(FORTUNE Magazine) – THE TOBACCO industry. What a strange place for corporate America to fight out the nature of its future. Who could imagine such a clear, almost ideological clash of strategies? Such strikingly divergent views of management's mission? In one scary, soaring fortnight Hamish Maxwell, head of Philip Morris, and F. Ross Johnson, his counterpart at RJR Nabisco, set off what promise to be the biggest deals so far: Maxwell's surprise, $11.5 billion offer for Kraft provoked an equally surprising counteroffer; the Chicago cheesemaker said it would spend $14 billion to escape takeover by recapitalizing. Then Johnson's proposal to take his company private in a $17.6 billion leveraged buyout brought on a bid by Kohlberg Kravis Roberts & Co. to do the job for an amazing $20.6 billion. It's enough to put Chevron's 1984 takeover of Gulf -- for a paltry $13.3 billion -- in the shade. Also to leave many a chief executive worrying about the future of his company. Both Philip Morris and RJR have faced identical problems. They could not get the investing public to bid up the price of their stocks to the level normally accorded companies as lushly profitable as theirs. The main reason: Most of those profits waft up from the tobacco business, nobody's sunrise industry. But what different solutions the two have hit upon. The question now: Whose strategy is best for shareholders? Philip Morris, a tobacco, food, and beer vendor with sales last year of $22 billion, is offering $90 a share for Kraft, a fluffy 23 times earnings and a 50% premium over market value on the day of the offering. If successful -- and Kraft obviously has other ideas -- the move would further insulate Philip Morris shareholders from the perceived dangers of the tobacco business and let them reap profits from such valuable brand names as Velveeta, Breyers, and Seven Seas. The deal would put Philip Morris on a level with Nestle and Unilever as global marketers, and further shield it, with size and debt, from takeover. RJR, too, has been pitching hard to get value for its shareholders. The cookie and tobacco combine (1987 sales: $16 billion) bought back some 25 million shares over the past year but has been unable to get a rise out of its stock. Lamented Johnson in a recent interview with FORTUNE: ''We can do something about how we run our business, but we can't do anything about the stock market.'' Now he has finally found somebody willing to pay up for the tobacco business's robust earnings: himself, with help from the investment bankers at Shearson Lehman Hutton and Salomon Brothers. Indeed, Johnson's bid flushed out a couple of bidders willing to pay even more than he thought the company worth -- namely, Henry Kravis and George Roberts, masters of the LBO game. SUPPOSE THAT once a year $1 billion piled up outside your doorstep like a heavy snowfall, and you had to shovel it into investments on somebody else's behalf. For a while now, RJR and Philip Morris have been wrestling with this kind of weight, a monetary downpour that security analysts call free cash flow -- by one definition, the amount of money left over after the company spends for new plants, dividends, taxes, and interest. The tobacco companies have become so efficient at making cigarettes that they can't reinvest much in their basic business. Philip Morris's operations are throwing off cash at a rate of over $1 billion a year, according to Emanuel Goldman, a Paine Webber security analyst. By borrowing $12 billion to buy Kraft, Philip Morris has in effect found a home for its free cash flow for the next few years. Maxwell lusts after Kraft's well-known brands and their potential. In Marlboro, Philip Morris owns the world's most successful brand of cigarettes, accounting for 62% of the company's tobacco sales. There seems to be a growing feeling among marketers today that brands, much like energy, can be neither created nor destroyed, at least not easily. The evidence -- a mortality rate among new brands approximating that of the Battle of the Somme -- is enough to convince even the most innovative manager that acquisition is safer than creation. This rationale spurred Philip Morris to acquire General Foods in 1985. The enterprise that Philip Morris paid $5.6 billion for then is now worth about $10 billion because it has grown and the stock market places higher valuations on food companies these days. That is good performance on Philip Morris's investment, but by no means great. The tobacco company sees itself in a position to build Kraft's businesses and increase profits through the magic of synergy. While they don't compete with each other, General Foods and Kraft both distribute refrigerated products: in Kraft's case, dairy goods; in General Foods' case, meat for its Oscar Mayer division. Another possible synergy comes from global marketing might. Philip Morris is already the largest advertiser in the U.S., and with Kraft aboard could use that clout to expand its shelf space on several continents.

Still, many security analysts aren't buying Maxwell's rationale. ''It's the wearing of the purple'' -- as in imperial -- says William P. Frankenhoff, a partner in Combined Capital Management, an investment firm. ''It's strictly a defensive move and not to the benefit of the shareholders. Kraft has good quality earnings, but so do Treasury bills.'' Even if Philip Morris could capture its prey at the original $90-a-share offer, it would be paying $11.5 billion for a company with operating earnings of $910 million last year (on sales of $11 billion). That's an implied return on investment of only about 8% (before interest and taxes). And now comes Kraft's recapitalization plan, which would let Kraft stockholders keep their existing shares while giving them a dividend of cash and junk bonds that the company values at $110 a share. Kraft Chairman John Richman has let Maxwell know that if Philip Morris wants to talk deal, he had . better start talking at that level. John McMillan of Prudential-Bache Securities comments on how Philip Morris stockholders would come out of the deal: ''You'd better not be a smoker, or you may not see the return.'' Adds Kenneth Heebner of Loomis-Sayles, a Boston mutual fund operator: ''As a shareholder I think it stinks.'' THE LETTERS L, B, and O started lighting up in Ross Johnson's head some time after Labor Day. Since he became chief executive in 1987, Johnson has struggled with two problems. The first was the need to bring order to a company that had diversified into consumer products, but without a consistent strategy. Second, he faced the old bugbear of getting some value for the tobacco earnings. By the middle of 1988 Johnson had the first problem figured out: He had sold off more than 30 businesses and fashioned a clearly identifiable food and tobacco company. The second problem proved more nettlesome. RJR had looked into spinning tobacco off into a master limited partnership in 1987, but Johnson concluded that ''no one was going to pay us for our earnings'' from those bad, bad cigarettes. A truly sophisticated set of investors -- like RJR's management -- would recognize that the risks of running a tobacco business are, believe it or not, lower now than they used to be. Since the cigarette business emerged unscathed from the latest round of product-liability lawsuits, RJR's cash flow from tobacco may be less threatened than at any time in recent history. And with the introduction of Premier, RJR's ''clean smoke,'' the company has launched an arguably safer line of cigarettes that Johnson believes could revolutionize the industry, even though initial sales are lackluster. The diminishing risks to cash flow made an LBO, by its nature a cash gobbler, all the more feasible. It also allowed Johnson to make a generous offer to the shareholders: On the day of the announcement, RJR Nabisco's share price rocketed $21 to $77. Ross Johnson probably understands the value of brands just as well as Hamish Maxwell, but he would as soon eat cigarettes for breakfast as pay 25 times earnings for anything. RJR passed on all the Beatrice companies put up for sale by KKR and Donald Kelly. Johnson was not impressed by the $1.2 billion Joseph E. Seagram & Sons paid for Tropicana Products Inc. ''We looked it over and saw a good company and good management. We asked ourselves what were we going to add to it to make the number work.'' Not enough. Johnson has never been one to stand in the way of buyers who see more value in RJR's assets than he does. That's why he sold Heublein, his liquor company, to Grand Metropolitan a mere ten days after Heublein acquired Almaden Vineyards. BY LAST MONTH the timing for an LBO had become perfect. Grand Met's offer for Pillsbury in early October was the first drop of blood in the water, and soon the feeding frenzy for food companies began in earnest. Johnson has shown great timing, selling Nabisco to RJR during an earlier frenzy. On Wednesday, October 19, Johnson told his board he wanted to do a deal and began lining up financing. He insisted that the directors attach a $75-a-share price on the deal when they issued a press release announcing a possible LBO. ''Ross wanted to establish a floor and let the market take it from there,'' says an RJR executive. Soon after RJR's announcement, Henry Kravis was negotiating with Shearson Chairman Peter Cohen about taking a piece of the deal. Since KKR is the biggest name in the business, with $40 billion available for such transactions, Kravis wanted in on the biggest LBO ever. No one was going to eat KKR's lunch, so he raised the price of the meal.

KKR's offer to take RJR Nabisco private for $90 a share shocked the Johnson gang. While Johnson never expected the $75 price to hold, he didn't anticipate a $90 nosebleed. The deal offered by RJR's management had been predicated on selling most of the food companies at deliciously high prices, keeping perhaps a few morsels. By holding on to some of the food businesses for a while, Johnson would maintain a higher cash flow than if he pared down all the way to cigarettes. The higher price triggered by KKR is apt to mean that more businesses will have to be sold, and that the prices they command had better be good. In other words, less margin for error. Leveraged buyouts haven't always been this risky. The idea, developed by Jerome Kohlberg Jr. when he was still an investment banker at Bear Stearns in the early Seventies, is to buy a company with borrowed money, often using the company's assets as collateral. The company's cash flow goes to pay the interest, and the principal is typically paid down by selling off some of the assets. The operating magic in an LBO comes from making the existing management into owner-managers. The pressure for cash flow invariably means the business must be made to run more efficiently, and it usually is, albeit with layoffs and other forms of cost cutting. The owners hope eventually to make big profits, sometimes by selling the business back to the public. UP UNTIL NOW, nobody seriously proposed doing an LBO on a company the size of RJR Nabisco -- and the very sight of it is causing shudders. A skeptic about the gargantuan deals, Leo Keevican Jr. of Doepken Keevican & Weiss, an LBO firm in Pittsburgh, says, ''It's like aerodynamics -- some things fly at 150 miles per hour that might not at 1,500 miles per hour.'' And the cost of the deals. Let's say this slowly: two hundred and fifty billion dollars. That's the amount of cash estimated to be out there ready to finance buyouts. With that kind of money chasing a limited number of objects, the prices being paid inevitably rise. With the concrete of equity replaced by the paperboard of debt, many a house may not last through the next storm. At least that is the chief worry of some lenders. ''A number of companies have overleveraged,'' says Irwin Engelman, president of Citytrust Bancorp in Bridgeport, Connecticut, and the former chief financial officer of General Foods. ''Those in cyclical industries will be in trouble in the next recession.'' The big unknown is when the next downturn will begin. If it's three years from now, most of today's LBOs should be out of danger. If it's next year and -- perish the thought -- is sparked by the Fed's pushing up interest rates to control inflation, all hell could break loose. One sure loser so far is the federal government. RJR, for instance, paid $370 million in corporate taxes last year; Kraft paid $254 million. Those payments will likely drop to zero next year as earnings disappear under an avalanche of debt. The companies currently going through LBOs or otherwise leveraging up with debt represent over 1% of all corporate taxes paid to Uncle Sam. Federal Reserve Chairman Alan Greenspan has become so worried about the debt that he has floated the idea of changing the tax laws to discourage highly leveraged transactions. Nor do all CEOs greet the LBO trend with unalloyed glee. David Roderick, the gruff chairman of USX, fears for U.S. manufacturing productivity. Says he: ''Is it desirable in a competitive world, where we are fighting for our manufacturing lives? The answer is no. It's going to make us progressively less competitive in those sectors that are being taken over with the use of debt.'' RJR planned to spend $4 billion over the next several years on productivity improvements, mostly on its food businesses. Now it's less likely that those dollars will ever reach the factory floor. Whether the buyers of the food companies will have that kind of money to spend, no one knows. But what if you don't do that LBO? Look at Kraft. What does one call a company that takes a balanced view toward short- and long-term objectives, has low debt, high-quality earnings, a double-digit price/earnings ratio, and wholesome products well positioned in the market? You call it history if Philip Morris has its way. The prospect leaves many CEOs scratching their heads as to exactly what their strategy should be. FOR SHAREHOLDERS one thing is clear: You would have been better off to own RJR than Philip Morris. If you had invested the same amount in both shares ten years ago, Johnson's move has suddenly made your stake in RJR worth nearly 40% more than your piece of Philip Morris. Another difference: In the buyout, RJR's shareholders will cash out, and then can make their own decisions about diversifying their risks. Philip Morris shareholders will still have Hamish Maxwell doing it for them. Unless . . . A successful LBO deal for RJR would put Philip Morris and other big companies like it in a new light. The purpose of the public markets is to raise capital for corporations that need it to grow. As a noncyclical, brand- name marketer with huge positive cash flow, Philip Morris -- and perhaps a host of others -- doesn't fit that bill any longer. It is, instead, a beguilingly attractive candidate for a leveraged buyout. Press your ear to Wall Street. The analysts are saying a price of $140 a share doesn't seem unreasonable.

CHART: NOT AVAILABLE CREDIT:NO CREDIT CAPTION: HOW A $100 INVESTMENT GREW Philip Morris and RJR Nabisco were running neck and neck on total return to investors until Ross Johnson made his bold move. DESCRIPTION: Color.