Will His Deal Go Up in Smoke?

By Frederick Ungeheuer

When Ross Johnson, president of RJR Nabisco, proposed last month that the tobacco-and-food conglomerate he had helped assemble only three years earlier be "put into play" and broken up, he had reason to believe that the company's board of directors would support him. After all, he had treated the outside directors on RJR's board well, paying them lavish fees and providing access to the company's corporate jets. Moreover, his offer was the largest leveraged-buyout bid in history and would give RJR's stockholders a rich, immediate payout.

Johnson, 56, may have grossly miscalculated. When he announced during an Oct. 19 dinner at Atlanta's Waverly hotel that he and seven other managers intended to take the company private in a $17.6 billion leveraged buyout, RJR's board members reacted with shock, one of them now says, "because he was raiding the company from the inside." At first blush, the $75-a-share offer seemed generous, compared with the market price of about $56 at the time. But the directors' shock became outrage when they later learned about the huge piece of the action that Johnson and his top executives planned to grab for themselves: a payoff that could conceivably amount to $2.6 billion in five years. The Johnson gang's greedy overreach could wind up entirely undoing the proposed LBO

A committee of the company's directors responded to Johnson's proposal on Nov. 7 by opening the bidding for RJR to all comers, setting last Friday as the deadline. Two days before the auction closed, one potential bidder, the Manhattan investment firm Forstmann Little, scrapped its planned offer. Forstmann's departure left two contenders: the RJR management group, which had upped its offer to $21 billion ($92 a share), and the investment firm Kohlberg Kravis Roberts, with its bid of $20.6 billion ($90). RJR's board could take as long as several weeks to study all new offers, including revised versions and ^ possibly even a joint bid by KKR and Johnson's group, before recommending one to the company's stockholders. In the end, it may not accept any of them.

Instead, the board could decide that the best course of action would be to sell off the company's subsidiaries without going through an LBO. The board might sell Nabisco's food divisions and distribute the proceeds to stockholders. Although this would take longer, RJR Nabisco could be worth more than $100 a share. Few corporations have a more marketable package of assets, which include such consumer brands as Del Monte canned goods, Blue Bonnet margarine, Planters nuts and dozens more.

The strategy of the RJR board seems designed to thwart Johnson's effort, in part because it would give him and his team too large a share of the goodies. While precise details of the Johnson group's stake have not been announced, several insiders have leaked the terms. Under Johnson's proposal, 90% of the company's equity, roughly $18 billion, would be swapped for debt. He and his group would control about 8.5% of the remaining equity, which would be sold to them for just $20 million but would immediately be worth about $200 million. The management group has also given itself incentive payments, which, if certain profit targets were met, would increase its stake to just under 20% over five years. If everything went as planned, the value could be as much as $2.6 billion by then. Johnson's personal share: $1 billion or more.

The booty would not have ended there. The management company envisioned by Johnson and the seven other executives was to receive $38 million a year in salaries and bonuses, along with veto power over the company's board of directors.

Charles Hugel, who serves as board chairman of RJR but holds no management post, did not fully realize just how sweet a deal Johnson had arranged for himself and his team until he read a detailed account of it in the New York Times. Shareholders also began to grow resentful. Smith Bagley, a grandson of R.J. Reynolds, the company's founder, complained in a letter to Hugel, "The stockholders have been paying these top executives, and paying them handsomely, to run the company for the stockholders' benefit and not to acquire it at the stockholders' expense."

Johnson hastily tried to reassure Hugel and other members of the committee that not just a few top managers, but hundreds and most likely thousands of lower-ranking RJR Nabisco employees were to be cut in on the management's stake. But his explanation came too late. "Johnson has lost all his friends on the board," a director told TIME. To them, Johnson's proposal seemed to benefit him first and the company second.

The board has other reasons to consider rejecting a management-initiated LBO. Two of the company's bondholders, ITT and Metropolitan Life Insurance, filed lawsuits against RJR last week, alleging that Johnson's failure to inform earlier bond buyers about his LBO plan cost them millions of dollars in losses. Reason: in light of the huge amount of additional bonds that would have to be floated to finance the buyout, the company's investment-grade debt is viewed as riskier and has slumped 20% in market value.

In the final analysis, the RJR directors must think of the shareholders, who will be forced to pass up their stake in future profits if a lump-sum buyout occurs now. Since the tobacco industry's earnings potential is growing as foreign sales boom and the threat of smokers' lawsuits diminishes, the RJR board has insisted that shareholders be given a continued piece of the action. If the directors adopt that strategy, they just might decide that the company needs a different president as well.

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