“I remember sitting in my office negotiating with every hedge fund who had a stake and all the mutual funds,” says Chu. “They all wanted the deal to go through, but they did not want to be part of the 75 percent.”
On March 29, 2004, the day the offer expired, the outcome still wasn’t clear, and Schwarzman was on pins and needles. “[Steve] walked into my office around three thirty and just sat there, because he was obviously concerned about the deal,” says Chu. “We had run up something like $25 million in expenses, which was no small matter. Steve said, ‘Chinh, how is it going?’ I’d say, ‘Steve, I’m on the phone negotiating with everybody. I don’t know how it’s going!’ ”
Schwarzman returned again with only minutes to spare till the 6:00 P.M. deadline. “We were 15 percent short. At six o’clock, Steve asked me, ‘What is the official tally?’ At that point, we were 1.5 percent short, but I told Steve, ‘I think we’re going to be fine when you wake up in the morning because a lot of guys came in at the last minute, and there is still stuff stuck in the computer system.’ ” The next morning Blackstone learned it had garnered at least 80 percent of the shares, and the final tally the following day was 83.6 percent. Blackstone controlled Celanese. It would take another four months before a shareholder vote could be held, however, two additional months before Celanese’s cash flow could be tapped to service the buyout debt, and more than a year and a half to buy up the rest of the German shares. In the fall of 2004 Blackstone offered 41.92 a share to the shareholders who had refused to sell out, but there were no takers. Two American hedge funds that owned almost 12 percent, Paulson and Company and Arnhold and S. Bleichroeder Advisers, held out for more. Finally, in August 2005, they both agreed to sell at 51 a share. A few stragglers stuck it out and ultimately got 67 per share. Paulson and Company would later gain fame for making billions in 2007 betting that the mortgage market would crash.
Blackstone didn’t wait for the last of the holdouts before setting about to reshape the company. That began as soon as it won control in April 2004.
The first step was to, in effect, de-Germanize the company, both to invigorate the management culture and to make the company more appealing to American investors for an eventual IPO. Celanese’s CEO, a thirty-eight-year veteran of Celanese and Hoechst, was slated to retire, and Blackstone wanted to install a brisk American-style leader. It settled on David Weidman, the company’s chief operating officer, an American who’d joined just four years earlier from Honeywell / AlliedSignal and thus represented fresh blood.
German companies have a reputation for being plodding and bureaucratic. The problem was exacerbated at Celanese by the fact that the company had three power centers: the head office in Frankfurt and large satellite offices in Somerset, New Jersey, and Dallas that it had inherited over the years and never bothered to consolidate. Some key executives were based in the U.S. offices, and the three duchies often bickered and tripped over one another. One of the first moves under Blackstone was to centralize power in Dallas, an action it hoped would reduce the organization’s inertia and reduce overhead.
The move to Dallas saved $42 million a year. Retooling at the North American plants sped up production and allowed more jobs cuts, saving another $81 million annually. Celanese also off-loaded a money-losing business that made glasslike plastics and sold its stake in an unprofitable fuel-cell venture, two drains on profits. It saved another $27 million annually by shifting most of its production of acetate fibers used in cigarette filters to China, where cigarette sales were rising and labor is cheaper.
To augment its business, meanwhile, in October 2004 Celanese struck a deal to buy Acetex Corporation, a Canadian company, for $490 million and the next month agreed to buy Vinamul Polymers for $208 million. Acetex brought new facilities in France, Spain, and the Middle East and made Celanese the number-one producer of acetyl products, with a 28 percent market share worldwide. That pushed cash flow up by another $60 million. Blackstone also endorsed Weidman’s plans to increase the capacity of several plants Celanese already was building in Asia.
The rapid-fire asset sales and acquisitions, the operational changes, and the switch of headquarters “would have been extremely difficult to carry out as a German public company,” says Weidman, because the costs—including payments to laid-off workers and investments in new plants—would have cut deeply into Celanese’s earnings in the short term. Celanese’s bureaucracy at the time also would have thwarted the changes, adds Weidman, who remained on as CEO long after Blackstone exited Celanese.
As the company was trimming fat and expanding through acquisitions, business was taking off as the global economy improved. Even before the deal closed in April 2004, demand had picked up enough that Celanese had begun raising prices. Over the course of that year it publicly announced thirty price increases, which helped lift its top line to $4.9 billion from $4.6 billion the year before and pushed cash flow up 42 percent. On the strength of that, Celanese was able to borrow more money in September 2004 to pay out a dividend. With that, Blackstone recouped three-quarters of the equity it had invested in April. Thereafter, most of what it would collect would be pure profit.
Two months after the dividend, in November, Celanese filed papers for an IPO to go public and in January 2005, only eight and a half months after Blackstone won control of the company, Celanese went public again on the New York Stock Exchange. As Chu had predicted, American investors valued the company more highly: at 6.4 times cash flow, or 1.4 “turns” more than Blackstone had paid. Celanese raised close to $1 billion in common and preferred stock, $803 million of which went to Blackstone and its coinvestors, on top of the dividend they received earlier. Blackstone and the coinvestors had now collected $700 million in profit on their $612 million investment, and they still owned most of Celanese. By the time they sold the last of their Celanese shares in May 2007, Blackstone and the coinvestors raked in a $2.9 billion profit on Celanese—almost five times their money and by far the biggest single gain Blackstone has ever booked.
Celanese was a tour de force of financial engineering. By Chu’s reckoning, the cyclical upswing of the industry and the higher multiple the stock commanded in the United States accounted for roughly two-thirds of the Celanese profit. The remaining third traced to the operational changes, such as pruning costs, selling the money-losing operations, and adding Acetex and Vinamul. Much of that was accomplished in the eight and a half months between the takeover and the IPO.
Those enhancements rather than the economy were responsible for roughly half the increase in the company’s cash flow from 2003 to 2006, Chu contends, and that appears to be corroborated by a comparison with other chemical companies. Celanese’s cash flow rose 80 percent in that period while none of its chief competitors—BASF, Dow Chemical, and Eastman Chemical—managed a gain of more than 50 percent.
More than eleven hundred jobs were cut along the way, but Celanese also created new jobs at the same time, so the net loss was four hundred jobs, or about 4 percent, while Blackstone was in control. Meanwhile, the productivity of Celanese’s workforce shot up by more than 50 percent, from $495,000 in revenue per employee in 2003 to $750,000 in 2006. Perhaps half of that resulted from the run-up in the chemical cycle, but much was due to the operational improvements and strategic changes on Blackstone’s watch.
Celanese sustained its performance for years after it went public. Its shares more than tripled over the next three years, from $16 in the IPO to a peak of almost $50 in mid-2008, outperforming its competitors substantially. The economic slowdown took a toll on the company in 2008 and 2009, but Celanese entered the downturn “a fundamentally stronger company,” its CEO, Weidman, says. As evidence he cites its cash flow, which never dipped below $800 million in 2008–2009, double its level in the 2001–2002 recession.
Even relisting in the United States—the ploy that at first glance looks like a financial sleight of hand—benefited the company. By shifting to the U.S. market, where its shares were more highly valued, Cela
nese gained access to cheaper capital, a crucial advantage if it wanted to expand or acquire other companies. To raise a given amount of money, it now has to sell fewer new shares than it would if it still traded in Germany.
The Nalco investment played out along similar lines. The company rode the rebound in the chemical markets, borrowed to pay a dividend to Blackstone, Apollo, and Goldman Sachs Capital Partners, and then went public in November 2004, two months before Celanese. At the IPO price, Blackstone’s investment was worth three times what it paid a year earlier. By the time Blackstone sold the last of its shares in Nalco in 2007, its profit was 1.7 times its investment in Nalco.
“You’ve got to have a lot of respect for the cycles,” Chu says, looking back. “No matter how smart an investor you are and no matter how great the company and its management team are, if you invested in U.S. or European chemicals in 2007 and exited in 2010, you’d take a loss.”
It was a lesson Blackstone failed to heed with TRW Automotive. Auto sales bottomed out in 2003, right after Blackstone bought the company, and began trending upward. When the company went public in February 2004, a year after Blackstone bought it, Blackstone recouped much of its investment and showed a huge paper gain on its remaining shares. For several years after that, the company grew rapidly, even though car sales were flat in both the United States and Europe after 2005. The stock never progressed too far from its $28 IPO price, though, as Blackstone held on to a 45 percent stake. At the stock’s peak of around $40 per share in 2007, Blackstone’s stake was worth $1.9 billion and the investment still looked like a success. But it had held on too long. Car sales plummeted in 2008 and 2009, dragging TRW’s sales down by a quarter. In the spring of 2009, when TRW shares troughed out at $1.52, Blackstone’s remaining stake was worth just $70 million. The stock rose back above $30 in 2010. Blackstone seized the opportunity and sold $264 million in shares. Its remaining stake rebounded in value to $1.2 billion, restoring much of its gain on paper. But it would now take much longer to exit TRW, and because Blackstone has had its capital tied up for so long, the absolute gain will equate to only a modest annual rate of return. Timing really is everything.
CHAPTER 18
Cash Out, Ante Up Again
To understand the explosion of buyouts in 2006 and 2007 and the unprecedented quantity of capital and power amassed by big private equity firms in that era, one must understand what happened several years earlier.
The year 2003 proved to be an economic inflection point, and Celanese, Nalco, and TRW were harbingers of a gush of profits to come. Other private equity firms, too, were able to cash out of investments as the economy and markets turned up, and the gains they showered on their investors in 2004 and 2005 ensured that the next round of buyout funds would attract far larger sums than the last. Together with the availability of credit on an unparalleled scale, the stage was set for a wave of LBOs that would mesmerize the business world across the United States and Europe.
The mood shift was abrupt. Between March 2003, when Blackstone kicked off its new $6.9 billion fund by investing in TRW Automotive, and the end of that year, American stocks rose nearly 40 percent, and investors became hungry again for IPOs. But their tastes had changed since the tech bubble ended in 2000. This time investors wanted no part of visionary dotcoms with no revenues or profits. They were perfectly content, thank you, to invest in mundane businesses provided that they produced steady income—precisely the kind of companies buyout firms tended to buy.
Blackstone raced to take advantage of the situation. In May 2002, when the IPO market first opened briefly, it pulled off an IPO of Premcor, the oil refiner David Stockman had bought in 1997. A couple of years earlier Premcor had looked like it would be a money loser for Blackstone. After a supply glut drove down oil prices in 1997 and 1998, the company began leaking cash. Then, in 2000, it was indicted for environmental violations. But by 2002 oil prices were up, the company was on the mend, and Stockman’s original premise for the investment—that Premcor would benefit from a chronic shortage of refining capacity in the United States—had been borne out. Premcor went public at a price two and a half times what Blackstone had paid, and the firm made six times its money selling down its stake as the stock rose in the following years.
After demand for IPOs became more sustained in late 2003, Blackstone prepped six more of its companies to go public. Centennial Communications, a Caribbean cell phone operator it backed in 1999, held its IPO in November 2003. Then Centerplate, Inc., a catering company Blackstone had bought from KKR eight years earlier, followed by Aspen Insurance, the reinsurer Blackstone had helped set up after 9/11. That December, Foundation Coal went public, just five months after Blackstone had bought the American mining company from a German utility. Nalco and Celanese rounded out the IPO list. In none of these cases did Blackstone cash out even half of its holding, but the IPOs began the process of locking in profits and set the stage for it to take its gains over time by selling shares.
Taking companies public wasn’t the only way to cash in on the market turnabout. There was also the dividend recapitalization—leveraging up the company more to pay a dividend. Together, the surging economy and the resuscitated credit markets made those the profit-taking methods of choice in many cases. Suppose a company had been acquired for $1 billion with relatively little leverage in 2002, when credit markets were tight, and it had debt of just $500 million. If the improving economy had pushed cash flows up 20 percent, the company could now borrow an additional $100 million (20 percent of $500 million) assuming its bankers applied the same debt–to–cash flow figure they had when they financed the deal originally. That money could then be paid out to the company’s owners.
But the takings were even larger than that because bankers had grown more generous as the debt markets improved. With a given annual cash flow, you could now borrow much more than you could in 2002. The high-yield bond market reopened in 2003 and 2004 and quickly matched its peaks in 1997 and 1998, sending interest rates tumbling as money cascaded in. A company issuing junk bonds at the beginning of 2003 had to offer an interest rate 8 percentage points over the rate on U.S. treasury bills. By December 2003 that spread had narrowed to just 4 percentage points. With their interest costs falling, companies could shoulder more debt and replace their old debt with new, cheaper loans and bonds. Thus the hypothetical company above might well be able to take on, say, $200 million of additional debt, paying back its owners 40 percent of the $500 million they originally had invested. Presto! An instant return. And the recapitalization might not even increase the company’s interest costs.
That’s what happened with Nalco. The buyout was quite highly leveraged from the start, with debt at six times Nalco’s cash flow going in, but within a week of the deal’s closing in November 2003, Blackstone and its coinvestors, Apollo and Goldman Sachs Capital Partners, were peppered with calls from bankers offering to lend Nalco even more money. “This was a wake-up call, evidence to me that something new was unfolding,” says one investor in the deal. “Between the time that we signed the Nalco deal in the summer and the time it closed in November, the availability, pricing, and structure of this kind of credit had undergone a big change for the positive in the market.”
The recaps were an irresistible move for buyout firms, because they allowed them to earn back part of their investment quickly, without the drawn-out process of an auction or an IPO, and the faster they returned money to their investors, the higher their annual rates of return.
To the uninitiated, the recaps could look like financial gymnastics. In fact, they were a tried-and-true move in the private equity playbook, and if the new debt simply reflected a healthier business with better prospects, or lower interest rates, there was nothing nefarious about the practice. It was no different from owning an apartment building where rents and the property’s value had risen sharply. There would be nothing irresponsible about refinancing the building to take out equity if the increases looked permanent or mortgage rates had fallen
.
Still, there had never before been a spate of recaps like this. Buyout firms big and small sucked $86 billion of cash out of their companies this way between 2004 and 2007—money that largely flowed straight back to their limited partners.
The recaps were in part a necessity at first, because it was still hard for private equity firms to find buyers for their holdings. Corporations had pursued so many misguided acquisitions in the late nineties that they were slow to resume buying once the recession ended. Merger activity didn’t match its 1999 and 2000 heights again until 2007.
To compensate for the lack of corporate buyers, private equity firms also created their own M&A market, buying companies from one another in what are known as secondary buyouts.
The secondary buyouts of the mattress makers Simmons Company and Sealy Corporation within months of each other in the winter of 2003 to 2004 advertised the strange tendency of some companies to be handed off repeatedly from one private equity firm to another. When Thomas H. Lee Partners bought Simmons from Fenway Partners for $1.1 billion, it was Simmons’s fifth consecutive buyout over seventeen years. A few months later KKR bought Sealy from Bain Capital and Charlesbank Capital Partners for $1.5 billion and became Sealy’s fourth private equity owner in fifteen years.
Again, it looked peculiar to outsiders. It called to mind Milo Minderbinder, the wheeling-and-dealing mess officer in Catch-22 who made a profit buying eggs from himself at 7 cents apiece and selling them for 5 cents. Were they just playing a financial shell game among themselves?
Secondary buyouts were usually not too baffling if you delved into the financials of the companies. Both mattress makers had steadily improved and expanded their businesses over the years under their successive private equity owners. They had consolidated smaller companies and launched new products, their businesses got a lift from a slow but steady increase in the number of bedrooms in the average American home, and they had expanded overseas. Their cash flows were predictable enough that they could be highly leveraged, generating gains for their owners from even relatively small improvements.
King of Capital: The Remarkable Rise, Fall, and Rise Again of Steve Schwarzman and Blackstone Page 23
