Barbarians on the Big Board

July 8th, 2010 by Phil Mattera

The barbarians have finally become full-fledged members of the business establishment. The buyout firm Kohlberg Kravis Roberts & Co., which for three decades has targeted publicly traded corporations, is about to start trading on the New York Stock Exchange. The one-time master of taking companies private is now taking itself public.

Seeing KKR featured on the business pages sparks flashbacks to the 1980s, when the firm was at the center of the largest transformation of corporate America since the days of the robber barons. Yet KKR is of interest not only for historical reasons. Its financial maneuvers harmed the American economy in ways that are still being felt today.

Fortune once called KKR founder Jerome Kohlberg Jr. “the spiritual father of the entire LBO industry,” LBO being short for leveraged buyouts – the process of buying control of a company using its own borrowing capacity. Frequently working with top executives who wanted to share in the windfall, KKR took over companies with the intention of restructuring them and later taking them public again at a fat profit. Workers were usually the ones who paid the price, through layoffs or intensified work.

Led by Henry Kravis and George Roberts (Kohlberg was pushed out), KKR used a series of such buyouts to became the country’s second largest conglomerate (after General Electric), with control of corporate trophies such as Beatrice, Safeway Stores and Owens-Illinois. A Business Week cover story dubbed Kravis “King Henry,” while Fortune dubbed him and his partner “Masters of the Buyout Game.”

The greed and reckless speculation of LBOs reached its apotheosis in 1988 in the battle for RJR Nabisco. KKR emerged victorious from the free-for-all and carried out what was then a record $25 billion takeover of the tobacco and food giant. The excesses of all involved inspired Time magazine to write that the process had “crossed an invisible line that separates reasonable conduct from anarchy.” Bryan Burrough and John Helyar titled their 1990 book about the takeover Barbarians at the Gate.

After the RJR Nabisco deal, the appetite for major LBOs waned, in large part because of the collapse of the market for the junk bonds that made most of those deals possible — a collapse hastened by the demise of Drexel Burnham Lambert amid an insider trading scandal. KKR survived, though its stature was considerably diminished. Its reputation took a big hit in 1991, when Sarah Bartlett’s book on the firm, The Money Machine, accused KKR of gouging its own investors, including public pension funds.

KKR held on during the deal drought of the 1990s and finally got its reward in the mid-2000s, when buyouts started to enjoy a resurgence. This time around, KKR and the other LBO firms, now operating under the sanitized rubric of private equity, avoided much of the risk of the dealmaking of the 1980s and shamelessly milked bought-out firms with bloated management fees. As a 2006 Wall Street Journal headline put it, “In Today’s Buyouts, Payday for Firms is Never Far Away.”

The Great Recession has put a crimp in the private equity game, but KKR could not resist one more big deal: itself. For the past three years it has struggled to go public in a convoluted process involving an offshore affiliate based in Guernsey. Now it finally seems to be succeeding, but this is hardly a cause for celebration.

KKR’s initial offering serves mainly as a reminder of how much the firm has done to bring about our current economic ills. KKR helped popularize the idea that wealth could be created out of thin air rather than real productive activity. Its buyouts were part of the inspiration for securitization and other machinations that precipitated the near meltdown of the financial system in 2008. Given that the interest paid on LBO debt was deductible on company tax returns, KKR’s buyouts also pioneered the dubious practice of having the federal government effectively subsidize wheeling and dealing, paving the way to the Big Bailout of Wall Street.

All those deals made Henry Kravis and George Roberts very rich, but they have left the country much poorer.

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