King of Capital: The Remarkable Rise, Fall, and Rise Again of Steve Schwarzman and Blackstone

by David Carey;John E. Morris;John Morris

  Nikko got what it desired from Blackstone, a collaboration to help its tiny band of New York bankers get up to speed on Wall Street. For Blackstone the surprise investment was even more valuable than it first seemed, for Nikko was part of the Mitsubishi industrial group, one of four enormous Japanese business combines that are linked by cross-ownership, commercial synergies, and a shared mind-set. As Schwarzman and Peterson trooped to meetings with other parts of the Mitsubishi network, they were greeted warmly. Mitsubishi Trust, Tokio Marine & Fire, and other group firms ponied up for the new fund.

  Peterson and Schwarzman hadn’t recognized how intimately linked the institutions were when they headed into these meetings. “We’d congratulate ourselves on being such great presenters,” Schwarzman says. “I came to realize later we could have sent monkeys in to make those presentations. The fact was, they tended to trust the lead investor, Nikko.” Even a member of a rival industrial group, Mitsui Trust, pledged $25 million. He and Peterson headed home with an additional $175 million in hand.

  Their hot streak continued upon their return. In June, Peterson bumped into an old friend, General Electric chairman and chief executive Jack Welch, at a birthday party for Washington Post publisher Katharine Graham. “Where the hell have you been?” Welch inquired. “I know you and Steve have started this business, and I haven’t heard from you.” Peterson answered, “Dear God, Jack, we’ve called and called on GE, and they said you’re not interested.” Said Welch, “You should have called me directly.” Peterson did so the next morning, picking up $35 million.

  Even more momentous was the $100 million General Motors’ pension fund put up. GM, like GE, had brushed off Blackstone several times, but a First Boston banker tapped a church connection to get Blackstone access to GM, and the firm soon captured another $100 million pledge. The GM imprimatur brought Blackstone a raft of smaller commitments—$10 million to $25 million—from other pension funds.

  Blackstone had now won anchor investments from three of the most important sources of investment capital at the time: the insurance industry, pension funds, and Japanese financial firms.

  By early autumn 1987, the Blackstone buyout fund had reeled in a total of more than $600 million. That was well short of their $1 billion target, but Peterson and Schwarzman began to think they should lock that up while they could. It was a perilous time, though it was not yet clear just how perilous. By the second week of October, the stock markets were jittery. Inflation was headed up, fanning talk of an interest rate hike, which would slow the economy and put a damper on a business such as a buyout firm that relied on borrowed money.

  “I was exceptionally nervous and putting pressure on everyone to close,” Schwarzman says. He worked the phones, and on Thursday, October 15, 1987, Blackstone wrapped up the fund at around $635 million, with some mop-up legal work on Friday.

  The following Monday the U.S. stock markets nose-dived 23 percent. Black Monday, as it became known, was the biggest one-day drop since 1914, outstripping even the 1929 sell-off that ushered in the Great Depression. If Blackstone hadn’t tied up contractual loose ends before the crash, undoubtedly many investors would have backed out. Instead, Blackstone could boast of raising the largest first-time leveraged buyout fund up to that time.

  No longer would Peterson and Schwarzman live off the unpredictable bounty of M&A fees. Blackstone now would collect 1.5 percent of the fund’s capital every year as a management fee for at least six years. This not only ensured Blackstone’s near-term survival, but it also meant that Blackstone, finally, could staff up and take on the trappings of a bona fide business.

  After an exhausting, two-year struggle, Blackstone had arrived.

  “We got in just under the wire,” Schwarzman says. “It was probably the luckiest moment” in Blackstone’s history.

  CHAPTER 5

  Right on Track

  Peterson and Schwarzman’s new firm had sailed through the 1987 crash in good shape and they were free of nagging financial worries after raising their fund. But the stretch ahead would be rocky not just for Blackstone but for the buyout business as a whole. A treacherous turn in the capital markets and misfires on the deal front would doom some of Blackstone’s fellow start-ups and imperil even some seasoned buyout firms. Through it all, Blackstone would struggle to establish footing. It didn’t help that turnover at Blackstone was notoriously high in the early years, owing partly to Schwarzman’s mercurial and demanding personality. The young firm, too, would make some bum bets on companies and people. But it would do more right than wrong.

  With its $635 million safely in the bag, Blackstone immediately ramped up its operations. Soon it spilled over with fresh hires and filing cabinets. In the autumn of 1988, the firm moved to 345 Park Avenue, a bland, hulking, cream-colored skyscraper right across Fifty-second Street from its former offices in the Seagram Building. It took a ten-year lease on sixty-four thousand square feet, twenty times the size of its original quarters. Surveying the cavernous new expanse, Schwarzman wondered if he’d been batty to sign a lease for so much more space than the firm needed at the moment.

  In rapid succession, Schwarzman and Peterson recruited three high-ranking partners with imposing pedigrees. The first, Roger Altman, forty-two, the Lehman banker, joined as vice-chairman. Peterson and Schwarzman had tried hard to lure him in 1986 and 1987, but their old colleague held off until Blackstone at last raised its fund and was financially stable. Altman’s coyness irked them, but they knew the well-connected banker would be a magnet for M&A fees. Lean, with a shaggy mane and suave manner, Altman was as adept as any Wall Street banker at winning over big-ticket corporate clients. His fascination with public policy clicked with Peterson, even though Altman was a staunch Democrat who had worked on Robert F. Kennedy’s 1968 presidential campaign and had put his Lehman career on hold from 1977 to 1981 to work in Jimmy Carter’s Treasury Department.

  In February 1988, Blackstone corralled Laurence Fink, thirty-five, who had helped create mortgage-backed securities—bonds backed by packages of home mortgages—and built First Boston’s successful mortgage securities unit. Securitization, as the process of making bonds out of mortgages was called, transformed the home lending business and created a huge new addendum to the debt markets. The next month, David Stockman, forty-one, a former Reagan administration budget czar, arrived.

  As Reagan’s first budget director, Stockman, a former two-term congressman from Michigan, was the point man for the supply-side economics the new administration was pushing—the theory that taxes should be lowered to stimulate economic activity, which would in turn produce more tax revenue to compensate for the lower rates. With his wonky whiz-kid persona, computer-like mental powers, and combative style, he browbeat Democratic congressmen and senators who challenged his views. But he soon incurred the wrath of political conservatives when he confessed to Atlantic reporter William Greider that supply-side economics was really window dressing for reducing the rates on high incomes. Among other acts of apostasy, he called doctrinaire supply-siders “naive.” The 1981 article created a sensation and prompted Reagan to ask him over lunch, “You have hurt me. Why?” Stockman famously described the meeting as a “trip to the woodshed.”

  Though the president himself forgave him, Stockman’s loose lips undercut his power at the White House, and in 1985 he left government to become an investment banker at Salomon Brothers. He was recruited to Blackstone initially by Peterson, who had known Stockman from Washington circles and, like Stockman, was deeply concerned about the federal deficit. Peterson and Schwarzman hoped to put Stockman to work with corporate clients on big-picture strategic, economic, and trade issues, but ultimately he evolved into one of Blackstone’s main LBO deal makers.

  Fink, tall and engaging, with a shrinking periphery of hair and old-fashioned rimless spectacles, was a well-regarded Wall Streeter whose star had fallen. A pioneering financier and salesman, he was considered the second leading figure, after Salomon Brothers’ Lewis Ranieri, in the develop
ment of the mortgage-backed bond market. At the time, Fink was about to lose his job at First Boston after his unit racked up $100 million in losses in early 1988. But Schwarzman and Peterson had from the start hoped to launch affiliated investment businesses and thought Fink was the ideal choice to head a new group focused on fixed-income investments—the Wall Street term for bonds and other interest-paying securities. They accepted Fink’s explanation that flawed computer software and bad data inputs had triggered the stunning trading losses, and they were further reassured by a conversation Schwarzman had with Bruce Wasserstein, First Boston’s cohead of M&A, who had become a friend and frequent tennis partner of Schwarzman’s. “Bruce told me that Larry was by far the most gifted person at First Boston,” Schwarzman says. Peterson and Schwarzman offered Fink a $5 million credit line to start a joint venture called Blackstone Financial Management, or BFM, which would trade in mortgage and other fixed-income securities. In exchange for the seed money, Blackstone’s partners got a 50 percent stake in the new business while Fink and his team, which included Ralph Schlosstein, a former Lehman partner and a good friend of Roger Altman’s, owned the other 50 percent. Eventually, the Blackstone partners’ stake would fall to around 40 percent as the BFM staff grew and employees were given shares in the business. Fink also got 2.5 percent interest in the parent, Blackstone.

  The arrangement with Fink reflected the Peterson and Schwarzman approach to building up Blackstone. They wanted to recruit top talent, but they were not about to surrender any significant part of Blackstone’s ownership. The implosion at Lehman had convinced them that they should keep tight control of the overall business. This was going to be their show. Altman, who might have gotten a bigger stake if he had joined his friends sooner, received a comparatively meager ownership interest of around 4 percent. Stockman’s piece was even smaller.

  By the spring of 1988, Blackstone had larded its buyout fund with an extra $200 million from investors who signed up after the original closing, pushing the fund’s total capital to about $850 million, and it was now scouring the country for investments. It was a heady time for the LBO business, stoked by Drexel’s junk-bond factory, and the larger corporate world was undergoing one of its periodic paroxysms of mergers and consolidation. There were more than sixteen hundred mergers in the United States worth nearly $90 billion in the first half of 1988, more than triple the dollar volume five years earlier and on a par with the frenzied level in early 1987. The slump in M&A following the October 1987 stock market crash was swiftly fading from memory.

  Blackstone was as yet only a midsized player in a field that had become more crowded since its launch. A Wall Street bank, Morgan Stanley, had raised $1.1 billion, while Merrill Lynch would close a $1.5 billion fund later that year, and two new Blackstone-style, M&A-cum-buyout boutiques had burst onto the scene with far more hoopla than Blackstone had aroused.

  The first was formed by First Boston mergers superstars Bruce Wasserstein and Joseph Perella, who jolted Wall Street when they left First Boston in February 1988 to form Wasserstein Perella and Company. They talked the cream of First Boston’s M&A bankers into joining them, and their names carried enough cachet that they quickly lined up $500 million toward a $1 billion buyout fund.

  More than anyone else, Wasserstein, forty, a rumpled, paunchy figure with a chess genius’s command of tactics, had restyled the genteel M&A business into a sophisticated, high-stakes sport of aggression. He first gained wide attention in 1981 in the $9 billion takeover battle for the oil company Conoco, Inc., in which he outflanked Mobil Oil Corporation and the liquor giant Seagram Company Ltd. to win the target for E. I. du Pont de Nemours and Company, his client, despite a lower bid. (The intricate tactic he hatched to capture Conoco, called a front-end-loaded, two-tier tender offer, was later banned by the U.S. Securities and Exchange Commission.) After Conoco, Wasserstein had a hand in some of the biggest takeovers of the mid-1980s, including Texaco’s hotly contested $10.8 billion purchase of Getty Oil Company in 1984 and Capital Cities Communications’ $3.5 billion acquisition of the ABC television network in 1985. He was known for exhorting gun-shy clients to pull the trigger on topping bids, which earned him a nickname he hated, “Bid ’Em Up Bruce.” Perella, forty-seven, the diametric opposite of his partner in height, girth, and sartorial savoir faire, was more of a traditional relationship banker in the mold of Peterson and Altman.

  Wasserstein Perella soon won the backing of Japan’s largest stock brokerage, Nomura Securities Company, which that July put up $100 million for a 20 percent stake in the firm. Most or all of that money ended up being funneled into Wasserstein Perella’s buyout fund. Nomura issued a press release expressing its delight at the chance to be an early investor in a firm so obviously “destined to be an international M&A powerhouse.” Wasserstein Perella looked to be halfway there already, raking in $30 million of M&A fees in its first four months. With those fees and the $100 million from Nomura, Wasserstein and Perella were spared the hand-to-mouth existence Peterson and Schwarzman endured for their first two years.

  The other headline-grabbing new firm was Lodestar Group, formed the same month as Wasserstein Perella by Ken Miller, Merrill Lynch’s M&A chief and vice-chairman and its highest-paid banker. Miller was not as lionized as Wasserstein and Perella, but he had secured his reputation by making Merrill a first-tier power in M&A and shepherding several high-profile LBOs that Merrill had led, including those of truck trailer maker Fruehauf Corporation and drugstore operator Jack Eckerd Corporation. In July, a day after Nomura announced its investment in Wasserstein Perella, Lodestar unveiled a comparable deal: Yamaichi Securities Company, Japan’s fourth-largest brokerage, would put up $100 million of the $500 million LBO fund Miller was raising and separately inject an undisclosed sum in Lodestar itself for one-quarter of the firm.

  Blackstone would have to vie for investors, talent, and deals with these flashier upstarts. None of the new players held a candle to KKR, though. It had recently amassed a $6.1 billion war chest—far and away the biggest buyout fund ever—and controlled about a third of the $15 billion to $20 billion of equity the buyout industry had stockpiled to date. It was no easy task to compete, for KKR was raking in profits on a scale its founders couldn’t have imagined a decade earlier. In May 1988, Henry Kravis and the other KKR partners personally pocketed $130 million in profits on just one investment: Storer Communications, a broadcaster they had bought just three years earlier, which they sold for more than $3 billion. KKR had pulled off gargantuan buyouts of name-brand companies—a $4.8 billion deal for the supermarket chain Safeway in 1986 and the $8.7 billion buyout of Beatrice Foods the same year. Late in 1988 KKR would reassert its dominance when it cinched by far the largest buyout ever, the $31.3 billion take-private of the tobacco and food giant RJR Nabisco—a bid that would define the era, crystallize the public image of private equity investors as buccaneers, and set a record that would not be matched for eighteen years.

  Unlike KKR, though, Blackstone had its M&A business, which by 1988 was capturing its share of plum M&A assignments. Early that year Blackstone took in more than $15 million from two jobs alone: handling negotiations for Sony Corporation’s $2 billion purchase of CBS Records, an assignment Blackstone picked up from Sony founder Akio Morito, an old friend of Peterson’s, and from Sony’s top U.S. executive, whom Schwarzman knew; and advising Firestone Tire & Rubber when it sold out to Japan’s Bridgestone, Inc., for $2.6 billion, a deal Schwarzman guided. As Peterson and Schwarzman hoped, the M&A business gave the firm access to executives that eventually turned up LBO opportunities.

  Blackstone’s first buyout developed that way. It was puny compared with KKR’s big deals—a mere $640 million—but it would have an immense impact on the young firm’s image and fortunes.

  It began when Altman telephoned Donald Hoffman, a top official at USX Corporation, the parent of U.S. Steel. USX was battling for its corporate life with Carl Icahn, the much feared corporate raider. In 1986 Icahn had amassed a nearly 10 percent
stake in USX and launched an $8 billion hostile takeover bid. U.S. Steel was three months into a strike that was crippling steel production and had pummeled the stock. Over the next year, Icahn hectored USX to off-load assets and take other steps to boost its share price. To back itself out of a corner and persuade Icahn to go away, USX eventually announced that it would sell more than $1.5 billion in assets and use the money to buy back some of its shares. (Companies often buy in shares to boost their share price because that increases the earnings attributable to each individual share.) Among the assets USX tabbed for full or partial sale were its rail and barge operations. The plan assuaged Icahn.

  Altman, Peterson, and Schwarzman flew to Pittsburgh to meet with USX’s top brass to see if they could strike a deal for the transport business, which Hoffman headed. In addition to Hoffman, USX chairman and chief executive David Roderick and Charles Corry, the steelmaker’s president, were at the meeting. USX hoped to raise $500 million from the sale, but two conflicting goals made it tricky to structure a deal. USX wanted to sell more than 50 percent of the transport business to an outside party so that under accounting rules it could take the unit’s debt off its books. However, it didn’t want to give up too much control. More than half the railway’s business came from other shippers, but U.S. Steel was almost wholly reliant on its subsidiary’s train and barges. The system hauled all the raw materials to U.S. Steel’s Midwest plants and 90 percent of the company’s finished products passed over its lines on the way to customers. Roderick couldn’t agree to a sale if the businesses would end up in unfriendly hands.