Authors: Richard Kluger
Accordingly, Johnson engaged a top Wall Street firm to represent him, selected a management team of six other executives to join him, including Horrigan, and worked out an intricate deal with the giant investment house of
Shearson Lehman Hutton. Under it, the Johnson team would in effect be allotted up to 18.5 percent of the equity in the bought-out RJR Nabisco, pieces of which could be distributed to others outside the core management at Johnson’s discretion—or not at all. The value of the management agreement, depending on how close the privatized company could come to hitting its performance incentives, was calculated to be as much as $2.5 billion over the first five years, with Johnson’s personal take as much as $100 million. Johnson’s team would get three of the seven board seats, one more than Shearson; the other two would go to independent directors. If major parts of the company had to be ditched to pay off the purchase price, so be it; Johnson fully expected to sell a sizable portion of the food business, starting with Del Monte. And if the buyout effort failed—if the board of directors he had so deftly cultivated now recommended against his proposition to the stockholders or another group outbid him—he would still walk away with a king-size severance package as one of the settlement costs to unseat him. It looked like a no-lose gamble to Ross Johnson, the non-company man.
But Johnson was a rookie when it came to playing with the big boys of Wall Street. He did not grasp that his role in so vast a transaction could not be merely to negotiate himself a goodly piece of the action and then retire to the sidelines to let his bankers do whatever punching and kicking might be needed. Whoever was putting up the money got to call the tune, even if Johnson had been the agent provocateur behind the effort. He also misjudged how the RJR board of directors felt about him. If he supposed that his steady cultivation had purchased from them a willingness to suspend the rules of the game or bend them in ways to facilitate his raid on his own company, he soon learned otherwise. For all his pledges of concern about the interests of stockholders, employees, and the corporate welfare, Johnson’s governing impulse was, in the end, recognized as thinly varnished self-interest.
The titanic struggle for possession of RJR Nabisco, the largest takeover battle yet in U.S. financial history, was played out over forty days beginning in mid-October of 1988. It was front-page news across the country and would be chronicled in a best-selling book that appeared soon after the event—
Barbarians at the Gate
. The trigger of the hostilities was the price per share that Johnson’s group offered to shareholders—$75, too low a premium over the market price of $55, to accomplish its purpose. Others, too, could calculate the liquidation value of the RJR Nabisco empire and figure how much more it might be worth in pieces than as a tobacco-driven money machine slowly running out of steam. Chief among the takeover specialists drawn to the prey was Kohlberg Kravis Roberts & Company, headed by the stern and daring Henry Kravis, a dealer credited with both rectitude and sharklike tendencies, who was far more disciplined and infinitely more calculating a player than Ross Johnson. The RJR board, pledged by law to obtain the best possible deal for its shareholders,
opened up the bidding. In the end, Johnson had succeeded in getting his stock’s price up, all right—to a winning bid of $109 a share, or almost twice what it had been before the LBO was announced—only it was Kravis’s firm that made the bid. The price, larger than the treasuries of whole nations, was nearly $25 billion, almost $19 billion of it represented by a complex package of debt instruments, most notably junk bonds.
The last person Kravis needed to make this immense gamble pay off was the airy chief executive officer who came with the prize. Wall Street had had Ross Johnson for lunch, but it tipped him lavishly; he descended from corporate Olympus on a golden parachute worth $53 million and left behind a once proud company, brimming with debt, fearful of imminent bloodletting all over the payroll, at the mercy of hard-eyed New Yorkers, and unlikely ever again to challenge Philip Morris for supremacy in the cigarette business.
VIII
PLAYED
out almost simultaneously with, but far less publicly than, the RJR buyout was exactly the opposite sort of scenario, orchestrated by Philip Morris’s chairman. Unlike Ross Johnson, Hamish Maxwell had elected to build his business, not to cash it in. And unlike RJR, his company was being amply rewarded by Wall Street for its problematic entry into the food business. Its stock had risen and split two for one within a year of the GF takeover as domestic tobacco margins kept growing, the international unit kept adding to its position in Europe—No. 1 in market share since 1982—and formerly closed or greatly restricted markets in the Far East were in the process of being forced open through the friendly services of the U.S. Trade Representative. And the company’s big, new stake in food legitimized Philip Morris as never before. Maxwell, relishing his expanded empire, went shopping again.
His keenest need was for dynamic management of his food business, and he thought he saw it in place at the company Wall Street valued higher than any other in the food industry—Kraft, Inc. Based in suburban Glen view a dozen or so miles north of Chicago, the big food processor had sales of $10 billion, the largest piece in the dairy products business, which it dominated with such brands as Kraft and Velveeta cheese, Philadelphia Brand cream cheese, Breakstone’s butter and sour cream, Parkay margarine, Miracle Whip salad dressing, and Breyers and Sealtest ice cream. Its per-share net had advanced 11 percent after inflation in 1987, far ahead of General Foods’ performance and among the best in the industry. It would mesh perfectly, moreover, with GF, since there was virtually no duplication in their respective product lines, and many obvious economies could be realized in marrying the two food businesses; the refrigerated trucks that delivered Oscar Mayer’s meat products, to cite one example,
could equally accommodate Kraft’s dairy line. To add to its allure in Maxwell’s eyes, Kraft was also the second-ranking entry in the U.S. food service business, supplying restaurants and institutional cafeterias, and recorded more sales overseas than any other American competitor.
Perhaps Kraft’s most important quality, from the Philip Morris perspective, was a managerial style and philosophy palpably different from General Foods’. The latter seemed to be distracted by the form of things—frilly business practices, exotic R&D, elaborate training programs, little of which seemed to be converted into higher earnings. Kraft, on the other hand, was very much a sales-and operations-directed company, not unlike Reynolds Tobacco in its heyday, with a bottom-line awareness that succeeded because, as one top veteran there put it, “We don’t have a lot of smartassed M.B.A.’s standing around here.” The only real knock against Kraft as a strong takeover candidate for Philip Morris was that its heavy dependence on dairy products made it vulnerable to changing dietary habits.
Kraft was run in 1988 by its sixty-year-old chairman, lawyer John M. Richman, and president and chief operating officer, Michael A. Miles, eleven years his junior and with the company since only 1982. Miles was widely rated the coming marketing and managerial superstar of the food industry. Cool, thoughtful, and articulate, he had majored in journalism at Northwestern and had worked for ten years as an account executive at the Leo Burnett ad agency in Chicago. Among his clients was Heublein’s Kentucky Fried Chicken subsidiary, which badly needed managerial help, and, liking both chicken and Louisville, where KFC was headquartered, Miles took up the challenge the company offered him. Preaching McDonald’s founder Ray Kroc’s back-to-basics formula of quality, service, cleanliness, and value, Miles rose to the KFC presidency in six years and turned the operation around. Its growing success was one of the reasons RJR had paid more than a billion dollars for Heublein in 1982, but when Reynolds could find no challenging use for him, Miles was glad to be offered the Kraft presidency. Richman soon found in him a rare blend of manager, communicator, analyst of both products and people, and, above all, “a man who doesn’t like to lose.”
As Kraft president, Miles enlivened the company’s advertising, redeployed talent, pushed for divestitures of distracting and less profitable non-food units like Tupperware plastic kitchen containers and Duracell batteries, and moved vigorously into fresh marketing avenues with 350 new products or line extensions. Special stress was put on “light” dairy lines for the weight-conscious, like Light n’ Lively yogurt and low-fat versions of its cream cheese and salad dressing. Miles spent money as well for some things not always measurable in earnings reports, like the hundred scientists enlisted to improve reduced-fat technology and a $35 million, two-year effort to develop tamperproof packaging.
“He’s crucial to the value of Kraft,” his former boss at Heublein, Hicks Waldron, said of Miles.
That value was very much on Hamish Maxwell’s mind as he sat down with his outside banking advisors and the Philip Morris planning brain trust in mid-1988 to determine how best to lay siege to Kraft. While the bloom was decidedly off the rose in Wall Street’s harvest of mergers and acquisitions following the stock market’s nosedive the previous October, it had not wilted altogether. Keener strategizing was the order of the day, though, in a more unforgiving bargaining climate. Bidding too low, as Ross Johnson discovered, succeeded only in stirring up your prey and inviting other bidders to the fray. Too high a bid, on the other hand, in an attempted preemptive strike ran the equal risk of exhausting the predator’s bankroll before adding the sweetener almost certain to be required to close the deal. Not wanting to be perceived as the aggressor in a knock-down takeover fight of the sort that had not been needed to win over the docile General Foods management, Maxwell and his advisors concluded that the way to win Kraft was to come in with a strong, all-cash bid hard for shareholders and the target management to spurn and for other bidders to match or top, and then to be prepared to pay whatever more it took. The truth was that Kraft had precisely what Maxwell wanted—solid and steadily growing earnings, famous brands to add to the General Foods collection, able management, global reach, low debt, and, for good measure, an overfunded pension plan.
Its own virtues were well known to Kraft’s management, and it was no secret that Philip Morris wanted to expand its commitment to the food industry. For several years Richman and his top executives had been meeting periodically with their New York counsel, staging “war games” to prepare for any takeover thrust, but the bigger Kraft became and more highly valued by the stock market, the less likely the threat seemed. Only a few entities had the money and need to risk a hostile takeover, and Philip Morris was the one usually cast as the model villain at Kraft’s skull sessions.
Even so, Richman was shaken during a Monday morning meeting with his executives in mid-October 1988 when he was handed a note saying that Hamish Maxwell had phoned and asked him, with British restraint, to please call back because “it is reasonably urgent.” Richman had met Maxwell at food industry events since Philip Morris had taken over GF and found him likably undemonstrative; he had never given the Kraft chairman a clue as to his intentions. Now, as he heard Maxwell out, Richman thought the PM chairman sounded cordial but scripted when he expressed regret that legal necessities dictated that the takeover move assume the form of a “tender” offer to Kraft shareholders, giving them twenty days to accept or reject the bid price. Technically, there was no pressing reason for the tender offer—Maxwell could have
tried negotiating directly with Kraft’s management and board. But a tender was swifter, and perhaps kinder because more honestly confrontational than protracted bargaining, which could readily turn bitter, since the targeted management had no wish to be ousted. Maxwell’s offer was ninety dollars a share, nearly 50 percent higher than the market price and twenty-two times Kraft’s 1988 estimated earnings. The bid, which Richman thought was “high and clever,” was worth $11.5 billion. The only costlier one had been Chevron’s $13.3 billion buyout of Gulf Oil.
Kraft’s New York lawyers and financial advisors took over three floors at its suburban Chicago headquarters for the next two weeks, as company officials met with them late into the night to plot a response to the assault by Philip Morris. And the clock was running. What kept the tension level tolerable for the Kraft executives was the understanding that they were not exactly being threatened by a savage marauder who would wolf them down and leave only a pile of bones in their memory. The high price of the tender offer was surely a compliment, albeit a backhanded one, for the way Kraft had been managed. “We were being acquired for all the right reasons—our franchises and our people—to be built on and not sold off piecemeal,” Richman recognized. Even so, they were not about to surrender without a fight; the goal was to extract every last dollar they could from their unwelcome New York admirer.
Kraft had several choices in trying to repel Maxwell’s advances. Its top officers could have tried to engineer a leveraged buyout of their own, as Ross Johnson was even then attempting at RJR. But that would have involved such extreme dislocations and pressures that the company might be wrenched to pieces in the effort. Nor did its core management feel compelled to own the company in the hope of vastly greater financial rewards—and, surely, in the face of grave risks. Alternatively, Kraft could have tried to enlist a “white knight,” another and presumably friendlier bidder who might defeat Philip Morris and leave current management in place. But as Richman knew, “There were not many out there that could afford it,” and few who had Hamish Maxwell’s incentive. “It never seemed to us that there would be another likely contender.”
Conceivably, though, Kraft might have driven off its insistent suitor by insulting it with a “merchants of death” defense. It could have denounced PM as a bunch of immoral killers trying to extend their deadly grip and marshaled the antismoking movement under its banner in an all-out public-relations campaign. The idea was hashed over in the Kraft crisis center for several hours, but neither Richman nor Miles had the heart for what would have amounted to a lie so far as they were concerned. “It was not a moral issue for us,” Richman recounted. “It was a straight business decision. Smoking has its risks—we all know that, and nobody made any bones about it.” Miles, known to be an exmoker
and rumored to be uncomfortable about the prospect of working for the nation’s leading cigarette seller, later denied harboring such sentiments. “I had no qualms [about the takeover] from the product point of view,” he said. “I had fear of the unknown about Kraft’s being taken over by anyone.” Upon familiarizing himself with the literature on smoking, he would tell interviewers several years later that “the risks attributed to cigarettes are greatly exaggerated” and that the causation charge had never been proven to his satisfaction. Smoking, like abortion, was a matter best left to the individual, Miles believed. Their personal convictions aside, the damning of Philip Morris might have had consequences inimical to Kraft investors. “The most you could probably have hoped for,” Richman calculated, “was the well would be so poisoned that maybe Philip Morris would go away—and you would have deprived your stockholders of a very attractive offer.”