Manchester, N.H. — Some members of the Manchester Board of Mayor and Aldermen (BOMA) who voted for Siemens over Philips in the awarding of a contract for LED street lighting were aware that Philips’ Netherlands-based corporate parent was close to divesting itself of its lighting division. Royal Philips NV consolidated its LED lighting and motor vehicle lighting operations into one entity in order to sell it off as part of a strategic plan to focus on more-profitable core businesses such as medical technology.
Philips has been in the light-bulb business since 1892, but the LED business is under intense pressure from lower-cost Chinese firms.
The operation, Lumileds, is expected to fetch a minimum of 2.5 billion euros ($2.7 billion) and may go as high as 2.9 billion euros. Royal Philips NV will retain a 20% stake in the new company, once it is spun-off.
“Barbarians at the Gate”
The most notable victim of a corporate acquisition was RJR Nabisco, a food and tobacco industry conglomerate created from the merger of R.J. Reynolds and Nabisco. A publicly traded company, in 1989 RJR Nabisco was taken private via the leveraged buyout (LBO) process. The RJR Nabisco LBO became a poster child for the unbridled greed of Wall Street in the 1980s.
After Boston-based Bain and Co. dropped out of the bidding for Philips Lumileds, the main suitor for Philips Lighting was KKR and Co., a private equity and investment banking firm that became notorious during the 1980s under its previous name Kravis Kohlberg Roberts. KKR & Co. made its reputation in the 1980s in the field of arranging management buyouts and the financing (or “leveraging” via debt) of the buyout (thus the term LBO).
One of the classics of non-academic financial literature is the 1989 book Barbarians at the Gate, which chronicles the struggles over the buyout of R.J. Reynolds Nabisco. The book is still used in business schools and it was made into an Emmy Award-winning TV movie in 1993. It is widely considered one of the best business books ever written.
The ultimate winner for RJR Nabisco was non other than: Kravis Kohlberg Roberts, which reportedly is about to close the deal for Philips Lumileds in partnership with CVC Capital Partners. It was Kravis Kohlberg Roberts which brokered the RJR Nabisco LBO valued at $25 billion plus $6.1 billion in assumed debt. The total acquisition price of $31.1 billion made it the largest LBO at the time, a record that would not be surpassed for two decades. For its services, Kravis Kohlberg Roberts received a fee of $75 million, in addition to possessing investments in the business that ultimately yielded a nine figure return.
The deal was financed by “junk bonds” that loaded the company down with debt.
Merchant of Debt
Once Kravis Kohlberg Roberts had its prize, it took RJR Reynolds private and then strip-mined it to pay down debt due to pressures from its bond-holders. Kravis Kohlberg Roberts resorted to selling off parts of the company to raise revenues, which was a cornerstone of the LBO philosophy of the 1980s. Corporate value, it was thought, was depressed by the conglomerate structure that had become standard as corporations began diversifying in the 1960s to hedge against downturns in their core businesses. The sum of the parts was more valuable than the whole.
RJR Nabisco eventually was taken public again, and the notorious company that now bills itself as KKR eventually used RJR Nabisco as collateral for its 1995 acquisition of Borden Inc., transferring the stock to Borden. Borden then sold off a block RJR Nabisco stock for nearly $700 million. KKR finally realized the last returns from its investment when Borden Chemical was sold for $1.2 billion in 2004.
Barbarians at the Gate focused on the machinations and personalities behind the RJR Nabisco LBO. Wall Street Journal columnist George Anders, in his 1992 book Merchants of Debt: KKR and the Mortgaging of American Business, detailed the crises that afflicted RJR Nabisco after the consummation of the takeover by KKR. According to a contemporary review in Business Week, Anders elucidated how the instability at RJR Nabisco after the LBO nearly ruined KKR itself.
Anders wrote that LBOs are “one of the most profoundly undemocratic ventures the United States had ever seen.” According to Business Week’s review of the book, in Anders’ opinion “Their only lasting impact…was to shift wealth from the mass of corporate employees to a managerial elite allied with Wall Street.”
A Vote for Stability
In conversations with BOMA members, the issue of the impending take-over of Philips was mentioned as a factor influencing their decisions. One of the members pointed out that Alderman William Shea, who was playing the part of cat’s paw for Mayor Ted Gatsas (a Philips partisan), in a last ditch effort to scotch the Siemens contract mentioned that the company was “foreign.”
“Isn’t it owned by the German government?” Shea said.
Philips’ corporate parent was “foreign” also, and soon to be the notorious KKR, according to press reports.
Initially open to awarding the contract to Philips, the alderman felt there was an added risk going with the Dutch firm, as the company the City of Manchester contracted with literally would not be the same company after the acquisition, which was imminent. While the new Lumileds would be bound by the terms of the contract, the possibility that the spin-off could destabilize the company called into question its ability to fulfill it.
The problem of dealing with a company going through the process of divestiture and reorganization under new owners is the instability created by the acquisition. Corporate acquisitions frequently are financed by debt to various degrees, with a proportion of the capital being raised via issuing bonds, typically at higher-than-market interest rates. The resulting debt load can cause the firm to become financially and managerially dysfunctional, as the company is then streamlined to create cost savings to boost revenues to pay down debt.
Extant management teams frequently are replaced, creating instability in corporate operations. The instability sows discord among senior- and middle-managers and the work force, invariably causing resentment and fear among the remaining managers and rank-and-file workers. The remaining staff often bridle under the new regime as they attempt to adapt to a novel management philosophy and new work conditions. More than one once-venerable company has gone down the tubes under such conditions.
In light of the impending spin-off of Philips Lumileds, some of the members of the BOMA saw Siemens as the more stable company and voted accordingly.