Buyout specialist wields levers of debt to reshape corporate America

Kohlberg, Kravis, Roberts & Co. - the king of the leveraged-buyout specialists in the United States - is hard at work once again. These days it has its eyes firmly focused on RJR Nabisco.

Already Kohlberg, Kravis is one of the largest conglomerates in the US, controlling some two dozen companies and employing thousands of workers.

What KKR does - targeting, then acquiring, some of the nation's best-known corporations - it does ``very well,'' says Warren Law, a specialist in finance at the Harvard Business School.

But, he adds, ``KKR is not inclined to throw its weight around in nefarious ways.''

In the current takeover atmosphere, however, no corporation in the US is theoretically beyond the reach of an LBO takeover, says James Grant, editor of the Grant Interest Rate Observer. That means even a corporate giant like IBM.

``You could do that if you had a spare $120 billion,'' says Mr. Grant, who follows corporate financing and takeovers. In fact, Grant recently put together a spoof depicting an LBO takeover of IBM, complete with a mock prospectus.

Buyout specialists such as Kohlberg, Kravis are helping to reshape the very nature of American industry, according to experts such as Dr. Law.

Companies that are part of the KKR banner include Safeway Stores, Beatrice Foods, Duracell Batteries, and Owen-Illinois. In annual revenues, estimated at close to $40 billion, KKR is the seventh-largest enterprise in the US, according to Fortune magazine.

At the moment, KKR is locked in combat with a management team from RJR Nabisco over control of that tobacco/food company. The management team has proposed a leveraged buyout of RJR Nabisco at a cost of $17.6 billion. KKR has countered with a buyout offer that is $3 billion higher.

Under a leveraged buyout, a firm like KKR takes a publicly owned company private. But it uses very little cash. Instead, the buyout firm finances the transaction by using the acquired company's own assets as collateral - and later selling off large chunks of those same assets.

At some point, though, the current LBO fervor has to end, says Grant, as the financing packages to sustain such deals become larger and larger, and more complicated.

``If [the LBO pattern] were to continue,'' he says, ``Henry Kravis would own everything in the country.''

KKR was started back in 1976 by three men from the New York investment house of Bear, Stearns & Co. - Jerome Kohlberg, Henry Kravis, and George Roberts. Mr. Kravis and Mr. Roberts are cousins. Kravis chooses to live in New York; Roberts prefers San Francisco.

Mr. Kohlberg, meanwhile, who was the main founder of the company, left KKR to establish his own LBO firm, Kohlberg & Co., reportedly after becoming increasingly uncomfortable with the eagerness of his two partners to engage in hostile takeovers, rather than friendly buyouts, as sought by Kohlberg. But one person who knows Kohlberg believes the KKR founder ``still has confidence in the firm'' from a financial point of view.

The uniqueness of this firm has been its ability to put together very large financing packages, using little of its own money, Grant says.

Its revenues derive from three main sources: a management fee (about 1.5 percent annually on its financing package), transaction fees, and a carrying fee (sort of a premium).

In the current RJR Nabisco transaction, about 70 financing partners are involved, including a number of prominent banks (Bankers Trust Company, Bank of New York, Chase Manhattan Bank), insurance companies (John Hancock), pension funds (Harvard University, the states of New York, Michigan, Oregon, and Washington), and others. The funds are committed on paper to an equity pool (worth about $5 billion in the RJR package), but are not actually transferred to KKR's management until called upon by KKR.

Thus, the buyout firm uses little cash, but takes on massive debt to consummate the transaction. It is the size of that debt that last week led Federal Reserve Board chairman Alan Greenspan to suggest that unless commercial banks showed more restraint in financing LBOs, Congress might want to consider drafting legislation to limit or bar such transactions.

It is precisely the leveraging available to takeover firms like KKR that has made observers wonder whether any company - and not just IBM, but also Sears, Roebuck, Kmart Corporation, or even General Motors Corporation - is totally immune to such a transaction.

Earlier this week, for example, Sears, the nation's largest retailer, announced that it would sell its commercial real estate business and its Sears Tower headquarters building in Chicago as part of a massive restructuring plan estimated at more than $2 billion. Sears has long been considered a prime takeover candidate, given its sagging stock price.

``From a regulatory point of view, there is probably nothing to stop such buyouts,'' says Samuel Hayes, a professor of investment banking at Harvard Business School.

``KKR, as well as other big players in this market, have well-established pipelines of capital that they can call on.''

But, he adds, ``there are probably upper limits to the magnitude of these transactions.''

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