RJR Nabisco case study
Nabisco was an American conglomerate selling tobacco and food products. It was formed In the year 1985 by the merger of Nabisco Brands and R J Reynolds Tobacco Company.
The case given discusses the leveraged buy out of the company, which was at that time the largest LOBO in history. A leveraged buyout can be defined as a situation where an investor group, which often includes some of the target company’s top managers, borrows billions to try to take the company private by buying its stock from the shareholders.
In October 1988, the share price of RAJA Nabisco stood at $55. 87 per share. Even though the company was doing well, the share price remained largely under valued.
The rising public awareness regarding the Ill effects of smoking had raised concerns about the future of the tobacco industry. Nonetheless, the RAJA had consistent growth and low debt ratio, making it a prime target for a buyout. F. Ross Johnson, CEO of RAJA Nabisco, feared the share price would go down even further if their new product, Premier, failed. He and the
Management group offered to take the company private by offering a share buyout price of $75 per share.
The opposition to Johnny’s bold for the company was made by KIRK, one of the pioneers of the leveraged buyout. KIRK offered a whopping $90 per share to takeover the company. Both the Management group and KIRK made different projects of the future cash flows based on their financing as well as sale of asset strategy. The Management group planned to sell the food assets of the company whereas KIRK Intended to keep them.
The following are the Valuations of the company based on the Probed cash flows, Management Group strategy as well as the KIRK group. We use the Capital cash flow method to arrive at the expected share price under each evaluation.
We use the capital cash flow method to arrive at the valuation primarily because of the fluctuating levels of debt in each scenario. With this approach we discount the capital cash flows using the rate of return on assets. CUFF = FCC + Interest tax shield Rate of return Is calculated using CAMP;
Ra = Ref + џ(rolls premium) where Ref Is the rate of return on 30 year US bonds In the year 1989, I. E 8. 45% while risk premium is the market historical average of 7.
4%. Beta of ease is given at 0. 67 Thus, rate of return on asset; Ra = 13. 41% Since RAJA is a mature firm, it will be expected to grow at somewhere between 0% to 5%. Terminal value n year 1999 = [SUFFICE(1 +guy Ra- g 1/(1 + Ra) After a fierce series of negotiations and proposals, the Special Committee decided to call for a blind auction.
The Special committee actively participated In the blinding process by laying down rules and regulations regarding the bid. They ensured that the best interest of not just the shareholders but also of all the primary stakeholders will be taken into consideration. The fact that the auction was sealed; it fuelled the competition between the competitors. In the end, the special committee accepted Kirk’s bid of $109 per share instead of a $112 per share bid offered by RAJA Nabisco. Conclusion: The primary reasons why KIRK won the bold could be that KIRK offered to
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Additionally, KIRK intended to only sell a part of the food subsidiaries whereas the Management wanted to dispose off the entire food assets. KIRK were more attuned to keeping the interest of the board in mind while formulating their strategies. They played it clever and with more intuition. At the time, the RAJA Nabisco leveraged buyout was widely referred to be the pre-eminent example of corporate and executive greed.