The New Tycoons: Inside the Trillion Dollar Private Equity Industry That Owns Everything (Bloomberg)

by Jason Kelly

  By the first quarter of 2012, Blackstone had already raised $10 billion, and had set its sights on $2 billion more.9 As the size of private-equity funds contracted, real estate was expanding.

  That boded well for Gray’s stature within the firm and he has emerged as a likely heir to Schwarzman’s seat. Already a member of the management committee, he was named to Blackstone’s board of directors in 2012.

  Credit was a business Blackstone had dabbled in, but it took the GSO deal, the first acquisition for the firm after the IPO, to cement it as a legitimate leg of the strategy. Probably because it was not born of Blackstone, GSO feels the most distinct in terms of style and culture. By some combination of circumstance and desire, GSO was able to keep its offices a couple of buildings down Park Avenue from headquarters for several years. The differences were subtle, but the kind that end up feeling important—GSO executives only put on ties when they have a meeting with Tony or Steve. They relished their relative independence.

  GSO has emerged as one of the most acquisitive branches of Blackstone, growing both by attracting new investors as well as snapping up CLOs (credit loan obligation funds) cast off by other asset managers. Goodman, given his longstanding relationship with James and the success of the business before and after the acquisition, has taken on a prominent role within the firm. His name is mentioned along with Gray’s as a potential someday CEO.

  If growth in credit and real estate were somewhat predictable, less so was the rise of Tom Hill’s group. Now formally known as Hedge Fund Solutions, what began as a side project to invest partners’ money has grown into Blackstone’s largest business by assets and the biggest business of its kind in the world. Hill bristles at the term fund-of-funds because he says it understates what his group actually does for its clients, which is a more bespoke approach to hedge funds.

  That Hill should be in this position is remarkable, or at least unlikely. His relationship with Schwarzman dates back to before their days working at Lehman together. As very young men, the two were assigned to the same Army reserves unit in New York, a dentistry detail. After earning an undergraduate degree and an MBA from Harvard, Hill was an early mover in the mergers and acquisitions business, helping create the M&A department at First Boston. His path crossed more meaningfully with Schwarzman and Peterson when he joined Lehman in 1982 as a partner, later rising to run investment banking there and serve as co-CEO. After the firm was sold (and Peterson and Schwarzman left), Hill was the co-president and co-chief operating officer of the new Shearson Lehman Holding Company.

  After he was ousted from the firm, Hill continued his investment banking career by reuniting with his two former partners at Blackstone in 1993, serving as the co-head of the corporate and M&A advisory business through the balance of that decade. Then Schwarzman asked him to step in to figure out the then-tiny hedge fund business. During a call with investors in 2011, Schwarzman noted that the business had grown by about 80 times since he asked Hill to take it over in 2001.

  Initially, Schwarzman asked Hill to conduct a search for a new person to run what was then known as Blackstone Alternative Asset Management, or BAAM. He gave him six months. After three, Hill realized it could be a big business and told his boss so. Schwarzman asked Hill if he wanted to just run it himself.

  Hill, with his Harvard credentials and Lehman pedigree, looks the part of an investment banker. There’s long been a rumor on Wall Street that at least the physical elements of the Gordon Gekko character in the seminal movie Wall Street were based on Hill, who is an impeccable dresser and slicks his hair back to this day. He has built a similarly pedigreed group—seeing them in a room is like walking into a living Brooks Brothers calendar—that is charged with taking big slugs of money for clients and picking hedge funds based on their appetite for risk. Blackstone has access to managers across the spectrum of hedge funds, from so-called macro funds to those who describe themselves as “event driven,” that is, focused on trades around something like a merger or acquisition.

  Blackstone’s hedge fund group has achieved such scale that it got into the business of helping start, or “seed,” other hedge funds. In those cases, Blackstone will give a new fund enough money to get started, in exchange for a cut of the fees and an equity stake in the management company of the fund. Blackstone then goes on to invest its clients’ money with those new funds.

  And then there’s the smallest Blackstone business, which happens to be the firm’s oldest: giving advice. Once headed by Tom Hill, it’s now run by former Morgan Stanley and HSBC banker John Studzinski, a colorful character (known within the firm and on Wall Street simply as “Studz”) who’s well known in London for his patronage of the arts and connections around the worlds of both finance and culture.

  While small relative to the massive investment banking operations of big Wall Street firms, Blackstone’s advisory group has managed to pull off some big assignments, including a key role advising insurer AIG on the disposal of its assets in the wake of the financial crisis.

  Within the context of the advisory business is another Blackstone effort that’s become a signature of the firm, the restructuring group headed by Timothy Coleman. The creation of that group was another hedge of sorts on Schwarzman and Peterson’s part and help put Blackstone in a business that blossomed in the wake of the credit meltdown. The group was created in the early 1990s by the late Arthur Newman, whom Schwarzman and Peterson had recruited as an early effort at diversifying what the firm could do for clients. Newman recruited Coleman, who later became his co-head and eventually took over the group upon Newman’s retirement (Coleman serves on the firm’s executive committee, an indication of its growing importance in the broader context of Blackstone).

  The group specializes in one of the more rough-and-tumble corners of Wall Street dealmaking: the fights between debtors and creditors as a company wrestles with how to fix a business or pursue bankruptcy. Blackstone’s team has emerged as one of a handful of specialty groups adept at these hairy situations, along with Houlihan Lokey, Moelis & Company, and Alvarez & Marsal. Coleman’s group has found a number of niches, including newspaper companies, gambling firms and, in 2011, began working with the Los Angeles Dodgers baseball team as it entered bankruptcy, triggered by the divorce of the McCourts, its then-owners. Coleman advised on the sale process, which culminated in a group led by former basketball star Magic Johnson buying the Dodgers for more than $2 billion.

  While parts of Blackstone, especially real estate and private equity, and Tom Hill, are strikingly similar in terms of personnel to what they were two decades ago, the firm also has the highest-profile alumni of any of its private-equity brethren. Blackstone is rare among the largest private-equity firms for having endured the departure of a founder and the hiring of a high-profile second-in-command as well as a host of notable departures. The turnover rate is cited by competitors as evidence that Blackstone is a tough place to work and Schwarzman an especially demanding boss. One person familiar with Blackstone told me it wasn’t a place you go for hugs. Firm insiders characterize turnover as evidence that Blackstone is a mature company.

  The “black” in BlackRock, the multi-trillion-dollar asset manager, is not a coincidence. That firm, run by Laurence Fink, started as an “affiliate” similar to John Schreiber’s real estate joint venture. Blackstone in 1988 staked what was then known as the Financial Management Group with a $5 million line of credit and office space in return for a 40 percent stake in the company. Six years later, after Fink and Schwarzman disagreed over how new hires at what became BlackRock should be given equity, the group spun out. PNC Bank bought BlackRock for $240 million.10 As of March 2012, the now-public BlackRock had $3.67 trillion in assets and a market capitalization of $30 billion, more than twice that of Blackstone.

  Roger Altman, the investment banker who has shuttled between jobs on Wall Street and in Washington and worked at Lehman Brothers with Peterson and Schwarzman, joined the pair in 1987 as vice chairman. He headed the firm’s adv
isory efforts and served on the investment committee until 1993, when he left to serve as President Clinton’s deputy Treasury secretary. Upon returning to New York, he created the investment banking boutique, Evercore.

  Mark Gallogly was an early Blackstone partner—he conducted Jon Gray’s on-campus interview at Penn—and left in 2005 to create Centerbridge Partners. That firm, which specializes in distressed financial and real estate deals, has remained close enough to Blackstone to partner on deals including BankUnited. Another partner, Chip Schorr, left in 2011 after overseeing the firm’s technology investments. He created a new firm as well, called Augusta Columbia Capital Group. Another tech specialist, Jamie Kiggen, departed in 2012 to become the president of Riverside Co., a private-equity firm that specializes in buying companies worth less than $200 million and describes itself as “more Gandhi than Gekko” on its website.

  Real estate, credit, and hedge funds at Blackstone dwarf private equity by most measures. Describing Blackstone as a buyout firm is insufficient. For marketing purposes, Blackstone refers to itself as “one of the world’s leading investment and advisory firms.” That lack of dependence on leveraged buyouts draws the most criticism from Blackstone’s private-equity brethren, who decry the firm as “asset collectors.”

  Inside Blackstone, from Schwarzman down, they tend to greet that moniker with some combination of a shrug and a chuckle. A Fortune story in 2011 was titled “The Triumph of Blackstone on Wall Street,” evidence that there’s a growing sense Blackstone got it right by downplaying private equity, or at least treating it as but one of a number of just-as-important businesses.

  One thing is clear: If this particular diversified model is the future of what began as private equity, Schwarzman got there first. In 2011, he tried to exploit his advantage, synthesizing Blackstone’s head start in diversifying with a drumbeat that was growing louder from investors. The deal with New Jersey’s pension plan, which came on the heels of the Texas teachers’ new arrangement with KKR and Apollo, was the first public indication of something that had been brewing inside Blackstone for much of that year, spurred largely by Schwarzman himself.

  Earlier that year, Schwarzman called a meeting of the entire firm and pressed each piece to talk about what they were seeing in the markets. He realized he was getting detailed analysis, the kind of insights the likes of Goldman Sachs had used to create its powerful and lucrative proprietary trading desk. Schwarzman was faced with a decision: use the firm’s money to trade on these ideas, or set up a new sort of business, or set of products, and start selling it to the biggest pools of capital in the world.

  The pitch to them is akin to what New Jersey is getting—the ability to more easily move money around to whatever Blackstone, in consultation with the client, decides is the best strategy for the current market or return expectation. In May 2012, CalPERS agreed to a similar separate account arrangement totaling $500 million.

  Since Blackstone wasn’t organized to manage big relationships in quite that way, Schwarzman and James appointed Blitzer, the private-equity co-chairman, to play the role of point man for the New Jersey deal.

  The set-up, Schwarzman said, has an added benefit for Blackstone: continuing to groom the younger partners and his and James’s successors. “In terms of integrated investors, that’s really been limited to me and Tony,” he said. No one else needed to think about what all the different pieces of the firm were doing unless they were directly involved. A real estate partner might tap a GSO executive for an insight into credit, and was encouraged to do so, but it was ad hoc. “This takes the next generation and gets them working together in a different way.”

  For his part, Schwarzman attributes his quest for the next product line to his investment banking days—the overall competitiveness among firms and the need to keep coming up with new products and services to offer corporate clients, whether it was stock and bond underwriting, merger advice, or the increasingly complex debt that defined Wall Street during the last two decades. He also saw waves of wanna-be bankers hang out shingles and be successful. “When you start out working in investment banking, you learn there are no barriers to entry in this business,” he said.

  Notes

  1. David Carey and John Morris, King of Capital (New York: Crown Business, 2012).

  2. Alex Pareene, “Billionaire Private Equity Mogul Will Get America Back to Work by Complaining about Government Spending,” Salon, September 12, 2011. www.salon.com/2011/09/12/schwarzman_dimwit/

  3. Matt Taibbi, “A Christmas Message from America’s Rich,” Rollingstone.com, December 22, 2011. www.rollingstone.com/politics/blogs/taibblog/a-christmas-message-from-americas-rich-20111222

  4. Jonathan Alter, “A ‘Fat Cat’ Strikes Back,” Newsweek, August 5, 2010. www.thedailybeast.com/newsweek/2010/08/15/schwarzman-it-s-a-war-between-obama-wall-st.html

  5. James B. Stewart, “The Birthday Party,” New Yorker, February 11, 2008.

  6. Steve Schwarzman, “An Olive Branch to Obama: I Will Share the Pain,” Financial Times, September 11, 2011. www.ft.com/cms/s/0/d5a798f8-db10-11e0-bbf4-00144feabdc0.html#axzz1rAzfYUue

  7. James B. Stewart, “The Birthday Party.”

  8. Peter Lattman, “Birthdays Are Still Big in Buyout Land,” New York Times Dealbook. August 18, 2011. http://dealbook.nytimes.com/2011/08/18/birthdays-are-still-big-in-buyout-land/

  9. Craig Karmin, “Blackstone Raises $10 Billion,” Wall Street Journal, February 24, 2012. http://online.wsj.com/article/SB10001424052970203960804577243352810410114.html

  10. Kambiz Foroohar and Bhaktavatsalam, “BlackRock Is Go-To Firm to Divine Wall Street Assets,” Bloomberg News, May 8, 2009.

  Chapter 12

  Not-So-Private Equity

  Out of the Shadows

  With the weight of its own secretive history bearing down, private equity is finally stepping out of the shadows. That’s how I ended up in Delaware City, Delaware, watching Tony James surrounded by politicians and workers in jumpsuits. It was October 2011, and the occasion was reopening a refinery owned by PBF Energy, a venture created and funded by Blackstone with private-equity energy specialist firm First Reserve. PBF bought the closed refinery in June 2010 from Valero, which had shuttered it a year earlier.

  The biggest private-equity firms are now very much in the public eye, and seeing James that day in Delaware was notable not so much for what he said, but that he or any top Blackstone or private-equity executive was even there.

  James was in charming PR mode, showing up for a Bloomberg Television interview scheduled around the reopening with a Fortune reporter in tow. The morning was well-scripted, evoking a stop on a campaign tour, a feeling enhanced by the half-dozen senior elected officials on the program. Under a white tent in the back parking lot, plant workers in jumpsuits and local executives munched on mini-quiches and cinnamon rolls. Small banners proclaiming “A New Beginning” and “Congratulations on a Job Well Done!” hung from one side of the tent.

  Blackstone and First Reserve pumped $450 million into updating the Delaware City facility and reopening it, returning 500 full-time jobs and 250 contract workers to the processing plant. This was big news for the area, and politician after politician took the stage to make sweeping pronouncements. “When a place like this shuts down,” said Chris Combs, Delaware’s junior U.S. Senator, “it leaves a hole. It’s like a punch in the gut to families.” Then he went even bigger. “We face a question: ‘Are we a great nation?’”

  Once James took the stage, after Coons, U.S. Senator Thomas Carper, and Governor Jack Markell, the Blackstone president echoed their grand sentiments and used the opportunity to make the case for private equity to the assembled media, refinery workers, and government officials with similarly elevated language. “This is the sort of partnership that should be a model for America,” he said, a winning applause line for the crowd that had dutifully given every speaker a standing ovation. “It takes a lot of money to save America’s industrial base.”

  After the speeches an
d the ribbon cutting, set on a patch of grass so as to use the soaring towers of the refinery as a backdrop, James milled about chatting with the plant bosses and politicians, as well as the designated union representative from the United Steelworkers. That friendly encounter was another twist in the day. Organized labor has long been a critic of private equity and remains one, given the industry’s reputation for cutting jobs, but here was a senior labor guy who’d flown all the way from Texas not to bury private equity, but to praise it.

  Gary Beevers, a Steelworkers vice president, was there because 350 of his “brothers and sisters in Steelworker blue” had been put back to work. During his brief speech, his gruff Texas baritone was a striking departure from the well-cadenced remarks of the politicians and moneymen, and he pointed out that private equity was, in this case, a good friend to organized labor. After the speech and the ceremonial ribbon cutting captured by a dozen local-media cameras, Beevers and I stepped to the side for a chat. When I asked if he wanted to sit down, he said he’d prefer to stand. He looked around and, with some relief, plucked a piece of Copenhagen from the round can in his pocket and talked private equity. He repeated what James had said during his remarks—that big oil had announced three refinery closures that very week, days away from this facility being officially reopened. At the end of the day, getting his members back to work was what he cared most about. “They got the financing for this when no one else could. What we worry about is long-term jobs. This is a group that provided them,” he said, pointing to the handful of workers still milling around after the event, “an opportunity to get back to work.”