“Barbarians at the Gate” is one of the greatest investment books of all time. The 1990 book, which inspired a 1993 movie, follows the story of F. Ross Johnson in his quest to merge and take over two of America’s biggest brands at the time: Nabisco and RJR Tobacco.
The book tells a dramatic tale of greed, private jets, golf course meetings, and a battle between Wall Street powerhouse investment banks and law firms, but amidst all the drama, there are more than a few lessons from this story that apply to modern investors.
A Buyout Gone Bad
“Barbarians at The Gate” begins with discussions about merging R.J. Reynolds Tobacco Company, a 100+ year-old firm from North Carolina, with Nabisco, one of America’s best known cookie and snack companies. The deal went through in September 1985 with a massive $4.9 billion purchase of Nabisco by RJR, putting Johnson atop one of America’s largest corporations.
That wasn’t enough for Johnson and others on Wall Street who wanted to take a new approach to RJR Nabisco to cash out big. After a dramatic, competitive bidding process, private equity firm Kohlberg Kravis Roberts & Co. (KKR) put in a winning $24.5 billion bid for the combined company, netting Johnson over $60 million and putting millions more into the hands of executives, lawyers, and bankers involved in the deal.
The company was never the same; it left the deal with $30 billion in debt that left the company still buckling under the pressure over a decade later. The company ultimately split, back into tobacco and food companies, in 1999. Ultimately RJR Nabisco didn’t survive the long-term effects of a leveraged buyout, or LBO.
Pros and Cons of Wall Street Buyouts
Not all buyouts go wrong, and most brings pros and cons to companies and investors. On the plus side, companies become bigger, more competitive, and ideally more profitable; in some cases, mergers make companies more resilient in a tough industry. For example, major telecom company CenturyLink bought up companies like Qwest Communications and Level 3 Communications, giving CenturyLink opportunities for efficiency, a reach into new markets, and competitive advantage against large rivals like AT&T and Verizon.
There are downsides, and companies involved in buyouts might also end up saddled with too much debt. Further, too much consolidation in any industry hurts consumers by limiting competition and hurts workers by eliminating jobs. And combining two poorly performing companies usually leads to a larger poorly performing company. The only real beneficiary from the Sears and Kmart merger, for instance, appeared to be its high-paid former CEO as the company ended up declaring bankruptcy.
What They Mean for Investors
As investors, the primary concern is a return on investment. A Wall Street buyout might see a rise in stock price, but not always.
A good merger took place in 2005 when Adidas and Reebok came together. The two shoe and apparel companies struggled against Nike and others for market share. In 2005, Adidas had a 15.0% share of the sports shoe market and Reebok had just 7.6% of the market share. In 2006, after combining, Adidas-Reebok reached a market share of 21.7%. In this case, the two companies fared far better together than they did on their own, at least in the United States.
Toys ‘R’ Us was a different story. The longtime US toy retailer is on track to shut its doors for good in 2018, and while many people would be quick to blame Amazon and the internet age for the fall of this toy chain, it was actually Wall Street that led to its demise. Toys ‘R’ Us was the target of a leveraged buyout from three Wall Street firms, including KKR, which put the retailer in $6.6 billion of debt. It was this, not slowing sales, that ultimately took down Toys ‘R’ Us.
Beware the leveraged buyout
Mergers and acquisitions can be a very good thing, as demonstrated by decades of successful mergers at a range of companies, but when the merger means putting the target company in billions of dollars in debt, it doesn’t always work well for investors.
By staying aware of mergers and buyouts involving companies you own, you can better decide if it is a hold or sell. Just don’t ignore it, as every merger and buyout tends to have a dramatic, long-term impact on every investor.