Book summary: Barbarians at the gate by Bryan Burrough and John Helyar

This book documents the series of events leading up to the successful leverage buyout (LBO) of RJR Nabisco.

Mechanism of an LBO exercise

  • Figure out the cheapest possible price to acquire the asset and its future cashflows while keeping transaction costs low
  • The acquisition team access the business to decipher potential cashflow, areas for cost savings and parts that could be sold off
  • The acquisition team raises private money to do the acquisition
  • During this period of time bandwidth of law firms and banks are fully engaged
  • Competing offers should be expected once a public announcement of an LBO buyout is made
  • Law firms and investment banks will charge fees even if the hiring party does not win the bid

Methods for financing an LBO exercise

  • issue of junk bonds
  • raising from private investors
  • issue of shares to directors to drive down level of cash required for the purchase
  • payment through cash
  • utilization of legal loop holes to reduce taxation on the LBO transaction

Motivations for an LBO exercise

  • The management team:
    • a option to exercise when the market is persistently undervaluing the shares of the business
    • free up value to reward themselves and their share holders
    • the CEO being the typical Type A personality got bored and restless from running his day to day business
  • The investment banks:
    • when the market is down but they still need to figure out ways to make money through business transactions
    • some needed an opportunity to enhance their prestige so as to attract future opportunities. Securing a prominent position in the transaction has that effect

Lessons from the LBO exercise

  • The inability to sit in a room and doing nothing is the source of most trouble.
    • The CEO ended off worst off than he did before the LBO event
  • Having inside support matters
    • Having support of the management team provides knowledge of where cost savings could be had in the operations
  • Just when you think shit will not happen, it usually does.
    • The management team was expecting an uneventful transaction. Unfortunately, the operation quickly escalated out of control when competing bids surfaced.
  • When money is cheap, Wall street gets creative
    • the Federal reserve provides cheap money which cannot be put to real economic use, LBO is just another method Wall Street utilizes to make a profit from this cheap money
  • When egos start getting involved, its no longer about making a profit
    • the successful acquirer ended up defaulting on a lot of the junk bonds issue
    • what started as an initial USD76/share bid quickly escalated to USD106/share
  • When an opportunity as large as this becomes available, the services of lawyer firms and bank credit becomes scarce and it is hard to gain access to such facilities as a new comer to the table
  • Companies actively manage Wall Street expectation
    • RJR Nabisco actively engaged in wasteful activities to project a steadily advancing year over year profitability and thus share price. It could have operated efficiently and have the share price reflect the actual value on day one
  • The core business will falter overtime when the operators get distracted by other activities and are no longer engaged and connoisseur of their own products
    • early employees of Reynolds cigarettes are themselves enthusiast smokers. They released a new product only when it passes their own taste test
    • later management were focused on milking the cash cow and started changing the culture as such
  • Negotiation dynamics
    • the senior financiers will generally play the diplomat (good cop)
    • the junior and middle level financiers will be in charge of hashing out the details (bad cop)


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