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Book of Mammon, Part II

dontreadtoofast.comBarbarians at the Gate – Bryan Burrough and John Heylar

“The reasonable man adapts himself to the world: the unreasonable one persists in trying to adapt the world to himself. Therefore all progress depends on the unreasonable man.” – George Bernard Shaw, Man and Superman

There is something fiendish about that element of finance directed purely at the acquisitive fabrication of money that did not previously exist.

One of the most enterprising of these solutions (progress of a kind: like the rack or the guillotine) is commonly referred to as ‘PIK’ debt or ‘payment in kind’ debt: I pay you for a company with a loan note (literally an ‘I owe you’); if needed, I can pay you back with more loan notes (more ‘I owe yous’). The price of my purchase shoots up and the amount of cash required remains the same. If things go well, you get paid when I refinance the PIK debt. If they go badly, Lehman Brothers collapses under the weight of its now ‘toxic’ I owe yous. Or as our protagonist, Ross Johnson puts it:

I mean,” Johnson went on, “we have found something that’s better than the U.S. printing press. And they’ve got it all down here on Wall Street. And nobody knows it’s going on. I wonder if the World Bank knows about it. You could solve the third world debt crisis with this stuff. It’s a brand new currency…”

The development of this practice is really the birthplace of Barbarians at the Gate, a steaming missive written by two Wall Street Journal journalists hot from the trail of one of the most decadent and extraordinary leveraged buy-out competitions (LBOs) of the already decadent 1980s. The confluence of an LBO market just coming to its adolescent maturity on the rise of PIK and other exotic debt types, the petrol burning machismo that fuelled it and the extravagant talent and whimsy of, Ross Johnson, CEO, “a man who devoted his life to shaking things up”.

The book centres around the bidding war leading up to the purchase by KKR of Johnson’s company RJR Nabisco. An LBO is essentially a purchase of a company by a private equity fund using debt and a friendly (well-remunerated) management team to secure a purchase. The existing shareholders are bought out at a premium. The managers take a large equity position in the company in exchange for performance incentives. The company is taken off the stock market. The private equity fund trims the company’s fat (in RJR Nabisco’s case, a thirty aircraft strong private fleet of jets compiled by Ross Johnson and colloquially known as the ‘RJR Air Force’) to make room in the cash flows to accommodate interest repayments on debt. Three or five or more years down the line the company is either broken up and sold in more valuable constituent parts or taken back to the stock market to be sold, hopefully at a profit.

The book is one of the few business thrillers I have ever read, and it gripped me more tightly than any novel I have read in the last year. It takes as its raw material such a rich subject, such intense characters (“Kravis went numb. He had been fighting for this for so long. He had lost eight pounds in the last six weeks…All he could think of was how much work was ahead”) that at times Burrough’s and Heylar must force on their writing a dead-pan description of “the biggest prize in history” without which the book would have become unreadable.

The authors gather around their plot a litany of Shakespearean characters, Henry Kravis, one of the three founders of KKR, plays a kind of Goneril to Ross Johnson’s Lear. Ted Forstmann, founder and CEO of Forstmann, Little & Co, a Cordelia, decries the debt funded buyout practices pioneered by KKR: “We are not comparable. When I started this business ten years ago, I said I wanted to be the best. I didn’t care about being the biggest. If you think the biggest is the best, go away. You belong with Kravis. Our returns are three and four times the returns they lie about getting.”

On the other side, the loose management style of Ross Johnson (“A few million dollars are lost in the sands of time”) and the extraordinary governance practices of RJR Nabisco make the problems of valuing this behemoth of a company intractable: “If missing figures weren’t bad enough, Stuart didn’t completely understand the ones he had. One number in particular puzzled them all. On the initial projections they had obtained from RJR Nabisco was a heading “Other uses of cash”. Beside it was a row of figures stretching out ten years, each ranging from $300 million to $500 million. Stuart had no idea what the numbers meant.” Never has so much fun been had reading about the accounting woes of others.

Barbarians at the Gate is a fast paced, American thriller. A book that doesn’t give up being read (“We’d like to think that Barbarians has aged well”, the authors coyly note) and has survived the twenty years since its publication, rather like the LBO market but unlike RJR Nabisco.

More notably for us, the PIK notes that fuelled the eventual $25 billion valuation of RJR Nabisco are still in use. Last year nearly $15.3 billion dollars of debt was raised by PIK notes in 39 different deals. Perhaps this is a cost of economic recovery. Perhaps it is the sign of the green shoots of economic progress that we would like to see. Regardless of interpretation, if ever there was a time to understand the unreasonable man it is now because doing the same thing over and over again and expecting a different result isn’t progress, according to Albert Einstein, it’s insanity.

The Editors

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