In The Belly Of The Buyout Behemoth


By George Anders

Basic Books -- 328pp -- $23

The definitive Wall Street middlemen of the 1980s were Drexel Burnham Lambert Inc. and its largest client, Kohlberg Kravis Roberts & Co. Each reaped vast, windfall profits as the preeminent promoters of symbiotic forms of high-leverage finance: Drexel popularized the junk bond, while KKR did the same for the leveraged buyout. Feeding off one another's ingenuity and greed, Drexel and KKR promoted ever-larger and more highly leveraged acquisitions until, in early 1989, they joined hands and jumped into the abyss of the ultimate megadeal: the $26.4 billion buyout of RJR Nabisco Inc.

The RJR deal helped catalyze the collapse of the junk-bond market. Stuck with massive inventories of unsalable securities, Drexel went bankrupt in 1990. In Merchants of Debt: KKR and the Mortgaging of American Business, George Anders convincingly asserts that RJR's post-deal crises also pushed KKR close to ruin. In this, he not only goes beyond what has been previously published but also turns inside-out the assumption that has underlain most writing about RJR, notably Barbarians at the Gate: that on Wall Street, victory is landing the deal.

According to Anders, KKR, in its eagerness to land RJR, made a critical concession: If RJR's $6 billion in junk bonds were to sag in price, KKR would boost the interest rate. As it turned out, the bonds lost so much value that the new rate that KKR was obligated to set would have capsized RJR. Marty Lipton, the famed Wall Street lawyer, urged Henry Kravis to put RJR into Chapter 11. "My jaw dropped when I heard that," Kravis told Anders, who writes: "Playing through Kravis's mind were a series of harrowing realizations: 'My God, can you imagine what that does to the financial institutions of America? And the world for that matter? Certainly KKR is out of business.' "

KKR skirted apocalypse by doing what it had always done best: securing large sums of other people's money. It persuaded its limited partners, mainly public-employee pension funds, to more than double their equity investment. In effect, KKR bungled its way into buying RJR twice. Unlike Drexel, KKR survives--though shorn of its Midas mystique and much of its clout.

In addition to its climactic depiction of the RJR fiasco, Merchants of Debt abounds with fresh, if not always enticing, detail. Anders, a veteran reporter for The Wall Street Journal, gained unparalleled access to Kravis and his cousin and partner, George Roberts. His exhaustively researched book provides the closest look yet at KKR's inner workings. But Merchants is weakened by the timidity of its analysis. Too often, Anders shies away from the sharp conclusion warranted by his account.

In a key passage, he describes how KKR's lawyers talked Kravis and Roberts out of charging RJR its standard "advisory" fee, roughly 1% of purchase price--or $300 million, which worked out to $89,000 an hour. For the next few months, KKR's partners saw RJR as a stepping stone to even bigger deals. Anders depicts Roberts leafing through the latest Fortune 500 "as if he were flipping through a Sears catalogue, picking out lawn furniture." Roberts casually informs a visitor that "there are two or three candidates in the top ten that might make good buyout candidates."

This is devastating reportage, but Anders punctuates it with the mildest of comments: "Only gradually did Kravis and Roberts realize that their world was coming undone. . . . Their Rolodexes brimmed with contacts, contributing to a supreme confidence that bordered on arrogance." Arrogance? Try megalomania.

Setting KKR's story in a larger context, Anders dismisses the LBO wave as a fad whose only lasting impact was to shift wealth from the mass of corporate employees to a managerial elite allied with Wall Street. The beneficiaries of buyouts, he argues, "to a remarkable degree used other people's sacrifices as a means of financing their own gentrification." In Anders' estimation, this makes buyouts "one of the most profoundly undemocratic ventures the United States had ever seen."

No one benefited more from LBO mania than KKR, which, Anders writes, has generated more than $7 billion in investment gains. But despite his largely negative view of LBOs, he lionizes KKR as "one of the great capitalist success stories of the century."

Are Kravis and Roberts heroes, villains, or something in between? Conspicuously absent from Merchants is any direct, sustained analysis of their motives or character. Indeed, the book contains only scant biographical information. It's as if Kravis and Roberts were beamed down, buyout-ready, from another planet. Their rise is implausibly presented as a triumph of manners: "For many people on Wall Street, rudeness was a way to show power. For the KKR executives, politeness was a way to gain power."

What truly separated Kravis and Roberts from rival LBO aspirants was the unrelenting intensity of their pursuit of success. Their essential achievement was to divert billions of dollars of institutional money into an obscure, declasse transaction originally called a "bootstrap" and now known as an LBO. Along the way, their resolve was steeled by drudgery and rebuff. If they ever suffered from self-doubt, they never let it show.

Unlike Michael R. Milken, one of their few equals in the art of securities promotion, Kravis and Roberts have remained on the right side of the law. But as with Milken, spectacular success induced in these driven, narrowly expert men a disbelief in the limits of scale: Today RJR, tomorrow IBM and AT&T. Kravis and Roberts were, according to Anders, temporarily embarrassed by their RJR debacle but not in the least humbled. He says: "Proud of their own record, Kravis and Roberts see nothing to apologize for." Coming at the end of Merchants, these words ring more ominously than the author seems to intend.

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