Getting Blackstone into some form that could be taken public entailed a herculean effort by the lawyers and accountants. To begin with, there was no one Blackstone. The “firm” was a cluster of a hundred or so partnerships and corporations and funds with contractual ties and overlapping management and ownership but no single parent company whose shares could be sold to the public. Control was complicated, too. Peterson and Schwarzman alone had voting rights in the buyout and M&A businesses. They divvied up the profits to the partners in those groups and consulted them, but the other partners had no legal right to a say in management. By contrast, the managers of the real estate arm—including its founder, John Schreiber, who was not even a Blackstone partner or employee—controlled half of the voting rights for that business, with Blackstone holding the other half. To go public, Blackstone would have to create a single entity—and ultimately two entities—at the top of the corporate pyramid.
The restructuring posed a thicket of tax, regulatory, accounting, and governance barriers through which Blackstone had to navigate. The firm wanted to list on the New York Stock Exchange, but it did not want to submit to the exchange’s rules giving shareholders the right to nominate, elect, and depose directors. On the regulatory front, Blackstone had to be an operating business that took a hands-on role in managing its holdings so that it would not fall under the onerous regulations governing passive stock market investors such as mutual fund managers. But for tax purposes, Blackstone wanted to be treated as a passive fund collecting income so it could avoid paying federal corporate taxes.
Going public also raised profound intangible issues: Would it alter the firm’s culture and change the incentives for management? Would Blackstone over time concentrate more on producing predictable short-term profits for shareholders instead of bigger, but less predictable, long-term gains for the investors in its funds?
Schwarzman and James had many qualms about going public, but they knew that if Goldman, Citi, and Morgan Stanley had talked to them about it, bankers would assuredly be knocking on the doors at KKR, TPG, Apollo, and Carlyle as well.
“If we don’t do it, someone else will” was the consensus around the table at the first Project Puma meetings, Puglisi recalls. “If someone else does it, everyone will have to follow. That’s the law of Wall Street.”
“There was an expectation that all the dominoes would fall,” says Morgan Stanley’s Porat.
Moreover, there were huge benefits to going public. Not only would it allow Peterson, Schwarzman, and other partners to sell down their stakes and diversify their wealth. It would give the firm “acquisition currency”—stock with which it could buy other businesses and lure talent. With stock it could afford to add much larger new businesses than it could if it had to pay in cash or with an illiquid ownership stake in Blackstone. That advantage would soon be demonstrated with GSO Capital, a debt fund manager formed by former colleagues of James’s from DLJ. In January 2008, after the IPO, Blackstone agreed to buy GSO, which managed $10 billion in assets, paying for it largely with stock.
James also saw other, less obvious payoffs. Unlike most of their counterparts at other private equity houses, Blackstone’s partners became fully vested in their profit stakes the day an investment was made. If they left the firm the next day, they would still collect their share of any gains when a company was sold years later. An IPO would allow the firm to create incentives for people to stay for the long haul. Under the plan that emerged, partners would receive their new stock in the company over eight years, forfeiting what they hadn’t yet received if they left sooner.
James also saw going public as a chance to break down the silos in the organization—the tendency of its units to operate in isolation. Instead of just being paid a share of the profits from their own units, partners would now be awarded stakes in the entire enterprise, binding them together economically.
Still, the prospect of being public was daunting. “Everyone was a bit ambivalent,” says James. “Do we want to live in a fishbowl? Do we want to disclose net worth and private compensation? This was a fundamentally different kind of decision” than raising a new fund on the stock market as KKR had.
To pull off an IPO, management would have to satisfy a multitude of constituencies: the investors in its existing funds (who might worry that the firm’s priorities would be altered), the partners (whose financial interests would be completely restructured), as well as potential public investors. “A couple of times a week, Steve and I would sit down and say, ‘Do we really want to do this?’ ” says James.
For all his concerns, James was convinced that it made sense for the firm, and acted, in Puglisi’s words, as “the coach and quarterback” of the effort. Schwarzman, who would make the final call, reserved judgment through the fall and winter. “I didn’t invest myself personally,” Schwarzman says. Although he was involved in the discussions throughout, he “wanted to stay objective to make a balanced decision once all the facts were in.”
Like prosecutor and judge, James would make the case and Schwarzman would take it under submission.
By the end of the summer of 2006, the lawyers at Simpson Thacher had drafted a plan to reform Blackstone as a master limited partnership, a structure commonly used for oil and investment partnerships. The public investors would be limited partners, or unit holders, and the partnership would be managed by a second partnership owned by Blackstone’s existing partners. In this form, Blackstone would pay no corporate taxes and the public unit holders would have few rights. They would have no vote on directors, for instance, and it would be very difficult for them to dislodge management.
There was just one problem. Partners would have to swap their share of future profits for equity in the unified Blackstone. To do that would involve estimating the future gains on each investment, because partners had joined at different times and thus were entitled to different slices of the pie. Projecting future investment profits would be a dicey and a monumental exercise, and one potentially fraught with politics since individual partners might argue that the investments in which they had a stake were more promising than others.
James devised an end run around the difficulty. Partners would keep their stakes in most existing investments, and the public company would own only the profits on the most recent investments and those made after the IPO. This bypassed the need to predict the success of older investments, but there was a catch: The firm would have few if any investment profits in the first few years after the IPO, as it would take time for current investments to ripen and be harvested.
The solution was a new accounting rule, Financial Accounting Standard 159, which allowed firms in some circumstances to book income based on projections of future profits. Each quarter, Blackstone would appraise each investment in its portfolio, based on cash flows and values for similar businesses, and using complex financial models, it would calculate the present value of the carried interest—its 20 percent of the profit—that it was likely to collect down the road. It would be a stupendous feat of theorizing and speculation, but the new accounting rules seemed to authorize it. James did much of the number crunching himself to put the plan together.
By October 11, he had mustered enough information that he called Porat and told her he wanted Morgan Stanley to begin work in earnest on an IPO. One of the bank’s primary tasks was to estimate more precisely what price Blackstone could command in the market. This was no small challenge. Investors and stock analysts typically look to comparable companies, but there weren’t any public private equity firms that truly compared. In Britain there was 3i Group plc, but it was smaller and focused on midsized, not large, companies. Then there was Onex Corporation in Canada, but like 3i, it invested heavily in its own funds, so that buying its shares amounted to taking a stake in an investment fund whose profits and value could oscillate, rather than a piece of a fund manager, whose income and value tended to be more steady. Moreover, Blackstone wasn’t just a private equity firm. It had its M&A and restructuring
businesses, and its hedge fund-of-funds business.
None of the normal measures for assessing stocks worked well either. Assets under management—the benchmark for mutual fund companies and many other money management firms that derive their income from fixed management fees—wasn’t an apt measure for Blackstone, because two-thirds of its profits in 2006 were investment gains. Likewise, price-earnings multiples, a standard benchmark for stocks, were pretty much meaningless because Blackstone’s earnings took unconventional forms and fluctuated so widely quarter to quarter. It would take some ingenuity, then, to make the case for any valuation of the business.
Project Puma got an unexpected boost in November 2006 when Fortress Investment Group, a smaller private equity and hedge fund manager, filed papers to go public. Fortress had adopted a parallel legal structure and its business was similar enough to Blackstone’s that it would be a useful trial balloon to gauge which way the market winds were blowing.
Through the late fall and winter, the lawyers and accountants ground away on the particulars. By January 2007 the planning was far enough along that Schwarzman finally met with Peterson to inform him of the IPO and to discuss the delicate issue of reducing his stake. It was a measure of how marginalized Peterson had become that six months of groundwork had been laid before he was made aware.
Though Peterson stood to gain the most from the IPO because he would be able to sell part of his stake, he wasn’t keen on the project.
“I had run a public company, so I knew a lot about what public companies were about,” Peterson says. “Steve and I must have had a two-hour discussion one day and I said, ‘Look, I’m about to retire and, while I have the power [under the founders’ agreement] to block it, I’m not going to do that. But I am going to insist that you have really thought this thing through. And I’m going to tell you how being public is very different from being private. You’re used to the privacy of your compensation and all your arrangements and so forth. You’re used to privacy in your private life. You as a CEO will become a center point or lightning rod and you’ll have to become beholden to a board of directors. You’re going to have to be meeting endlessly with equity analysts, [making] investor telephone calls, spending an enormous amount of time. If there happen to be any public problems, you’re going to be the focal point.’ ”
By then the process was gaining momentum, and Blackstone was ready to bring in a second bank because the offering would be too big for Morgan Stanley to market single-handedly.
Adding bankers was more than an exercise in spreading the risk. It was also a division of spoils. The IPO would yield $246 million in fees and commissions for its underwriters, and every major investment bank would want a piece of the action. The first bone was thrown to Michael Klein, the Citi banker who had first floated the $20 billion valuation figure the spring before over lunch with Schwarzman. In January, Schwarzman chose Citi to colead the IPO with Morgan Stanley.
James summoned a team of Citi’s capital markets bankers to Blackstone’s headquarters on the evening of January 15, the Monday of the Martin Luther King Jr. holiday weekend, to let them in on the plans and to sign up Citi as an underwriter. Schwarzman and James were still so obsessed with secrecy that they didn’t tell Morgan Stanley that Citi had been hired, or vice versa, for several weeks. As leads, each bank would be responsible for selling 20 percent of the shares, but Morgan Stanley would receive a bigger part of the fees because its bankers had labored for months laying the foundation.
As the IPO date drew close, Blackstone repaid favors to other banks that had backed its investments, adding Credit Suisse, Lehman Brothers, and Merrill Lynch & Co., each of which got a 14 percent slice. Deutsche Bank, which had financed many of Blackstone’s LBOs but did not have the retail brokerage network needed to market large blocks of shares like those in Blackstone’s offering, was tacked on at the end, after complaining about being left out. It was allocated just 5 percent of the stock and appeared one symbolic line further down in the list of banks on the cover page.
While the IPO preparations were moving ahead in secret, Blackstone was everywhere in the public eye in the first months of 2007. Jon Gray’s real estate team was waging an all-out war for Equity Office Properties in January and February, and in Britain, Blackstone, KKR, TPG, and CVC Capital Partners were pursuing a closely watched $22 billion bid for J Sainsbury plc, one of the country’s leading supermarket chains—a deal that, had it come to pass, would have set a new buyout record for Europe.
Meanwhile, Schwarzman had gone on the conference circuit and had become something of a quote-meister. That January at the World Economic Forum in Davos, Switzerland, the annual conclave of business, financial, and political leaders from around the globe, he expounded on how executives dreaded the headaches of managing a public company. The CEO of an unnamed $125 billion corporation, he told the audience, was tired of the hassles of answering to the public markets and said to him, “Geez, I wish you could buy us, but we’re too big.”
It was Schwarzman’s sixtieth birthday party on February 13 that elevated him from being one more Wall Street bigwig to a symbol. It transformed him into a cliché for the age and a punching bag. The scale of the bash stunned even jaded Wall Streeters, and to the man in the street the extravagance reinforced every negative stereotype of financiers. It was the reality version of Bonfire of the Vanities, and the press had a field day, for the event encapsulated the power and wealth of private equity and of the small band of men who controlled its biggest firms.
The potential political fallout from the party worried Henry Silverman, the ex-Blackstone partner who had left to run Cendant. He says he bluntly asked Schwarzman, “Why would you do this?” Silverman was involved in a business group that lobbied in Washington and he knew that there were people in Congress who were looking at ways to raise taxes on hedge fund and private equity partners. “I said to Steve, ‘This is a very bad idea because these guys read the newspapers, also.’ ”
It wasn’t just the party. In the month that followed, Schwarzman continued on what seemed from the outside like an orgy of self-promotion. Just a week after the party, a cover story in Fortune dubbed him “the New King of Wall Street.” Arms crossed, poker-faced, in his trademark blue-striped shirt with white collar and a navy pinstripe suit, Schwarzman looked every inch the Master of the Universe. “Steve Schwarzman of Blackstone wants to buy your company and has a $125 billion war chest to do it,” the subhead read. A few weeks later, on March 16, Schwarzman showed up on CNBC in a lengthy interview with the network’s glamorous anchor Maria Bartiromo.
Some of the press coverage was a fluke. Fortune had compiled a package of stories about private equity and whipped out the profile of Schwarzman at the last minute, without his knowledge, relying on a stock photo for the cover. But in the wake of the party, the exposure had made Schwarzman the very public face of the high-rolling world of leveraged buyouts.
Going into February, Schwarzman still hadn’t given the final go-ahead for the IPO. “The very last thing we wanted to do was file the papers to go public and then change our minds,” James says. “You get all the negatives of being public and none of the positives.” They didn’t want to launch an IPO “until we were absolutely sure we could complete it.”
When Fortress went public on February 9, it became clear that Blackstone’s plan was viable. Fortress priced its shares at $18.50, at the top of the estimated range, and they more than doubled on their first day of trading, hitting $38 at one point.
“Not only did they get public, but they got public with great success—with great fanfare and a great valuation,” says James.
Now there was a sense of urgency, for Schwarzman and James had learned that KKR had designs to go public and there were rumblings that TPG had sought out bankers for advice. They also were concerned that the window of opportunity might slam shut. “Steve and I both instinctively felt that the public markets are inherently flighty,” says James.
The publicity from the steadily e
scalating wave of buyouts unveiled that spring was bound to help, conveying that private equity was on a tear. On February 26, KKR and TPG announced they would buy TXU Corporation, a Texas electricity and gas utility, for $48 billion, eclipsing the record Blackstone had set just weeks earlier when it closed the buyout of Equity Office Properties. Three days later, KKR clinched the largest LBO ever in Europe, an $18.5 billion takeover of the publicly traded drug store chain Alliance Boots plc.
By then, a number of other partners had been consulted about Blackstone’s IPO or had caught wind of it, but Schwarzman and James still hadn’t officially informed rank-and-file partners when CNBC broke the news on TV on March 16 that Blackstone would soon file offering papers—the first leak since the planning had begun more than nine months earlier. Three days later Schwarzman and James convened partners in the thirty-first-floor conference room at Blackstone’s headquarters, with partners in other offices beamed in on video monitors, to explain the IPO and the restructuring that would precede it.
On March 22, Blackstone made it official, lodging a draft prospectus with the Securities and Exchange Commission for an offering that could raise up to $4 billion. The 363-page document was long on words but short on the kinds of juicy details others really wanted to know, such as how much Peterson, Schwarzman, and James made and what their stakes in the firm were. (Under SEC rules, details like that do not have to be disclosed until later in the months-long process of going public.)
King of Capital: The Remarkable Rise, Fall, and Rise Again of Steve Schwarzman and Blackstone Page 29
