Don’t Ignore ‘Barbarians at the Gate’ — Summer Reading

by Jeff Reeves | June 21, 2013 9:16 am

Editor’s note: We’re pleased to be rolling out a summer series on investing books. Each week we’ll be reviewing two books — one classic, one a bit newer. Our editors and contributors will offer their perspective on some popular titles. We hope you find some inspiration.

SummerReading-05[1]As an investor, stock price is everything. It needs to go up — or at least be stable — for you to make any money.

But what happens when share price dictates everything, and a CEO’s endless pursuit of the tape leads to decisions that nearly destroy a company?

That’s the story of F. Ross Johnson and Nabisco, as chronicled in Barbarians at the Gate: The Fall of RJR Nabisco.

Here’s the gist: In the 1980s, a struggling Nabisco was fighting to move its share price higher. Hard-charging exec Johnson, sensing the buyout frenzy of the era, orchestrated a buyout by tobacco company R.J. Reynolds — and eventually, the leveraged buyout that would take the newly joined company private.

That last step won him a “golden handshake” payout of $53.8 million for seeing the deal through with private equity firms led by Kohlberg Kravis Roberts (KKR[2]).

But it came at the cost of the company itself, and the employees and brands that made Nabisco and R.J. Reynolds what they were.

Authors Bryan Burrough and John Helyar busted their tails as reporters from the Wall Street Journal as events transpired, and recreated the events with the same journalistic attention to detail in longer form via Barbarians at the Gate. The text is a bit thick with facts, including a host of people and products and companies and dollar amounts. But the details are crucial, because they help give the true scale of this affair — even 30 years later.

To me, here are the most important takeaways from Barbarians at the Gate for investors in 2013:

Bankers Behaving Badly: Why were leveraged buyouts all the rage in the 1980s? Well, because in a stagnant economy, there was no way to find growth — so instead, buyouts allowed big fees to flow into Wall Street insiders’ pockets and also led to bigger profits at select corporations. Of course, this came by slashing jobs, cutting corners and destroying long-term value at the expense of a quarter-over-quarter EPS bump to pump up share prices. Sound like a familiar narrative?

CEO Shenanigans: F. Ross Johnson wasn’t a bad exec, per se. He was ambitious and loved shaking up a lazy organization by forcing people to think differently. That’s not always wrong … however, he was convinced that he knew best and had no interest in dissenters. The hubris that exists in corner offices in 2013 is no different than it was in the 1980s, whether it be a CEO like Jamie Dimon[3] of JPMorgan (JPM[4]) who survived a threat to separate his chairmanship from chief executive role, or ousted JCPenney (JCP[5]) CEO Ron Johnson[6] who failed miserably in his reinvention of the company.

The Rich Get Richer: Johnson was loosely representing the idea of increasing shareholder value in his quest to get Nabisco bought by R.J. Reynolds — then ultimately bought out by private equity investors. But it cannot be overlooked that each deal enriched Wall Street bigwigs and resulted in mammoth payouts to senior management at the companies subject to these deals. Shareholders might have gotten a modest premium as a result, yes. But the collateral damage via layoffs and restructurings cannot be overlooked.

Short Term vs. Long Term: Ultimately, companies and investors are faced with a choice. Do you pursue the path to the biggest gains in the fastest manner? Or do you seek lasting growth, even if it takes time? RJR Nabisco worked on paper. But the wreckage afterward — including layoffs and restructurings to help pay for the sheer cost of financing the buyout — shows there are real consequences. The subsequent divestitures to ensure cash kept flowing might have kept the lights on and served Wall Street overlords, but to those who built the underlying companies and relied on their long-term health for employment … well, it’s hard to argue that Johnson chose the right path.

The facts of the RJR Nabisco debacle are fascinating, and Barbarians at the Gate offers a lot of history worth rehashing. But investors today can learn a lot from the missteps of F. Ross Johnson and his crew, especially since the environment of low earnings growth and high executive compensation is very similar to life on Wall Street in 2013.

Jeff Reeves[7] is the editor of and the author of “The Frugal Investor’s Guide to Finding Great Stocks.”[8] Write him at[9] or follow him on Twitter via @JeffReevesIP[10]

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