'GREED REALLY TURNS ME OFF' Henry Kravis tells how his firm won the RJR Nabisco deal, how safe an investment it is, and why Washington should leave LBOs alone. He also has a few pointed words about the loser.
By Colin Leinster Henry Kravis REPORTER ASSOCIATE Cynthia Hutton

(FORTUNE Magazine) – FORGET about red-rimmed eyes. It is midmorning, a few hours since Henry Kravis won the $25 billion battle for RJR Nabisco, and his eyes seem red all over. Sipping constantly from a glass of water, Kravis talked with associate editor Colin Leinster in the office of Kohlberg Kravis Roberts's lawyer, and later at KKR, about his victory in the biggest corporate buyout ever -- and about how it almost didn't happen.

''Once, only a few hours before we won, we wanted to call the whole thing off. 'Let's drop out,' I said. 'Let's all go home.' George ((Roberts, co-founder of KKR and Kravis's cousin)) agreed. It was Wednesday ((November 30)), already a full day later than the deadline that RJR's special committee had set for final bids. This was quite a mood change from the elation I'd felt 16 hours earlier when we were told KKR's offer of $106 a share was the highest. That made me feel the best I'd felt since the whole transaction had started five weeks earlier. You live these things, you know. People say: What happens to you physically? Well, what happened to me personally is, I lost eight pounds -- in five weeks. It's just the greatest diet. But for the same five weeks, I would wake up in the middle of the night and I'd think about the deal. Is RJR the right company to acquire? What happens to the people if we buy the company? Does this make sense for KKR's limited partners? What does it mean for my personal life if we buy something like this? You name it, everything you could think of about this deal, I woke up and thought about. When the committee announced it had received another offer ((from a group led by First Boston, the investment banking firm)) and was reopening the bidding, my immediate reaction was: Have the rules changed? We played by the rules, we always do. What could we do now? In fact, what we did was go home around dawn on Wednesday, shower and shave, and come back at 9:30. Later we put in our final offer for $109 a share and started the waiting all over again. It was an intense, emotional day, a real roller coaster. The half dozen people on KKR's team sat in one conference room at Skadden Arps ((the attorneys for the RJR committee)) and the management group's team in another, everybody ready to answer last-minute questions or change the offer. It was during this day that the special committee asked if KKR would guarantee as many jobs and benefits as we could. We said 'Yes.' I think this is what swung the decision our way. You try to think and talk about something else in these waiting situations, other deals that had been just as frustrating, things like that. I've never seen a transaction go exactly the way you expect, and we've been buying companies for over 20 years. When we waited for Beatrice ((the conglomerate KKR bought in 1986 for $8.2 billion)), we played poker, and I'd just won a hand and was raking in the pot when the good news came. This time around, we had a $20 pool to see who could call the time of the announcement closest. The KKR people sat in the room or went for walks, like I did with George around 3 p.m. Sometimes we pretended that this was just another deal, but nobody really believed that. Then, when we were sitting alone with Dick Beattie ((a senior partner at the Simpson Thacher & Bartlett law firm and KKR's senior legal adviser)), the frustration got to me. I thought I'd had it. Good adviser that he is, Dick said, 'Let's just wait it out, Henry.' So we did. FRUSTRATION is your worst enemy. You have to continue to stop yourself from letting the frustration drive you to make irrational decisions -- or rely on your advisers to stop you. KKR is an incredibly disciplined place, and we focus very narrowly on what we're doing, how to play the transaction, and how to structure it best. When we put a deal together, I have the ability to focus on exactly what we're working on and close everything else out. You just have to. But the waiting is something different. At about 9:30 P.M. -- long after anybody had a chance of winning the pool -- Felix Rohatyn and Peter Atkins, special advisers to the committee, came in and asked for ten more minutes. George told them, 'Ten minutes is okay. But that's it.' Eight or nine minutes later, they were back. Rohatyn beckoned George, Dick, and me into another room. Atkins had his thumb somewhere in the middle of the documents containing our offer, flipped them open, and pointed out a small, technical change that the special committee wanted. Dick agreed to it. And Atkins said, 'Congratulations. You've won.' The transaction was done. The wait was over. I think Ross Johnson ((RJR's chief executive)) made a number of mistakes. When he made his first offer, a management buyout at $75 a share, my first reaction was to think that RJR was in play -- and at a price substantially lower than its real value. Was he actually just putting up a For Sale sign on the company? Or did he really want to own it? If the latter, the one thing we were very certain of was that the management group was stealing the company. As we got into it further, we also saw that they were very confused. It was as though they were thinking: Let's get this thing done quickly, and nobody will come after us because of the size of it. At KKR we didn't see it that way. RJR is a terrific company with exceptionally good products and an exceptionally good track record. Based on the analysis we'd done, we knew it was worth a minimum of $90 a share. I daresay that by the end, as the committee weighed its decision, Ross Johnson turned out to be the best thing we had going for us because of all the adverse publicity he was collecting. We read the press, too, of course. The most important thing is to have as perfect knowledge as you can of the transaction, and if you read enough, you're going to pick up something somewhere. Dick Beattie keeps reminding me of the flip side of that: Don't believe all you read. There have been things written that might lull you into false hope or a false belief. Of course, you have to figure the other side is reading everything, too. It was reported during this transaction that I was upset when others came in after RJR and that I'd said deals this big are KKR's franchise. I never said that. We don't make decisions because we think we have a franchise, and it's an insult to say we do. If we did, we wouldn't have used Morgan Stanley and Merrill Lynch as two of our financial advisers. They are very competent people in the leveraged-buyout business, and compete with us every day. There's room for ten investment banking firms or more doing leveraged buyouts, plus KKR, plus all the boutiques that are doing them. Of course, it's fine to think of KKR as the leader. I want to point out that we have never made a hostile offer for a company and we will never make one. Any offer we've made in the past and any we make in the future has to be approved by the board of directors or we will not buy the company. In the case of RJR, we came along very quickly after the management group made its announcement with our offer of $90. This was not a knee-jerk reaction as some have suggested, but because we knew a lot about the company. I had dinner with Ross Johnson a year ago September in my apartment. I brought up the idea of doing a leveraged buyout of RJR Nabisco. He called ! back several days later to say he had no interest. We've been looking at the company ever since, and we know it very well. One thing that is very important about this deal is that we never wanted to overleverage it. It's important to us to know that we could perform well in a downturn. All the numbers we ran, all the analyses we did, had recession scenarios. We took management's projections -- we always haircut management's projections -- and then ran our own numbers based on inflation scenarios, with higher interest rates and a downturn in the economy. In any event, KKR is going into a company that will have $7 billion in equity and $23 billion of debt. That's a debt to equity ratio of 3 to 1, really low. We've rarely bought a company with a ratio that low, and I can't name many that have. It's usually 10 or 12 to 1. Others have gone as high as 25 to 1. This is because we want to make sure that it is a safe transaction. We will be selling some of the food businesses over the next couple of years, and keeping tobacco. The company still will make a great deal of money, pretax. Remember, as owners we won't be as driven by security analysts to produce good results every quarter.

I THINK there's going to be a slowdown in LBOs. The biggest concern that Washington, Wall Street, and the banking community have expressed about the RJR transaction is its sheer size. LBOs are not an industry, remember; they're a financing technique. But Washington will have to work its way through various concerns and issues. Obviously, I view the Washington scene as very serious. It could be that they'll introduce some kind of legislation, perhaps eliminating the deductibility of corporate interest payments. But the problem is that for every action, there's a reaction. I know that if they end the deductibility of interest on acquisition debt, it will have a severe impact on the stock market. Fortune wrote a terrific article on this subject, saying how much the government stands to collect ((in taxes)) on LBO transactions ((Fortune, December 5, 1988)). Everybody else has forgotten that. One of the biggest missing ingredients in Congress right now is information and understanding about LBOs. We're prepared to take the necessary time, as are others in the business, to try to increase public understanding of these transactions. People say that R&D investment is cut back after an LBO to help pay interest, and that plants are closed, causing mass layoffs, and when subsidiaries are sold they disappear. None of this is true. When we owned Tropicana as a part of Beatrice, for example, we more than doubled our investment in it. We're not going to take the heart out of a corporation. People who produce things will stay. We look at the people who report to people who report to people. We'll often cut fat at the corporate level. There'd be much less of this, and companies would be valued more accurately, if chief executives felt the pressure from their directors to do the cutting that they only do when they're threatened by a takeover. As it is, most directors just don't have the incentive to push. One reason is that they don't have much by way of an investment in the company, just stock options, which is a heads-I-win, tails-you-lose situation. SURE THERE are bad LBOs. But they are only hiccups in the business, the exceptions. Knock on wood, KKR hasn't had any like that. Don't forget, we manage our companies very well, and our executives are rewarded on their performance. We say to management, 'Where do you want to be five years from now, and let's not worry about quarter-to-quarter earnings.' Having the debt makes them accountable -- they know what they have to do. One more thing: Forget about reported earnings. Usually, any company that's been taken private shows a loss -- an accounting loss. You have all new accounting adjustments, including goodwill, which you have to write off. It's not a cash charge; you just have to amortize it over 30 or 40 years. Washington is also concerned about greed. It should be. Greed really turns me off. To me, money means security. I do what I do because it's a challenge and I love it. I really enjoy it. But the money is not the important thing. I have a responsibility to the people in our firm, and to our investors, who have made a lot of this possible. And having been fortunate enough to have accumulated some money, the greatest pleasure I get today, aside from my family, is being able to give it back to the community, whether for hospitals, education, the cultural arts, or the fight against AIDS. My parents taught me that. My father started out penniless, made some money, and then lost it on the stock market and went broke in the Depression. He didn't file for bankruptcy, fought his way through, paid back every penny he had borrowed. Since then, he's been fortunate to make some money as a consultant in the oil and gas business. He's always been extremely generous. My mother ran the Baby's Milk Fund in Tulsa, which is where I grew up with my older brother George ((now the owner of a chain of radio stations)). I've always had an entrepreneurial drive. In junior high school, I sold magazine subscriptions. I sold subscriptions for two years and won the yearly grand prize twice. It was a barrel of pennies, and the winner would take a shovel and as many pennies as you could put on the shovel, you got to keep. It was one big shovel. How many pennies do you think it held? $34 worth. I thought that was great. In college I worked summers for Goldman Sachs. My first job was as a runner, a messenger. Then I went into the research department, and then into corporate finance and institutional sales to get a view of what was going on. But I didn't understand how one day the institutional salesmen could have a special on Chrysler and the next day on XYZ Co. I asked myself: How do they know so much about these companies? I made up my mind to find out how an institution analyzes the investment and makes its decisions on purchasing equities. So I called Ed Merkle of the Madison Fund ((a mutual fund)) and asked him if he'd put me to work the next summer. I wanted to learn the other side of the business. I'M AN IMPATIENT PERSON, and I wanted to get out in the work world. I was at Columbia business school in 1968, during the student riots, but I left it to my liberal friends to do things like getting arrested. I had my mind on business. The working relationship between my cousin George and me is phenomenal. He's in San Francisco most of the time, and I'm in New York. But we talk to each other at least once a day. We make decisions together. If one of us feels very strongly about not doing something, we don't do it. I have enormous trust and confidence in him, and I think he has the same in me. I can't think of a better relationship with anybody, on both a professional and personal basis.

He and I both encourage our people to speak their minds about transactions we're considering. We always start with the junior people so that they aren't intimidated by us. That's the way they're going to be the best for KKR. With RJR, for example, a couple of the junior guys, who were the ones working with the numbers, said they were concerned about offering more than a certain amount, and they said they were very concerned about putting more cash into the transaction. They also questioned whether KKR should even be getting into the tobacco business, with its health risks. We've been very lucky with our people. We're a small firm, 18 professionals, of which three are in the accounting area. That leaves 15 to work on our transactions. We've seen them all under pressure, which is the way to judge them. They keep looking for possible deals. They also make sure that companies we have acquired perform. George and I will be concentrating on RJR. I've talked to Ross Johnson, and he has said he'll help us in our transition. For a very brief while, it seemed just possible that we'd end up on the same side. But after a couple of late- night meetings with him, some of his people, and Shearson and Salomon ((the investment bankers working with Johnson's management group)), it was clear to us and to him that this wouldn't work. Basically he's a good guy; you like to be with him. He just got carried away. One of the reasons he didn't want to do the deal with us was because we wouldn't give him what he wanted ((in terms of personal profit from a buyout)). You won't look at our transactions and see that management has gotten huge payoffs to do the deal. Once the transition is over, Ross will be moving on. He will not be a part of our ongoing operation.''