Authors: Richard Kluger
Kraft’s only realistic response to the takeover bid was a recapitalization of its assets to give its shareholders a plump dividend, big enough for them to accept in place of the Philip Morris proffer but not so rich as to drive the company deep into paralyzing debt. A leveraged “recap,” as the Wall Street patois termed it, pledged the company’s assets for the loan to pay out the big bonus to stockholders without actually buying out their equity interest, which remained in the form of a “stub,” or small piece of the overall recapitalization until the loan could be paid down. The arrangement would surely have required rigorous economies and a sell-off of weaker units (and possibly some strong ones), but it was preferable to limply surrendering the company intact.
But how high would Kraft have to go to stave off Philip Morris? Not all Kraft people were convinced the sky was the limit for Maxwell, no matter what his resources. Some believed that he might go to $100 a share, but no higher. “We really believed the Philip Morris offer was inadequate in the world in which we lived,” Richman recalled. “This was not just a struggle on our part to remain independent and to drive up their price.” Richman’s management team had no illusions, knowing, as he put it, that “we weren’t going to be doing business at the same old stand. But it was by no means obvious that we wouldn’t succeed in the recap proposal,” so long as it was “a legitimate, competitive offer.” Deep down, though, Richman felt that Philip Morris would keep on coming.
He gave Miles the critical job of formulating an operating plan on which the recap could be based; how much could Kraft extract in earnings from each of its units compared with what it would bring if put on the auction block? “There was no thought given to saying, in effect, ‘We’ll figure all of that out later,’” said Richman. “We had to be able to live with it.” The offer to Kraft shareholders, announced a week after the Philip Morris tender, was a package said to be worth $110 a share—or $14 billion for the whole bundle, the largest recap proposed in American corporate annals. Each holder was to receive
$84 per share in a cash dividend, $14 in junk bonds, and the rest in the equity “stub,” its value placed at $12 in accordance with an overall debt/equity ratio of 90 percent. In presenting the package, Richman portrayed Kraft as the victim in a situation “not of our making” but part of a prevailing temper in the economic community that favored “short-term financial gratification over steady, long-term growth.” The recap, he was confident, would work but would “require herculean efforts by our employees.”
But Wall Street analysts and traders scrutinized the Kraft package with concern. The value of the junk bonds in it was debatable because they were of the “cram down” variety, not to be sold on the open market but foisted on shareholders with the maturity and interest rate to be determined. Nor was the true value of the stock “stub” beyond debate. The true value of the package was between $100 and $103, according to the Street consensus. Quickly exploiting this appraisal, Maxwell issued a statement suggesting that there were serious questions about the “feasibility” and “real value” of the Kraft counteroffer. In contrast, he said, the Philip Morris tender offer would keep Kraft intact and not require it to mortgage its future.
The next day, Richman fired back that Maxwell’s “disparaging remarks” had been “totally consistent with Philip Morris’s pressure tactics to buy Kraft on the cheap.” Pressure it surely was, but there was nothing cheap about Maxwell’s offer. Indeed, it was Richman’s offer that was the more suspect, as Kraft’s stock price peaked at $102, well below the level that Richman said the recap package was worth. Meanwhile, Maxwell stayed his hand, in no hurry to raise his offer against the recap, and investors began to wonder if Philip Morris would counter at all. Slowly Kraft shares began to dip. They fell below 100, the suspected Philip Morris resistance level, to 96
½
when the market closed at the end of the second week of the tender offer. It was low enough to bestir the watchful PM chairman. He signaled his Wall Street counselors to contact Richman’s people and suggest a meeting of the principals. Philip Morris was not about to match Kraft’s recap number, but it would come close enough, Richman heard, to justify the session.
Maxwell jetted into Chicago’s O’Hare Field that same evening and came to Kraft’s airport hotel suite for a face-to-face showdown. Although their advisors were hovering in the wings, the meeting was mostly just between Maxwell and Richman. The two chairmen were hardly a pair of frothing bears locked in combat to the death. Their earlier public exchange, it was understood by the parties, had been as sharp as need be yet as civil as could be. Soda and cookies were the refreshments.
Richman had come into the room with his mind fixed on $106 a share. Maxwell, who struck the Kraft CEO as astute and deceptively low-key throughout the course of the evening, opened at $104, and Richman, having extracted another $1.75 billion for his company above the initial tender,
breathed easier. He said $106 would be more like it, and Maxwell, too, knew there would be a meeting of the minds—but since each half-dollar he raised the per-share ante would tack on $62 million to the final price, he was in no hurry. They talked of many things—about their companies, about how Philip Morris had no intention of moving Kraft from its Illinois moorings, about managing the food business, with promises neither sought nor made that Kraft people would run a giant Kraft-General Foods division, although both parties understood that was one of the prime motives for the transaction. Maxwell raised his offer fifty cents, and they talked some more, and then he raised it again and they called in one of Kraft’s financial people to discuss the pension fund—and by 1 a.m. Maxwell put out his hand and agreed to Rich-man’s price.
The final figure came to $13.1 billion. When the deal was disclosed to the press over the weekend, Maxwell was asked if he had any further immediate acquisition plans. “No,” said the Philip Morris chairman, “this is enough for this year.” His newly expanded company became the seventh biggest in the nation in terms of revenues and the largest single advertiser—the latter distinction spurring cries of alarm from public-health advocates, fearing that the media would be all the more readily muzzled on the smoking issue. The company soon issued a statement pledging that it would not apply its growing musculature in so unseemly a fashion.
Among the 47,000 new employees Hamish Maxwell had acquired in the Kraft deal, perhaps the single most important was Michael Miles. But Miles was not overdosed with hubris; he was not even certain that he had a job with the takeover management. Reassurance was quick in coming. Maxwell had him fly to New York toward the end of the week in which the deal was sealed and apologized that he could not place the Kraft president on the Philip Morris board of directors just yet in view of Richman’s designation as vice chairman—it would have been a bit too much Kraft representation too soon. Miles was promptly named, though, to coordinate the new Kraft General Foods operation (no hyphen), whose products would now capture one out of every ten dollars spent in U.S. grocery stores.
IX
THE
job that Michael Miles won, running the largest U.S. food company, had been coveted by the man who had played a central role in projecting Philip Morris into the midst of that industry—chief corporate planner Ehud Houminer. Having masterminded the General Foods and Kraft deals, Houminer could conceive of no more stimulating challenge for him than running the food enterprise.
Intellect was never Houminer’s problem. “He was a brilliant and enjoyable man in private exchanges,” said one colleague from their days together at Philip Morris International. “But he didn’t understand that you needed other people’s skills to run an organization. He’d always worked only for Hamish.” Maxwell, known to prize brains and modesty as prime virtues in his executives, settled for only the first in Houminer’s case, and probably suspecting that his crack Israeli staff man had been stricken by one of his occasional episodes of egomania in asking for the top food job in the nation without ever having run anything before, said no. But he had a nice consolation prize for Houminer—the presidency of PM-USA, where unit sales were only creeping ahead and, reports had it, the chairman felt that complacency had taken hold. Houminer might serve as his lash and keep the company’s biggest moneymaker trim and driven.
It was one of Maxwell’s few mistakes as chief executive. Houminer trusted nobody and was thought to be constitutionally incapable of accepting counsel from his intellectual inferiors,
i.e.
, everyone he dealt with. “He had to prove every hour of every day how bright he was,” recalled one top subordinate. “He took other bright people and drained them and spit them out, like Dracula.” Houminer was heard to berate most of the staff he inherited for incompetence and could not understand why the company had to waste money on the Masters program, rewarding wholesalers for doing what they should have done in the first place, and on larcenous placement fees to retailers who should have been eager to give prominent display to Philip Morris’s top-selling brands. “It stuck in Ehud’s craw that we were No. 1 in the marketplace,” recounted his sales vice president, Vincent Buccellato, “but couldn’t call the tune for the industry.” Houminer frightened and offended jobbers with claims of Philip Morris’s infallibility and invincibility, and if some of them could not survive without a dole from the company, that was unfortunate. “He was not thought of as our friend,” said Ronald Sosnick, a major West Coast wholesaler. He also made life miserable for many working under them, forever carping, sometimes showing them up at high-level meetings, and finally carrying penny-pinching to the point of obsession. In the end, several of Maxwell’s trusted younger executives went to the chairman and told him that the situation was out of control. Since PM-USA’s unit sales had done no better under Houminer, there could be no pragmatic justification for retaining him. He was replaced after a year and a half by the personable and mercifully less scintillating William Campbell, a Maxwell devotee.
The stock market loved Maxwell and his confident direction of Philip Morris’s torrent of surplus cash. With its position in the food business solidified by the Kraft acquisition, the company’s stock doubled in price, and by the middle of 1989 it announced a 22 percent dividend increase and a four-for-one stock split. On top of the two-for-one split only three years earlier and previous
splits, the action meant that each share of PM stock bought in 1966 was now worth 192 shares in 1989 dollars.
Nor was the company resting on its laurels. Finding arch tobacco rival RJR reeling from debt after the leveraged buyout, Philip Morris moved to widen its market share lead by adding to its sales force and persisting in aggressive pricing, which served to hurt Reynolds’s fading full-price brands and drive it deeper into the discount business, where lower margins threatened to drain off the cash flow the new Kravis ownership needed to pay down its immense debt. “I can assure you that we plan to take advantage of any opportunities that the changed situation [at RJR] may bring,” Philip Morris vice chairman William Murray told
The Wall Street Journal
, a hint of relish in his words. The company was on such a roll that even when a situation did not work out quite as envisioned, it made money. Its $350 million investment in Rothmans in 1981, in the hope of eventually buying out the South African company’s founder and controlling force, Anton Rupert, and meanwhile preventing RJR from becoming a major player in the international cigarette business, had led nowhere in particular. Rothmans remained a distant third behind leaders Gallaher and Imperial in the British market; joint selling efforts by Rothmans and Philip Morris like the one attempted in Malaysia had proven ineffective; and Rupert, at seventy-three, was showing no willingness to part with his jewel. Maxwell, confident that his company’s growing penetration of the European market made its large minority holding of Rothmans stock superfluous, cashed it in for $860 million, a half-billion-dollar capital gain.
A
Fortune
magazine survey reported in January of 1990 found Philip Morris to be the second most admired American corporation, largely because it had given its investors just what they were after. Over the ’Eighties, the company had posted an average return on equity capital of 30 percent a year, the highest in U.S. industry for the period, and annual per-share gains in net of more than 20 percent (compared with 16 percent for Ford, the most lucrative American automaker, and 7 percent for no-longer-so-blue-chip IBM). And Hamish Maxwell’s appetite had not yet slaked. Presented with an inviting opportunity later that year to add to his swiftly coalescing food empire—precisely the sort of move that RJR could no longer entertain, given its groaning debt burden—the Philip Morris chairman snatched it.
Klaus J. Jacobs, by avocation a Swiss Olympic equestrian and leader in the scouting movement, was also a complex and combative entrepreneur, of the Anton Rupert stripe, out to build an empire in the coffee and chocolate business. Grandnephew of the founder of the Jacobs coffee business, launched in Hamburg late in the nineteenth century, he took over the family enterprise after establishing a holding company in Zurich in 1974. Eight years later, he shocked the confectionery world by purchasing the leading Swiss chocolate makers, Suchard and Tobler, Belgium’s celebrated Cote d’Or chocolates,
Italy’s Du Lac, and Palvides of Greece, all added to Jacobs’s leading market position in both the chocolate and coffee business in Germany, France, and Austria. For good measure he plowed $720 million into U.S. candymaker E. J. Brach, best known for its jelly beans, and inquired of Hamish Maxwell whether he might care to part with General Foods’ problem-ridden coffee business.
Maxwell did not encourage Jacobs, but then, in an unexpected turn, the Swiss tycoon discreetly reapproached the Philip Morris chairman to ask if he might be interested in buying control of his entire operation, Jacobs Suchard AG, then grossing $4.7 billion. The company was netting just 4 percent on its sales, but Maxwell had several reasons to covet it. Profit margins in the European food business traditionally ran behind those in the U.S. market because of the smaller scale of operations and higher distribution expenses due to trade barriers. But those barriers were expected to begin falling in 1992 as the European Economic Community became a reality and a huge transnational market beckoned. The acquisition, moreover, would add substantially to the Kraft General Foods (KGF) presence on the Continent, making the Philip Morris food venture the third largest in Europe, where the industry was growing at a faster rate than in the U.S. And the price was right—$3.7 billion, or about twenty times earnings. Just why the volatile Jacobs was prepared to sell so soon after his flurry of buying was unclear; financial analysts suspected that his resources had been overextended, especially by the Brach purchase, which was losing heavily.