The Cost of Concentration

Corporate agribusiness' latest rash of mega-dollar mergers rocked the $240 billion U.S. food industry.

First came news of the unsuccessful $5.03 billion takeover bid of Kroger Co., the nation's second largest supermarket chain, by Kohlberg, Kravis Roberts & Co. in 1988.

Two years earlier, KKR bought Safeway Stores, the nation's largest supermarket chain, for $4.2 billion. Before that, in 1984, KKR purchased Beatrice Foods Co., one of the United States' food manufacturers, for $6.4 billion and then promptly sold many of its assets in order to pay off its buyout debt and interest obligations. Despite Kroger's rebuff, KKR accumulated a 9.9 per cent stake in the Cincinnati-based firm "solely as an investment."

As debate over the Kroger-KKR sale raged, Grand Metropolitan PLC, the world's largest liquor producer and Great Britain's fourth largest company, bid $5.23 billion for Pillsbury, the giant MinneapoIis food producing company. Although Grand Met originally claimed that it sought a "friendly" takeover, Pillsbury immediately mounted a defensive recapitalization effort to maintain its independence and hinted that it might go private.

Grand Met quickly retaliated. It sought the support of Pillsbury's financially-troubled Burger King franchises. Grand Met wanted to send a message to Pillsbury share holders that the franchises were no longer supporting their parent company and that tendering shares to Grand Met would be in the best interests of everyone. Pillsbury countered with a threat to sell off its Burger King subsidiary, thereby making it a considerably less attractive takeover target.

While the financial community watched in fascination as these two food giants battled it out, Philip Morris, with 1987 food, beverage and tobacco sales of $27.7 billion, offered to buy out Kraft Co. for $11 billion, the second largest takeover attempt ever.

Kraft, with 1987 sales in international foods, food services and ingredients and consumer food products totalling $9.9 billion, initially opposed the Philip Morris offer. After lengthy negotiations, however, Philip Morris finally accepted a $13.1 billion bid. Thus, a company once known only for its tobacco products became the world's number one consumer products firm, moving ahead of Europe's multinational giant, the Unilever Corp.

"People may ultimately stop drinking or smoking, though I don't believe it," declared Hamish Maxwell, Philip Morris' deal-making chairman, "but you can bet your life they will keep on eating."

Only three days later, however, the Philip Morris acquisition was dwarfed. Four members of the management team of RJR Nabisco announced that they planned to take the nation's 19th largest corporation private with a $16.9 billion leveraged buyout.

Their offer was immediately topped by KKR with a $20.28 billion bid, only to be countered by a $20.6 billion bid by a RJR Nabisco's "gang of four" and a consortium of investment firms led by Shearson Lehman Hutton, Inc., the America Express Co. subsidiary. KKR later topped this bid with a $24.88 billion offer, which in fact was the final sale price.

The Price of Mergers

Amidst all this wheeling and dealing, the public has been left to wonder who actually profits and who pays for all these acquisitions, mergers and leveraged buyouts and what effect such transactions have on the economy, jobs and the food supply.

First, it is important to grasp the scope of the amounts of money involved in these mergers. KKR's final bid of $24.88 billion for RJR Nabisco exceeds all the money held by the investment firms of Merrill Lynch, Salomon Bros., Shearson Lehman Hutton, Dean Witter, Prudential Bache, Goldman Sachs, First Boston, Drexel Burnham Lambert, Bear, Stearns, Paine Webber and Morgan Stanley, according to the Washington Post.

The amount also tops the combined fortunes of the six richest men in the United States: Sam Walton ($6.7 billion); John Kluge ($3.2 billion); H. Ross Perot ($3 billion); S.I. and Donald Newhouse ($5.2 billion); and Henry Lea Hillman ($2.5 billion). The almost $25 billion could also fund all the Central American governments for two years, sponsor 80 million destitute children around the world for one year through various international charities, or place the nation's 1.5 million homeless in apartments at the national median monthly rent of $412 for 32 months the Washington Post reported.

As for the question of who profits from these giant mergers, the focus of attention must turn to the Wall Street investment house of Kohlberg, Kravis Roberts & Co., which remains a central focus in all the latest acquisition and buyout activity. (It was even widely rumored at one time that Kraft might be considering assistance from KKR in its initial efforts to stave off Philip Morris.)

Henry Kravis, KKR's chief, was among the first to develop the leveraged buyout (LBO). He recognized that companies whose stocks were undervalued could be taken private with mostly borrowed funds, restructured and streamlined, and then resold at tremendous profit. KKR quickly mastered the technique.

In the more than 35 buyouts, worth approximately $40 billion, that it has completed, KKR has earned billions of dollars in profits and accumulated a war chest of about $5 billion for use as equity in future buyouts. Buyout firms usually borrow about $9 for every $1 of equity in a buyout. This ratio gives KKR the total purchasing power of close to $50 billion. KKR has just five partners and a total of 15 professionals on the staff, split between New York and San Francisco. The firm's partners reportedly each take home in the neighborhood of $50 million a year.

The general partners have invested a little of their own personal capital, a total of $115 million, to help finance deals in conjunction with the capital from KKR's $5 billion equity fund. After purchasing RJR Nabisco, KKR's annual revenues from its holding total over $50 billion.

Since KKR is registered under the corporate laws of Delaware, the identities of its investors are not a matter of public record. The New York Time's Anise C. Wallance, however, obtained a list of the general partners in the KKR fund, many of whom are believed to have participated in the RJR Nabisco bid.

Much of KKR's equity comes from large U.S. and international banks, including Citicorp, Continental Illinois, Bank of America, Canadian Imperial Bank, Indus-trial Bank of Japan, and Nippon Credit; 11 state pension plans, including Washington, Iowa, Illinois and New York; Equitable Life and John Hancock insurance corn panies; and non-profit funds such as Harvard, Yale, M.I.T. and the Salvation Army; corporate pension funds such as H.J. Heinz, Coca Cola and Ralston Purina; and foreign entities like the British Coal Board pension fund and the government of Singapore.

Many social policy questions regarding KKR's use of its money have already been raised by investors. For ex-ample, there is concern that RJR Nabisco is the second largest U.S. employer in South Africa, where its Del Monte subsidiary maintains a large food operation.

Dr. Jean Mayer, president of Tufts University and former chairman of the White House Conference on Food, Nutrition and Health, raises another important question: "I find it alarming that some of the country's largest food companies are being acquired by tobacco and liquor companies. The first line of quality control for our manufactured foods has been the professional conscience of chief executives of independent food companies."

He adds, "Tobacco companies are by their nature indifferent to health considerations. To have our food supply in their hands is something to which the United States people and Congress should give attention."

Union officials, such as William Olwell, head of collective bargaining for the United Food and Commercial Workers International Union, have also expressed concern about "the substantial negative impact" on workers as companies seek a growing number of consessions or sell off operations once a buyouthas been completed.

Banks, of course, has become a main source of lending captial for LBOs and although they maintain that leveraged buyout loans are based on conservative practices, their loans represent a large percentage of their capital Federal Reserve Board Chairman Alan Greenspan has warned banks to consider the impact of a recession on their loans to highly leveraged borrowers.

It is estimated that in 1988 banks have loaned out over $48 billion, without including the proposed KKR-RJR Nabisco buyout. This would make their total acquisition financing of all types in the last two years almost $150 billion, according to Oppenheimer & Co.

In the past, when banks made large loans they kept the loans on their books, but recently several banks have committed themselves to multi-billion dollar loans and then sold most of them in small increments to other regional and foreign financial institutions, pension funds, insurance companies and other corporations. In the past year Japanese banks have become particularly active in this field, acquiring nearly 30 percent of such loans, an increase of 10 percent from 1987.

These companies may be hard-pressed to make their additional interest payments should interest rates rise. And if the economy weakens, highly leveraged companies might find it difficult to generate enough cash to pay their interest.

Reflecting on the LBO frenzy that has seized corporate America, Jay Butler, a partner in the LBO firm of Weiss, Peck & Greer, points out that, "These deals are getting more and more overpriced. As soon as we get some flatness in the economy or rising interest rates, a lot of these highly leveraged deals are going to fall apart.... The next crash isn't going to be stocks," he adds, "it's going to be all these companies that can't make interest payments."

By the end of 1988, nonfinancial corporations will have in the past six years nearly doubled their debt to $1.8 trillion and retired more than $400 billion in equity. This year alone, the nation's corporate interest charges will equal nearly one-quarter of all its corporate cash flow.

And with the increased debt comes increasing bankruptcies. Some 51 large companies defaulted on $11 billion in debt in 1984 compared to 87 companies, with over $21.4 billion in debt that defaulted in 1987.

Behind the Mergers

A major reason for the trend toward substituting debt for equity is a tax policy which makes debt capital cheap, by allowing interest payments to be tax-deductible while dividend payments are not.

A small group of New York law firms are prospering from these multibillion dollar transactions. "Bankers seem to be comfortable dealing with a small group of law firms in New York that they're most familiar with," is how one N.Y. lawyer described the relationship. These law firms generally charge up-front retainer fees as high as $250,000 and stand to earn fees of as much as one percent of the transaction price.

All this buyout activity has had a serious impact on the bond market. Bonds have been sinking in value, as companies are taken over by buying out shareholders with huge amounts of new debt and existing bondholders are left holding securities that are not as safe as before.

It is important to remem ber that when a highly regarded firm goes public in a leveraged buyout the proportion of equity represented by its public stockholders is usually reduced from 75 percent of its capital structure to less than 10 percent. The balance of its capital structure comes from debt (between 50 and 65 percent) and subordinated debt, or what are called high-yield "junk bonds," which are sold to investors.

Analysts attribute the increase in mergers in recent years to the following factors: Big banks lending money on large deals because they can charge up-front handling fees in addition to interest; big investment banking houses producing new and large profits from such trans-actions and employing staff that promote such mergers; and the government subsidizing those deals involving loans by making borrowing cheaper, as it explicitly guaranteed some $2.8 trillion worth of obligations through bank deposits and mortgages. In addition, the government has acted as a lender of last resort as it did in the rescue of Continental Illinois.

Since the October 1987 crash, takeovers and acquisitions are being fueled by a combination of several factors: increased interest by foreigners in U.S. assets and property as a decreasing American dollar makes everything cheaper; the Reagan/Bush laissez-faire approach to corporate mergers; lower stock prices following the Black Monday disaster; and low interest rates making financing easier.

The Reagan administration's lax application of government antitrust laws also has a host of critics. "All this frenzy may be good for investment bankers, but it's not good for the country or investment bankers in the long run," " says prominent New York investment banker Felix Rohatyn.

Harvard Professor Robert Reich agrees. "Instead of generating new wealth, corporations are playing a giant game of asset rearrangement that is largely unproductive.... Although the fee system doesn't take money out of the economy�it only moves it from one segment to another�the time and attention it takes away from the development of new products and services is enormous. Look at the newspapers today. You don't see stories about new products or innovative breakthroughs. You see stories about the thrusts and the parries of corporate law and finance. That's the most innovative part of our economy right now and that, in essence, is the problem," Reich asserts.

Commenting specifically on the food sector, Jay Higgins, head of Salomon Brother's Mergers and Acquisitions Group said, "There are fundamental reasons for these mergers in the food industry. But even if there were no driving economic force, we'd still be seeing this momentum. The more it happens, the more the remaining companies worry about being acquired or there being enough other companies to acquire."

This merger mania "will definately have an effect on the cosumer," adds food consultant Lynn Larsen. "It makes it more competitive. We'll see battles between giants, and fewer new marketers entering a category. [...] Muscle is being amassed in distribution and manufacturing

that is going to be very difficult to fight."

Bigger vs. Better

Not everyone agrees, however, that merging many different food lines under one company's aegis makes good economic sense even for the companies involved.

"The acquisitions have not done that well. Most have kind of floundered around," says tobacco analyst Bill Beardsley at IDS Financial Services in Minneapolis, in evaluating Philip Morris' past acquisitions of Seven-Up, Miller Brewing and General Foods.

"The acquisition record has been poor," " agrees analyst Roy Burry at Kidder Peabody. Earnings of the three acquired companies have grown "closer to zero than five percent annually in the past several years, well behind the profits of other food companies."

Indeed, a study of 96 "unfriendly" corporate tender offers during the 1960s and 1970s by F.M. Scherer, a professor of economics at Swarthmore College, revealed that even after eight years none of the corporations had increased their profitability. Further, an analysis of 6,000 "friendly" mergers during the same period showed "a wash" as to profitability and, Scherer observes, the aver-age impact on profit performance was negative.

Agricultural economist John O'Connor warns that the bigger food companies become, the greater their efforts to steal market shares from one another through advertising wars. And these packaging and advertising costs will be passed on to the consumer. "Either retailers or consumers will pay for a more expensive form of commercial battle. Some people call that competition. I call it rivalry."

To illustrate O'Connor's point, one need only look at the advertising budgets of these huge companies. In 1987 Philip Morris surpassed Procter and Gamble as the nation's number one advertiser, spending some $1.56 billion, while Kraft itself was the nation's 22nd largest advertiser, spending $400.7 million. Together, these two firms now have over $2 billion to spend on advertising. In fifth place, spending slightly less than $850 million on national advertising, was RJR Nabisco.

The importance of having an established name brand such as Jello and Nabisco and being able to advertise such brands was illustrated in a recent study of 30 product categories by the Boston Consulting Group. The study found that of the brands that were number one in their category in 1930, 27 were still number one today. John M McMillan, who monitors the food industry for Prudential-Bache Securities, Inc., concurs with such predictions.

"While the earnings of corporate America have been largely stagnant at best in recent years, the profits of the food industry have increased an average of 10 percent a year. Unless there is a significant rebound in the smoke-stack sector of the economy in 1987, the earnings and shares of most major food companies should continue to be attractive."

Food industry analysts also believe that consumers will continue to demand more and more commodities that are "out of season" as well as paying more for what they perceive to be healthier foods.

Thus, corporate acquisitions should continue in the food industry at an accelerated rate, as companies look for strong cash flow that will give them what they think is an important edge in the fight for shelf space in supermarkets.

The Battle for Shelf Space

That edge has now become of paramount importance to the major food companies as more and more supermarket chains demand payments to put their suppliers' products on the shelves.

The introduction of over 10,000 new food products in a single year puts the small food processor and manufacturer at a distinct disadvantage when it comes to challenging the established name brands for valuable shelf space in these supermarkets.

The situation facing Ben & Jerry's Homemade, Inc., a popular premium ice-cream maker in Burlington, Vermont illustrates this point. Ben & Jerry's must compete with Kraft's Frusen Gladje and admits to being outgunned. The Philip Morris merger is like "adding a couple more nuclear bombs," says Fred Lager, Ben & Jerry's general manager.

While food manufacturers are bidding for valuable shelf space, more and more grocers are also demanding that manufacturers advertise heavily in the local media, a practice that, again, clearly benefits the large food manufacturing firms.

The Spoils

It is little surprise that in acquisitions, food companies are premier. "They can register 8 to 10 percent increases in operating earnings consistently, in good times and in bad," said William Maguire, a Merrill Lynch analyst.

Maguire's forecast proved accurate in the days immediately following Black Monday, when investors re-gained some of their appetite for stock bargains. Most major food stocks rebounded as investors chased "defensive" stocks�stocks that fare relatively well in a bad economy. Big food companies are "recession resilient because people still have to eat," said Nomi Chez, an analyst for Goldman, Sachs & Co.

Michael Silverstein, a vice president of the Boston Consulting Group, adds that "if people are going to treat themselves to any luxury during a recession, one of the cheapest ways to do so is with brand items."

Many food analysts now believe that brand-name food firms have almost overcome the problem of the rising prices of raw materials, a factor that remains an increasingly large burden for other manufacturers.

Corporate agribusiness' long-sought goal of substituting capital for efficiency and technology for labor while standardizing the food supply and creating substitute foods has finally begun to pay handsome dividends controlling the nation's food supply.

"The actual food is just 7 to 10 percent of most of these companies' costs," notes analyst Pavlos Alexandrakis of Argus Research Corp. Thus, any big rise in raw material prices can be covered by a relatively small increase in the price of the packaged food. Even if consumers notice such a rise they tend to stick by these big-name brands, according to food analysts and consultants.

Making a Drought Pay

In recent months, analysts at Bear, Stearns & Co., Merrill Lynch Capital Markets, Shearson Lehman Hut-ton, Inc. and Dean Witter Reynolds have been issuing regular reports that provide their customers with the "breakup value" of companies in the food, energy and media industries.

"If you can't eat it, drink it, smoke it or use it in the bathroom, you don't want to own it," explains Steven A. Kroll, president of Shearson Lehman Hutton Asset Management, the $30 billion investment management subsidiary of Shearson Lehman Hutton, Inc.

One sector of the food industry that remains particularly vulnerable to acquisitions and buyouts is the food retailing business. Indeed, industry analysts often refer to the entire food retailing industry as one giant LBO.

Publicly traded megachains, with the lower profit margins, steady cash flows, valuable real estate and operations that can easily be split off and sold, are ripe acquisition candidates.

The allure to bidders is simply that the parts are worth more than the whole. Chain-store companies are particularly vulnerable because their shares are so widely held.

Yet, even as this corporate concentration in the food industry continues seemingly unabated, there has been little discussion of what authors Walter Adams and James W. Brock describe as "the unpleasant fact that concentrated power exists and that it has social consequences."

In their book, The Bigness Complex: Industry, Labor and Government in the American Economy, Brock and Adams note that the United States is afflicted by a "structural malaise" which springs from the myth that "industrial giantism is the handmaiden of economic efficiency and consumer welfare."

For consumers, these mergers and acquisitions mean "an endless elaboration of the sizes and flavors," says Leo Shapiro, a Chicago-based food consultant. "Seeing the same brand over and over means you are shopping for differences that aren't meaningful, in stores that are quite sterile.

The threat inherent in such redundancy is obvious with the product hording involved with the giant LBOs. "When a company as large as Philip Morris buys a company as large as Kraft, it can concentrate on one product, like mayonnaise, and run all the other mayonnaise processors, large and small, out of the market," warns one Washington-area supermarket executive.

Such a development could affect pricing by restricting the availability of items at given outlets, the grocery executive adds, because "there is no law that says that a Philip Morris has to sell to a given store." This stranglehold on supply gives Philip Morris an inordinate power.

Such a point was vividly illustrated by financial analyst Stephen Carnes of Piper Jaffray who, in speculating about how the Philip Morris buyup of Kraft might affect our future eating habits, observed that one "could well start with a Miller Lite beer, eat a whole meal, then light up a Marlboro after you get done," and never have to use a product outside the new behemoth.

Or, as Michael Pertschuk, former Federal Trade Commission chairman,predicted, the way tobacco companies are accumulating cash and diversifying, "by the year 2000 there will be two consumer goods companies in the United States: RJR Nabisco will be selling all the consumer goods west of the Mississippi, and Philip Morris will be selling all the consumer goods east of the Mississippi."

In this era of multi-billion dollar corporate agribusiness acquisitions and buyouts, Pertschuk's words are more than food for thought.

A.V. Krebs is an agricultural policy consultant, the former editor/publisher of The AgBiz Tiller and co-director of the Agribusiness Accountability Project. He is currently awaiting publication of his book, The Corporate Reapers: Eradicating the Family Farm System in America.