RJR Nabisco

A Leveraged Buyout

Special Committee
Leo Leung
Aaron Ng
Marcus Lam
Jennie Liu
Wendy Ma
 Agenda

• LBO Evaluation
• Value of Company
 Pre-bid
 Management
 KKR
• Sources of Gains
• Use of One-Round Auction
• Bid Recommendation
 LBO Evaluation

• Low debt level

• Sufficient tangible assets
• Steady growth of sales and stream of cash flows
• Not a volatile industry
• Little capital investment required
• Undervalued

n di d a t e
o d Ca
Go
 Pre-Bid Operating Strategy

D E
WACC  E ( rd )(1  t )  E ( re )
DE DE

• E(rd):
 1987 interest expense / debt level

• E(re): CAPM
 Risk Free Rate: 10-year US T-Bills in 1989
 Market return: 1982 to 1987 NYSE annual return
 Beta: 1987 regression data
 Pre-Bid Operating Strategy

5,204 11,133
(.0940)(1  .34)  (.1451)  .1187
5,204  11,133 5,204  11,133

• Projected cash flows

 1989 to 1998: Cash flows available for capital payments
 Future growth after 1998: 3%
 Pre-Bid Operating Strategy

• Present value of cash flows: $28,276

• Current Debt: $5,204
• Equity: $23,072
• Number of Shares: 247.4
• Value per Share: $93.26
 Management’s Operating Strategy

D E
WACC  E ( rd )(1  t )  E ( re )
DE DE

• E(rd)
 1989 to 1998 interest expense / avg. debt level

• E(re): CAPM
 Risk Free Rate: 10-year US T-Bills in 1989
 Market return: 1982 to 1987 NYSE annual return
 Beta: 1987 regression data
 Management’s Operating Strategy

11,186 4,202
(.1276)(1  .34)  (.1517)  .1026
11,186  4,202 11,186  4,202

• Present value of cash flows: $34,512

• Current Debt: $5,204
• Equity: $29,308
• Number of Shares: 247.4
• Value per Share: $134.24
 KKR’s Operating Strategy

18,932 4115
(.1518)(1  .34)  (.1584)  .1106
18,932  4115 18,932  4115

• Present value of cash flows: $38,416

• Current Debt: $5,204
• Equity: $33,212
• Number of Shares: 247.4
• Value per Share: $118.46
 Sources of Gains
• Pre-Bid
 From continuous operations
• Management
 From continuous operations through better management
 Sale of food business
 Cost cutting & operational improvements
 Tax shields
• KKR
 From continuous operations
 Sale of non-essential assets
 Cost cutting & operational improvements
 Tax Shields
 Use of One-Round Auction
• Pros
 Forces bidders to deliver their most competitive offer
 Most time and cost efficient
 Bids are more comparable

• Cons
 Does not allow for follow-up counter offers

• Alternative
 Multiple-round auction
 Management Bid

Not converted Converted

Cash: $90 $90
PIK preferred: $ 6 $ 6
Convertible: $ 4 $18.26
$100 $114.26

@85% projected firm value: $111.52

@115% projected firm value: $116.99
Note: Convertible stock is callable by company
 KKR Bid

Not converted Converted

Cash: $75 $75
PIK preferred: $ 11 $ 11
Convertible: $ 8 $26.67
$94 $112.67

@85% projected firm value: $108.67

@115% projected firm value: $116.67
 Value Comparison

• Pre-Bid: $93.26
• Management: $134.24
• KKR: $118.46

• Management Bid: $100.00

• KKR Bid: $112.67
 Bid Recommendation
Management
KKR
Value Higher Lower
Equity Lower Higher
O ff e r!
Debt Higher ter
BetLower
PIK Lower Higher
Callable Yes No
Cash offer Higher Lower
Total offer Lower Higher
Questions?