Book Review: Barbarians at the Gate

Continuing on with the finance books, I recently finished Barbarians at the Gate, written by Bryan Burrough and John Helyar of the Wall Street Journal. Published in 1989, it tells the story of the Leveraged Buy Out (LBO) of the tobacco and consumer food firm, RJR Nabisco.

I enjoyed this book greatly. Though I have to admit I don’t think it’s for everyone. The story is told through seemingly endless back and forth negotiations between business people, lawyers, and investment bankers. The authors also spend time on the backstories of the companies and people involved, but all the action is boardroom drama.

At the time (1988), the deal was the largest of its kind in history, worth over 20 billion dollars. It’s notable today mostly for afterwards not being very successful in the stated goal of generating returns. More on this later.

The main character, is a man named F. Ross Johnson, a Canadian by birth, he rose through the ranks of several companies, often encouraging them to merge with others, and ended up in the late 80s as CEO of RJR Nabisco.

RJR Nabisco is an interesting entity. The RJR part is tobacco, the Nabisco part is crackers and cookies (most notably, Ritz and Oreos). Today, in 2023, this appears to be a strange mix, but in the 80s it wasn’t so odd.

Johnson was, by the book’s account, a provocateur. Extremely comfortable with enjoying large and conspicuous wealth, he pushed all around him to make better deals, better products, and more money.

He had a problem though, the stock price of the company was undervalued. Not just by his estimation, but also by the company’s board and many analysts.

Frustratingly, the book seems a bit weak on this point of exactly why the market undervalued RJR Nabisco in the mid to late 80s. The obvious answer was that the wider market was discounting the tobacco business due to ethical and moral concerns. Tobacco litigation in the US was just getting going. Whilst the book mentions this in passing, it doesn’t explicitly state it. Rather, the book shares Johnson’s confusion about why the market wasn’t giving the company its due.

Reading between the lines, I think the authors, who interviewed the large cast of characters involved, probably had a kind of deal with those they spoke to. Perhaps an unwritten or unspoken deal. “Don’t hammer tobacco ethics if you want us to talk”. There’s a kind of conundrum here I feel, if investing in tobacco wasn’t controversial in 1989, why was the business undervalued?

I don’t want to labour this point too strongly, because the real interesting stuff in the book is the ego, dick-swinging, chest-beating largesse on display during the intense six-week bidding process for the company.

But it’s worth noting a couple of things. There’s an alleged quote from Warren Buffet, asked about the deal, he describes tobacco as a great business (profitable and reliable). But he cites tobacco litigation as he declines an invitation to invest. It’s also surprising to note that tobacco is still hugely profitable today. By some measures over some recent time periods, tobacco industry returns have outperformed those of the technology sector.

Of course, today, most well-known investors eschew anything morally dubious, such as guns and tobacco. The tobacco business was the most profitable part of RJR Nabisco, and the part of the company least likely to be sold off. Whilst hindsight is always 20/20, the book fails to explain what the long-term plan was, other than “get the stock price up”. Was F. Ross Johnson happy to run a tobacco company for the rest of his life?

The book is friendly to the stories participants in another way. This tale would be easy to spin to play up the greed angle. Indeed, much of the interest in the story at the time came out of the cultural zeitgeist that corporate America was out of control. The book mostly takes a matter of fact approach to the wealth on display. F. Ross Johnson is the easiest to criticise, but all the conspicuous big spending went through the business on private jets and company-owned swanky apartments. These can all be justified in one way or another as good for company as a whole and the book doesn’t question it.

So in late 1988, exasperated at the low stock price (trading in fifty dollar range), Johnson agreed to an LBO. This process involves taking on large amounts of debt to take a public company private, and it results in a huge payday for all the existing shareholders.

Johnson makes an offer for the company at 75 dollars share. And this is where the story takes off, with many onlookers deciding that that price was too cheap and that Johnson was trying to steal the company. Without spoiling the story too much, things do not go Johnson’s way.

I think Johnson was later vindicated in two respects. The company was worth more than 50 dollars a share, and with hindsight, we can now say that 75 dollars a share was probably closer to fair value than the price the company actually went for.