Book Review: “Barbarians at the Gate”

Barbarians at the gate

“Barbarians at the Gate” (Click to view the book on Amazon.co.jp)

* Advice for a busy gaijin: If you are in a rush start reading from chapter seven.

When the Portuguese first approached Japan by sea in 1542, they were not at all welcome. As far as the Japanese were concerned, they were happy in their quiet world and called these unrefined intruders “nanbanjin” or “Southern Barbarians” because the ships came from the South. This book has nothing to do with our Portuguese friends, it is about the hostile takeover over RJR Nabisco in the late 1980s. The scene isn’t Japan, but I’m sure the people in the quiet town of Winston-Salem might have found solace in Japanese history as they combated the Northern barbarians who robbed them of their local icon. (I’ll let the reader decide who the real barbarians were.)

There are only a few finance books about the greed of the 80s which have stood the test of time. Stick with Liar’s Poker by Michael Lewis if you are interested in a quick and entertaining read about the eccentricities of traders and the other famous players of the day. If, on the other hand, you are looking for a slightly more detail oriented story explaining what happened behind the scenes in the less well understood world of leveraged buyouts, then this is the book for you. The RJR Nabisco transaction covers everything you could desire for in a corporate transaction: MBO, LBO, hostile takeover, junk bonds, white knights, stalking horses, you name it.

In 1988, the share price of RJR Nabisco had been depressed for several years. At the time, RJR Nabisco was a holding company for Reynolds (the father of the modern cigarette in the US, boasting brands such as Winston, Salem and Camel) and Nabisco (one of America’s largest food companies boasting the “Oreo” and other favorites from your family cookie barrel). An increase in anti-smoking sentiment in equity-land due to increased litigation risk had meant that even the food assets of RJR Nabisco were trading at a discount (i.e. investors were pricing the company as if the litigation risk was just as strong for Oreos as it was for Camels).

At the time leveraged buyouts (LBO) were all the rage and investment banks were constantly trying to convince management and other potential acquirers of the merits of an LBO. (Given the huge fees involved, the banks didn’t need much convincing.) Unlike a traditional takeover where you need a lot of (your own) money to buy a target company, the acquirer in an LBO borrows almost all of the money needed to buy the company. At the time, junk bonds (highly risky bonds which promise to pay the holders very high interest rates) were extremely popular amongst investors and so it was very easy to raise huge amounts of cash. Whereas a bank will often take property and other fixed assets as collateral for a conventional loan, in an LBO the acquirer uses the future cash flows of the company as the collateral for their debt – meaning they can stretch the boundaries of financing beyond traditional levels (a bit like you or I would do when we buy an investment property).

This book tells the story of how the CEO of RJR Nabisco, F. Ross Johnson, frustrated with a low stock price, decided to propose a management led LBO – the largest in history – of the firm. Given the stability of the cash flows that Reynolds churned out, the company was the perfect candidate for leverage but until then no-one had thought it would be possible to close an LBO of such scale ($20 bln USD). Unbeknownst to Johnson, his announcement made it clear to every LBO fund on The Street that it was possible. The flood gates now open, the supposed simple transaction soon turns into an aggressive bidding war amongst other potential acquirers. The authors (two ex wall-street journal reporters) amaze you with seemingly endless detail concerning the conversations and negotiations that went on behind closed doors between the various bidders. Anyone who is contemplating a career as an investment banker will enjoy reading about the high moral standards that the various bankers exhibit as they all try to romance management and steal “the deal” from the teeth of the original financer.

Barbarians is more than just a historical account of the largest LBO ever, it delves into numerous themes in its five hundred plus pages. Prior to the LBO, RJR Nabisco was the classic example of a cash-rich company that has ceased to innovate. Much of the book is a wakeup call to the average investor, showing you how little control shareholders have over their investments and how ego, politics, money and (broken) promises might often play the largest roll in determining shareholder returns. All in all it portrays an exciting world and it wouldn’t surprise me if a lot of young people have chosen to pursue a job in private equity after reading this book. At the very least, I’m sure there is a fifty-fifty chance you’ll be ringing your head hunter to ask if KKR is active in Japan (the answer is “Yes”).

If I could make one complaint about the book it would be the abrupt ending. The entire book is focused on the personalities involved in the lead up to the ultimate transaction. While there is a short reference to what happened after closing the deal, I found myself wondering what actually happened to RJR Nabisco in the following years. Did these guys end up making any money?? A quick Google search gives us a few clues. As one would expect, it appears that much of the company was broken up. Nabisco was ultimately sold to Kraft. The international tobacco business was sold to good old Japan Tobacco and the US tobacco business has been relisted under the ticker RAI. But that doesn’t really answer our question. Comments are welcome from any readers who can shed light on this.

While the book talks about an event from almost 20 years ago, it’s surprising how relevant the story is for the Japan of today. Years of low interest rates combined with hundreds of lazy companies with over capitalized balance sheets has meant that Japan is ripe for LBOs. Skylark got a lot of media attention when its management announced that it would follow follow Johnson’s footsteps. Ironically, there were no other bidders as it appears Skylark may not have been really that cheap. Japanese management seems to be happy buying their own companies just to relieve them from the pains of dealing with minority shareholders.

Softbank raised even more eyes with their LBO of Vodafone Japan. Usually the management of an LBO focuses on selling off non-core assets and cutting costs aggressively in order to pay back the debt as soon as possible. The strange thing about the Softbank transaction is that it was common knowledge that Vodafone plc had already cut all of the low hanging fruit. With no obvious room for cost cutting, the huge amount of debt (and the rumored covenants associated) could potentially restrict Softbank in their expansion of the business going forward.

The one thing that we don’t usually see in modern day Japan is the hubris and abuse of power that was evident in Nabisco. While I’m tempted to make some comparisons with some of the adventures that we’ve seen in Roppongi Hills over the last year or so, I’d prefer to champion those entrepreneurs as a slightly different breed. (right guys?)

The rebirth of the LBO is not a Japan specific phenomenon. Junk bond defaults were less than 2% last year (Moody’s tells us that the long run average should be about 5%). The number of LBOs recently completed in the US that seem to ignore EBITDA multiples suggests that the market for junk bonds is invincible once again. The rest of Asia is no exception. Imagine if Carl Icahn and Warren Lichtenstein (Steel Partners) had successfully pulled off their $US 10 bln attempt to buy Korean Tobacco & Ginseng (KT&G) back in March. I wonder how KT&G’s cash flow yields compared with Reynolds, or better yet, our own JT? How long until we see a hostile LBO on Japanese soil?

“Barbarians at the Gate” (Click here to view the book on Amazon.co.jp)

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