Preparing for an LBO?

Management had been discussing a leveraged buyout for some time as a way to get the stock price up, but the LBO was one of several approaches that RJR examined. From discussions, some people in the company gave the impression that they were aware of Johnson’s intent to buy the company himself, dropping hints that Ross and his team planned to become super-rich.

One financial staff member reported just such a conversation on a flight to Palm Springs, just before the Management Incentive Plan and restricted stock plan were closed. This was one of a series of moves Johnson made to “clean up the books” and make the company more appealing to investors.

What Ross Johnson had in mind is anybody’s guess – whether an LBO or just getting the RJR house in order. The “cleanup” included:

Stock Options

Holders of options got demands, not requests or suggestions, to exercise their stock options. An option is the right to buy a specific number of shares at a specific fixed price for a set period of time. RJR stock was about $50 and options holders received $55-$65 shortly before the LBO. When the board announced the LBO, the price quickly soared to over $100 a share. Forcing the exercise of the options would save the LBO several million dollars. Afterward some option holders brought a class action suit that was settled out of court. One participant in the suit said he lost $500 thousand on his options and recovered only $80,000 from the suit. A separate suit went on for years with an indeterminant outcome.

The annual report detailed stock option redemptions of 261.246 shares. At a redemption price $57 vs $109, those shares would have been redeemed by the company for $13.6MM less than at the LBO.

Bad Debt Reserve

Tobacco had no reserve for bad debts when Southland, one of its major customers, went under, causing a $30 million loss. As a result, Tobacco finance set up a reserve for bad debts that was perhaps $50 million. RJR pulled this reserve money back into the corporate treasury.

Offshore Insurance Fund

Similarly, RJR created a reserve for tobacco liability lawsuit losses, contracting with AIG insurance to set up an offshore insurance policy fund.  Contribution were $25-$50 million a year. AIG treated payments to the fund as insurance premiums, tax-deductible. If the fund were tapped to pay a tobacco litigation claim, the proceeds would come back from offshore as an insurance payment and would be tax-free. RJR repatriated this money back to the U.S, again to the corporate treasury.

Buyout of Pension Liabilities

RJR carried on its books the liability for several pension plans for businesses that the company no longer owned. This meant that the company would bear the obligation and expense of sending a monthly check for life to the retirees of these companies. Buying an annuity for each employee was an accepted way of discharging RJR’s liability. Of course, the company wanted to pay as little as possible for the annuities but was fiduciarily responsible for making a safe investment for the retirees. RJR’s choice of the insurance company raised questions about whether the annuity was backed by a quality “guarantee.” Executive Life Insurance won the bid as one of the lowest-cost choices. However, the extremely low bid should have raised questions about the quality of Executive Life’s underlying assets backing the guarantee. Only a couple of years later, the insurance company went bankrupt. It had been able to bid low because it assumed a very high rate of return on the, then popular, high yield junk bonds that failed, leaving the annuities much underfunded.

A group of pensioners, among them people at Aminoil, sued RJR over the loss of their pensions. In 1993, I gave a deposition on their behalf during the suit. Years later, the suit had still not been settled.


A series of sales of unwanted businesses for cash.

Such actions suggested that Ross was building a “war chest.” for his proposed LBO of RJR. Advocates of this theory saw the moves as hard evidence, but objectively they fall more under the heading of speculation by those willing to believe the worst of Ross and his motives. This again is one of those questions that can never be answered. Even today, each side will adamantly defend its position.