CASE STUDY RJR NABISCO LBO 2Important PlayersPeter Cohen- Chairman and Chief Executive, Shearson Lehman HuttonNick Forstmann-Senior Partner, Forstmann Little & CompanyJohn Greeniaus -President and Chief Executive Officer of Nabisco division of RJR NabiscoCharlie Hugel-Chairman of the Board, RJR NabiscoEd Horrigan- President and Chief Executive Officer of R.J. Reynolds Tobacco division of RJR NabiscoF. Ross Johnson-President and CEO, RJR NabiscoHenry Kravis-Senior Partner, Kohlberg Kravis Roberts & Co.George R. Roberts-Senior Partner, Kohlberg Kravis Roberts & Co.Jim Robinson- Chairman and Chief Executive, American ExpressMack Rossoff- Managing Director of Wasserstein Perella & Co. financial advisor to Kohlberg Kravis Roberts & Co.The RJR Nabisco LBO is a story of greed, betrayal and ego. In the mid 1980s, tobacco giant RJ Reynolds merged with Nabisco Brands because it was concerned about its future as a controversial one-product company. Cigarettes were known to be cancer causing and the litigation was getting costly. This was a Record-Breaking merger for non-oil related companies of 4.9 Billion, CEO J. Tylee Wilson and The CEO of Nabisco F. Ross Johnson (a name that will be mentioned a lot as you read more) met to discuss a friendly merger in which Wilson would become chairman of the newcompany and Johnson would be vice chairman, president and chief operating officer (COO) as well. The two CEOs soon found that they had very different views. Wilson who was very cost conscious and Johnson who would spend freely. Johnson was using corporate expenses as his own personal ATM like private jets and many other over the top extravagant expenses, all run up on RJR Nabisco’s tab. “The ease and the apparent glee with which Johnson spent RJR's money
Presentation on theme: "RJR Nabisco Some genius invented the Oreo. We’re just living off of the inheritance. F. Ross Johnson."— Presentation transcript:
1 RJR NabiscoSome genius invented the Oreo. We’re just living off of the inheritance.F. Ross Johnson
2 Fair Market ValueFair Market Value: “…the price at which the asset would trade between two rational individuals, each in command of all of the information necessary to value the asset, and neither under any pressure to trade.”Rocky Higgins Analysis for Financial Management (p. 318)
3 Capital Budgeting 101 Step 1: Estimate Discount Rate
Step 2: Project Cash FlowsCash flows for in tablesTerminal valueStep 3: Compute Net Present Value (NPV)Accept positive NPV projects
4 Discount Rate where t = tax rate,
As we discussed, the discount rate is the weighted average cost of capital (WACC).where t = tax rate,E(rd) = expected cost of debtD = amount of debt in capitalizationE(re) = expected cost of equityE = amount of equity capitalization
5 Discount RateTo calculate the WACC using 1989 figures under the three strategies:NOTE: since the capital structure changes over time, we need to recompute the WACC each year to reflect the change in capital structure.
6 Projected Cash FlowsProjected cash flows for 1989 are calculated as follows:
7 Projected Cash FlowThe following cash flow represent the cash flow computed from the tables:
8 Terminal ValueTo estimate a terminal value, we need to make an assumption about future growth after 1998.If cash flows grow by 2.5% per year (and the WACC remains constant), then for the pre-bid strategy:For the Management Group scenario:For the KKR scenario:
9 Terminal Value Results will depend on the growth rate assumption.
Values in 1998 of cash flows for 1999 and beyond for different assumptions are (“Sensitivity Analysis”):Growth Rate
10 Present ValueThe present value of the cash flows for the prebid strategy is (using the 2.5% growth rate assumption after 1998): ($ millions)This represents the total value of RJR Nabisco (ASSETS).
11 Present ValueTo figure out the value per share of RJR Nabisco to the CURRENT shareholders, consider the pre-bid valuation:Total Assets = 22,607Current Debt = 5,204Equity = 17,403
12 ValuationEstimates of the value per share under the alternatives (again, using the 2.5% growth rate assumption):
13 Sources of ValueThe company is worth substantially more under either the KKR or the Management Group plan.There are smaller differences between the KKR value and the management value.The buyout plans propose toincrease debttrim excessesdecrease capital expendituressell food assetsdecrease operating profitsAll gains are based on projections.
14 What Happened? Per share bids: Case (11/18) 11/29/88 MGMT $100 $101
15 Activities of Special Committee
Concluded that First Boston bid was impractical.Began to negotiate terms with KKR.Letter from Management Group protesting negotiations with KKR, offering to negotiate all aspects of its proposal.Special Committee decided to consider new bids.
16 Activities of Special Committee
Summary of final bids (substantially equivalent):Bid ValuationMGMT $ $108KKRChose KKR:more equity (25% vs 15% for mgmt)retain more businessesfewer PIK securitiesmore benefits to terminated employees.
17 Summary: RJR NabiscoFundamentals of firm valuation: discounted cash flow techniques.Relation between managerial decisions and firm cash flows.Operating decisions can create or destroy value.Role of a corporate governance system that encourages value-enhancing decisions.