Barbarians at the Gate: Wall Street Buyouts and Your Investments

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"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 the U.S.'s biggest brands at the time: Nabisco and RJR Tobacco.

The book tells a vivid tale of greed, private jets, golf course meetings, and a battle between Wall Street powerhouse investment banks and law firms. Amid all the drama, there are more than a few lessons from this story that apply to modern investors.

A Buyout Gone Bad

The novel begins with details about a merger between R.J. Reynolds Tobacco Company, a 100-year-old firm from North Carolina, with Nabisco, one of the U.S.'s best-known cookie and snack companies. The deal went through in 1985 with a massive $4.9 billion purchase of Nabisco by RJR, putting Johnson atop one of the U.S.'s largest firms.

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 competitive bidding process, private equity firm Kohlberg Kravis Roberts & Co. (KKR) put in a winning $24.5 billion bid for the merged 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. In 1999, the company ended up splitting back into tobacco and food companies. In the end, 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 bring pros and cons to firms and investors. On the plus side, companies become bigger, more competitive, and ideally more profitable. In some cases, mergers make companies stronger in a tough industry. For instance, major telecom company CenturyLink bought up companies like Qwest Communications and Level 3 Communications. This move gave CenturyLink the chance to be more efficient, reach into new markets, and gain a competitive edge against large rivals like AT&T and Verizon.

There are downsides, too. Firms involved in buyouts might also end up saddled with too much debt. Further, too much merging in any sector hurts consumers by limiting competition and hurts workers by taking away jobs.

What's more, merging two companies that aren't doing well often only creates a bigger company that continues to perform poorly. The only real beneficiary from the Sears and Kmart merger, for instance, seemed to be its high-paid former CEO as the company ended up bankrupt.

What Mergers Mean for Investors

As investors, the main 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 U.S.

Toys ‘R’ Us was a different story. The longtime U.S. toy seller was well on track to shut its doors for good in 2018. 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 slow sales, that ended up taking 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 stocks 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.