a show-stopping but tentative offer of cash
and securities worth up to $26.8 billion, of $118 a share, for
RJR stock that traded for $56 a share in mid- October.

That bid, quickly dubbed a "Chicago submarine" because it would
torpedo the competition, easily surpassed both rival offers. The
Johnson team had bid $23 billion, or $100 a share, while KKR had
proposed a package worth $21.6 billion, or $94 a share. Board
members extended the deadline until Tuesday, Nov. 29, to take
any counteroffers and allow time to study each proposal. If none
is accepted, the directors could supervise an RJR restructuring
themselves.

The donnybrook was only the most colossal of the deals that
persisted last week in rearranging the U.S. corporate
landscape. Hospital Corporation of America, the nation's largest
hospital chain, ended more than a month of dickering and agreed
to be acquired for $3.6 billion in an LBO put together by the
company's management. Triangle Industries, which just two
years ago acquired the packaging division of American Can in an
LBO, agreed to be bought for $1.3 billion by Pechiney, the
state-owned French metals firm.

Leveraged buyouts seemed like a small-time unglamorous financial
gimmick when KKR began hawking them on Wall Street in the
mid-1970s. But the arrangements were an immediate hit with
managers who saw the wisdom of taking their companies private to
escape corporate raiders. LBOs were also a boon to promising
firms that wanted to grow outside Wall Street's harsh spotlight.

Perhaps the most attractive feature of LBOs is that they give
managers a sizable chunk of equity in newly structured
companies. By using borrowed money to buy out the
stockholders, executives can cash in their old shares at a
profit even as they become owners of their firms. The managers
are then free to sell parts of the business at a handsome
profit. The ultimate payoff comes when they put their companies
back on the market. The sale of well-run corporations can return
up to 100 times the amount of a manager's original investment.
With investors lured by such prospects, the value of completed
LBOs soared from just $13.4 billion in 1984 to $76.8 billion so
far this year. Since 1985, four of the ten largest LBO
acquisitions have been made by KKR.

Some deals have fallen short of their fanfare. KKR hailed the
purchase of Beatrice as the "deal of the century," but wound up
getting stuck with businesses that have not yet found buyers.
"Beatrice was overadvertised as a spectacular deal when it was
really just a good one," said one investor. "Everybody's
making money; they're just not making as much money as they
thought they would, or as fast as they could."

At RJR Nabisco, the benefits of LBOs were hardly lost on
Johnson. Born in Winnipeg, Man., he had parlayed a keen eye for a
deal and the nerves of a gunslinger into the top job at three
major corporations. He was president of Standard Brands, the
producer of Planters nuts and Baby Ruth candy bars, when it
merged with Nabisco in 1981. Four years later, as Nabisco's
president, Johnson sold out to RJR Reynolds for $4.9 billion
and soon became president of the merged company. After adding
the title of chief executive officer in 1987, he swiftly moved
RJR Nabisco headquarters from Winston-Salem to Atlanta, sold
the Heublein liquor business and slashed the corporate staff
from 1,000 to 400. The dapper Johnson, a friend of such sports
figures as hockey star Bobby Orr and broadcaster Frank Gifford,
is described as a "charmer" by one associate. Another warned
that when the boss was displeased, "swift as a sword, he would
chop your head off."

Amid the brawl for his company, Johnson has remained aloof from
most outsiders and workers at RJR Nabisco headquarters in the
elegant Galleria complex north of Atlanta. "We don't know what
is going on," says an employee. "Some of us are going to lose
our jobs, but we don't know who, or where."  Feelings of
helplessness were hardly confined to the South. Said a 15-year
employee at an RJR Nabisco cookie plant in Fair Lawn, N.J.:
"When you're at the bottom of the ladder and you got money men
at the top, you take it one day at a time."

Whoever wins the grab for RJR, a highly leveraged takeover
could add more dept to the U.S. economy than any previous
business deal. All told, corporate debt has climbed from some
$965 billion in 1982 to $1.8 trillion this year, a rise from 32%
to 37% of U.S. gross national product. LBOs can be especially
worrisome of borrowing, because they replace virtually all of a
company's equity with IOUs that must be repaid. A sudden
downturn can thus put a firm heavily in hock out of business.
"High leverage is unsafe, not just for a company but for the
entire economy," says M.I.T. economist Franco Modigliani, a
Nobel laureate. Modigliani adds that while the debt mountain
has not yet grown perilously high, "LBOs are reducing the
safety. Management loses the power to do many things. It has
no margin for error and less margin for additional risk."

A company mired in debt can ill afford to build new plants or
develop new products, since most of its earnings go to pay off
borrowings. The shortage of investment can then dampen U.S.
growth and damage the ability of American firms to compete
abroad. In a slump, the impact can be dramatic. A study by
the Washington-based Brookings Institution, a liberal think
tank, estimated that a new recession could jolt 10% of major
U.S.companies into bankruptcy.

Bankers, too, are taking a harder look at the risks, and some
junk-bond buyers are becoming picky. While cash has poured in
from such staid investors as the Harvard and Yale endowment
funds and many state pension plans, other money managers are
refusing to play. Says New York City comptroller Harrison
Goldin, who oversees the investment of some $30 billion in
pension funds:  "I cannot condone activities that divert so
much time and energy from investments that create new jobs and
opportunities to those that reshuffle chairs. Pension-fund
managers are supposed to invest in the American economy."

While that may be true, even the U.S. tax code is a strong ally
of LBO artists. Since the interest on junk bonds and bank
loans is tax deductible, companies like RJR Nabisco can borrow
at Government expense. Some--but not all--of the Treasury's
loss can be recouped from capital-gains taxes on the profits of
shareholders who sell their stock.

The way the tax code treats stock profits is another plus for
LBOs. Corporate earnings are taxed twice:  they are first paid
to stockholders out of a company's after-tax profits, and the
shareholder then pays taxes on the dividends. "There is no
question that our tax laws have a bias toward debt that must be
rectified," says a top congressional aide.

The buyout binge produces some big-time losers as well,
particularly investors who owned a company's top-quality bonds
when the same firm's junk bonds hit the market. Since the new
IOUs would saddle the company with a riskier load of debt, the
old bonds get clobbered. No sooner had Johnson disclosed that he
wanted to buy RJR Nabisco, for example, than the company's $5
billion of outstanding bonds lost 20% of their value. Furious
bondholders, including Metropolitan Life and ITT, immediately
sued for damages. Declared Metropolitan Life chairman Creedon:
"No one in his right mind wants to invest in corporate bonds
anymore."  In fact, the LBO binge has created a financial
innovation called the "poison put," which guarantees bondholders
against the risk of buyouts and other unexpected deals that
might depress their holdings.

Shareholders can lose out in LBOs even when they sell their
stock for a profit. That is because stockholders usually
receive far less than executives make when they break up a
company and then put it back on the market. LBO critics argue
that managers who fatten their wallets in this way are really
profiting at the expense of other stockholders. So far,
shareholders have brought eleven class-action suits against RJR
Nabisco charging executives with acts ranging from "unfair
self-dealing" to "not acting in the best interests of the
stockholders."

The RJR deal also raises the salary competition among
executives to absurd levels. Says John Swearingen, former
chairman of Standard Oil of Indiana:  "There is a limit to what
managers ought to be paid for managing other people's money."
Adds a top executive involved in a current takeover:  "The
yardstick for compensation has just gotten twelve inches longer.
The chief executive who's doing a first-class job running a
major U.S. corporation for $890,000 a year is going to start
thinking he's some kind of fool."

Washington lawmakers readily recognize the populist sentiments
aroused by the spectacle. "What's going on is corporate
cannibalism," says Congressman Edward Markey. "We have to ask
whether it is in the national interest to allow companies to go
so heavily into debt."  As chairman of a House subcommittee
that covers finance, the massachusetts Democrat will play a key
role in drafting any legislation to curb LBO excesses when
Congress reconvenes next year. But lawmakers are uncertain how
to limit buyouts, or even if they should.

Washington's reformers concede that the stock market is still
edgy after its collapse. Wall Street showed just how nervous it
was when stocks dropped nearly 79 points in the week that George
Bush was elected President. "Nobody wants to be blamed for
setting off another stock market crash," says a brokerage-house
lobbyist. Legislators are still haunted by charges that
proposals to restrain take-overs last year helped cause Black
Monday. Many Wall Street insiders are now convinced that
buyouts and mergers are among the market's few remaining props.

Yet Congress cannot ignore growing public fears that greed,
debt and buyouts are all spiraling out of control. "The
deal-makers have gone too far," says Samuel Hayes, professor of
finance at Harvard Business School. "They have defied that
tolerance that allowed them their freedom."  Federal Reserve
chairman Greenspan urged the Senate in October to consider
tax-law changes to curb the debt buildup. Said he:  "The laws
still provide substantial incentives to borrow."

House Speaker Jim Wright last week urged steps to slow the pace
of buyouts, which he said were having a damaging "psychological
and economic impact."  Meanwhile, members of the Senate Finance
Committee have been quietly pondering measures that would
reduce the tax loopholes for dividends. To cushion the Wall
Street impact of such provisions, they might be included as part
of a general tax bill that would seek to narrow the budget
deficit.

LBOs do have some strong defenders, and not just among the
executives who grow rich from them. Some financiers and
economists argue that increased leverage can be a benefit to
companies, especially those in mature industries like tobacco.
Reason:  these businesses produce a lot of cash but call for
relatively little research or development. For them, one
efficient way to distribute profits to shareholders is simply by
buying up stock.

Proponents say many companies have become stronger than ever
after being taken over and reorganized. The point is driven
home in a study by Abbie Smith, a University of Chicago
economist who surveyed 58 acquired companies--among them, R.H.
Macy, Mary Kay Cosmetics and Uniroyal--most of which had been
bought out since 1984. The findings indicated that the firms
were generally more profitable and productive after they were
bought.

Even so, the results underscored a common criticism of the
motives for buyouts. Richard Thevenet, vice president of Stern
Steward & Co., a Manhattan-based management efficiency
consultant, put it bluntly:  "Managers have an incentive to
underperform before a buyout. Records of dramatic turnarounds
after an LBO raise a troubling question. Why were these
managers unable to accomplish these feats before the LBO?
Shareholders bear all the costs, but not the rewards of the
turnaround."

American business is built on a rock of lawfulness and trust
between companies and those who hold a stake in them. But when
avarice grows out of proportion, cracks start to appear in the
foundation. "Greed can be good," says M.I.T.'s Modigliani,
when it spurs profitable and productive growth. "But it can
also be bad," he warns, when it outpaces all other
considerations.

In the fight for RJR Nabisco, that seems to have happened in
spectacular fashion. No matter how the battle turns out, the
unseemly scramble for riches has, for the moment at least, given
overreaching a bad name. In the end, the RJR brouhaha may turn
out to be a useful testing of the limits:  of greed, of debt,
of dealmaking. The resulting outcry may prove an effective
regulating device. "In its own way, the deal has been typically
American, where nothing is in moderation, including the enormous
selfishness of management," notes James Bere, chairman of
Borg-Warner. "It's touched a nerve. Sometimes we have to do
things in extremes before we can put the total in perspective."
Without that perspective, the wages of greed may be a less
productive and ever more debt-ridden economy.

--By John Greenwald. Reported by Richard Hornik/Washington,
William McWhirter/Chicago and Frederick Ungeheuer/New York

________________________________________________________________
The Cast of Characters

ROSS JOHNSON. A native of Canada, the RJR Nabisco president,
56, has always risen to the top. In 1985, as head of Nabisco
Brands, he advocated the merger between that company and RJR
Reynolds. Just three years later, as head of RJR, Johnson
apparently changed his mind. In October he and a group of top
managers offered shareholders $17.6 billion to take the company
private, a price they later increased to $22.7 billion.

HENRY KRAVIS. With his reputation as the No. 1 leveraged-buyout
specialist on the line, he was not about to let RJR Nabisco go
private unless he consummated the deal. A founding partner in
the buyout firm of Kohlberg Kravis Roberts, the Manhattan
socialite, 44, countered Johnson's proposal by offering to pay
as much as $21.6 billion for the Atlanta-based company. As
RJR's new owner, Kravis, whose firm also controls Beatrice and
Safeway Stores, would probably keep the food divisions and sell
the tobacco business.

JAY PRITZKER. The publicity-shy chairman of the Hyatt Corp.,
Pritzker, 66, with his brother Robert, 62, surprised both
Kravis and Johnson by joining the First Boston investment firm
in an informal last-minute bid for RJR Nabisco valued at as much
as $27 billion. Allied with the Pritzkers is Philip Anschutz of
Denver, a billionaire oil and mining magnate. They have since
combined forces with an acknowledged master of the hostile
game, HARRY GRAY, 69, the taciturn former chairman of United
Technologies, who heads his own investment firm. The First
Boston group is offering a highly complex package of cash,
securities and stock warrants, which is still only a hazy
proposal rather than a firm bid. The sheer size of First
Boston's bid persuaded RJR's board to give the group until No.
29 to make the offer more concrete. If successful, the
high-rolling group would probably keep RJR's tobacco business
and sell its food groups to such consumer-product companies as
Ralston Purina and Procter & Gamble.