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

by David Carey;John E. Morris;John Morris

  “James’s IQ was off the charts,” says Blackstone partner J. Tomilson Hill III, who joined Blackstone in 1993.

  Away from the office, the University of Toronto graduate got his intellectual kicks dabbling in astrophysics and mathematical esoterica like string theory. A late 1987 photograph in a Blackstone newspaper ad shows a grinning Mossman in dark-framed glasses standing aside a group of colleagues, a ringer for Clark Kent minus the neck muscles. But unlike Superman’s alter ego, Mossman was anything but fumbling and meek. His primary social deficiency—some viewed it as a strength—was his unvarnished candor. If he thought an idea was flawed or dim-witted, he’d say so.

  “James saw the world in black and white,” says Kenneth Whitney, a longtime Blackstone partner. Mossman’s personality was similarly split, Whitney says. “He had a great sense of humor, but as soon as he focused on something, he turned very serious. It was like Jekyll and Hyde.” He had an obsessive-compulsive side, sometimes going two or three days without sleep when immersed in a deal. Says Whitney: “He had the kind of personality that only had one speed, full speed ahead.”

  Inside 345 Park Avenue, verbal clashes between the equally headstrong Mossman and Stockman drew crowds. “People would show up at investment committee meetings to see David and James debate,” says partner Chinh Chu. “It was intense.” When Stockman was on the defensive, one could almost see steam blowing out of his ears. A leg bobbed rapidly up and down, his speech raced, his body trembled. Mossman kept his cool throughout, delivering logically elegant counterthrusts.

  “James was professorial, but he could drive a point home,” says Chu. “He could take a deck of analysis and zero in on the top three issues within minutes. That’s an innate ability.” By contrast, Stockman, the data-point and trend-line junkie, could spout decades of actuarial statistics for a pension plan or reams of figures on oil-refining capacity but often lost the forest for the trees, his former colleagues say.

  Three years after his arrival, Mossman became a partner, and he evolved into the firm’s de facto chief investment officer—the point man through whom all deals had to flow. In that role, he distanced himself entirely from the messy particulars and distractions of deal making. Aside from Transtar and CNW, he never involved himself in sourcing or spearheading buyouts. At most, he occasionally rigged up an ingenious asset-backed financing scheme or the like. He never met with the management of a prospective portfolio company, never spoke with limited partners. Instead, he holed up in his office, where he vetted his partners’ investment proposals on paper.

  It was a peculiar modus operandi for a chief investment officer, but it served a function in the organization, keeping Mossman at an emotional distance from the pitches he received and helping to keep the firm from succumbing to the momentum the investment process can take on when people have invested weeks or months probing a company. “He doesn’t have deal fever,” says Simon Lonergan, who worked at Blackstone from 1996 to 2004. “Doing nothing is as good as doing something in James’s mind. He was an analytically rigorous guy—very disciplined.”

  Even though Schwarzman made the final call on investments, he seldom second-guessed his young adjutant. As a result, Mossman became the behind-the-scenes arbiter of which deals got done, and his cerebral approach had a quiet but profound impact on Blackstone’s investment agenda over the rest of the nineties and into the next decade.

  CHAPTER 11

  Hanging Out New Shingles

  While the buyout business was in suspended animation during the downturn of the early 1990s, Schwarzman set out to nurture new business lines more suited to a period of tumbling markets and a drought of leverage. In May 1991, he poached a six-member crew of debt-restructuring specialists from Chemical Bank led by Arthur Newman, an ace in the field. The move paid off quickly as assignments poured in from America West Airlines, R. H. Macy and Company, steelmaker LTV Corporation, and other bankrupt corporations needing advice on reorganizing their finances. In time Blackstone’s restructuring advisory group would expand to forty-four professionals and would draw some of the most challenging restructurings in the early 2000s and again at the end of that decade.

  Schwarzman had set out to establish a real estate investment arm, too, as the Resolution Trust Corporation—the federal agency charged with cleaning up the S&L mess—prepared to unload thousands of properties and distressed loans the government had taken over from failed savings and loans. The quick departure of Joe Robert in 1992 had set back that plan, but Schwarzman began looking for a replacement and soon found his way to John Schreiber, forty-six, who had retired from his job as head of acquisitions for JMB Realty Corporation, a Chicago-based real estate empire that specialized in syndicated real estate investments, a forerunner to today’s multibillion-dollar real estate private equity industry. JMB had pioneered the kind of real estate private equity Schwarzman had in mind, buying properties on the cheap or in need of upgrading, and selling them a few years later. Schwarzman first contacted Schreiber for advice on whom he might hire, but after talking with other property investors and bankers, he called Schreiber back in the summer of 1992 and tried to woo Schreiber for the position.

  “I told him I had no interest,” Schreiber says. Schreiber had promised his wife he wouldn’t go back to work full-time, he was sick of managing, and there was no way he was moving to New York. But Schwarzman pressed him and pressed him. Finally, Schreiber’s wife suggested that he make what seemed to both husband and wife to be ridiculous demands. He told Schwarzman he’d be willing to consult and help Schwarzman recruit a hands-on management team in exchange for an ownership stake, but he would work just forty days a year and from Chicago. To the Schreibers’ amazement, Schwarzman agreed.

  The business was structured along the lines of Blackstone Financial Management, Larry Fink’s fixed-income operation. Blackstone owned 80 percent and Schreiber 20 percent, but Blackstone agreed to hand off part of its stake to managers as they were hired so that the business eventually would be owned fifty-fifty by its executives and Blackstone. Schreiber would remain, in his words, “third-base coach.”

  By late 1992, JMB Realty, which had once boasted $24 billion in assets, was in trouble as some of the highly leveraged deals it had engineered in the good times were unwinding, and many of its executives were looking for jobs. Schreiber targeted one of them, Barry Sternlicht, to head up the new business at Blackstone. “We had basically agreed on terms to bring Barry and his group,” Schreiber says, “but at the last minute he changed his mind.” Sternlicht went on to form Starwood Capital, his own property investment firm. In his place, Schreiber in 1993 recruited Thomas Saylak, who had worked at Trammell Crow Company, another big property firm, and a year later hired another JMB alumnus, John Kukral, to be his field commanders.

  Schwarzman reckoned there was a windfall to be made in distressed real estate, as the property boom of the eighties came to a harsh end. Developers and lenders were struggling in the aftermath, and the government was shoveling billions of dollars of savings and loan property out the door to anyone who could make a solid bid. The problem was that Blackstone had scant capital to invest in such deals. The firm tried in 1991 to persuade the investors in Blackstone’s first fund to plow up to $400 million—close to half the fund—into properties being auctioned by Resolution Trust. But because many of the limited partners were U.S. and Japanese institutions already freighted with troubled real estate, they nixed the idea. With a new team on board, Blackstone set out to raise hundreds of millions of dollars for a dedicated real estate fund.

  In late 1993, Schreiber clinched his first trophy deal. Edward J. DeBartolo Corporation, which owned stakes in fifty-seven regional malls, the Ralphs supermarket chain, and numerous parcels of land, had fallen on hard times, and DeBartolo’s lenders were eager to rid their books of its debt. Through his long-standing ties to the First National Bank of Chicago, Schreiber arranged to buy $196 million of secured debt from the bank for 56 cents on the dollar. Because DeBartolo owned a mix o
f corporate assets and real estate, Blackstone could tap its LBO fund.

  The deal turned into a winner. When a company defaults on its debt, creditors can often swap the debt they hold for equity when the company restructures. In April 1994, Blackstone did just that, and in 1996 it cashed out, more than doubling its $109 million investment.

  Schreiber’s next major deal involved a failed JMB Realty investment he knew all too well: Cadillac Fairview. The Canadian shopping mall owner had been JMB’s crown jewel, owning Toronto’s Eaton Centre and Toronto-Dominion Centre and the Pacific Centre in Vancouver. Schreiber had helped engineer JMB’s $5.1 billion buyout of Cadillac Fairview, which was the largest real estate deal of the 1980s, but in 1991, with the economy in the dumps, the company was buckling under its debt. Cadillac Fairview’s financial downfall, more than any other event, triggered JMB’s demise. Now Schreiber would have a chance to try his hand at vulture investing. Just as Leon Black had established Apollo’s reputation by picking up the broken remnants of deals he had fathered when he worked at Drexel, Schreiber would use his knowledge of Cadillac Fairview to make money from its restructuring.

  With the confidence that comes from knowing the target, in February 1995 Blackstone’s real estate team swooped down and bit off a $10 million morsel of Cadillac Fairview’s bank debt. It ultimately was angling for equity in the restructured company. By this time, Schreiber’s group was flush with money, having stockpiled $330 million in commitments in 1994 for the real estate investment fund, and later in 1995 it joined up with the giant Ontario Teachers’ Pension Plan Board and pushed through a bailout plan for Cadillac Fairview that Schreiber had taken a hand in crafting. In exchange for injecting $200 million, the two acquired a combined 32 percent stake. Goldman Sachs, the largest creditor, swapped its bank loans for 22 percent. Two years later, Cadillac Fairview went public. The deleveraged company thrived, and when Blackstone later cashed out, it made a $73 million profit on its $65.5 million investment.

  JMB had blazed the trail for real estate private equity long before Blackstone. But Blackstone was the first large corporate-LBO specialist in America to launch a real estate venture, and it was the only one that developed into a top-tier player. Apollo and the Carlyle Group launched their own units in 1993, but Apollo Real Estate Advisors eventually split from Leon Black and renamed itself, and Carlyle’s property business remained relatively small.

  The hiring of Schreiber, Saylak, and Kukral drew little attention at the time. Much more ballyhooed was the hiring of J. Tomilson “Tom” Hill III, an old friend and fellow partner of Peterson’s and Schwarzman’s at Lehman. Hill was a steely M&A gladiator who’d been in the thick of some of the most memorable hostile takeover battles of the 1980s, siding with Federated Department Stores in its defense against Robert Campeau and working with Ross Johnson, the CEO of RJR Nabisco, in the fight for control there. Hill had also been an architect of some of the most iconic friendly mergers of the age: Bendix Corp.’s $1.8 billion merger with Allied Corp. in 1983, American Stores’ $2.5 billion takeover of Lucky Stores in 1988, and Time Incorporated’s $14 billion merger with Warner Communications in 1989.

  He dressed the part to perfection, from his back-combed coif to his impeccably tailored Paul Stuart suits and tasseled loafers. Rumor had it that Gordon Gekko in the movie Wall Street was styled after Tom Hill.

  In 1993 Hill was ousted as Lehman’s co-CEO, and Blackstone soon tapped him to cohead M&A and assume Roger Altman’s mantle as a brand-name rainmaker. From the moment Altman left, Schwarzman and Peterson had searched doggedly for a worthy replacement, Schwarzman remarked when Blackstone hired Hill. “Tom fills that bill,” he said.

  The timing seemed propitious. Merger activity, which bottomed out in 1991 and 1992, was rebounding, nearly tripling from 1992 to 1995, and Hill spoke boldly of capitalizing on the upturn. Blackstone hoped it might even steal business from M&A powerhouses such as Goldman and Merrill Lynch. There was little doubt Hill would transform M&A into a stout fourth leg of Blackstone’s business platform.

  But it wasn’t to be. Though a new merger wave was taking off, Hill and the group’s other cohead, Michael Hoffman, never met Schwarzman’s lofty expectations. Hill and Hoffman weren’t wholly to blame. As the regulatory barriers between commercial banks and investment banks came down, investment banks became free to make commercial loans and commercial banks moved into the traditional preserve of the investment banks, advising on mergers and capital raising. Deregulation gave birth to so-called one-stop shopping, with one bank, or a small group, handling every financial element of a merger or acquisition, from strategizing and crafting it to the underwriting and marketing of both loans and bonds. LBO sponsors, in particular, were elated to be rid of the hassle of scraping together debt from multiple sources. But the new full-service banks siphoned off advisory work from boutique advisers such as Blackstone that didn’t lend or underwrite.

  A few long-established M&A boutiques such as Lazard Frères maintained strong franchises as pure advisers. Wasserstein Perella, an M&A-cum-private equity shop like Blackstone, also pulled in big fees. But Blackstone’s M&A group struggled, and it was a sore point with Schwarzman. Whenever a plum assignment fell through or anything bad happened, he would erupt. Schwarzman often would vent his fury at Hoffman, a former Smith Barney M&A executive who had been at Blackstone since 1989. “The animosity between Michael and Steve was unbelievable. You’ve got to give Michael credit. He endured it all. Every day, it seemed, he got dumped on,” recalls one ex-partner.

  What galled Schwarzman most, says Hoffman, was the fact that Bruce Wasserstein, his old rival, was eating Blackstone’s lunch in M&A. “I thought we did well” considering the obstacles, Hoffman says. According to Hoffman, Blackstone’s yearly M&A fees nearly tripled during the 1990s, rising from $25 million early in the decade to $70 million. Still, that was less than one-fifth the $400 million that Wasserstein Perella pulled in. Schwarzman “dumped on the fact that the M&A business was not as big as Wasserstein’s,” Hoffman says. Hoffman’s unit turned a fair profit, but that fact didn’t placate Schwarzman, he says. Hoffman left in 2001 to advise the State of California on a financial crisis and later moved to Riverstone Holdings, a private equity firm that specializes in energy investments.

  Hill eventually would excel and leave a lasting mark at the firm, but not in M&A. By the mid-nineties, Blackstone’s hedge fund-of-funds business, which David Batten had conceived in 1990 to invest the money Blackstone had received from Nikko, was managing money from outside investors, charging them a fee to screen hedge funds and spread their money across a variety funds, and had become a profit-making business in its own right. Called Blackstone Alternative Asset Management, BAAM for short, the unit would scuffle along under a series of overseers until the time Hill relinquished his M&A post and took charge of it in 2000. At BAAM, Hill would find his groove, and the business’s assets under management would soar in size.

  CHAPTER 12

  Back in Business

  The resuscitation of the buyout market was nothing like the violent crash that preceded it. There was no one deal that announced private equity was back in business. No clarion sounded. Instead, it was a gradual thaw.

  The junk-bond market experienced a revival in 1992 and 1993, as Donaldson, Lufkin & Jenrette and other banks hired the best and the brightest out of Drexel Burnham after it went under in 1990 and put them to work. But little of the money raised via junk bonds was being used to finance new buyouts. LBO was still a dirty word. It was clear that the freehanded lending practices of the eighties were obsolete. Scarred by the failures of scores of businesses they’d helped lever to the hilt, the Wall Street banks wised up, imposing a stricter lending regimen. Unlike the old days, when buyout sponsors could get away with inserting a mere sliver of equity—10 percent or less of the purchase price—lenders now demanded that they have much more at risk. From 1993 through the early 2000s, lenders almost always demanded at least 20 percent and often 30 percent of the cost to be f
inanced with equity.

  That forced a new calculus on the LBO set. No longer could they take control of massive enterprises with a smidgen of their own money, as KKR had done with RJR and Beatrice. With less debt for the same quantum of equity, the average size of LBOs inevitably shrank. With less leverage, sponsors were also staring at lower returns, because minute gains in a company’s value could no longer be multiplied ten or twenty times. The only good news was that the price tags for companies came down.

  In the new environment, buyout firms were forced to reexamine how they went about making profits, and what the LBO game was all about. Slowly, they began to focus more on making operational improvements at their companies. Where they had once simply slashed costs and sold off assets whose value was masked inside a larger enterprise, they began focusing on the top line—revenue. They began asking how they might alter a company’s mix of profits to emphasize higher-margin items, how they might expand its geographic reach or fill in gaps through acquisitions, or how they might improve relations with customers.

  A few, like Clayton Dubilier & Rice, built up stables of executives they could parachute in to help reform the companies the firm bought. CD&R showcased its approach with an ambitious carve-out of IBM’s office product lines in 1991. No office products division existed when IBM approached CD&R about taking on the assets. It was just a mishmash of slow-growth or dying products such as Selectric typewriters and dot matrix printers that IBM sought to sell. CD&R would have to create a company around them and then take on bigger, more nimble competitors such as Hewlett-Packard that dominated the inkjet printer business. It was a tall order—something other buyout firms would never attempt. But CD&R succeeded, building the IBM castoffs into a new company called Lexmark, accelerating product development and shaping it into a serious competitor in inkjet and laser printers before taking it public in 1995. (CD&R claims that when its partners first met with IBM chairman John Akers, he brandished a copy of Barbarians at the Gate and said, “The reason I am talking with you is because you are not mentioned in this book.”) KKR had undertaken ambitious overhauls such as Safeway’s, but few firms had experience with this sort of hands-on investing. It was an approach they would increasingly come to emulate—or at the least pay lip service to.