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

by David Carey;John E. Morris;John Morris

  Owning 1.1 million DLJ shares from the merger that wouldn’t vest until the summer of 2002, James had to sit tight until then, but it clearly was time for a new job.

  To Schwarzman, James possessed the ideal background and skills: “Tony was, in effect, a natural entrepreneur. And he was also for many years at DLJ what they call a trigger puller—their master investor, who would do the go–no go decisions.” The parallels in the businesses DLJ and Blackstone had built were striking, too. “In effect, his career was a carbon copy of mine. This was a very curious coincidence.”

  They had a preliminary discussion at Blackstone’s offices. Both were a bit surprised but thought the relationship had promise. “We each walked out of that first meeting and said, ‘Hmm. I didn’t realize how good this fit was,’ ” James says.

  Schwarzman wanted to probe deeper, and for that he wanted a more relaxed and discreet setting, so he invited James to dinner at his apartment at 740 Park Avenue. “I didn’t want to meet him in a work setting. I wanted to really learn how his mind worked,” Schwarzman explains.

  Over a long meal they traded experiences and their takes on the world. “I really had a great time because we could speak shorthand about just about anything in the financial world,” says Schwarzman. “Here’s a situation. How did you think that worked out? What do you think went wrong? What would you have done there? I think we both found out there was an enormous convergence of investment style and outcome, and conservatism.”

  The conversation continued over several more dinners at Schwarzman’s apartment as each man sized up the other. “There was a lot of talk with each other, without talking about the job so much,” James says. “Just talking about the world, comparing notes, just getting on the same page, without really a sense of where it would go.”

  The rapport was there, but in many ways they made an unlikely pair. The tall, lanky James—formally Hamilton E. James—was a prep-school New Englander from the suburban professional classes. His father had headed the management consulting practice at the elite consulting firm Arthur D. Little, Inc., and the younger James, who attended Choate prep school before collecting his bachelor’s and MBA from Harvard, had a patrician patina that Schwarzman lacked. In the words of a woman who has worked with him, he is one of those rare men who can get away with wearing a seersucker suit to the office.

  James had a more cerebral style than Schwarzman. While Schwarzman could devour the numbers his underlings generated and interrogate them about their analyses, at the end of the day he made decisions by instinct. James relished the analysis itself.

  While Schwarzman found it hard to pretend he was interested in or cared about people when he didn’t, James seemed to take an interest in everyone from the mailroom staff on up. He enjoyed playing teacher and mentor and happily performed scut work on a deal in a crunch—an attitude that was repaid with fierce loyalty from those under him. When engaged by work, his intensity and mental powers were downright intimidating. But he also liked to party and was equally at home with a beer in hand entertaining employees at his Connecticut home or raising eyebrows with his wild dancing at DLJ parties.

  James had his own sizable ego—some people in other firms found him arrogant—but it expressed itself very differently than Schwarzman’s. At DLJ, James had been happy to run the bank while more senior executives took the spotlight. He had no need to see his name in the paper and, indeed, it rarely appeared in print. Instead, he drew his satisfaction from keeping his subordinates perpetually in awe of his imposing intellect, his stamina, and his charm.

  In a quiet way, too, he chafed at the conventions by which überbankers were expected to abide. He rode the subway, and as a longtime director of Costco, the discount retailer, he often wore Costco dress shirts to the office. While Schwarzman vacationed at his homes in the traditional playgrounds of the super rich—the Hamptons on Long Island, Palm Beach in Florida, and St. Tropez in France, or on his yacht in the Caribbean—James was a die-hard fly fisherman who tied his own flies and ventured up the Amazon and to Mongolia on fishing trips with his friend David Bonderman, the iconoclastic founder of TPG.

  In other ways, though, the men were much alike. Like Schwarzman, James had been a competitive athlete, playing varsity soccer at Harvard. Into his fifties, he would play on the weekends. He was every bit as competitive and ambitious as Schwarzman, and every inch as much an entrepreneur.

  Because Schwarzman had begun his own financial career at DLJ after college, he knew many of the senior executives who were later James’s bosses. After his initial dinner conversations with James, he decided to do a background check by calling up five of them, including DLJ founders Bill Donaldson and Dick Jenrette, to get their views on James.

  “They all said exactly the same thing. They said that Tony was brilliant, he was a workaholic, that he was a great investor, he was a natural leader, that the people who worked for him were incredibly loyal. He was a brilliant manager and that he had tremendous loyalty to the institution. And, at a personal level, he would never betray you—meaning me. ‘You two are a perfect fit.’ ” The fact that five people who had known both Schwarzman and James for decades thought the match would work was persuasive.

  It was an enormous gamble for both men. Schwarzman had never been afraid to bring in big personalities with their own ambitions and agendas. He had wooed Roger Altman, David Stockman, Larry Fink, and Tom Hill to Blackstone in the early years. But this was different. This time he was not looking for a single rainmaker or someone to launch a new business line. This hire would have a much more profound impact across Blackstone. Blackstone had been the Steve Schwarzman show for a decade and now he would be sharing the role. It was more like finding a spouse than a deputy. None of his counterparts at other buyout firms had ever attempted to bring in someone at this level from the outside, and few had clear succession plans, so in every way it would be a first.

  James understood what it represented. “It’s a very intense firm with a very intense leader and intense people. If he meant what he said about turning over the core businesses to me, and helping him run the firm, it was a huge leap of faith for him—to [trust] any outsider that he didn’t really know that well.”

  Blackstone wasn’t James’s only option. He had discussed forming a new firm with Garrett Moran and Bennett Goodman, two senior DLJ bankers. He also talked with TPG’s founders, Bonderman and Jim Coulter, about joining their firm. He could see the Blackstone job carried special risks. Entrepreneurs and founders like Schwarzman often find it difficult to cede control and make a hash of things when they try to bring in deputies and designated heirs. The rising stars they hire often end up bloodied, dumped in the ditch at the side of the corporate road a year or two later. For James, who had enjoyed enormous autonomy at DLJ, this was a crucial issue.

  “Does he really mean it? Is he going to give me the scope to do my thing? It was like I hadn’t had a boss in twelve years. I’d been a very independent manager, running my businesses the way I thought. That’s important to me. I’m not very respectful of hierarchy or authority. I like to make my decisions. I like to run a business my way and be held accountable for the result. I want to be able to make the decisions and refashion things my way.”

  Friends say that James had his doubts. Schwarzman’s split over money with Larry Fink and Ralph Schlosstein, the BlackRock heads, was well known on Wall Street, as was the fact that there was no love lost between Schwarzman and Altman. The growing rift between Schwarzman and Peterson was known to many in the financial world, too. Certainly no one had ever called Schwarzman the dream boss. Was he capable of giving James real latitude to run the firm day to day? It was a theme that threaded through their dinner conversations.

  “There’s no epiphany or one thing he can say,” says James. “When you’re looking at a CEO and entrepreneur, you’ve got to take the measure of his intent and his ability to follow through emotionally and personally.” Ultimately, James came to believe it could work. “I made the bet that
he meant it and that he could, and he did.”

  By the last of their dinners, Schwarzman, too, was convinced. “At the end, I said, ‘Really, this should be an absolutely perfect partnership.’ I said, ‘You and I are only going to have one type of disagreement working together. You’re going to be interested in starting a lot of new businesses, some of which may not really be big enough to really affect us. That’s because you’re a better manager than I am. I prefer starting fewer things but having them be huge. But that’s a matter of taste. That will be a difference in the way we approach things. We’ll never disagree about deals or investments.’ ”

  By the end of that summer, James agreed to join, lured in part by a major stake in the firm. (By the time of the IPO in 2007, he would hold 6.2 percent, slightly more than Peterson.) He agreed to finish the year at CSFB, but soon Schwarzman was pestering him for advice and help. “As soon as I accepted the job, Steve started calling, saying, ‘We’ve got this crisis. Can you come up and think about this?’ Or ‘We’re about to make this big investment’ or ‘We’ve got to pay people. You really should be a part of that process,’ and so on.” James simply couldn’t juggle the two sets of responsibilities and moved to Blackstone ahead of schedule in early November.

  James wasted no time putting his mark on the organization. “He arrived and you knew he was there,” says former Blackstone partner Bret Pearlman. “He didn’t spend six months behind closed doors” developing ideas of what he wanted to do.

  His mandate from Schwarzman was to manage the entire firm, but Schwarzman wanted him to focus initially on reinvigorating the M&A business and whipping the private equity group into shape.

  One of James’s first moves was to impose more discipline on the investment process. He instituted a screening regimen so that partners, who had been free to pursue investment possibilities for weeks or even months without supervision, were required to submit an outline at the outset so management could decide if an opportunity was promising enough to warrant the partner’s time.

  He also pressed partners to analyze the risks of deals more rigorously. Like their counterparts at other firms, Blackstone’s partners were accustomed to producing voluminous projections, often a hundred to one hundred and fifty pages, forecasting “every item of every division, down to how many Coca-Colas they’re buying in their conference rooms and the price of Coke,” as James puts it, to come up with the base case—the minimum projected financial performance. But he insisted that they take the analysis a step farther, factoring in more carefully the possibility of fluke events that could sink a company or turn the investment into a success—what economists dub optionality.

  He cites a hypothetical investment in an airline: “You say there’s a chance there’s a major terrorism event blowing up an airline, but that happens once in twenty years, so that doesn’t affect the base case because it’s one in twenty. Then there’s a chance that oil goes from $30 to a $140 a barrel in a year. It’s never happened before—the most oil has ever gone up is twenty bucks in a year. How could it go up a hundred? But there’s a probability to that.” There is a risk of labor problems, “but, geez, we’ve got good relations with the unions and we’ve got three years before [the contract is up].

  “All these unlikely things are one in ten, one in twenty, one in fifty, whatever they are, so you don’t put them in your base case because they’re very unlikely.” But they are hazards nonetheless. “The chance of any one of them happening is tiny, but the chance that none of them will happen is also tiny. You multiply it out and you find that there’s [say] a 55 percent chance that one of them will happen, and it kills you.”

  The same analysis worked on the upside. Some investments were like call options on a stock, which give you the right to buy shares at a fixed price at some point in the future. If Blackstone could leverage a deal enough that it had little money at risk and the freak possibilities on the downside were few and the payoff from an unlikely event on the positive side of the ledger was huge—such as Paul Allen’s grabbing up Blackstone’s U.S. cable holdings in 1999 and 2000 at inflated prices—it was like a cheap call option. James hammered home the point that “there was enormous option value for us in getting lucky,” says Larry Guffey, the partner who led the distressed round of investing in the German cable companies.

  The concept wasn’t new, but the rigor and consistency with which the analysis was performed, on both the upside and the downside, was. (Schwarzman had his own, more colloquial way of framing the same issue. “What’s the tooth fairy scenario?” he liked to ask partners about the investments they were pitching.)

  At the same time, James started a series of internal workshops and strategic reviews. Despite the new procedures, he also sped up decision making, which had been as sluggish as molasses in the past. Before he instituted the screening process, Mossman was the gatekeeper through which everything passed. “Eight train tracks ran to one station,” in the words of partner Chinh Chu, with every proposed investment passing Mossman’s desk over and over before the investment committee signed off. James was just better at making decisions and moving on than the Blackstone veterans.

  James also set out to improve the personal dynamics in a culture he saw as “edgy.” He put his weight behind “360 reviews” in which partners were reviewed by peers and those under them as well as senior management. He “wanted to judge people not just on their talent but on how you trained people, et cetera,” says Guffey.

  He commissioned an exhaustive study of the firm’s past investments to find out exactly where and how the firm had made its money—and how it had lost it. The report contained some provocative conclusions.

  It came as no surprise that the firm had profited mightily by timing the markets shrewdly—buying during troughs and selling at the peaks. But there were some surprising patterns over the years. It turned out, for instance, that partners had a tendency to overestimate the abilities of those managing the companies Blackstone bought. In deals where the partners in charge had rated management highly at the outset, returns tended to be disappointing. “Management acumen drives ability to meet the plan,” the headline in the summary read. “Unfortunately, we don’t seem to be able to accurately determine this and calibrate the operating projections up front,” the subhead wryly noted. The results led the firm to turn to outside consultants and psychologists to evaluate executives at potential portfolio companies. The study also made clear that Blackstone was lagging behind competitors at improving operations at its companies—a discovery that led to the expansion of its in-house consulting and management support group.

  James also reexamined Blackstone’s relations with its bankers. He began tracking how much Blackstone paid to individual investment banks so it could see which bankers were bringing it deals, and which weren’t. At the same time, he made overtures to the banks, hoping to counter the reputation the firm had gained for being a hard-nosed and difficult customer.

  “Tony said, ‘We’re not in this for the last basis point’ ”—haggling over fractional differences in interest rates—remarks one banker. “You know Steve—that’s not really his speech.”

  Across the board, there was more structure. Before James arrived, “we were run like a small company that had gotten big—like five boutiques,” says real estate partner Chad Pike. “We had no standard operating procedures.” Now, Pike says, “the back of the house is kind of catching up to the front of the house.”

  Everyone could recognize the improvement, not least Schwarzman. He occasionally would bite his tongue when he disagreed with something James said, but he quickly came to see that James was indispensable. For his part, James never questioned that Schwarzman was the ultimate boss, and he respected Schwarzman’s prerogatives. Over time the two developed a bond, talking or leaving long voice mails for each other ten or twelve times on a typical day. Schwarzman could often be seen slouched comfortably in a chair in front of James’s desk.

  Schwarzman understood that it would be a delicate m
atter to insert James at the top of the organization between Schwarzman and the partners, and it would have to be handled carefully.

  “This was not Tony [coming] in as president with everyone reporting to him, like a corporate appointment,” Schwarzman says. “That is not how this worked.” It had been Schwarzman’s decision to hire James, but he had discussed the hire with other partners so they wouldn’t feel it was imposed on them. He understood, too, that it would shake up the existing relationships within the ranks. It would require “my strategizing how that would work in terms of his relationship with each important person at the firm,” Schwarzman says.

  Some partners were anxious as they tried to decipher what James’s arrival would mean for them. Mossman was the person most directly affected. He had always taken a narrow view of his job as chief investment officer, which frustrated Schwarzman. Not only did Mossman not deal with outsiders, but he also had no interest in supervising people internally, and he wanted to work one day a week from home. Beyond his personal quirks, his very role—the funnel through which all investment proposals had to pass—was becoming impractical as the firm expanded and became more global. Now James had arrived, effectively running private equity. Mossman stayed on for a while but in 2003 he left, retiring to Connecticut to pursue his studies in the sciences.