How 'G. Shepherd' Helped Improve the Credit Market

G. Shepherd's last hope was a private jet out of Palm Springs...

He should never have bitten that security guard.

Fortunately for Shepherd – who usually went by "Rocco" – he was close with F. Ross Johnson... CEO of RJR Nabisco in the 1980s.

When Johnson heard what happened, he pulled out all the stops. He put Rocco on the next flight out of California on one of his company's 10 private jets... straight to headquarters in North Carolina.

He even assigned an RJR Nabisco executive to accompany Rocco.

Folks, if you haven't caught on yet... Rocco wasn't a man. He was Johnson's beloved dog.

He was smuggled out of Palm Springs, where Johnson was playing in a golf tournament, to keep him out of trouble after the bite.

And yes, the flight manifest actually listed him as "G. Shepherd."

Rocco was lucky that Johnson was so cavalier with his company's money. We can't say the same about RJR Nabisco's creditors, though... Johnson seemed to care a lot more about his own paycheck and social life than any of the companies he worked for.

And as you'll see, his actions changed the credit market – and the nature of bond investing – forever.

RJR Nabisco itself came into being when Johnson merged his business with a tobacco company called R.J. Reynolds...

At the time, Johnson was CEO of snack maker Nabisco. He merged the companies purely because it gave him more money to play with.

He renegotiated his pay package much higher when he took over the combined company. He spent a lot of time golfing on the job, even with pros like Jack Nicklaus. He reportedly bought two dozen country-club memberships.

And then there was that fleet of 10 RJR Nabisco private jets.

Combining R.J. Reynolds and Nabisco was a novel idea, but a snack company and a cigarette company were never going to work well together.

When Johnson realized it was a failed experiment... and that he could borrow a ton of debt, take Nabisco private, and make himself more than $100 million in the process... he was, of course, all for it.

That's what private-equity firm KKR promised he could do. KKR was one of the earliest companies to buy broken businesses with extreme debt, fix them up, and sell them at a huge profit... also called a leveraged buyout ("LBO").

Johnson was on board for the "huge profit" part. But he had no interest in fixing up the business. So he decided to try buying Nabisco himself for $17 billion.

This sparked a brutal bidding war. It went back and forth until KKR offered $25 billion, which the board finally agreed to.

Nobody seemed to care about the mountain of debt piling up... except for bondholders.

All they could do was sit and watch as their bonds – which were supposedly high quality and investment grade – lost value with each bid. Every extra dollar added to RJR Nabisco's share-price bid meant more high-yield debt for the company.

Its whole credit structure was getting a lot riskier. It would need to use more cash for interest payments... and it had a lot less room for anything to go wrong.

Several bondholders tried to sue the company for intentionally prioritizing stock returns. But the bond contracts didn't do anything to stop RJR Nabisco from taking on more debt for a takeover.

Bondholders were horrified. Some worried that LBOs would be the death of investment-grade bonds.

But while these folks couldn't get any reparations for the RJR Nabisco debacle... all future bond investors should be glad it happened.

Within the year, new bonds started to include a clause called a "change of control provision." If a company got bought out, its bondholders were protected. They could sell their bonds back at a predetermined price.

That meant management teams couldn't load up on risky debt without paying off prior bondholders... often at a premium.

All credit agreements are publicly available. So you can see for yourself whether you're protected before you put any money to work.

When they're first registered for sale, they're in a form called an S-4. If it's an update to a previous agreement, it might be in an 8-K press release instead.

These days, most companies will offer bondholders the opportunity to sell back their bonds for 101% of par value (the face value of the bond, typically $1,000).

Bonds make up a massive market...

And to most people, it's a foreign one. It seems so complex and different than stocks that it can be downright scary.

But in times of economic uncertainty – like we're seeing today – the bond market can give your portfolio a sense of security... and even a unique edge.  

Bonds come with legal protections that you won't find with stocks. These protections all but guarantee investors will get at least some of their money... even if the company can't pay.

All that stands between you and lower-risk, predictable gains is a little bit of homework.

Regards,

Rob Spivey
with Joel Litman
October 2, 2024

P.S. Credit agreements can be long... And bond language is often dense and filled with jargon. That's why so many investors steer clear of credit (and miss out on stock-like returns or better).

And that's why a year ago, we launched a monthly bond-research service called Credit Cashflow Investor.

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The bonds in our model portfolio currently yield between 5% and 15%. All 15 recommendations are up (three are up double digits)... and all without having to worry about the stock market's daily moves.

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