Lessons for HOA Management Owners From One of History’s Biggest Buyouts

On October 20, 1988, Ross Johnson, the CEO of RJR Nabisco, walked into a meeting with the company's board with an extraordinary proposal. RJR Nabisco was one of America's largest companies, a sprawling collection of household brands that included Oreo cookies, Ritz crackers and Winston cigarettes.

Johnson presented a proposal from a group of investors to acquire RJR Nabisco for $75 per share, valuing the company at roughly $17 billion. It would have been the largest corporate buyout ever attempted, and the proposed price represented a substantial premium to where RJR Nabisco's shares had been trading before the proposal became public.

For a moment, $75 looked like an enormous number.

Four days later, it looked small.

KKR, the private equity firm led by Henry Kravis and George Roberts, entered with an offer of $90 per share, approximately $20 billion in total. KKR's interest had not emerged overnight. Henry Kravis had reportedly discussed the possibility of leading a buyout of RJR Nabisco with Johnson roughly a year earlier, and KKR had already developed an interest in the company.

What followed was remarkable. The original investor group increased its own offer to $92 per share and later to $100. KKR similarly increased its offer from $90 to $94 and continued bidding from there. By the end of November, the original investor group had submitted an offer carrying a headline value of $112 per share, while KKR had reached $109.

In roughly six weeks, the original group had gone from offering $75 per share to $112 for substantially the same company, while KKR had moved from $90 to $109.

RJR Nabisco had not become a dramatically better business during that period. Its earnings had not increased enough to explain billions of dollars of additional purchase price. Instead, as the competition intensified, the same buyers repeatedly found room to increase the amount they were willing to pay.

Johnson later acknowledged as much. When asked why his group had initially offered $75 per share for a company it was subsequently willing to pay $100 per share to acquire, he said that he had expected the original proposal to be negotiated upward.

The first offer was clearly not the most the group was willing to pay. It was where the negotiation started.

How Competition Changes the Math

A buyer evaluating a company develops assumptions about its future cash flows, growth, financing and eventual value, and uses those assumptions to determine the purchase prices at which an investment can generate an acceptable return.

If an acquisition produces an exceptional return at $7 million, an attractive return at $7.5 million and only the buyer's minimum acceptable return at $8 million, there is little reason to begin by offering $8 million. If $7 million is enough to acquire the company, the buyer would rather preserve the additional economics for itself.

Competition changes that calculation. The buyer must now weigh the lower return associated with paying more against the possibility that refusing to increase its offer will cause it to lose the opportunity altogether.

This is what made the structure of the RJR Nabisco process so important. The major bidders were evaluating substantially the same company over a compressed period, with defined opportunities to submit and improve their proposals. A later academic analysis concluded that the rules established by RJR Nabisco's board helped reduce the possibility of collusion among bidders and increase the potential gains available to stakeholders.

Had one buyer evaluated RJR in October, another six months later and another the following year, the comparison would have been far less meaningful. The company's performance, financing markets and available information could all have changed in the interim. Instead, the competing groups were being asked, at roughly the same time, how much they were prepared to pay for substantially the same opportunity.

That distinction matters just as much in the sale of a privately held business. Speaking with several buyers sequentially over a year is not the same as having several credible buyers evaluating the same information on the same timetable while each knows that the seller has other alternatives.

Applying the Lesson to HOA Management

Many private equity firms and strategic buyers have now spent years studying HOA management, following individual companies and developing their own views on attractive markets, margins, growth, ancillary revenue and consolidation opportunities. By the time a particular management company becomes available, a serious buyer may already have a well-developed thesis about what it could do with that business.

What it does not necessarily know is how much it will have to pay to own it. One buyer may initially offer $7 million but be capable of paying $8 million while still achieving its required return. Another might justify $8.5 million because it already has infrastructure in the market, expects greater operating efficiencies or sees additional opportunities that the first buyer does not.

The company does not need to add another customer or generate another dollar of EBITDA for those prices to be different. What changes is how much of the potential economics each buyer must give to the seller in order to win the business.

This is also why timing matters. Once an owner spends months negotiating exclusively with one buyer, walks away and then approaches another, the buyers are no longer competing against each other. The leverage created by having multiple credible alternatives available at the same time has largely disappeared.

The Highest Number Does Not Always Win

There is one final lesson from RJR Nabisco. The highest headline offer did not win.

The original investor group ultimately submitted a proposal it valued at $112 per share, while KKR's final proposal was valued at $109. Nevertheless, RJR Nabisco's board selected KKR after considering the composition, certainty and other terms of the competing proposals.

The same principle applies to the sale of an HOA management company. A higher offer containing substantial contingent consideration, uncertain financing or significant closing conditions can be less attractive than a somewhat lower offer with more cash at closing and greater certainty.

The objective of a well-run process, therefore, is not simply to collect the highest number. It is to give credible buyers the same opportunity, at the same time, to put forward their best executable offer, and then compare those offers on equivalent terms.

RJR Nabisco was an extreme example, but the lesson is straightforward. Different buyers can justify different prices for the same company, and even the same buyer may be willing to pay materially more than its first offer when faced with credible competition.

A buyer's first offer tells you what it is willing to pay when it believes that amount might be enough. A competitive process helps reveal what it is willing to pay when it knows it might not be.‍