Njr Nabisco

1) What are the agency costs? How big are they? Was RJR Nabisco a good LBO candidate?

Agency costs:

The main agency cost is that with the mangement of the company also being bidders in the process, they would have even bigger incentives to withhold information that might be useful for other bidders and, therefore, would increase the amount of the biddings. For instance, the difference in the level of margins that KKR and the management used in their cash flow forecasts might be due to agency costs.

The level of information available to the board of directors in order for them to make the decision is another possible example. As management is probably the main source of information for them, there is a possibility that they will select the kind of information they will forward to the directors in order to favor themselves.

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LBO candidate:

Nabisco had characteristics that made it an attractive target:

- Low long-term debt – in 1987, it was equivalent to only 23% of the value of the company. That was a clear opportunity to improve the financial structure.

- Stable results (especially food is relatively insignificantly affected by seasonality or economic downturns), meaning they have reasonable growth with low variability, no need for further aggressive investments or R&D spend (only 2% of revenues in 1998 accounted for capital investment) and, therefore, predictable cash flows.

- Likely market undervaluation of company’s strong cash flows from the tobacco business and of value of its food business due to its association with tobacco

- Exit strategy – if anything went wrong for the bidder, he could sell the divisions separately.

2) What was the value of RJR Nabisco under

a) The pre-bid operating strategy?

b) The Management’s Group’s operating strategy?

c) KKR’s operating strategy?

3) What accounts for any difference in the value of the three operating plans?

a) DISCOUNT RATES and WACC vs APV:

In the three...