Warren Buffett’s Investment in RJR: A Unique Value Play

• First Investment: RJR Reynolds (Equity, 1980-1984)

  • Total Investment: $269 million

  • Stake: ~5% of RJR Reynolds

  • Initial Share Price: ~$35.42

  • Exit Year: 1984

  • Return: 27% over four years (excluding dividends)

  • Missed Opportunity: Had Buffett held his shares until 1988, he would have earned a 44% annualized return due to the leveraged buyout that pushed the stock to $109 per share.

• Second Investment: RJR Nabisco (Junk Bonds, 1989-1991)

  • Total Investment: $440 million

  • Average Yield: 14.4%

  • Market Conditions: Bonds were heavily discounted due to concerns over RJR’s massive debt from its $25 billion leveraged buyout by KKR.

  • Outcome: In 1991, KKR redeemed all RJR bonds at face value, giving Buffett a 34% return in less than two years (~$150 million profit).

Phase 1: The RJR Reynolds Equity Investment (1980-1984)

Why Buffett Bought RJR Reynolds

Buffett’s first foray into RJR came in 1980, when he began acquiring shares in RJR Reynolds, a company that was trading at what he saw as an absurdly low valuation. At the time, RJR was a diversified conglomerate with not only a lucrative tobacco business but also significant non-tobacco assets, including an oil subsidiary called Aminoil and a shipping business.

What made RJR particularly attractive to Buffett was how the market was severely undervaluing the company. When he began his purchases, RJR’s stock price was just $35.42 per share, yet the valuation of its tobacco business alone was only $5.50 per share, less than one times annual earnings. The bulk of the company’s value was tied up in its oil assets, and the market was essentially ignoring the cash-generating power of its core tobacco business.

Between 1980 and 1984, Buffett gradually built up his stake, eventually reaching a 5% ownership position. At this stage in his career, Buffett was not yet the globally recognized investing figure he would later become, and his presence as a major RJR shareholder largely went unnoticed by company executives.

An RJR analyst later recalled how undervalued the business truly was, noting that the oil subsidiary alone was worth about $2.3 billion, while the entire company had a market capitalization of just $3.6 billion. Buffett, with his keen eye for intrinsic value, clearly recognized that RJR was a classic sum-of-the-parts mispricing and saw an opportunity to profit.

Why Buffett Sold His Stake in 1984

Despite RJR’s undervaluation, Buffett ultimately exited his position in 1984, earning a 27% return over four years, excluding dividends. This was a solid gain, but it paled in comparison to what was about to happen.

Had Buffett held onto his shares for just four more years, he would have quadrupled his money, as the RJR Nabisco leveraged buyout in 1988 pushed the stock price to $109 per share. In hindsight, this would have amounted to a 44% annualized return over four years, instead of the 20% return he locked in by selling early.

The exact reason Buffett decided to sell remains uncertain, but a few theories exist. One possibility is that he simply believed the stock had reached fair value and no longer had the same margin of safety. Another explanation is that he was increasingly wary of the tobacco industry, which was starting to face rising regulatory and legal pressures. Whatever the case, he chose to move on, missing what could have been an even more lucrative outcome.

Phase 2: The RJR Nabisco Junk Bond Play (1989-1991)

The Infamous RJR Nabisco Leveraged Buyout

In 1988, RJR Reynolds merged with Nabisco in a deal that created RJR Nabisco, a corporate giant straddling the tobacco and food industries. Soon after, RJR Nabisco became the target of one of the most famous leveraged buyouts in history, orchestrated by private equity firm Kohlberg Kravis Roberts & Co. (KKR).

The LBO, valued at $25 billion, was the largest corporate takeover of its time and was fueled by junk bonds, which were issued in massive amounts to finance the highly leveraged deal. Once the buyout was completed, RJR Nabisco was burdened with enormous debt, and as concerns about its financial stability mounted, the value of its junk bonds collapsed in 1989.

Buffett’s Opportunistic Bond Investment

While Buffett had largely moved on from RJR’s stock, he saw a classic case of bond market mispricing in RJR’s junk bonds. In 1989, as investors panicked and dumped the bonds at deep discounts, Buffett stepped in and purchased $440 million worth of RJR Nabisco junk bonds, yielding 14.4%.

His reasoning was simple: despite its debt load, RJR Nabisco was still a fundamentally strong business, and the company was actively selling off assets to reduce its obligations. Buffett recognized that while the market feared default, the actual risk was much lower than perceived.

This investment was a contrarian move, as many investors were avoiding junk bonds after the market had collapsed in the late 1980s. Buffett, however, understood that not all junk bonds were truly “junk.” In his 1990 Letter to Shareholders, he explained his rationale, stating that RJR had added significant equity and was being run well, making its bonds a far better credit risk than the market believed.

The Outcome: A Rapid 34% Return

Buffett’s thesis was proven correct in 1991, when KKR redeemed all of RJR Nabisco’s junk bonds at face value. This redemption resulted in an immediate 34% return for Berkshire Hathaway, generating $150 million in profit in less than two years.

The timing of the trade was perfect, as Buffett had bought into the bonds at a discount and exited at full value. This investment was a textbook example of Buffett’s ability to capitalize on market inefficiencies and investor fear.

Why Buffett Avoided Long-Term Tobacco Investments

Despite profiting from RJR on two occasions, Buffett has largely avoided direct investments in the tobacco industry. While he acknowledges the economic advantages of tobacco businesses—high margins, addictive products, and strong brand loyalty—he has consistently voiced ethical and regulatory concerns.

At the 1997 Berkshire Hathaway annual meeting, Buffett explained that while he had been offered the opportunity to buy a chewing tobacco company, he turned it down. Charlie Munger added, "It wasn't because we thought it wouldn't do well. We knew it was going to do well." However, they were reluctant to be associated with a product that had significant social and legal risks.

This cautious stance has remained consistent over the years. Buffett prefers businesses that he can own indefinitely, and the tobacco industry’s increasing regulatory challenges and public scrutiny made it a sector he was unwilling to commit to long term.

Conclusion: Buffett’s Strategic Play on RJR Nabisco

Buffett’s involvement with RJR showcases his flexibility and willingness to invest in mispriced opportunities, even in industries he generally avoids.

In 1980, he saw a company trading far below its intrinsic value and made a solid return before exiting in 1984. In 1989, he identified a distressed debt opportunity in RJR Nabisco’s junk bonds, securing a 34% gain in just two years.

While he never became a long-term investor in the tobacco industry, his ability to separate emotions from market realities allowed him to make two highly profitable investments in RJR. His story with RJR remains a powerful example of how deep value, market mispricing, and a disciplined approach to risk can lead to exceptional returns.

The information is provided for educational purposes only and does not constitute financial advice or recommendation and should not be considered as such. Do your own research.