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Scritto da nel Economia e Mercati, Numero 69 - 1 Maggio 2010 | 0 commenti

The Barbarians of the 80s, An Epic

During the 1980s, in the financial market scene, the meaning of the term “barbarian”, took a slight divergence from what it traditionally denotes. Instead of the ugly, barely clothed and savage character that many have associated a barbarian to be, a barbarian at that time and setting took the form of a suave, smartly dressed and highly educated player in the financial market. In 1980s Wall Street, barbarians referred to those who work (especially those in the higher levels) in private equity firms that engage in Leveraged buyouts (LBOs).

The less than pleasing label came to be because of the way by which private equity firms then operate. Such firms go on a hunt for a company of good potential (but performing badly), take-over it through a combination of equity and debt (the LBO), and subsequently maximize the value of the venture to gain profit. This sudden (often hostile) take-over of the company by the private equity firm, along with the “undesirable” measures such as cost-cutting and layoffs (that will be eventually taken to increase the value of the company), are often seen by company insiders and observers as acts of savagery. Hence, the brand “barbarian” was placed on the heads of these private equity firms.

Like any outsider blazing through a different territory, barbarians, in the 1980s Wall Street sense, have been seen as an agent of change. Whether the change is for a better outcome or for the worse depends on which side one is in. For shareholders of an ailing company, a barbarian's entry might be a welcome prospect. For those who risk losing their benefits as the barbarian arrives (such as those in the management of the troubled company), the barbarian is an obvious enemy. At the end of the day, a consensus usually arises whether the barbarian is an angel or a devil of change. However, such accord only happens after all the dust cast by barbarian's adventure has settled and so the judgement of the barbarian's character is left for history to do.

The barbarians of 1980s Wall Street have often been judged in light of the outcome of the largest LBO launched at that time. In 1989, the private equity firm, Kholberg Kravis Roberts & Co. (KKR), took-over the conglomerate RJR Nabisco for the staggering sum of USD31.1B. Such take-over to this day, remains the biggest LBO in history.

The story of the RJR Nabisco take-over, immortalized in the novel “Barbarians at the Gate: The Fall of RJR Nabisco” unfolds with RJR Nabisco CEO, F. Ross Johnson trying to squirm out of a failed company project. To avoid having to answer to shareholders and keep his position, F. Ross Johnson moves to buy-out the rest of Nabisco's shareholders. Sensing the opportunity for profit, Henry Kravis, founder and head of KKR enters in the game and makes his own firm's offer to Nabisco's shareholders. A bidding war ensues with the winning bid hitting USD109 per share (from a starting bid of USD75). The winning bid was tendered by KKR. Victory has come to the barbarian.

Pre-take-over RJR Nabisco was known for many excesses on the part of its management. Anecdotes of its extravagance include sumptuous parties hosted for the mere purpose of watching boxing matches on live television, and product launches costing millions of dollars that are unjustified by the product's subsequent performance in the market. The most infamous symbol of RJR Nabisco's lavishness, however, was its so-called “Air Force” which was composed of over 20 private jets with standby pilots ready to fly executives (or the executive's beloved dog, if we believe the film adaptation of the novel). The conquest of the barbarian, KKR, would then be received as a welcome change that will curb the excesses of the poorly performing but promising company.

However, the events that followed the take-over have proven the perception wrong. The take-over began with an equally profligate celebration, thrown by the company's new management. F. Ross Johnson, the man who fought the barbarian and was pointed to, as the one chiefly responsible for the overindulgence and lacklustre performance of pre-take-over RJR Nabisco, left the empire he once ran, head-down but USD 53M richer. Two years following the take-over, frustratingly unable to carry the huge debt the company has incurred due to the monumental LBO, KKR sold its shares of RJR Nabisco back to the public at almost no profit. In 1999, ten years after the take-over, RJR Nabisco split its tobacco and food businesses and sold its foreign tobacco company. The move was meant to gain some cash for the company to use in reducing the same said debt.

The barbarian's raid was then a disaster. If there were any benefit or good change that this episode of “barbarianism” has brought, it was that the pitfalls of LBOs, then a rave in the 1980s, has been exposed and has resultantly placed the practice into distaste. Thus, unlike most stories about barbarians, where the victorious one relishes the spoils of war, this particular tale ends with the barbarian and its contemporaries learning the bitter lesson about the evils of greed.

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