Yet in just the last three years, much has changed, and that includes the verdict on Kohlberg Kravis Roberts & Co. The house that debt built is firmly established as a premier investment power that understands the 1990s as well as the 1980s and, according to one KKR critic, has become a leader in incentive-based management. It has a pervasive presence: every time you slip a Duracell into your Walkman, crunch down on an Oreo or push a cart through Safeway, you are putting money into Henry Kravis’s pocket (chart). If you collect a pension from one of the many corporate or state pension funds that invest in KKR, you’re sharing in those profits. The companies KKR controls or invests in have annual sales of about $50 billion, making it the equivalent of number seven on the Fortune 500 list. And KKR has also helped create corporate superstars: IBM just named as its would-be savior Louis Gerstner Jr., partly because of his record in running Oreo maker RJR Nabisco for Kravis (page 46).
For all his clout, Kravis is no barbarian-not, at least, to his many admirers, and not even to some who have only lately softened their view of LBOs, which are fewer in number these days. The market for junk bonds has been resuscitated. And while no one has forgotten such buyout blowouts as United Airlines, Macy’s or KKR’s own Seaman Furniture Co., there is no groundswell to kill off LBOs, as there was when Congress held months of hearings in 1989.
Does all this mean that the harsh judgment of the 1980s was wrong? Well, yes and no. The 1980s was the decade for takeovers, whether they were engineered with stock or debt. Big public companies used their own stock to acquire other companies or investors borrowed money to buy up the stock themselves and “take the company private,” as KKR did with, among others, Owens-Illinois, Beatrice, Stop & Shop and Motel 6. (Another word for debt is “leverage”; hence “leveraged buyout,” or “LBO.”) After the buyout, investors do whatever is necessary to pay off the debt and boost profits: sell assets, change management. If it works, they sell the company again, reaping big rewards.
LBOs weren’t new to the 1980s. The strategy behind them was articulated in 1958 by two economists who later won Nobel Prizes, and firms such as KKR proved the idea highly lucrative in the late 1970s. By the early 1980s, Kravis, his cousin George Roberts and their now estranged mentor, Jerome Kohlberg, were reaping returns on investment above 40 percent, on top of huge fees. The deals got bigger and, as others caught on, the bidding became fiercer. Riskier deals were financed with high-interest loans that got nicknamed “junk bonds.” But the biggest deal of all was for RJR Nabisco in 1989, when KKR paid $26 billion for the prize in a contest unseemly even by ’80s standards.
Critics still say that ego triumphed over analysis and KKR paid too much. When both junk bonds and tobacco profits skidded just a year later, KKR had to pump more money into RJR to keep it afloat. And RJR is still struggling. Last week Kravis was too busy with RJR to talk, but partner Paul Raether admits they “didn’t get any bargains” in buying RJR. He won’t discuss it in detail, because RJR will soon make a stock offering. But defenders of the deal argue that RJR is still likely to pay healthy but not stunning returns. Last week RJR named two of its respected managers-finance chief Karl von der Heyden and general counsel Lawrence Ricciardi-to succeed Gerstner.
Even though RJR investors have reason to be optimistic, KKR partners believe that media attention to the deal has obscured their real genius. In HBO’s “Barbarians,” Kravis’s gilt-encrusted digs and original Monet stun even greedmeisters like RJR’s former president F. Ross Johnson. Kravis, a small man with an Oklahoma drawl who projects considerable charm, is portrayed by Broadway star Jonathan Pryce as a tall, humorless ghoul who, when asked how he will torpedo competitors for RJR, says smoothly, “Napalm.” Lately, to protect his image, Kravis has bought up rights to photos of himself, hesitates to let reporters tour KKR’s posh offices and has taken pains to project KKR’s human face. KKR just issued a glossy KKR Review that focuses on the firm’s tonic effect on the national economy.
And there is a story to tell. While RJR has its place in popular culture, KKR’s many happy endings are relatively unknown. KKR has successfully taken public such firms as Motel 6 and Duracell. And Duracell chief Robert Kidder says he has tripled R&D spending since the buyout, a sign that, contrary to some charges, KKR can focus on the long term. George Anders, a Wall Street Journal reporter and critic of KKR, gave the firm credit in the Harvard Business Review for implementing some of today’s hottest management reforms, such as insisting that managers hold meaningful stakes in the company to ensure their motivation.
Meanwhile, some of the draconian moves associated with such takeovers as Safeway look a little different now. That buyout became notorious because of how the debt-laden company rushed to shrink operations and fire thousands of workers. It seemed to epitomize the worst effects of LBOs. Indeed, in his book “Merchants of Debt,” Anders notes that KKR executives, “cocooned among [extraordinary] creature comforts … never grasped the grim side of debt.” Since then, there has been plenty of grim news from giant public companies such as GM and Boeing which followed the example set by companies such as Safeway. LBOs may be more disruptive because debt exerts pressure to make cuts more quickly than a falling stock price, says Dean Baker of the Economic Policy Institute, a Washington think tank. “But that’s what increased productivity is about; the same work with fewer workers.”
Economists such as Baker still hold LBOs in low regard. Huge debt levels make it harder for companies to invest, he argues, and the huge fees paid to Wall Street bankers and lawyers (and firms like KKR) eat up money that could be put to better use. But the LBO is in essence a technique that, like any other, can be used for good or bad. The failed LBOs are the products of people who weren’t “thoughtful or sophisticated” but simply jumped on the LBO bandwagon, argues Joseph Rice, partner in Clayton, Dubilier & Rice, another leading LBO firm. “It got to be fashionable to leverage up a balance sheet as high as you could go,” says Rice, “and then hope for someone to bail you out-the ‘greater fool’ theory.” Adds The Private Equity Analyst’s Steven Galante: “Today, the only way you make money is to make sure the companies themselves make money.”
After the RJR deal, LBO activity slowed down markedly. This was in part the effect of the lingering stigma. After RJR, says Raether, CEOs were afraid they’d be “thrown out of the boardroom” if they even suggested an LBO. Unions and politicians have pressed pension-fund managers not to invest in LBOs. “A lot of people stayed away from us for a while,” says Raether. When KKR did its biggest deal in a while last year, buying American Re-Insurance from Aetna, chief Ed Jobe says he was “uneasy” himself at first. And he had to spend time reassuring clients that KKR wouldn’t destroy the culture of long-term thinking at American Re, which reinsures insurance companies. But the main reason for the slowdown is simply capital-market dynamics. With the stock market priced so high, stocks are too expensive to make many buyouts possible. Returns, while still impressive, may be half what they were in the early 1980s.
This hasn’t hurt KKR too much. The firm has adjusted its strategy with apparent success, proving that it can prosper, even as other LBO firms flee. KKR is already showing profits on its creation, in 1989, of publishing venture K-III, which bought properties such as Seventeen and New York. And its investment in Fleet Financial Group, which bought the bankrupt Bank of New England, has doubled in value, says Fleet chairman Terry Murray.
Now, says Raether, even LBO “activity is starting to pick up again.” Kravis has been combing Europe for the right opportunity that will introduce KKR to the Old World, and the partners raised $1.8 billion in new capital last year to spend on new deals. Despite the audience-pleasing caricatures in “Barbarians,” history’s verdict on the LBO is far from written. One day, the chapter on the debt-defying KKR may paint a kinder portrait of Henry Kravis.
