In most cases where the vultures descended, the companies continued in business. The owners and vulture creditors were simply fighting over who would lose how much and who would emerge with control—Wall Street at its opportunistic, merciless best.
In addition to the debt plays, beginning at the end of 2008 there was also a trickle of private equity–sponsored bank bailouts. J.C. Flowers and Company, a buyout firm that invests exclusively in financial institutions, and other investors bought a collapsed California mortgage lender, IndyMac, from federal bank regulators. After looking at more than forty institutions, in May 2009 Blackstone joined with Carlyle, Centerbridge Partners (the buyout shop founded by ex-Blackstone partner Mark Gallogly), and turnaround artist Wilbur Ross to buy Florida’s BankUnited, another deal orchestrated by the regulators.
Late in 2009, Blackstone began making more conventional investments. It bought the Busch Gardens theme parks for $2.7 billion from the brewer Anheuser-Busch InBev NV, adding more visitor attractions to its portfolio alongside Merlin Entertainment and Universal Orlando. Another of its companies, Pinnacle Foods, which owns well-known brands such as Swanson and Armour meats, bought the Birds Eye frozen-foods business for $1.3 billion. Blackstone’s real estate group, meanwhile, came to the rescue of two overstretched commercial property companies, buying a half-interest in the Broadgate office complex in London from British Land and a 60 percent stake in two shopping malls owned by a property firm in Ohio.
Perhaps more important than the new investments for the future of the business were the exits from older investments. The IPO and credit markets reopened just enough beginning in the fall of 2009 that there was a chance again to take some profits after a two-year drought. The first big company out of the gate was Dollar General Corporation, a discount retailer KKR bought in July 2007. KKR made a 150 percent gain on paper, showing that some investments made at the peak of the market could turn a hefty profit. Blackstone quickly followed with an IPO of Team Health, which provides health-care staff to hospitals and other institutions, more than doubling its money on paper after four years. Soon after Graham Packaging, which Blackstone had held since 1998, went public, yielding a modest profit on paper. Carlyle, Cerberus, TPG, and others also managed IPOs of portfolio companies in late 2009.
Around the same time, corporations came out of hibernation and began making acquisitions again, creating another avenue for exits. The pharmaceutical giant GlaxoSmithKline paid $3.6 billion for Stiefel Laboratories, Inc., a dermatological drug maker that was one-quarter owned by Blackstone. Blackstone booked a 40 percent gain barely two years after investing. A few months later, Blackstone doubled its money on a 2006 investment in Orangina Schweppes Group, the soft drink company, when the Japanese drinks company Suntory Holdings, Ltd., bought it for $2.7 billion. Kosmos Energy, the company exploring for oil off the west coast of Africa that Blackstone and Warburg Pincus had seeded in 2004, meanwhile, received an offer for one of its fields where it had confirmed big oil deposits. That promised to yield a huge profit for Kosmos’s backers.
Even dividend recapitalizations staged a comeback. While credit in general was tight, healthy companies could borrow again, and private equity firms jumped at the chance to take some money out of their companies. Vanguard Health Systems, a hospital operator owned by Blackstone, borrowed to pay a $300 million dividend. Astonishingly, HCA, Inc., the hospital chain KKR had bought for $33 billion in 2006, was doing so well that it borrowed to pay its backers two dividends in early 2010 totaling $2.3 billion. HCA followed that by filing to go public.
The profit taking was crucial for the industry, because it would prime the fund-raising pump again. Every dollar returned to an investor was one less dollar in their private equity allocation and had to be replaced. It was the first step toward restoring the virtuous circle of profits and fresh fund-raising that sustained the business in the 2000s.
In the short term, private equity will have less capital at its disposal because its investors’ assets have fallen in value and, with them, the absolute amounts they can invest. After two years of knocking on investors’ doors, by July 2010 Blackstone had raised just $13.5 billion for its next buyout fund, a huge come-down from the $21.7 billion fund it closed in 2007. KKR postponed its fund-raising plans altogether in 2009 because its investors were tapped out. Until buyout firms realize profits and send money back to the pension plans and other investors, their asset pools will slowly shrink.
Even so, the longer-term trends work in the favor of private equity, for as populations in the developed world age, pension plans will have more money to deploy, and private equity is likely to gain a bigger share of a bigger pot. In 2009, when private equity was taken for dead, three of the largest public pension funds, the trendsetting CalPERS and CalSTRS in California and New York State’s pension plan, each decided to raise the portion of their assets going to private equity.
In the postcrisis era, private equity won’t look like it did in 2006 and 2007, to be sure. Even the protagonists recognized at the time that it was a freakish period—too good to be true. With hindsight, the $20 billion–plus deals may look as anomalous as RJR Nabisco was in its day, when it was nearly four times the size of the next biggest LBO to that point. It may take a generation before there are buyouts on the scale of TXU, EOP, or Hilton again, many people in the business believe. The big question for private equity and its importance in the capital markets is not when the next $40 billion buyout occurs, but how long it takes before there are $5 billion or $10 billion deals—deals big enough to sustain private equity organizations on the scale they had operated at before the crash.
The securitization of buyout loans and junk bonds, and other debt like mortgages, created a credit bubble, so when leverage returns, it will not be on the same monumental scale seen in the mid-2000s. Still, the debt markets are vastly more sophisticated and deeper than they were in the 1980s, when the collapse of one firm, Drexel Burnham, put the buyout business on ice for years. Two decades on, LBO financing is provided by scores of institutions around the globe.
Notwithstanding the contraction of credit, the private equity business will rebound for no other reason than its $500 billion capital stockpile. Blackstone alone went into 2010 with $29 billion to invest in corporate buyouts, real estate, and debt—the largest pool of any of the big private equity houses. If history is a guide, that money will earn rich returns because investments made when the economy was weak have performed best. Buyouts in 1991 and 1992 and 2001 and 2002 earned returns near 30 percent on average, about double what investments in other years made, and the most successful funds ever were those raised and deployed at earlier troughs in the business cycle.
It isn’t just the enormous war chest that ensures the industry’s long-term survival, though. Private equity has carved out a unique role for itself. Today private equity is best understood as a parallel capital market and an alternative, transitional form of corporate ownership. Unlike the money a company raises in the stock or bond markets, or with a bank loan, this capital comes with an agenda attached, and the supplier of the capital has the power to see that plan carried out. Put another way, private equity takes risks that other investors don’t want to shoulder, in exchange for control and high returns.
The LBO continues to be the paradigm and will come to the fore again when the debt markets recover, but it no longer defines the business. At lows in the business cycle, buyout capital is used to deleverage struggling or bankrupt businesses or to buy debt at big discounts, because undercapitalized and distressed companies have the most upside for investors in a bad economy. In better times, investment flows to companies that need operational improvements. Some money will also go to stake start-up businesses, as it did with the two reinsurers Blackstone helped form after September 11 and with Kosmos Energy, the oil exploration company.
The common thread in all these, except for pure debt trading, is that private equity serves as a bridge between two stages of the company’s life. Just as venture c
apitalists fund young companies and lend management and market know-how, private equity has developed into a form of ownership where other forms of capital and ownership have fallen short. Sometimes the target is a public company like Celanese or Safeway that has not rationalized its businesses to maximize long-term value, or a major subsidiary of a public company, such as Travelport or Hertz, that hadn’t received the management it deserved. In other cases, private equity firms step in when a subsidiary such as Merlin or Gerresheimer has had its ambitions thwarted by its parent. In distressed and turnaround investments, private equity buyers provide capital and bear the risks while a troubled business regains its footing.
Not only has the nature of private equity investing evolved beyond the LBO. The firms themselves have branched out. “All of these large buyout firms are now in the process of transforming themselves from being just private equity firms into alternative investment management firms,” says David Rubenstein, the cofounder of Carlyle. Since the last downturn, Blackstone and most of its peers have become global businesses, managing a variety of asset categories and investing in emerging economies such as China and India. Three firms, Fortress, Blackstone, and (after a long delay) KKR, have gone public and Apollo hopes to soon, a process that forced them to complete the transition from secretive personal fiefdoms to mainstream institutions.
Private equity still must contend with the refinancing crunch that looms in 2012 to 2014, when the companies bought in the peak years will need to repay their loans and bonds and find new financing. Some companies, worth less than their debts, will surely be forfeited to creditors, their backers writing off their investments. But predictions of catastrophic waves of failure are probably overstated. Lenders and private equity firms alike have several years to renegotiate and postpone maturities. Billions in loans were modified, reduced, or extended in 2009 and 2010, and billions more were certain to be replaced or extended by the time the original due dates come around. By the spring of 2010, for instance, the $34 billion in debt that was originally scheduled to come due at Blackstone companies in 2013 had been reduced to just $15 billion through a combination of restructurings, extensions, and debt purchases. Its competitors had similarly worked down their totals in order to avoid a refinancing crisis. There will be a day of reckoning, but it won’t sink the private equity business or the economy.
Meanwhile, new regulatory constraints on banks may work to private equity’s benefit, forcing big banks to retrench in the areas where they encroached on private equity’s turf. Some of the biggest competitors of Blackstone’s real estate group, for instance, were the property investment arms of Goldman Sachs, Morgan Stanley, Merrill Lynch, and Lehman Brothers. Each has severely shrunk or disappeared from real estate private equity altogether after suffering big losses. The financial reforms of 2010 will limit how much of their own capital banks can invest in buyouts, which could curb rivals such as Goldman Sachs Capital Partners and the private equity operations of other banks such as Citigroup, Morgan Stanley, and Credit Suisse.
At the same time that banks pull back, private equity firms are pushing further onto what had been the banks’ exclusive territory, as Blackstone had from the beginning with its M&A and restructuring groups. KKR served notice in 2007 that it was setting up its own securities arm to sell shares and bonds. In part, this was a bid to service its own companies, cutting banks out of the loop and generating underwriting fees for itself, but KKR aims to be more than an in-house service unit. By 2010, it had participated in more than fifteen offerings, including floating bonds for Britain’s leading sports franchise, the Manchester United soccer team, in which KKR had no stake.
“If we don’t reinvent ourselves continually, we’re dead,” Schwarzman likes to tell his troops. At the end of the day, there are thousands of sources of pure capital. The trick is to supply something extra.
Amid the financial upheaval, Blackstone was observing that maxim, elaborating on the concept of private equity through new investments and investment vehicles in China. On the heels of the investment by China’s sovereign wealth fund, Chinese Investment Corporation, in Blackstone in 2007, Blackstone took a minority stake in China Bluestar, a state-owned specialty chemicals company, for $500 million and agreed to work with it to acquire chemical makers elsewhere in the world. Two years later, Blackstone’s real estate group invested with a local Chinese developer to build a shopping mall, and the firm followed that by launching a $730 million private equity fund denominated in the Chinese renmimbi currency that will invest in the Shanghai region. (Carlyle was forming a similar fund in Beijing.)
It wasn’t Blackstone’s capital that won it these roles; the Chinese have a surplus of capital. Instead, Blackstone was parlaying its financial, management, and real estate know-how into stakes in high-growth businesses. At the same time, CIC said it would invest a half-billion dollars in Blackstone’s hedge fund-of-funds, suggesting a rich new vein of capital for Blackstone to tap.
Coming out of the crisis, Blackstone’s buyout portfolio had withstood the crunch better than many of its competitors, and because it had fallen behind in the race to launch public investment funds, it dodged the meltdowns suffered by Apollo, Carlyle, and KKR’s publicly traded debt funds. Blackstone remains the biggest firm, too—only Carlyle is close in the amount of capital it manages of all types—with by far the most diversified mix of businesses.
Twenty-five years on, Blackstone still conforms to the blueprint Peterson and Schwarzman drew up in 1985 for a new form of financial institution built around private equity with other niches added as opportunities arose. And, as the Chinese initiatives show, Schwarzman hasn’t lost his knack for finding and supplying capital—and for spotting a way for Blackstone to get its cut.
ACKNOWLEDGMENTS
Even before we got under way in earnest with this book we had accumulated debts to many others. Leah Spiro at McGraw-Hill first set us thinking about a primer on private equity and then helped persuade us that David’s barely conceived notion of a more time-consuming book on Blackstone alone would be much more interesting. From the start, Zoë Pagnamenta encouraged us and then won us entrée to three first-rate agents, including Larry Kirshbaum, who ultimately represented us.
We are enormously indebted to Larry for his savvy, for his understanding of the financial and book worlds, and for, well, just being Larry. His levelheadedness and e-mail wisecracks helped smooth out the inevitable bumps in the road in a three-year project.
In John Mahaney we were blessed with an editor who grasped the nuances of the subject yet had the perspective to keep us from losing our way among the trees. The manuscript benefited enormously from his comments and suggestions.
Bob Teitelman, our boss at The Deal and an author himself, from the start lent his moral and intellectual support. His thoughts on an early draft also helped steer us back toward the big picture. We owe thanks to Vyvyan Tenorio, Christine Idzelis, and Vipal Monga at The Deal, who were forced to take up the slack at many points when we were absent. John is also grateful to Arindam Nag, Susanna Potter, and the rest of his subsequent colleagues at Dow Jones, who indulged his preoccupation and erratic schedule as the book entered its later phases. All will be relieved that we are emerging at last from our Blackstone-centric world.
Kinsey Haffner, Sean Daly, and Adam Sachs each contributed detailed, thoughtful comments on the manuscript that were incorporated in one form or another.
This book would not have been possible without the cooperation of Blackstone. From Steve Schwarzman, Tony James, and general counsel Bob Friedman on down through the ranks, people made themselves accessible and gave generously of their time, both in interviews and later in the lengthy process of fact-checking. Some were reticent at the outset, but without exception they respected our independence and never tried to turn the book into an authorized history. Steve Schwarzman gave more of his time than anyone else—more than a dozen extended interviews over nearly two years during which the financial world was upended. His candor and his
exceptional memory allowed us to incorporate the firm’s, and his, perspective on events over a twenty-five-year period to an extent we had not anticipated at the outset.
We are enormously indebted to John Ford, Blackstone’s longtime press officer, whose integrity and courtesy had earned him the respect and affection of the financial press long before this book was conceived. His knowledge of the firm was a huge asset, particularly in the early stages of our reporting, and he shepherded the hundreds of fact-checking queries we submitted for a year after he retired officially. Two other people deserve special mentions: Stephanie Kokinos, John Ford’s assistant, who miraculously buttonholed one partner after another for interviews during the early stages when we were reporting most heavily, and Christine Veschi, to whom fell the laborious task of checking dates, prices, and profits on scores of investments.
Many others in the financial world, named and unnamed, provided valuable background, recollections, and insights that informed the story and filled in details from other perspectives.
To all, our sincere thanks.
NOTES
Many basic facts about Blackstone’s private equity investments—deal values, closing dates, the equity invested, profits and rates of return, the strategic plans behind individual investments, and accounts of how they played out over time—came originally from the confidential prospectuses known as private placement memorandums for Blackstone’s fifth and sixth buyout funds, which were obtained by the authors. These documents are given to prospective investors in Blackstone’s funds and are not publicly available. Details from these sources were later verified with Blackstone.
King of Capital: The Remarkable Rise, Fall, and Rise Again of Steve Schwarzman and Blackstone Page 36
