Commentary: Lessons From Rjr: Funny Money Then And Nowby
It's a cautionary tale for our time. Just as the '90s draw to a close on a note of financial frenzy, the most wretched excess of the '80s returns to haunt us--and perhaps guide us. Ten years after it used junk bonds to pull off one of the biggest leveraged buyouts in history, RJR Nabisco Inc. is dismembering itself. Today, as Net stocks soar and the Dow Jones industrial average lurches toward 10,000, it is sobering to remember that the $25 billion paid for RJR Nabisco by investment bank Kohlberg Kravis Roberts & Co. is now worth $9.5 billion. An out-of-control bidding war, blindly driven by ego and greed (so wonderfully captured in Barbarians at the Gate), led, in the end, to disaster. Only KKR's partners appeared to have done O.K., thanks to their huge fees.
What are we to make of this denouement? Perhaps it's the idea that funny money can lead to sloppy market discipline and lax decision-making. True, junk bonds, in the hands of builders such as William G. McGowan and Ted Turner, financed pioneering enterprises like MCI and CNN. But junk money also begat junk companies, because it let the less astute overpay, often with little consequence to themselves.
In the case of RJR, easy financing helped rationalize a harebrained combination of cigarettes and snacks that was somehow supposed to produce a tobacco company with a future. No one could have foreseen how tobacco litigation would undermine the financial assumptions of the LBO. But even at the start, it was hard to see the great added value of placing Camels and Chips Ahoy! under the same, highly mortgaged, corporate roof.
But what of today? There's plenty of funny money around. This time, instead of high-yield debt, it is hyperinflated stock and pooling-of-interest accounting that has some dealmakers throwing caution to the wind. General Electric's Jack Welch has a name for the funny money of the '90s: wampum. And he believes that it makes the valuing of many mergers and acquisitions impossible.
Among Internet issues, basic valuation methods such as price-to-earnings ratios are meaningless. Wall Street is trying to invent gauges to justify p-e's of 200 to 300. Ever hear of TEMA, theoretical earnings multiple analysis?
Don't get me wrong. High-octane stock will surely build many solid, profitable high-tech companies, just as junk financed many of today's media giants. But I still have to gape when At Home Corp., a company with negligible profits that provides access to the Net via cable, buys Excite Inc., a Net portal with no profits, for $6 billion--in stock, of course.
What is any of that really worth? If Welch doesn't know, I certainly don't. Maybe At Home will grow into the next MCI. Maybe not. Place your bets. In fact, gambling may be the best business model to use. At least that would be an honest approach that recognizes the role of wampum in today's economy.
Excess is part of the human condition. People eat to excess. Markets rise and fall to excess. And business cycles end in excess. In an economy as well-balanced as ours is now, the nutty valuation of so many stocks is the one alarming note. The unraveling of last decade's most egregious deal is a chance to stand back and examine the current frenzy of the markets. Unless the mania subsides, we'll all be reading books with titles like CyberHuns on the Net and The Virtual Visigoths very soon.