Copyright © 2010 by David Carey and John E. Morris
All rights reserved.
Published in the United States by Crown Business, an imprint of the Crown Publishing Group, a division of Random House, Inc., New York.
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CROWN BUSINESS is a trademark and CROWN and the Rising Sun colophon are registered trademarks of Random House, Inc.
Library of Congress Cataloging-in-Publication Data
Carey, David (David Leonard), 1952–
King of capital / David Carey and John E. Morris. — 1st ed.
p. cm.
1. Blackstone Group. 2. Private equity. 3. Consolidation and merger of corporations. 4. Leveraged buyouts. 5. Financial services industry—United States. 6. Investment advisors—United States. I. Morris, John E., 1957– II. Title.
HG4571.C37 2010
338.8’3–dc22
2010018286
eISBN: 978-0-307-45301-3
v3.1
Dedicated to our parents, Robert B. and Elizabeth S. Morris and Miriam Carey Berry, and to the memory of Leonard A. Carey
CONTENTS
COVER
TITLE PAGE
COPYRIGHT
DEDICATION
CHAPTER 1: The Debutants
CHAPTER 2: Houdaille Magic, Lehman Angst
CHAPTER 3: The Drexel Decade
CHAPTER 4: Who Are You Guys?
CHAPTER 5: Right on Track
CHAPTER 6: Running Off the Rails
CHAPTER 7: Presenting the Steve Schwarzman Show
CHAPTER 8: End of an Era, Beginning of an Image Problem
CHAPTER 9: Fresh Faces
CHAPTER 10: The Divorces and a Battle of the Minds
CHAPTER 11: Hanging Out New Shingles
CHAPTER 12: Back in Business
CHAPTER 13: Tuning in Profits
CHAPTER 14: An Expensive Trip to Germany
CHAPTER 15: Ahead of the Curve
CHAPTER 16: Help Wanted
CHAPTER 17: Good Chemistry, Perfect Timing
CHAPTER 18: Cash Out, Ante Up Again
CHAPTER 19: Wanted: Public Investors
CHAPTER 20: Too Good to Be True
CHAPTER 21: Office Party
CHAPTER 22: Going Public—Very Public
CHAPTER 23: What Goes Up Must Come Down
CHAPTER 24: Paying the Piper
CHAPTER 25: Value Builders or Quick-Buck Artists?
CHAPTER 26: Follow the Money
ACKNOWLEDGMENTS
NOTES
ABOUT THE AUTHORS
CHAPTER 1
The Debutants
More Rumors About His Party Than About His Deals,” blared the front-page headline in the New York Times in late January 2007. It was a curtain-raiser for what was shaping up to be the social event of the season, if not the era. By then, the buzz had been building for weeks.
Stephen Schwarzman, cofounder of the Blackstone Group, the world’s largest private equity firm, was about to turn sixty and was planning a fête. The financier’s lavish holiday parties were already well known in Manhattan’s moneyed circles. One year Schwarzman and his wife decorated their twenty-four-room, two-floor spread in Park Avenue’s toniest apartment building to resemble Schwarzman’s favorite spot in St. Tropez, near their summer home on the French Riviera. For his birthday, he decided to top that, taking over the Park Avenue Armory, a fortified brick edifice that occupies a full square block amid the metropolis’s most expensive addresses.
On the night of February 13 limousines queued up and the boldface names in tuxedos and evening dresses poured out and filed past an encampment of reporters into the hangarlike armory. TV perennial Barbara Walters was there, Donald and Melania Trump, media diva Tina Brown, Cardinal Egan of the Archdiocese of New York, Sir Howard Stringer, the head of Sony, and a few hundred other luminaries, including the chief executives of some of the nation’s biggest banks: Jamie Dimon of JPMorgan Chase, Stanley O’Neal of Merrill Lynch, Lloyd Blankfein of Goldman Sachs, and Jimmy Cayne of Bear Stearns.
Inside the cavernous armory hung “a huge indoor canopy … with a darkened sky of sparkling stars suspended above a grand chandelier,” mimicking the living room in Schwarzman’s $30 million apartment nearby, the New York Post reported the next day. The decor was copied, the paper observed, “even down to a grandfather clock and Old Masters paintings on the wall.”
R&B star Patti LaBelle was on hand to sing “Happy Birthday.” Beneath an immense portrait of the financier—also a replica of one hanging in his apartment—the headliners, singer Rod Stewart and comic Martin Short, strutted and joked into the late hours. Schwarzman had chosen the armory, Short quipped, because it was more intimate than his apartment. Stewart alone was known to charge $1 million for such appearances.
The $3 million gala was a self-coronation for the brash new king of a new Gilded Age, an era when markets were flush and crazy wealth saturated Wall Street and especially the private equity realm, where Schwarzman held sway as the CEO of Blackstone Group.
As soon became clear, the birthday affair was merely a warm-up for a more extravagant coming-out bash: Blackstone’s initial public offering. By design or by luck, the splash of Schwarzman’s party magnified the awe and intrigue when Blackstone revealed its plan to go public five weeks later, on March 22. No other private equity firm of Blackstone’s size or stature had attempted such a feat, and Blackstone’s move made official what was already plain to the financial world: Private equity—the business of buying companies with an eye to selling them a few years later at a profit—had moved from the outskirts of the economy to its very center. Blackstone’s clout was so great and its prospects so promising that the Chinese government soon came knocking, asking to buy 10 percent of the company.
When Blackstone’s shares began trading on June 22 they soared from $31 to $38, as investors clamored to own a piece of the business. At the closing price, the company was worth a stunning $38 billion—one-third as much as Goldman Sachs, the undisputed leader among Wall Street investment banks.
Going public had laid bare the fantastic profits that Schwarzman’s company was throwing off. So astounding and sensitive were those figures that Blackstone had been reluctant to reveal them even to its own bankers, and it was not until a few weeks before the stock was offered to investors that Blackstone disclosed what its executives made. Blackstone had produced $2.3 billion of profits in 2006 for the firm’s sixty partners—a staggering $38 million apiece. Schwarzman personally had taken home $398 million that year.
That was just pay. The initial public offering, or IPO, yielded a second windfall for Schwarzman and his partners. Of the $7.1 billion Blackstone raised selling 23.6 percent of the company to public investors and the Chinese government, $4.1 billion went to the Blackstone partners themselves. Schwarzman personally collected $684 million selling a small fraction of his stake. His remaining shares were worth $9.4 billion, ensuring his place among the richest of the rich. Peter Peterson, Blackstone’s eighty-year-old, semiretired cofounder, garnered $1.9 billion.
The IPO took place amid a financial revolution in which Blackstone and a coterie of competitors were wresting control of corporations around the globe. The private equity, or leveraged buyout, industry was flexing its muscle on a scale not seen since the 1980s. Blackstone, Kohlberg Kravis Roberts and Company, Carlyle Group, Apollo Global Management, Texas Pacific Group, and a half-dozen others, backed by tens of billions of dollars from pension funds, u
niversity endowments, and other big investors, had been inching their way up the corporate ladder, taking over $10 billion companies, then $20 billion, $30 billion, and $40 billion companies. By 2007 private equity was behind one of every five mergers worldwide and there seemed to be no limit to its ambition. There was even talk that a buyout firm might swallow Home Depot for $100 billion.
Private equity now permeated the economy. You couldn’t purchase a ticket on Orbitz.com, visit a Madame Tussauds wax museum, or drink an Orangina without lining Blackstone’s pockets. If you bought coffee at Dunkin’ Donuts or a teddy bear at Toys “R” Us, slept on a Simmons mattress, skimmed the waves on a Sea-Doo jet ski, turned on a Grohe designer faucet, or purchased razor blades at a Boots pharmacy in London, some other buyout firm was benefiting. Blackstone alone owned all or part of fifty-one companies employing a half-million people and generating $171 billion in sales every year, putting it on a par with the tenth-largest corporation in the world.
The reach of private equity was all the more astonishing for the fact that these firms had tiny staffs and had long operated in the shadows, seldom speaking to the press or revealing details of their investments. Goldman Sachs had 30,500 employees and its profits were published every quarter. Blackstone, despite its vast industrial and real estate holdings, had a mere 1,000 employees and its books were private until it went public. Some of its competitors that controlled multibillion-dollar companies had only the sketchiest of websites.
Remarkably, Blackstone, Kohlberg Kravis, Carlyle, Apollo, TPG, and most other big private equity houses remained under the control of their founders, who still called the shots internally and, ultimately, at the companies they owned. Had there been any time since the robber barons of the nineteenth century when so much wealth and so many productive assets had come into the hands of so few?
Private equity’s power on Wall Street had never been greater. Where buyout firms had once been supplicants of the banks they relied on to finance their takeovers, the banks had grown addicted to the torrent of fees the firms were generating and now bent over backward to oblige the Blackstones of the world. In a telling episode in 2004, the investment arms of Credit Suisse First Boston and JPMorgan Chase, two of the world’s largest banks, made the mistake of outbidding Blackstone, Kohlberg Kravis, and TPG for an Irish drugmaker, Warner Chilcott. Outraged, Kohlberg Kravis cofounder Henry Kravis and TPG’s Jim Coulter read the banks the riot act. How dare they compete with their biggest clients! The drug takeover went through, but the banks got the message.
JPMorgan Chase soon shed the private equity subsidiary that had bid on the drug company and Credit Suisse barred its private equity group from competing for large companies of the sort that Blackstone, TPG, and Kohlberg Kravis target.
To some of Blackstone’s rivals, the public attention was nothing new. Kohlberg Kravis, known as KKR, had been in the public eye ever since the mid-1980s, when it bought familiar companies like the Safeway supermarket chain and Beatrice Companies, which made Tropicana juices and Sara Lee cakes. KKR came to epitomize that earlier era of frenzied takeovers with its audacious $31.3 billion buyout in 1988 of RJR Nabisco, the tobacco and food giant, after a heated bidding contest. That corporate mud wrestle was immortalized in the best-selling book Barbarians at the Gate and made Henry Kravis, KKR’s cofounder, a household name. Carlyle Group, another giant private equity firm, meanwhile, had made waves by hiring former president George H. W. Bush and former British prime minister John Major to help it bring in investors. Until Schwarzman’s party and Blackstone’s IPO shone a light on Blackstone, Schwarzman’s firm had been the quiet behemoth of the industry, and perhaps the greatest untold success story of Wall Street.
Schwarzman and Blackstone’s cofounder, Peterson, had arrived late to the game, in 1985, more than a decade after KKR and others had honed the art of the leveraged buyout: borrowing money to buy a company with only the company itself as collateral. By 2007 Schwarzman’s firm—and it had truly been his firm virtually from the start—had eclipsed its top competitors on every front. It was bigger than KKR and Carlyle, managing $88 billion of investors’ money, and had racked up higher returns on its buyout funds than most others. In addition to its mammoth portfolio of corporations, it controlled $100 billion worth of real estate and oversaw $50 billion invested in other firms’ hedge funds—investment categories in which its competitors merely dabbled. Alone among top buyout players, Blackstone also had elite teams of bankers who advised other companies on mergers and bankruptcies. Over twenty-two years, Schwarzman and Peterson had invented a fabulously profitable new form of Wall Street powerhouse whose array of investment and advisory services and financial standing rivaled those of the biggest investment banks.
Along the way, Blackstone had also been the launching pad for other luminaries of the corporate and financial worlds, including Henry Silverman, who as CEO of Cendant Corporation became one of corporate America’s most acquisitive empire builders, and Laurence Fink, the founder of BlackRock, Inc., a $3.2 trillion debt-investment colossus that originally was part of Blackstone before Fink and Schwarzman had a falling-out over money.
For all the power and wealth private equity firms had amassed, leveraged buyouts (LBOs or buyouts for short) had always been controversial, a lightning rod for anger over the effects of capitalism. As Blackstone and its peers gobbled up ever-bigger companies in 2006 and 2007, all the fears and criticisms that had dogged the buyout business since the 1980s resurfaced.
In part it was guilt by association. The industry had come of age in the heyday of corporate raiders, saber-rattling financiers who launched hostile takeover bids and worked to overthrow managements. Buyout firms rarely made hostile bids, preferring to strike deals with management before buying a company. But in many cases they swooped in to buy companies that were under siege and, once in control, they often laid off workers and broke companies into pieces just like the raiders. Thus they, too, came to be seen as “asset strippers” who attacked companies and feasted on their carcasses, selling off good assets for a quick profit, and leaving just the bones weighed down by piles of debt.
The backlash against the buyout boom of the 2000s began in Europe, where a German cabinet member publicly branded private equity and hedge funds “locusts” and British unions lobbied to rein in these takeovers. By the time the starry canopy was being strung in the Park Avenue Armory for Schwarzman’s birthday party, the blowback had come Stateside. American unions feared the new wave of LBOs would lead to job losses, and the enormous profits being generated by private equity and hedge funds had caught the eye of Congress.
“I told him that I thought his party was a very bad idea before he had his party,” says Henry Silverman, the former Blackstone partner who went on to head Cendant. Proposals were already circulating to jack up taxes on investment fund managers, Silverman knew, and the party could only fan the political flames.
Even the conservative Wall Street Journal fretted about the implications of the extravaganza, saying, “Mr. Schwarzman’s birthday party, and the swelling private equity fortunes it symbolizes, are manifestations of … rising inequality.… Financiers who celebrate fast fortunes made while workers face stagnant pay and declining job security risk becoming targets for a growing dissent.” When, on the eve of Blackstone’s IPO four months after the party, new tax proposals were announced, they were immediately dubbed the Blackstone Tax and the Journal blamed Schwarzman, saying his “garish 60th birthday party this year played into the hands of populists looking for a real-life Gordon Gekko to skewer.” Schwarzman’s exuberance had put the industry, and himself, on trial.
It was easy to see the sources of the fears. Private equity embodies the capitalist ethos in its purest form, obsessed with making companies more valuable, whether that means growing, shrinking, folding one business and launching another, merging, or moving. It is clearheaded, unsentimental ownership with a vengeance, and a deadline.
In fact, the acts for which private equity firms are usual
ly indicted—laying off workers, selling assets, and generally shaking up the status quo—are the stock in trade of most corporations today. More workers are likely to lose their jobs in a merger of competitors than they are in an LBO. But because a buyout represents a different form of ownership and the company is virtually assured of changing hands again in a few years, the process naturally stirs anxieties.
The claim that private equity systematically damages companies is just wrong. The buyout business never would have survived if that were true. Few executives would stay on—as they typically do—if they thought the business was marked for demolition. Most important, private equity firms wouldn’t be able to sell their companies if they made a habit of gutting them. The public pension funds that are the biggest investors in buyout funds would stop writing checks if they thought private equity was all about job destruction.
A growing body of academic research has debunked the strip-and-flip caricature. It turns out, for instance, that the stocks of private equity–owned companies that go public perform better than shares of newly public companies on average, belying the notion that buyouts leave companies hobbled. As for jobs, private equity-owned companies turn out to be about on par with other businesses, cutting fractionally more jobs in the early years after a buyout on average but adding more jobs than the average company over the longer haul. In theory, the debt they pile on the companies they buy should make them more vulnerable, but the failure rate for companies that have undergone LBOs hasn’t differed much from that of similar private and public companies over several decades, and by some measures it is actually lower.
Though the strip-and-flip image persists, the biggest private equity profits typically derive from buying out-of-favor or troubled companies and reviving them, or from expanding businesses. Many of Blackstone’s most successful investments have been growth plays. It built a small British amusements operator, Merlin Entertainments, into a major international player, for example, with Legoland toy parks and Madame Tussauds wax museums across two continents. Likewise it transformed a humdrum German bottle maker, Gerresheimer AG, into a much more profitable manufacturer of sophisticated pharmaceutical packaging. It has also staked start-ups, including an oil exploration company that found a major new oil field off the coast of West Africa. None of these fit the cliché of the strip-and-flip.
King of Capital: The Remarkable Rise, Fall, and Rise Again of Steve Schwarzman and Blackstone Page 1
