The bridge loan was part Essay
The bridge loan was part
In the spring of 1990, the firm of Kohlberg Kravis Roberts & Co. (KKR) was in negotiation with lenders regarding the refinancing of a $1.2 billion bridge loan due to be repaid in full by February, 1991.
The bridge loan was part of the $24 billion financing of KKR’s leveraged buyout of RJR Nabisco in early 1989. Originally, KKR had planned to retire the loan with the proceeds of a $1.25 billion public offering of senior debt. However, in December, 1989, Moody’s failed to give the issue an investment-grade rating. Moody’s also down-graded RJR’s other debt, a move that triggered substantial declines in the market prices of RJR’s securities.
Faced with an unreceptive public market, KKR withdrew the debt offering and began discussions with RJR’s lending banks. For the banks, a major concern was the uncertainty surrounding the upcoming interest rate reset on $7 billion of RJR’s pay-in-kind (PIK) bonds.
Indentures required that on or before April 28, 1991, RJR reset the rate so that the bonds would trade at par (see Exhibit 1). In the spring of 1990, the bonds were selling at steep discounts to par (Exhibit 3). The market obviously saw substantial risk that the reset would fail, which would put RJR in violation of its bond covenants. The reset bonds came into being as the “cram-down” securities in the RJR buyout.
The distinctive feature of these bonds was the reset provision, which at the time of the buyout was a key factor in KKR’s victory over a management group led by then-RJR Nabisco CEO, F. Ross Johnson.1 Weeks of escalating bidding, which had begun with a $75 per share all-cash bid by the management group, ended with the RJR board of directors having to choose between two final bids: KKR’s offer of $81 per share in cash plus PIK reset bonds it valued at $28 per share versus the management group’s offer of $84 per share in cash plus PIK bonds it valued at $28 per share.
The latter PIK bonds did not have a reset feature, however. The board’s financial advisors, Dillon, Read and Lazard Frères, concluded that the two offers were “substantially equivalent,” in effect valuing the management group’s PIK bonds at only $25 per share.
2 They reasoned that the KKR bonds were effectively “guaranteed.” If the market didn’t judge the securities to be worth $28, the interest rate would be reset to make them worth $28. KKR had put its money where its mouth was, something the management group had been unwilling to do.
With a “substantially equivalent” opinion from its financial advisors, the board felt free to evaluate the offers based on other considerations. The board declared KKR the winner on the basis of the firm’s pledge not to effect large layoffs and in view of the fact that KKR
Burrough, Bryan, and Helyar, John, Barbarians at the Gate, 1990, Harper & Row, New York, pp. 441–442, 485, 493, 497–498. 2 Burrough, Bryan, and Helyar, John, “How Underdog KKR won RJR Nabisco Without Highest Bid,” The Wall Street Journal, 12/2/88.
Reearch Associate Joel Barber prepared this case under the supervision of Professor André F. Perold as the basis for class discussion rather that to illustrate either effective or ineffective handling of an administrative situation. Copyright © 1990 by the President and Fellows of Harvard College. To order copies, call (617) 495-6117 or write the Publishing Division, Harvard Business School, Boston, MA 02163.
All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School offered stockholders the option to acquire up to 25% of the new company at a point in the future, whereas the management group offered them an option for only 15%.3
As a consequence of the buyout, RJR’s total debt ballooned to $29 billion. KKR’s strategy for servicing this debt rested on asset sales and improved internal cash flow.
Except for the stumbling block created by Moody’s downgrade, the plan had proceeded as forecast: through March 31, 1990, asset sales (Exhibit 2) and cash flow met or exceeded targets and all required debt payments were made.
University/College: University of Chicago
Type of paper: Thesis/Dissertation Chapter
Date: 25 May 2018