Will Joe Camel Have To Hoof It Alone?

After years of financial gymnastics--a $24.9 billion leveraged buyout, a $6.5 billion refinancing, sales of huge divisions, a botched $1.7 billion special stock offering, and the sale just this month of $1.5 billion of preferred stock and $1 billion of bonds--RJR Nabisco Holdings Corp. could be nearing the end of its exhausting


Next April marks the fifth anniversary of the LBO that left Kohlberg Kravis Roberts & Co. in control. Under Internal Revenue Service rules, RJR Nabisco then becomes eligible for a tax-free spin-off of its Nabisco food business. And next May, many of the restrictive bonds KKR used to finance the LBO can be redeemed. If Wall Street's appetite for branded-food company stocks improves by then, RJR Nabisco is widely expected to split up its businesses, which were joined when R.J. Reynolds Industries Inc. bought Nabisco Brands Inc. for $4.9 billion in 1985.

The rationale for the split is simple: Even at current depressed levels, food companies are valued by investors at an average of 18.4 times earnings, while tobacco companies are valued at only 8.8. At a recent 43 4, RJR Nabisco, which went public again in 1991, trades at a multiple of 8.6. Freed from the drag of the tobacco business, the value of Nabisco's impressive roster of food brands might soar. KKR, which still controls RJR Nabisco with its 49% stake, "has had an eye toward doing [the spin-off] for years," says an investment banker who has advised KKR in the past. "It's the largest investment in their portfolio, and they are doing everything they can to create value in a business where the fundamentals have not improved since the time they bought it."

BOND BARRIERS. For evidence of an impending split, spin-off watchers point to KKR's hiring of former ConAgra Inc. Chairman Charles M. "Mike" Harper as chief executive in June, after Louis V. Gerstner Jr. left for IBM. Harper's task, they believe, is to bolster the value of the food business as KKR continues to hunt for an exit strategy. Harper was a renowned builder of brands in his two decades with ConAgra, but the 65-year-old executive came out of semiretirement to take the RJR Nabisco job, and he spends weekends back home in Omaha. Executives from KKR and RJR Nabisco declined to be interviewed for this story, but company spokesman Jason H. Wright insists that the days of frenetic "financial engineering" are behind the company.

That's not likely. KKR has been trying to split the company since last December, when it devised a special category of stock tied to the performance of the Nabisco food business. The planned offering valued Nabisco at $6.7 billion--$120 million more than the current market value of the entire company. But because the two businesses wouldn't have been legally separated, investors balked, and RJR withdrew the offering in June. Still, with tobacco under fire because of a shrinking domestic market, regulatory concerns, and a price war launched by market leader Philip Morris Cos., the pressure to separate the businesses is only intensifying.

To pull off a real divorce next spring, RJR will first have to pay off $2.1 billion of bonds that contain covenants restricting such a move. Another $1.5 billion in other, noncallable debt would also need to be renegotiated or tendered. "Most of those covenants can be renegotiated," says Larry Weissman, portfolio manager for the College Retirement Equities Fund, which is the second-largest RJR Nabisco shareholder, after KKR.

Besides buying off or negotiating with its bondholders, the company has to win the support of its numerous commercial bankers, who hold $3.7 billion of its debt, for any attempted spin-off or refinancing. In a possible effort to soothe those bankers, RJR Nabisco earlier this month sold $1.5 billion in preferred stock with a yield of 9.25%, though it also issued $1 billion in bonds. The company said that it issued both to enable it to pay down higher-cost debt and to fund general corporate expenses. But none of that debt can be called until May, and Prudential Securities Inc. tobacco analyst Leigh Ferst figures RJR Nabisco issued the preferred stock now to beef up its equity to a level bankers may find more comfortable. RJR and KKR are "working toward some sort of breakup, however structured," she says. "That's the focus of their balance sheet right now, [engineering] higher equity."

What would R.J. Reynolds Tobacco Co. and Nabisco Foods Group look like as independent companies? Since the two businesses have always been run separately and with few synergies between them, their operation and management would probably be remarkably unchanged. Analysts and investors alike point to the well-regarded top managements of both businesses, led by H. John Greeniaus as president of Nabisco and James W. Johnston as chief executive of R.J.

Reynolds. The tricky part will be divvying up the parent company's still sizable debt of $13.9 billion.

"WIZARD OF OZ." Ideally, KKR and RJR Nabisco management would pile most of the debt on the tobacco business, whose rich cash flows, high profit margins, and mature, low-investment business could most easily cover the payments, says Sanford C. Bernstein & Co. analyst Gary Black, who figures that a spun-off Nabisco would assume 25% of the debt. Tobacco, with 1992 sales of $9 billion and operating income of $2.2 billion, is much larger than the food business, with its $6.7 billion in sales and $770 million in operating income. Nabisco's lighter debt load would reflect its lower margins and its need to spend to expand its business. Bondholders might balk at an arrangement that saddles the tobacco company with more than its share of debt. Says Standard & Poor's Corp. analyst Kenneth Shea: "Why should the whole company [suffer] when Nabisco Foods is a good company?"

RJR Nabisco's glum shareholders are likely asking the same question. The share price has slipped 63% from its 1991 peak of 13. KKR's 1987 buyout fund invested $3.2 billion in RJR Nabisco, and the backers of the 1987 fund aren't happy, since the shares that cost them 5.61 are now worth 15% less than that. "The perception of KKR is undergoing a transformation," observes an official at one of the original investors. "They're looking more like the Wizard of Oz. When you strip away the curtains, they're just an ordinary group that's fallible." But with the break it has been waiting for just around the corner, KKR may be gearing up to pull off one last feat of financial legerdemain.

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