King of Capital: The Remarkable Rise, Fall, and Rise Again of Steve Schwarzman and Blackstone
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EOP’s management made the best of it they could. “Of course, we immediately went back to Blackstone and said it was terrific,” Zell says.
Vornado’s posture was understandable. Vornado’s market capitalization was only slightly bigger than EOP’s, and it would have had to borrow a lot of money to make an all-cash bid, which likely would have knocked down its stock price. Its stock was trading at an all-time high, and at a much higher earnings multiple than EOP’s, so it had every reason to prefer to pay with stock. But Zell had been clear with Roth the previous summer and was clear in his own mind. He wanted cash and only cash.
“You know how when you’re in a discussion with your spouse?” says one person who was involved in the talks about Roth’s bid. “Sometimes you hear what you want to hear.”
Zell hadn’t managed to ignite the bidding war he expected, but another one was heating up at Blackstone, where the phones were ringing off the hooks. Everyone in the commercial property business was clamoring to pry loose a piece of EOP. Gray and Frank Cohen were caught off guard shortly after the deal was announced when they had lunch with a property mogul who unexpectedly began to quiz them about what they would sell. None of the men had notepaper. They had to summon a waiter and borrow his order pad to jot down a list of the cities.
The inquiries and offers vindicated Blackstone’s bet that it could off-load assets to finance the buyout. The flood of calls also made it clear to Gray’s team that they could sell much more than the one-third or so of EOP’s square footage they had projected. The godfather bids it was receiving for the buildings would make it possible to raise Blackstone’s offer for EOP if it needed to.
It turned out that it soon would. Just as Blackstone had been forced to boost its bid for Freescale a few months earlier to preempt a firm offer from KKR and Silver Lake, Blackstone found itself under pressure to lift its offer for EOP even though there was no other binding bid from Vornado on the table. EOP’s share price had risen past Blackstone’s $48.50 offer, which meant some investors had paid more than that for their stock and wouldn’t want to sell at a loss into Blackstone’s offer. Blackstone was now bidding against market expectations as much as against Vornado.
The solution was to firm up the offers Blackstone was receiving for EOP’s buildings so it could elevate its offer for EOP. To do so, Gray needed permission to share EOP’s internal financial information with the real estate firms that wanted pieces of EOP. EOP quickly gave it.
Just as in Freescale, Blackstone had the jump on the competition because it had the support of the target’s board and had had access to the target’s internal financial information for months. Vornado had neither, and Blackstone would have to exploit its advantage. Gray’s group launched a hectic round of talks, negotiating with real estate firms by day and then convening at night to deal with the EOP side of the deal. It quickly became clear that Blackstone would have to sell far more than the one-third of EOP it had planned, but the lofty offers Blackstone was fielding were nearly impossible to refuse.
The decisive factor was a jaw-dropping bid from Harry Macklowe, a New York office baron, who offered to buy most of EOP’s New York buildings for $6.6 billion, a cap rate of between 3 and 3.5. That was equivalent to a cash-flow multiple of 29 to 33—well into nosebleed territory. Macklowe would have to pay more than 3.5 percent interest on the loans to buy the buildings, so he was guaranteed to lose money at least in the short run. It made sense only if he could sharply boost the rents he collected or if the buildings were destined to rise in value.
The New York portfolio was one of EOP’s jewels, and one of the chief lures to Blackstone in the first place, but Macklowe’s offer was irresistible. The $6.6 billion would go a long way toward Gray’s goal of owning the rump of EOP for far less than its current value. He was now ready to offer EOP a bit more.
On January 22, Blackstone’s bankers told EOP that Blackstone would pay $53.50 a share—a $5 boost over the price they had agreed on in November—provided EOP would increase the breakup fee to $700 million, or 3 percent of EOP’s market capitalization. EOP’s board held out for more, and eventually Blackstone agreed to $54 a share and settled for just a $500 million breakup fee. At that level, the fee amounted to $1.40 per share, effectively raising the cost to Vornado by that much.
Now it was crucial to keep pressing hard toward the EOP shareholder vote on February 5, just eleven days away, because Vornado was still posing questions to Kincaid and EOP’s advisers. “We had a big timing advantage,” says Brian Stadler, one of the two lead lawyers at Simpson Thacher & Barlett on the deal for Blackstone. “We wanted to keep the momentum.”
When the Chicago Tribune reported January 31 that Vornado was going to bid $58.50—$4.50 more than Blackstone—the Blackstone team feared that, notwithstanding their push, the game was over. “That was the low point for us,” Gray says. But Vornado’s next proposal, once again, fell short of its advance billing. Bidding solo now, Vornado offered just $56 a share, and it lowered the cash portion to 55 percent from 60 percent.
To Zell and Kincaid, this was not really an improvement, and in some ways was worse than the disappointing January 17 proposal. Roth and Fascitelli seemed to be haggling as they might with another real estate firm over a building sale. They didn’t seem to realize they were dealing with the board of a public company that had to have a compelling offer to present to shareholders.
For the moment, Blackstone stood pat and didn’t up the ante. But EOP’s shares continued to rise in anticipation of another round of bidding, and neither Gray nor the EOP executives were confident that shareholders would go for its $54 offer.
On Super Bowl Sunday, February 1, on the eve of the EOP shareholder vote, Gray was at home in Manhattan glued to the TV as his hometown team, the Chicago Bears, faced off against the Indianapolis Colts. He had just watched the Bears’ Devin Hester run back the opening kickoff for a ninety-two-yard touchdown when word came that Vornado had made another offer. Within minutes Gray and his fellow Chicagoan, Kincaid at EOP, were commiserating about the interruption to the game. “Can you believe this?” Gray said to Kincaid. They would miss the rest of the big game trying to figure out what Vornado was up to.
As it turned out, the offer was less dramatic than the runback. Vornado had stayed at $56 but offered to buy up to 55 percent of EOP’s outstanding shares in advance of Vornado’s shareholder vote. That would guarantee EOP’s shareholders some cash immediately, but there was a downside: If Vornado’s own shareholders voted down the full merger, Vornado would win control of EOP without paying for the whole company, and EOP’s investors would be left as minority shareholders. What’s more, even this offer was not legally binding; Vornado was free to back out.
Vornado’s nickel-and-diming played into Blackstone’s hands. “We hoped that Vornado’s final bid for EOP would be flawed—riddled with conditions, not legally binding, not all cash—and it was,” says James. “When Vornado’s proposal was announced, we said, ‘Aha! We could really put a stake through the heart of it.’ They gave us that opening by their weak half measure and we took it.”
Gray huddled with Schwarzman and James. Blackstone had already been forced to come up 11 percent from its original $48.50 offer in the fall, to $54. Did it make sense to increase its offer again, particularly when the Vornado bid seemed so unattractive? Time and again in Blackstone’s internal meetings, Schwarzman invoked the memory of KKR’s overpaying for RJR Nabisco. “We don’t want another RJR,” he would tell Gray.
“We talked about putting the firm’s reputation at risk in so big a deal,” Gray said. “If we had overpaid and the deal had gone spectacularly badly, we could have really hurt a franchise that took twenty years to build.” But the offers for EOP properties were so high that the leftovers would end up costing Blackstone less than they would have at the original, November price, Gray demonstrated to Schwarzman and James.
Blackstone went back to EOP and offered another $1.25, or $55.25 a share. EOP’s board pushed for an e
xtra 25 cents, and the deal was struck at $55.50, with the breakup fee lifted to $720 million. The buyout would now be worth $38.7 billion, topping RJR Nabisco by an even wider margin than the original deal would have.
Vornado folded. Two days after the shareholder vote, which had been postponed to February 7, Blackstone owned EOP.
Gray’s team had no time for a victory dinner. Gray’s wife, Mindy, came to his office with a double magnum of Veuve Clicquot and a box of chocolate-covered raisins. The weary deal makers spent ten minutes toasting their accomplishment before turning to the daunting task of finalizing $19 billion of property sales they had in the pipeline. The biggest piece was already done: Macklowe’s $6.6 billion deal for most of EOP’s New York portfolio closed with the main buyout. A $6.4 billion sale of the Washington and Seattle holdings to Beacon Capital—the company headed by Alan Leventhal, whose theories of replacement value had inspired Gray—was nearly in the bag. But EOP emerged from the buyout with $32 billion in debt and the $3.5 billion of equity bridge financing, and knowing how torrid the market was, Gray sensed he had only a small window to sell off what he didn’t want to get those numbers down.
From February to June, Blackstone unloaded sixty-one million of EOP’s roughly one hundred million in square footage for about $28 billion and was left holding only properties in prime markets. The prices it received were so extraordinary that its effective cost for the remainder was far below their market value. With the benefit of leverage, Blackstone’s $3.5 billion equity investment was worth about $7 billion when the sales were complete. It had doubled its money on paper simply by breaking up EOP.
Having pulled off by far the biggest deal Blackstone had ever attempted, Gray, Cohen, and Caplan could now turn their attention back to Hilton, the company they had been wooing on and off before EOP consumed all their energies.
CHAPTER 22
Going Public—Very Public
I’m not going to get beat twice,” Schwarzman promised Michael Puglisi, Blackstone’s longtime chief financial officer, after KKR raised a $5 billion investment pool on the Amsterdam stock exchange in May 2006.
That offering demonstrated that public investors were hungry to buy into private equity, but KKR’s success in soaking up all the demand for such funds in Europe and preempting the field stung. Behind the scenes, amid the frenzied bidding for NXP, Freescale, Clear Channel, and Equity Office Properties, Schwarzman and James began crafting their response. This would be an even more groundbreaking deal: an IPO of Blackstone itself.
By 2006 the rivalry between Schwarzman and Henry Kravis had passed into legend—perhaps even myth. Was it a deeply personal mano a mano thing? Or just a run-of-the-mill testosterone-charged competition between Wall Street chieftains—Coke versus Pepsi with a financial twist? It was clear there was no love lost between them, and no professional camaraderie, but there were partisans of each who claimed their man didn’t give the other much thought and that any melodrama was a creation of the press. After all, their firms collaborated on some of the largest buyouts of the decade, including the data company SunGard, the TV ratings firm VNU/Nielsen, and TDC, Denmark’s telephone company, and they had teamed up for the unsuccessful bid for Clear Channel.
The two men were certainly different in background, temperament, and tastes. Kravis, who had grown up wealthy, was only three years older than Schwarzman but had a decade’s head start in the buyout business and was already fabulously wealthy in his own right by the early eighties, when Schwarzman was a little-known banker at Lehman. KKR’s deals had made Kravis an A-list celebrity in the eighties, and with his second wife, the fashion designer Caroline Roehm, on his arm, he had gained entrée to New York’s elite social circles. He had worked the charity circuit for decades and his third wife, Marie-Josée Drouin, a Canadian economist and TV personality, made a name for herself hosting dinner parties sprinkled with intellectuals. Kravis seemed comfortable with his position and had retreated from the public eye after the 1980s. Schwarzman still had something to prove.
One didn’t have to scratch hard to see the antipathy. Schwarzman never missed a chance to put down KKR, as he did when he called it “a one-trick pony” to BusinessWeek, and he conspicuously neglected to invite Kravis to his birthday party in 2007. While it was hard at times to distinguish between what was a genuine blood feud and what was simply good newspaper copy, there was nonetheless more than a bit of truth to the quip of someone who knows them both that “the psycho-dynamics of Steve and Henry drove an entire industry.”
The notion that a major private equity firm would soon go public was in the air by early 2006. The previous December, Art Peponis, a banker at Goldman Sachs, had floated the idea with Schwarzman, but Peponis had tossed out a possible valuation of just $7.5 billion, far less than what Schwarzman had in mind, so that discussion went nowhere.
By the spring of 2006, a chorus of bankers was serenading Blackstone with the same tune, and with the momentum of buyouts building and in the wake of the KKR Amsterdam fund-raising, the value the market would put on a business like Blackstone was rising. Michael Klein, a senior Citigroup banker whose job it was to liaise with buyout firms, brought it up with Schwarzman over lunch at Schwarzman’s weekend home in the Hamptons. Klein didn’t know how profitable Blackstone was, but he knew that it had roughly $70 billion in assets under management and was in the best niches of the alternative asset management business. It collected both its steady 1.5 percent management fee plus 20 percent of the profits on its biggest funds, buyouts and real estate, and the investors in those committed their money for up to ten years; they couldn’t cut and run like mutual fund or hedge fund investors if the firm had a rough year or two. “It made them decisively more valuable than hedge funds,” Klein says. As a rough number, he suggested to Schwarzman that Blackstone might be worth upward of $20 billion—a figure that was much more to Schwarzman’s liking.
James meanwhile was batting around the same ideas in more detail, with three senior bankers from Morgan Stanley: Ruth Porat, Edward Pick, and Michael Wise. In five brainstorming sessions in May 2006, they debated the merits both of raising a fund like KKR’s and of Blackstone itself going public. The benefits of an IPO were clear enough. It would raise money for the firm and allow partners to “monetize” their stakes—turn them into cash. James pressed the bankers instead to focus on the downsides to going public. Jotting prodigiously on yellow notepads, with a can of Diet Dr Pepper invariably at his side, James conducted a Socratic interrogation of the trio.
“Please tell us how bad this could be?” was the thrust, says Porat, Morgan Stanley’s head banker for financial services clients at the time and later the bank’s chief financial officer.
An IPO would make sense only if the price were right, but there was no way James and Schwarzman were going to open up Blackstone’s books to Morgan Stanley—not even to Porat, whom James had known for twenty years and had once tried to recruit to DLJ. No one outside the firm—not even rank-and-file Blackstone partners—knew what the firm as a whole made. And Morgan Stanley was a competitor in private equity, real estate investing, and merger advice. James’s solution was to give Morgan Stanley some theoretical numbers. “We told them they would be disguised” but representative of the business, James explains. “Then we created a fictional set of numbers that reflected trends, mix, and margins but did not give absolute levels.” Based on the valuations the bankers came back with, Blackstone would get a sense of what it might be worth without tipping its financial hand. From Morgan Stanley’s response, James could see that they would end up not far off Klein’s $20 billion figure.
Porat heard nothing back after the last meeting and thought perhaps James had cooled on the whole idea. In fact, she and her team had been so enthusiastic about the prospects that in early June, Schwarzman and James summoned Blackstone’s CFO, Puglisi, and Robert Friedman, its general counsel, and asked them to figure out what needed to be done to prep the firm to go public.
Schwarzman laid out a couple of c
onditions. Control of Blackstone would have to remain with him and management. He didn’t want to upset the system of benign dictatorship that had gotten the firm to this point and had suppressed internal rivalries. (“You have to understand where they came from—Lehman,” says Puglisi.) Second, the IPO would have to be engineered to retain employees and not to provide a means for them to cash out and walk away. However the IPO was structured, it also had to be done in a way that didn’t subject Blackstone to corporate taxes. (Blackstone was organized as a partnership and partnerships generally don’t pay corporate taxes. Instead, their partners pay income tax on their respective shares of the partnership’s profits.)
The top-secret project was dubbed Project Puma, an echo of Project Panther, the aborted bid to list a fund in Amsterdam. Only this small band and a handful of outside advisers would be let in on it. “I was fixated on confidentiality, in large part because I wasn’t completely sure I wanted to do this. I wanted to make sure that virtually no one at the firm knew,” Schwarzman says. “I didn’t want to raise expectations. It could be a diversion.” Joshua Ford Bonnie, a young IPO specialist at Simpson Thacher, Blackstone’s law firm, was brought in to work on the legal issues, and Deloitte & Touche, Blackstone’s audit firm, was consulted. But Blackstone required each individual outside lawyer, accountant, and banker to sign a personal confidentiality agreement—a virtually unprecedented demand. Other partners, even Peterson, would not learn about the plan for months.
There was no small irony in the move to take Blackstone public at a time when the firm was playing a starring role in a sweeping privatization of American and European business. But there were powerful reasons for Blackstone itself to move in the opposite direction. While its partners spent their days trying to devise ways to sell the assets Blackstone owned at a profit, they had no way of capturing the value in the business they had built. The issue was particularly acute for Peterson, who turned eighty in 2006. Under his original 1985 agreement with Schwarzman, if one of them died, his estate was entitled to receive income from the firm only for five to seven years; he could not pass on his stake in the firm to heirs, let alone sell it. Allowing the public to buy in would provide a route for Peterson to cash out and would help the firm ease out a founder who was de facto retired even though he shared fifty-fifty voting power with Schwarzman in its core businesses and continued to collect a sizable chunk of their profits.