The New Tycoons

by Jason Kelly

  The traditions of the Smith dinner call for the speaker to deliver a humorous talk, roasting some of the luminaries in the room, including the guest of honor. Schwarzman, who’d worked with his staff, an outside speechwriter, and his wife to draft his remarks, didn’t disappoint. He skewered Moynihan by equating Bank of America with his brother’s orphanage in Haiti (“Their parents must be so proud to have two sons each running an underfunded non-profit institution”); referenced disgraced Governor Eliot Spitzer’s sexual indiscretions; and proposed a merger between Catholicism and Judaism.

  He referenced his own philanthropy, alluding to his New York Public Library donation. “Through Blackstone’s growth and successes, I’ve remained a regular, down-to-earth, guy,” he said. “For example, like a lot of folks, if I want a book, I’ll go to my local library, check out the book, and leave my name . . . carved into marble at the entrances to the building.”

  He didn’t spare himself, making a well-received joke at the outset about his much-talked about sixtieth birthday party, “I look around at this audience: hundreds of New York’s most powerful people, dressed to the nines, all in one room—and I think to myself: Is it my birthday again already?” The audience largely missed some of the wonkier private-equity and hedge fund jokes—Schwarzman attempted a joke that equated breaking bread with breaking up underperforming companies—but roared at the broader Wall Street-focused humor, including a timely reference to the protesters gathered just a few miles downtown, who had marched outside a number of high-powered apartment buildings including Schwarzman’s, under the aegis of the Occupy Wall Street movement. He went through the necessary thanks and recognitions about the dinner, then quipped, “or as I call it, Occupy Waldorf.”

  After the speech, Schwarzman stepped down into the ballroom from the stage to chat with well-wishers and receive congratulations. While most of the dignitaries departed quickly (the titular host of the evening, New York Archbishop Timothy Dolan, gave a quick benediction to close the ceremony and excused himself to catch the end of a game featuring his beloved St. Louis Cardinals in the World Series), Schwarzman stayed until the room was almost empty, basking in the afterglow of what he knew was a successful speech.

  Congratulated on the Moynihan joke, which as the comedians say, killed, he said he might have to place an apologetic call the following day. “I’m going to pay for that,” he joked, noting that Blackstone is a large customer of Bank of America.

  This is Schwarzman. He has a devilish streak to him and gives the distinct impression that he sometimes just can’t help himself. He carries himself with the demeanor of a man who can’t quite believe this is all happening and, to Hill’s point, that it could all disappear. The joke on himself about the birthday party was something of a seminal moment, showing that he finally was able to publicly laugh about it. For several years after the actual event, he was alternately befuddled by the attendant hoopla and defiant about his choice to throw the party in the first place.

  He told Stewart in the New Yorker profile titled “The Birthday Party” that part of what drove him, including throwing the bash, was a rare protein deficiency that’s potentially fatal, and for which he’s tested every few weeks. “We have limited time, and we have to maximize it. Live life intensely—I’ve always believed in that,” he was quoted as saying. “I’m happy to be here. I was happy to make it to 60. That’s the simple reason for the birthday party.”7

  Much to Schwarzman and Blackstone’s public relations team’s chagrin, the party has become an emblem for excess, shorthand for what’s wrong with private equity and Wall Street and its highest-profile and best-paid practitioners. It is difficult to have a conversation about the LBO boom, or the perception of private equity, without someone uttering the phrase “the birthday party,” with something ranging from a smirk to a scowl. Most people don’t even mention Schwarzman’s name, but the details—a black-tie affair at the Park Avenue Armory in midtown Manhattan, replicating part of his apartment in the cavernous space, including a portrait of himself; the performances by Rod Stewart, Patti LaBelle, and Marvin Hamlisch—all are well-documented. What rankles Schwarzman and his defenders is that it’s far from the only party of its type in the annals of private equity. TPG’s Bonderman had thrown himself a sixtieth birthday blowout five years earlier, in Las Vegas, with the Rolling Stones as the entertainment. In 2011, Apollo’s Leon Black threw a lavish sixtieth in the Hamptons featuring Elton John. A New York Times article about that event in part presented the party as a compare-and-contrast to Schwarzman’s.8 It seems all private-equity sixtieths, before and after, will be judged against Steve Schwarzman’s.

  While Schwarzman remains inextricably tied to the firm in economics and the public imagination, he did something few of his peers were willing or able to do: He began the process of replacing himself. Tony James’s arrival in 2002 portended a radical acceleration in Blackstone’s business.

  James practically oozes the languid confidence of a modern Wall Street man, with the requisite dark suit and expensive shoes. His lanky frame and his relaxed demeanor are a counterpoint to the shorter and wired Schwarzman. Part of Schwarzman’s charm is the uncertainty about what may come out of his mouth next. James gives the appearance of being almost preternaturally controlled. He inspires fierce loyalty among those around him, an admiration that comes with a healthy dose of fear, according to those who’ve worked with him before. He is an unrelenting worker himself, as evidenced by his habits. Leaving the office after a dinner one night at 9 p.m. with a bagful of reading material, he admitted that he would go home and read until he fell asleep, then naturally wake up around 3a.m. to continue reading and responding to e-mail. After an hour or so of that, he’d catch another few hours, then head into the office.

  One striking thing about James’s work habits and his drive at Blackstone is the fact that he was already rich and accomplished before Schwarzman came calling. James worked at Donaldson, Lufkin & Jenrette for more than a decade, ultimately running that firm’s investment banking operations and helping engineer its sale to what was then known as Credit Suisse First Boston in 2000.

  “Wall Street doesn’t have a surplus of people with a sophisticated understanding of financial markets who are also good managers,” Peterson said. “This is because investment bankers often tend to be high on the short-term chase of getting deals and not to be focused on building the firm and its culture over the long term. Finding Tony and hiring him was a seminal moment.”

  With Schwarzman plying him with a chunk of Blackstone (James owns about 5 percent of the firm) and the chance for an encore on a potentially even bigger stage, James jumped. Within Blackstone, he emphasized some elements of DLJ’s near-legendary and increasingly foreign to Wall Street focus on culture and teamwork. He didn’t initially find fertile ground, given Blackstone’s heritage as a deal shop with lots of egos and competing interests. James brought in elements like 360-degree feedback and formalized reporting structures.

  To replicate the DLJ culture, he hired people he knew from there, including Garrett Moran, who served for a time as Blackstone’s chief administrative officer, and Joan Solotar, a former DLJ research analyst who had gone on to run research at Bank of America. As the head of all of Blackstone’s public markets activities and a member of the executive committee, she is among the highest-ranking woman in private equity. A DLJ founder, Richard Jenrette, sits on Blackstone’s board, one of four independent directors on a board that also includes Harvard Business School’s Jay Light, former Canadian Prime Minister Brian Mulroney, and former Deloitte Touche Tohmatusu CEO William Parrett. Schwarzman, James, Tom Hill, and Jonathan Gray are the four Blackstone directors.

  James’s biggest DLJ alumni recruitment doubled as Blackstone’s biggest bet during the last decade, and it was not leveraged buyout but a deal for itself. In early 2008, James convinced a skeptical Schwarzman that the best way to grow Blackstone’s then-small credit business—the unit that bought debt and provided so-called mezzanine loa
ns to companies—was to make an acquisition, something Blackstone had never done in any sort of scale. The world was a mess. The leveraged buyout boom had collapsed in the summer of 2007 and Blackstone and its peers were staring nervously at both deals that hadn’t been closed, and maybe more nervously at the ones that had. Blackstone had, after all, agreed to buy Hilton the previous June for $20 billion, weeks ahead of the credit markets freezing.

  This was the best time, James argued, to boost the firm’s ability to invest in and around troubled credit. He proposed an acquisition of GSO Capital, an independent firm that had spun out of CSFB after the DLJ acquisition. Bennett Goodman, Tripp Smith, and Douglas Ostrover (the G, S, and O) agreed to be bought for upwards of $900 million, instantly adding about $10 billion in assets to Blackstone’s credit portfolio.

  James, while overseeing the likes of GSO, the advisory business that includes both mergers and restructuring advice, real estate, and the hedge fund group, remained a private-equity guy at heart. Until 2011, he was the de facto head of that business. That year, he installed Chinh Chu and David Blitzer as co-chairmen of private equity. James’s willingness to delegate more of the private-equity oversight may signal how much Blackstone has evolved from a dealmaking firm that does some other things to a much more broadly based asset management firm.

  James is officially designated as Schwarzman’s successor, a point spelled out for investors when the firm went public. The clear line gives both private and public investors some measure of comfort, especially in contrast to Carlyle and KKR, which have made no such designations. Still, it’s possible that Schwarzman will last longer than James, in part because, as one observer says, “Blackstone is Steve’s life.”

  Not so for James, who can’t imagine going the Pete Peterson route and staying at Blackstone until he’s 80, which Schwarzman is likely to do, in some form or another. That’s in part due to Schwarzman’s statesman ambitions. Blackstone gives him the infrastructure to both gather the intelligence he needs to form his opinions, and the stage from which to deliver those pronouncements. Having James run the show allows Schwarzman to experiment with things like his own geography. In late 2010, Schwarzman and his wife temporarily relocated to an apartment in Paris from New York, in part to deal with Schwarzman’s Asia and Middle East-heavy travel schedule.

  So who will eventually run the show?

  Jon Gray was a young Blackstone analyst in the early 1990s, a freshly minted graduate from the University of Pennsylvania with bachelor’s degrees in English literature and business. Blackstone was still relatively tiny then, with a couple of dozen employees, and while it had a small private-equity fund, working in that business was a mix of investment banking and investing as the firm split its time advising companies on deals and looking for its own.

  Gray liked the looking for and doing deals part and was asked to work on the private placement memo for a new fund dedicated to real estate. Schwarzman and Peterson initially created real estate as a joint venture, its M.O. for businesses beyond M&A advice and LBOs in those days. The partner for real estate was a fellow named John Schreiber, an already-seasoned hand in the business who could help the nascent Blackstone with credibility.

  A few analysts, including Gray and Blitzer, were summoned to assist Schreiber. The first fund was described as a $330 million pool, which technically overstated it by two-thirds. Only $110 million was committed to the discretionary pool. The balance was committed as co-investment dollars by investors in the fund, meaning they would have a say as to which deals they did and didn’t commit to.

  It was an unqualified success on a financial basis, with a net average annual return of 39.7 percent and a multiple of invested capital of 2.4 times, according to a document created to pitch the latest fund to pensions. Blackstone would go on to raise increasingly bigger funds every three to four years until 2006 and 2007, when it raised a fund each year.

  There at the creation, Gray two decades later is the head of Blackstone’s real estate business and has led the firm’s two largest deals of all time, the purchases of Equity Office Properties and Hilton Hotels. The renovation of Blackstone’s offices in 2010 and 2011 elevated Gray literally and figuratively. He occupies a corner office with northwestern views of Manhattan, pictures of his wife and four daughters lining the windowsills. He holds meetings in an adjacent living-room-like setting with couches and chairs in place of the traditional conference table.

  Unlike private equity, which proved in the LBO bust that it may be scalable only to a certain point, real estate appears to have room to grow, and Blackstone’s ability to raise a new real estate fund bears that out. Unlike private equity, where Schwarzman’s sixth fund was about 40 percent smaller than his fifth, the seventh real estate fund stands to collect more than its most recent $10 billion predecessor.

  Blackstone’s main brand of real estate investing has roughly the same economics as its private-equity business, which makes sense, since the leveraged buyout industry lifted its model from existing partnerships like real estate and oil and gas. While doing it well and lucratively is far from easy, the underlying premise is relatively simple. Just as in leveraged buyouts, borrowed money is the key to success. Blackstone’s twist was to come at real estate in part from a private-equity perspective, using some tools in the financial arsenal to make even better deals on the front end to maximize profits.

  The approach through the 1990s was relatively straightforward. Blackstone would pool money and use some of the fund’s cash, along with bank loans and bonds, to buy real estate assets they had decided were undervalued, do some amount of work to them, and sell them as real estate values rose. The breakthrough started right after the turn of the century, when Gray and his group started investing in the so-called extended stay hotel business. These are hotels designed as “suites” for longer-duration visits, often for traveling sales reps. Blackstone bought Homestead Studio Suites, one such chain, right after the September 11 terrorist attacks.

  As that investment gained in value, Blackstone looked around for more, and some key things happened. First, Gray’s team took advantage of an increasingly friendly and more creative debt financing market. They sought bigger targets by using forms of debt not typically used in these types of deals, specifically commercial mortgage backed securities (CMBS) and so-called mezzanine loans, a riskier type of borrowing.

  Blackstone was willing to put additional risk on the deals because of the second realization tied to its extended stay forays. Big publicly listed hospitality companies were trading at values Gray believed were less than the sum of their parts. With that in mind, Blackstone bought Prime Hospitality for $790 million in 2004, then turned around and sold Prime’s AmeriSuites hotels for $600 million to Hyatt later that same year. “I’d bought a fruit basket,” Gray said. “Then I sold the pears to the guys who really wanted pears, and so on.”

  The template was set: Gray tapped banks for CMBS and started shopping for fruit baskets. Blackstone went on to create the same trade, with minor variations, almost a dozen times over the next three years. The strategy culminated with the then record-setting $40 billion purchase of Equity Office Properties in 2007, when Gray basically bought the fruit basket and started hawking fruit almost instantly. Deals for pieces of the sprawling Equity Office empire were announced within days—all told, Blackstone sold $27 billion worth of properties.

  The Equity Office transaction stands as Blackstone’s biggest in its history. The second-biggest also belongs to Gray: the $20 billion takeover of Hilton Hotels announced just as the credit markets seized. Announced on July 3, 2007 (within hours of KKR’s first filing for its long-delayed IPO), the Hilton deal in retrospect marked the end of an era. Given its profile and timing, it may stand as a defining deal for Gray and Blackstone.

  While the price tag in 2007 was borderline pedestrian (after all, it stands as only the eleventh-biggest LBO in history). It involved a huge bet by Blackstone with an equity check of $5.7 billion, split between real estate and privat
e-equity funds; Blackstone added $800 million more around Hilton’s debt restructuring. Beyond that, the timing of the purchase and the notoriety of the target ensured that it would be a high-profile deal.

  In the intervening years, Gray told anyone who’d listen that Hilton would turn out to not just be a good deal, but a great one, and he presses the case that it proves private equity can grow a business. Chris Nassetta, who was recruited by Gray to run Hilton after the purchase, is an unabashed fan of both Gray and Blackstone. Nassetta, a longtime hotel executive, had met Gray on his second day at Blackstone, back in the early 1990s. He knew John Schreiber from the board of directors of Host Marriott, where Nassetta served as CEO prior to being recruited to Hilton. “You want to keep up with them,” Nassetta said. “You want to run with the horses.”

  Gray wooed Nassetta to Hilton on the basis of the opportunity. “It was a sleeping giant,” Nassetta told me. “This sort of deal allows you to reboot the company’s hard drive, to really ask yourself what it should be.”

  Nassetta replaced more than half of the company’s top 100 managers and turned his focus to the international markets, where the Hilton brand was known, but without having a significant number of actual hotels. The percentage of Hilton’s hotels under construction that are outside the U.S. increased to almost 80 percent in 2012 from roughly 11 percent at the time of acquisition.

  The growth of the real estate business within Blackstone seems instructive as to the mindset of the firm—Schwarzman’s idea, relentlessly executed. Timing and luck played a role. After growing steadily for 15 years, Blackstone was able to seize on the financial crisis to its great advantage, exploiting the relative weakness of its biggest competitors—in-house real estate arms of investment banks—to create what in 2011 looked like an insurmountable lead over its private-equity competitors, at least in terms of assets under management and scope of the business. Asked on a 2011 investor call about the chances a competitor could raise a $10 billion real estate fund in 2011, James said: “I think the only one who has a shot at it is us.”