There was no bloodletting, no corporate-style purges. But the truth was that while Schwarzman was still the top boss, everyone did now report to James. On the few occasions when people tried to go over him to Schwarzman, Schwarzman backed James. For many of the veterans, things just felt different.
“Before, everyone had their own relationship with Steve—their own understanding of how they fit in the organization,” says ex-partner Howard Lipson. “For the senior guys to be in what looked much more like a hierarchy” was a shock.
One by one, they began to filter out. The motives and feelings were complex. It ran from “ ‘I don’t know if I want to work at all,’ like James [Mossman], to ‘I need to be my own boss and I want to run my own show,’ like Mark [Gallogly], to somewhere in between in that spectrum,” says Lipson.
They recognized that Blackstone needed to grow up and that James was taking the firm “to the next level”—the business cliché they nearly all invoke for the transition. But they were no longer sure they wanted to go along for the ride. “People had made their money and they had families and weren’t kids anymore,” says Lipson. “So they said, ‘If I’m going to do something different, now is the time.’ ”
The fact that they had become fabulously wealthy helped, as did the fact that Blackstone’s partners did not forfeit their share of the firm’s profits on past investments, as partners at many other buyout firms do once they depart. They could start new careers and continue to collect checks from Blackstone for years to come as investments from their time there were sold off.
For Bret Pearlman and Mark Gallogly, the boom in private equity in the years that followed James’s arrival enabled them to raise their own funds, as investors deluged the private equity world with new capital. Pension funds and other institutions that a few years earlier would not have considered handing over money to a firm with no past record were suddenly open to doing so. In 2004, Pearlman, who had pressed Schwarzman to wade deeper into the technology and media sectors in the late 1990s, teamed up with a group of Silicon Valley executives and investors and Bono, the lead singer of the rock group U2, to form Elevation Partners to invest in media, entertainment, and consumer companies. The next year Elevation raised $1.9 billion. In October 2005, Gallogly, who had mulled going out on his own in 1999, finally took the plunge, forming Centerbridge Partners with a veteran vulture investor. By the next year they had a $3.2 billion fund at their disposal—half again as big as the 2000 Blackstone communications fund Gallogly had headed.
Lipson left that year, too, to join Bob Pittman, an ex–Time Warner executive Lipson had known from the Six Flags theme park deal, at Pilot Group, a private equity firm specializing in media deals. John Kukral, who had returned from London when his cohead of the real estate group, Thomas Saylak, left in 2002, served notice the same month as Gallogly. Other than Peterson and Schwarzman, by the end of 2005 there was just one partner who had joined the firm before 1990: Kenneth Whitney, who oversaw relations with Blackstone’s investors.
Soon there were some fresh faces in the senior ranks, too. In 2003, Prakash Melwani, a highly regarded investor who had cofounded Vestar Capital Partners, was recruited to the buyout team. Paul “Chip” Schorr IV, who had led technology investments at Citigroup’s private equity unit, joined in 2005. The same year James hired Garrett Moran, one of his key lieutenants at DLJ, to be chief operating officer of the buyout group, putting James’s stamp even more firmly on the unit. James Quella, a seasoned management consultant who had advised DLJ Merchant Banking on its investments, was also hired that year to build an in-house team of corporate managers to work with the buyout operation.
Three years after James arrived, Blackstone was a very different place—more disciplined, more collegial, and a little less colorful. In private equity, the partner class of 2000—the thirty-somethings on whom the firm had gambled in a clutch situation—had firmly assumed the mantle. As junior partners, their worlds were altered less by James’s assumption of the reins, and the departures of Mossman, Lipson, and Gallogly cleared the way for their ascension. Even before Gallogly and Lipson left, the new partners were taking the lead on many of Blackstone’s biggest investments in 2003 and 2004—deals that would establish new records for profits and set the stage for Blackstone’s own ascendancy later in the decade. It was the final step in a transition away from the freewheeling, personality-driven culture of the firm’s first early years.
Meanwhile, Kukral’s departure made room for Jonathan Gray and Chad Pike, the next generation in real estate, to take over as joint heads of that unit. They, too, were soon steering their group in new directions, buying whole real estate companies rather than individual buildings.
The successful integration of James into the firm was plainly due in part to his talents. But the process revealed even more about Schwarzman’s evolution over the years. Schwarzman had pulled off a feat that none of his peers—and few other entrepreneurs—had managed: bringing in a successor from the outside and sharing real power with him. Moreover, he engineered the transition without the turmoil, bitterness, and recriminations of the firm’s first decade. The raw, and raw-edged, ambition he had shown in driving Blackstone to the top of the private equity heap with time had tempered.
“He’s pretty self-aware,” one banker says of Schwarzman’s decision to bring in James. “He hides it well.”
CHAPTER 17
Good Chemistry, Perfect Timing
As they sized up each other over their dinners at Schwarzman’s apartment in 2002, one of the issues on which Schwarzman and James saw eye to eye was the state of the market. They shared a conviction that they were looking at the opportunity of a decade to buy assets cheaply. James had cemented his reputation as a private equity investor with DLJ’s spectacularly profitable 1992 fund, raised when the economy was still in recession. Likewise, Blackstone’s 1993 fund, much of it invested early in the 1990s upturn, was the firm’s most successful to date. Blackstone was putting the finishing touches on a fresh $6.9 billion fund the summer they began talking. When the debt markets would allow it, both men wanted to dive back into the old-fashioned LBO business. What attracted them most was cyclical businesses—companies whose fortunes ebb and flow sharply with the economic tides.
Theirs was a contrarian view at the time, when most buyout firms were still nursing wounds from their mistakes of the late nineties, but Schwarzman’s conviction was visceral. “I recall Steve very early in that particular cycle [saying], ‘Look what’s going on! You’ve got to be buying,’ ” says Mario Giannini of Hamilton Lane, a firm that advises pension funds and others on private equity investments.
It would be risky. Timing is everything when you are borrowing to buy a cyclical company. Like cliff diving in Acapulco, plunging in too soon or too late can be disastrous, which is why many private equity firms steer clear of cyclical businesses. Nimbly timed, however, a leveraged investment at the bottom of the cycle can magnify any earnings gains. In addition, valuation multiples for cyclical companies tend to rise at the same time that profits do because buyers will pay a higher multiple of cash flow or earnings when those are on the upswing. Harness both the earnings growth and the increase in valuations, and returns can shoot off the charts. The exit must be timed as deftly as the entry, however, because in a declining economy multiples can recede at the same time earnings are falling. A company that sold for seven times earnings in good times could easily trade for just six times in a down market. If earnings drop at the same time, the two factors together could slice the value by a third, leaving the company worth less than its debt and wiping out the value of the equity, at least on paper. That is the inherent risk of leverage.
Despite the perils, instinctively Schwarzman and James wanted to pounce. “We got very active, very aggressive, and went out and bought big, chunky, industrial assets,” says James. In 2003, the year the economy turned the corner and began expanding again, Blackstone far outpaced its rivals, signing up $16.5 billion worth of deals. Goldman
Sach’s private equity unit was the only other buyout investor that came close. The totals for TPG and Apollo, Blackstone’s next closest competitors, were only half Blackstone’s.
The first big cyclical play was the TRW Automotive deal. Neil Simpkins, one of the five new partners promoted in 2000, was already talking to the company’s parent, the defense contractor TRW Inc., about buying the parts business in 2002 when Northrop Grumman, another defense firm, made a hostile bid to take over TRW Inc. The latter eventually relented and agreed to be absorbed into Northrop, but Northrop had no interest in the parts business and moved to sell it even before it had completed the TRW acquisition. Since Simpkins knew the business, he was able to cut a quick $4.6 billion deal with Northrop.
At the same time, Chinh Chu, another member of the new crop of partners from 2000, was chasing two other companies in the chemicals industry, which was at least as cyclical as the car business.
Chu had followed an unusual route to Blackstone. While most of his peers were the products of affluent families and Ivy League schools, Chu’s family had fled Vietnam when the United States pulled out, and he had earned his bachelor’s degree from the University of Buffalo. After a short stint as a banker, he joined Blackstone in 1990 and soon was apprenticed to the mercurial David Stockman. Chu didn’t shy from questioning his superior’s views and earned a place in Blackstone lore for an incident in 1996 when he was working with Stockman on a proposed investment in an aerospace components maker, Haynes International. When Stockman made his pitch to the investment committee, Schwarzman asked Chu what he thought about Haynes. Chu replied frankly that he didn’t think it would be a good investment. Stockman was so incensed that his underling would undercut his position that he refused to talk to Chu for weeks. Finally Schwarzman had to take Stockman aside, pointing out that it would be nearly impossible to close the deal if he wasn’t communicating with the associate who had worked on the project from the beginning.
Chu turned out to be right about Haynes: Blackstone lost $43 million of the $54 million it invested. With Stockman’s departure, Chu and the rest of the class of new partners from 2000 and 2001 would be put to the test as they led their first deals.
The first buyout Chu signed up, in September 2003, was Ondeo Nalco, known as Nalco, an Illinois-based maker of water-treatment chemicals and equipment owned by Suez SA, a French water, electricity, and gas utility that was selling off peripheral businesses.
Long before he began pursuing Nalco, though, another company had caught Chu’s eye: Celanese AG, a publicly traded, Frankfurt-based chemical company. It would take two years to get it to agree to a buyout and another two years to complete the last step of the transaction, but when it was all over Celanese would generate by far the biggest profit Blackstone had ever seen. It would prove to be a showcase for the art of private equity, a brilliant mix of financial wizardry with a hefty dose of nittty-gritty operational improvements. Together with Nalco, which also repaid Blackstone’s money many times over, Celanese secured Chu’s position as the fastest-rising star of the buyout group.
When Chu first began running the numbers on Celanese in 2001, the company was in a slump. With the economy ailing, demand was down for its key products: acetyl derivatives used in paints, drugs, and textiles; acetates for cigarette filters and apparel; plastics used in automobiles; farming chemicals and detergents; and food and beverage additives.
Celanese was also something of an orphan. Originally an American company, it had been acquired by the German chemical and drug maker Hoechst AG in 1987. When Hoechst agreed to merge with a French pharmaceutical company in 1999, it sold off Celanese via an IPO on the Frankfurt stock exchange. More than half Celanese’s operations and revenue were in the United States, however, and only 20 percent or so in Europe, so it was a German company in name only and never found much favor on the German market. Moreover, German stock valuations tended to be lower than those in the United States. The logical thing, it seemed, would be to shift Celanese’s main stock listing to New York. Chu figured that Celanese would trade for one multiple more there: five times cash flow, for example, if it traded for four times in Germany.
Beyond that, Celanese looked ripe for cost cutting. “We believed there were significant costs that could be taken off Celanese because Celanese was the [product] of a number of acquisitions and mergers,” Chu says.
Identifying the target was one thing; buying a public company in Germany was another. Private equity had received a frosty reception in Germany, where managements were reluctant to sell out to investors who would unload their companies again in a few years. It was a cultural matter, in part. German firms tend to be paternalistic, guarding their workforces and preserving corporate traditions. In addition, large German companies are required by law to give nearly half the seats on the boards to employee representatives, who uniformly regard private equity firms with suspicion. As a result, private equity firms had made many more investments in Britain and France, even though their economies were much smaller.
Twice Chu approached Celanese and twice he was rebuffed, first in 2001 and again in 2002. In May 2003 he came back a third time, this time allied with General Electric, the American industrial and financial conglomerate. They proposed to merge Celanese’s plastics businesses—about a quarter of the total business—into GE’s global plastics division, leaving the rest of Celanese for Blackstone. Celanese’s stock was trading for around four times its cash flow at the time, a bargain price for a company whose profits were sure to soar if the economy picked up speed.
With GE at Blackstone’s side this time, Celanese’s board was finally willing to grant Blackstone a hearing, and Celanese soon allowed Blackstone and GE to begin the process of due diligence, talking to managers and combing through internal records to understand the business and unearth any problems.
But no sooner was that under way than GE’s management did an about-face and decided it did not want to invest more in the plastics industry. (Four years later GE sold its plastics business.) The talks continued with Blackstone, but Celanese seemed to be dragging its heals and Chu began to worry that he was going to find himself rejected again and back at square one. To keep up the momentum, he did an end run around management, appealing to Celanese’s biggest shareholder, the Kuwait Petroleum Corporation, which owned 29 percent. The Kuwaitis signaled to management that they supported a buyout, and the process got back on track.
Celanese’s executives were deeply divided over the idea of selling the company and working for American financiers. “It did take some time to become comfortable with how such a deal would be structured, managed, and create value for shareholders,” says David Weidman, then Celanese’s chief operating officer.
Winning over the company was only the first challenge. Nothing about Celanese would be simple.
The financing and the mechanics of the takeover were complicated by Germany’s takeover laws. Like most LBOs, Blackstone’s purchase would take place via a new holding company, which would borrow money to buy the operating business and use profits from that to cover the cost of the debt. But German law bars a buyer from taking cash out of a company until any remaining public shareholders have approved the move—a vote that could take a year or more to arrange. Blackstone therefore had to inject extra cash into the business at the outset so there would be money to pay the interest on the buyout debt in the interim.
Scaring up the equity also proved to be a problem. Blackstone needed about $850 million of cash to close the deal, but that would amount to 13 percent of Blackstone’s new fund—far more than it was willing to risk on any single investment. Chu had assumed he would be able to bring in other buyout firms to take smaller stakes but soon found that he was alone in his conviction that the chemicals market was turning up. All six of the competitors he approached turned him down. “A lot of them thought the cycle would get worse before it got better and told us, ‘You guys overpaid,’ ” Chu recounts. Ultimately he lined up $206 million from Blackstone investors, w
hich invested directly in Celanese in addition to their investments through Blackstone’s fund. Bank of America, Deutsche Bank, and Morgan Stanley, the lenders for the buyout, agreed to buy $200 million of preferred shares—a cross between equity and debt—to fill the remaining hole.
In December 2003 the pieces finally came together and Celanese’s board agreed to sell the company to Blackstone for 32.50 per share, for a total of 2.8 billion ($3.4 billion). It was by far the biggest public company in Germany ever to go private. The 32.50 was 13 percent above the average price of the stock in the prior three months, but it still looked good to Chu, for that was just five times cash flow.
There was still one more hurdle: getting the shareholders to agree. The Kuwaitis had committed to sell their 29 percent, but other shareholders were free to refuse the 32.50 offer, and German takeover rules gave them a perverse incentive to do so.
In the United States and many other European countries, once a buyer gets 90–95 percent of the shares of a company, it can force the remaining shareholders to sell out at the price the other shareholders accepted. In Germany, by contrast, shareholders can hold out and insist on an appraisal, and the arcane formulas mandated for the appraisals almost always yield a far higher price—sometimes well above the stock’s highest price ever. Until the appraisal process was complete, Blackstone therefore wouldn’t know exactly what it would cost to buy Celanese.
Because of the holdout right, Chu found himself playing a multibillion-euro game of chicken with the hedge funds and mutual funds that owned most of Celanese’s stock.
Blackstone had conditioned its offer on winning at least 75 percent of the shares at 32.50. Any less than that and the whole deal was off. The hedge funds and mutual funds didn’t want that to happen, because Blackstone was paying a premium, and the stock would likely fall back well below 32.50 if the deal was scotched. However, it was in each investor’s interest to demand an appraisal so long as most of the other shareholders opted for the 32.50.
King of Capital: The Remarkable Rise, Fall, and Rise Again of Steve Schwarzman and Blackstone Page 22
