Barons of the Big Buyout

By Stephen Koepp

Not all of today's big dealmakers operate with the high profile of a T. Boone Pickens or a Carl Icahn. Case in point: Kohlberg Kravis Roberts, a clannish, almost obsessively reclusive investment-banking firm that often determines the fate of giant corporations. Kohlberg Kravis is Wall Street's master of a generally friendly form of takeover, the leveraged buyout. In an LBO, a small group of investors buys a company's stock with mostly borrowed money and takes the corporation private. Last week Kohlberg Kravis and a group of outside investors announced that they would do an LBO of the largest U.S. supermarket chain, Safeway Stores, for about $4.3 billion in cash and securities. Safeway's management accepted the plan so that it could escape a takeover bid from Dart Group, a retail chain.

The scale of the Kohlberg Kravis buyouts is pushing the reticent company into the spotlight and raising skepticism about the ambitious reach of its deals. In April the firm wrapped up the largest LBO in history, the $6.2 billion purchase of Beatrice, the food and consumer-products conglomerate.

To buy out a company, Kohlberg Kravis taps a pool of money from outside partners (minimum investment: $20 million each), which it combines with some funds of its own to form essentially a down payment. The new owners raise the rest of the purchase price by having the company take out bank loans and issue securities, which are often called junk bonds because they pay high interest rates but are unusually risky. Kohlberg Kravis makes its profits from several different aspects of the deals, including fees for arranging them, estimated at $160 million last year, and capital gains on its stock investment when the bought-out company is later sold or goes public again.

Kohlberg Kravis was formed in 1976, when Jerome Kohlberg, now 61 and the firm's patriarch, and George Roberts, 42, left the Bear, Stearns investment house to start out on their own. Roberts recruited a cousin, Henry Kravis, 42, and later his brother-in-law, Robert MacDonnell, 47. They began arranging buyouts of small companies like A.J. Industries, a manufacturer of brake drums and other components, in which Kohlberg Kravis invested only $1.7 million in 1977 but earned back $66.3 million after it was resold. Today, after more than 20 buyouts, the four partners are worth an estimated $150 million to $500 million each. A fifth partner, Paul Raether, 39, joined the firm in April. Kravis, the only member of the group with any visibility, lives in a $5.5 million Park Avenue apartment, collects 19th century British oil paintings and serves on the board of the New York City Ballet.

As the firm's exploits have grown, so has the criticism. Some investors claim that Kohlberg Kravis leverages its deals too far, loading up the bought- out companies with a debt burden that could be fatal in a recession. Another development that may derail Kohlberg Kravis is the federal tax reform movement, which appears likely to limit some of the write-offs that help make LBOs such lucrative investments. That prospect has already slowed the pace of most Wall Street LBO specialists, with the notable exception of Kohlberg Kravis.

With reporting by Thomas McCarroll/New York