The First Boom and Bust Cycle ‘82-’92
Corporate takeovers grew to become an important facet of American business in the 1970s and 1980s as hostile takeovers and LBOs made the transition from small target firms to large and well-known public companies with the use of significant debt portions. In 1982, former Secretary of Treasury William Simon’s Wesray Corporation bought Gibson Greetings, which was then a subsidiary of RCA, via leveraged buyout. The $80.6 million deal ($58 million in equity and $22.6 million in assumed debt. Within 18 months, Wesray Corporation exited on its investment with Gibson Greetings’ $330 million public offering in which Simon saw a personal return on investment of nearly $66 million. A take private LBO transaction where the target firm is later taken public again is known as a reverse leveraged buyout (reverse LBO).
The rise in LBO activity over this Cycle could be attributed to both regulatory and economic factors, including Delaware’s Anti-takeover Statute of 1982, the overall de-regulation of many industries, the laissez-faire antitrust policies of the Reagan administration, and the introduction of high-yield debt instruments known as junk bonds which provided private equity firms with a significant amount of financing capital. In response to the new trend, corporate managers lobbied for legal restrictions to help ensure their ownership and control while increasing debt levels to restructure their companies and payout dividends shareholders. This ushered in a period of mega buyouts, the most notable buyout of the First Boom and Bust Cycle is by far private equity firm Kohlberg Kravis & Roberts’ leveraged buyout of RJR Nabisco in April 1989. Including the assumption of debt, the RJR Nabisco deal was valued at $31.1 billion, making it the largest leveraged buyout in history.
The RJR Nabisco deal originally began as a management buyout led by the company’s CEO, F. Ross Johnson and backed by Shearson Lehman Hutton and its parent company, American Express, at a proposed $17 billion, nearly half of the final deal value. When the MBO was announced in October 1988, RJR Nabisco was trading around $55 per share, making the $17 billion price tag or $75 per share, a significant increase and inadvertently advertising the potential for sky-high advisory fees to all of Wall Street. This led to a six-week bidding war, ended with KKR paying a supremely debt-laden $109 per share. RJR Nabisco, then loaded up with over $20 billion in debt, would require a $6.9 billion refinancing plan to stay afloat in 1991. In fact, many of the buyouts throughout the 1980s resulted in a bankrupt target company as a result of the sizable debts they were left with and thus the term “corporate raiders” became associated with private equity buyout shops.
Michael Milken, then head of investment bank Drexel Burnham Lambert’s high-yield bond division, is popularly cited for the development of the high-yield market which substantially led to the incredible fundraising capabilities in the 1970s and 1980s and, subsequently, the increased number of leveraged buyouts. In March 1989, Milken was indicted on 98 counts of racketeering and fraud by a federal grand jury and in April 1990 pleaded guilty to six counts of securities and tax violations. Michael Milken’s total fines of $1.1 billion and 10 year jail sentence (he ended up serving 22 months) aided in the collapse of the junk bond market and thus, the leveraged buyout boom. Drexel Burnham Lambert would file for Chapter 11 bankruptcy protection in 1990.