The Stress Test Every Business Needs

7Do your financing choices support flexibility and efficiency?

K.C. Brechnitz

Before Henry Kravis could pull off the biggest leveraged buyout (LBO) in history at the time—the 1988 acquisition of RJR Nabisco for US$25 billion—he and his deal makers had to have a strategy for the capital structure of the company. They knew that most corporate loan and bond agreements contain provisions that require redemption of the debt in the event of a change in control. Hence, the LBO would wipe the slate clean of RJR Nabisco’s capital structure so that Kohlberg Kravis Roberts & Co. (KKR) could start from scratch.

Kravis is one of the founders of legendary buyout firm KKR. He and his bankers at Drexel Burnham Lambert must have asked themselves what the defining characteristics of that business were. The maker of cigarettes, Oreo cookies, and Ritz crackers certainly exhibited low earnings volatility commensurate with its strong position in a stable food and cigarette market. It also had a fairly low level of capital expenditures, strong free cash flow, a moderate growth profile, and a portfolio of discrete brands that not only were valuable but could be sold off separately.

They also analyzed RJR Nabisco management’s intermediate and long-term plans for the business. With the high debt levels needed to effect the acquisition, RJR Nabisco’s future would not be business as usual, and managers would have to revise these plans. Indeed, KKR intended to sell off numerous parts of the business after ...