Wall Street's Merchant of Debt
WHY YOU SHOULD CARE
Because countless corporate raiders have taken over struggling companies, but few take over Wall Street itself.
By Sean Braswell
Driving home after playing golf in Westchester, New York, in the mid-1970s, Henry Kravis reached the self-described turning point in his life. Kravis, who at age 30 had recently become one of the youngest partners at the esteemed investment giant Bear Stearns, turned to ask a question of the man sitting next to him — his father, Ray, a wealthy Oklahoma oil consultant. Henry’s family, including three young sons, had grown too big for their current accommodation and, well, could Daddy help them land a larger apartment on Park Avenue?
The elder Kravis refused, and there and then Henry determined never to ask him for anything again, vowing to get himself, he later confessed, “into a position where I can give, and I don’t ever have to be beholden to anybody.”
OK, so it might not exactly be a Horatio Alger tale, but Henry Kravis had something far better than his bootstraps to pull himself up by — he had “bootstrap acquisitions” or leveraged buyouts (LBOs), as they would become known. And even if he failed to close the deal with his father that day, Kravis would later drive home some of the biggest deals in U.S. corporate history, including the $25 billion takeover of RJR Nabisco in 1988, kick-starting a $2.5 trillion-dollar industry and making the iconic corporate raider a poster boy for the Gordon Gekko era on Wall Street.
From his birth in Tulsa in 1944, Kravis was determined to emulate his father’s financial success. He studied economics at California’s Claremont McKenna in the turbulent 1960s, where, as he later recalled, “I left it to my liberal friends to do things like get arrested. I had my mind on business.” That focus, as Sarah Bartlett chronicles in The Money Machine, would take Kravis to Columbia University for an MBA and then to Bear Stearns in Manhattan, the investment firm where his cousin, and close friend, George Roberts already worked.
KKR’s deals became increasingly unfriendly, and it no longer backed away when a target’s managers declined its overtures.
The two cousins soon fell under the wing of partner Jerome Kohlberg, a seasoned investor specializing in a then-unusual breed of corporate transaction, the “bootstrap acquisition” or leveraged buyout. In an LBO, a small group of investors borrow a gargantuan sum of money from outside sources to purchase the company from shareholders and take it private, after which the debts are repaid by selling the company’s assets and streamlining its operations. Just the threat of an LBO can make companies more disciplined, but carrying them out requires a certain type. “To make an LBO work, you can’t have a trace of sentimentality,” Bryan Burrough, author of Barbarians at the Gate, recently told Bloomberg Business. “You have to be able to slash and burn.” It was a line of work that Kravis, with his “cold analytical eye,” says Burrough, was well-suited to perfect.
But LBO deals take a long time to play out, something Bear Stearns did not have the patience for. So Kravis, Roberts and Kohlberg took a gamble, leaving their high-paying jobs and starting their own shop, Kohlberg Kravis Roberts & Co., in 1976. At the start, so-called “hostile” takeovers weren’t always so hostile. KKR, looking for companies with predictable cash flows and large growth upsides, preferred to work with existing company managers, and to put their own money on the line.
KKR’s run of early LBO successes, however, spawned rampant competition, and the proliferation of “junk bonds” and easy debt on Wall Street broadened the scope of what was possible in the new market. KKR’s deals became increasingly unfriendly, and it no longer backed away when a target’s managers declined its overtures. By the time KKR took over Beatrice Foods Company — with brands ranging from Tropicana to Samsonite — for $6.2 billion in 1986 and dismantled it for a whopping $45 million in fees, the firm was soaking up a 20 percent cut of the profit from investments, a 1.5 percent management fee and numerous other baked-in fees. The human costs at the companies being slashed and burned, including tens of thousands of layoffs, were even greater.
But KKR was just getting warmed up when its biggest takeover candidate entered its sights. RJR Nabisco, the enormous cookie and tobacco company, with its swollen divisions and steady cigarette revenue, seemed an ideal target. But Kravis and Co. hadn’t banked on its CEO F. Ross Johnson forming an alliance with another bank, Shearson Lehman, to buy the company from within. An epic bidding war ensued, each side scrambling to line up billions of dollars in financing. “Everything on Wall Street stopped,” says Burrough. “It was like two gunfighters out on the street and everybody wanted to watch, or everybody wanted to grab a gun.”
When the dust settled, KKR had won with a bid of $109 per share (over twice RJR Nabisco’s previous value), netting a $75 million transaction fee and securing a $25 billion deal, the highest price ever paid for a commercial enterprise. In the end, though, Kravis and Roberts’ relentless desire to win the war probably forced them to overplay their hand. Just seven years later, KKR unloaded its stake in RJR Nabisco for a negligible return on the mammoth investment. Yet it’s always been about the long game for the firm, and Kravis, now 71 and worth $4.8 billion, still presides over KKR’s vast corporate empire — a portfolio including stakes in more than 90 companies with a combined annual revenue exceeding $200 billion.
As Jim Robinson, former head of American Express, which was on the losing side of the RJR Nabisco battle, describes Kravis, “He’s an innovator, he’s an icon, he’s in the same category as the J.P. Morgans, the Rockefellers.”
And Henry Kravis, as he vowed, is not beholden to anybody.