Jan. 25 (Bloomberg) -- Blackstone Group LP increased its offer for Sam Zell's Equity Office Properties Trust to $38.3 billion to thwart Vornado Realty Trust in the world's biggest leveraged buyout.

Blackstone's offer for Chicago-based Equity Office is $54 a share in cash, 3.8 percent more than the $52-a-share cash and stock proposal from a group led by Vornado. Blackstone's earlier bid was $48.50 a share.

The contest for control of the largest U.S. office landlord pits developer Steven Roth of Vornado against Blackstone's Stephen Schwarzman, a dealmaker who has helped lead $160 billion in leveraged buyouts. In raising its bid before Vornado can make a formal offer, Blackstone is looking to win approval from Equity Office shareholders in a Feb. 5 vote.

``Blackstone is obviously trying to pre-empt board approval of the Vornado bid and preserve their No. 1 position,'' said James Corl, who oversees 29 million shares of Equity Office and 6.8 million Vornado shares for Cohen & Steers Capital Management in New York. ``I'm sure we'll hear from Vornado relatively soon once they do some extra homework, which I'm sure they're doing right now.''

The two sides are vying for a real estate investment trust that owns or has stakes in 543 office buildings in the U.S. at a time when rents are rising and vacancy rates are falling.

Formal Offer

Equity Office this week opened its books to Vornado and its partners so they could prepare a formal offer by Jan. 31. The company said today it continues to provide information to the Roth- led group. Blackstone would have three business days to match any rival bid.

``Vornado is continuing to conduct its due diligence and will respond at the appropriate time,'' Vornado spokeswoman Wendi Kopsick said.

The proposal from New York-based Vornado, Starwood Capital Group Global LLC and Walton Street Capital LLC is 60 percent in cash and 40 percent in Vornado shares. It's worth $37.6 billion including $16 billion in debt.

Vornado would have to issue 83.5 million shares under its current proposal, Sri Nagarajan, an analyst at RBC Capital Markets, wrote in a note to investors. If the Vornado-led group bid $56 a share for Equity Office, it would have to issue 96.7 million shares, an additional 13.2 million shares, Nagarajan estimated in the note.

Equity Office shares rose above the offer price to close at $54.90 in New York Stock Exchange composite trading. Equity Office shares are 21 percent higher than their closing price on Nov. 17, the last trading day before Blackstone's original bid. Vornado shares gained $1.11 to $125.76.

`Superior' Bid

``We wanted to put an all-cash deal on the table which shareholders could feel good about and which was sufficiently compelling to keep us on track for a shareholder vote on Feb. 5 and closing on Feb. 8,'' Blackstone spokesman John Ford said in a statement. ``Our offer is now materially superior on price, timing, form of consideration and certainty.''

Equity Office directors will recommend Blackstone's offer to shareholders. The company said today it would raise its breakup fee, payable to Blackstone if it does a deal with anyone else, to $500 million from $200 million, according to the statement.

The higher termination fee ``stands in the way of a competing bid,'' said Rob Haines, a REIT and insurance analyst at New York- based CreditSights Inc. ``It doesn't necessarily cement the deal but it certainly is a more onerous breakup fee.''

Haines does not own Vornado or Equity Office shares.

The breakup fee in REIT acquisitions over the past four years averaged almost 3 percent of the equity value of the deal, or just under 2 percent of the total value including assumed debt.

At the higher breakup fee of $500 million, Blackstone would get slightly more than 2 percent of the equity value, or almost one-third less than the typical termination fee.

Zell's Take

The bidders are competing for properties that include San Francisco's Ferry Building, built in 1898, and offices such as New York's 1301 Avenue of the Americas, which houses law firm Dewey Ballantine LLP. Other prime holdings are Worldwide Plaza in New York, Columbia Center in Seattle, the Verizon Building in New York, and Two California Plaza in Los Angeles.

Zell stands to reap about $735.5 million from the sale at Blackstone's bid of $54 a share, excluding stock options that vest when the purchase closes, based on his holdings outlined in a Dec. 14 regulatory filing. The Chicago billionaire owns about 13.6 million shares of Equity Office, comprising about 1.78 million so- called operating units, and about 11.8 million other units in which he has a financial stake with no voting rights.

Equity Office Bondholders

Blackstone and Equity Office have already agreed with bondholders to buy back their bonds at a price about $127 million over its original tender offer. Buying back the bonds will allow Blackstone to increase borrowing at Equity Office in the mortgage market to increase returns.

Terry Holt, a spokeswoman for Equity Office, declined to comment beyond the company's statement.

John Stewart, an analyst with Credit Suisse Group, said the $54 a share bid, coupled with the new $500 million breakup fee, likely reaches Equity Office's full value.

Vornado could still win the company, even with a combination of cash and stock, by matching Blackstone's price because shareholders might prefer to keep some of their money in a high- quality office REIT, Stewart said.

`Good as Money'

``Vornado's stock is just as good as money,'' Stewart said.

Roth built Vornado over 27 years from an owner of discount department stores into Manhattan's biggest commercial landlord. He founded Interstate Properties in the 1960s with David Mandelbaum, a New Jersey attorney who still sits on Vornado's board.

Together they invested in Vornado Inc., an appliance maker that owned Two Guys Discount Department Stores, a chain of outlets in New Jersey. By 1980, they gained control of Vornado in a proxy battle, closed the stores and developed strip malls on the sites.

Starting in the late 1990s, Vornado passed up multiple chances to buy New York's General Motors Building on Fifth Avenue starting at about $700 million, Roth said in June. New York developer Harry Macklowe bought the GM Building for $1.4 billion in 2003 and it's now valued at about $3 billion.

``In this environment in the last 10 years, every single deal we didn't do was a mistake,'' Roth told the National Association of Real Estate Investment Trusts conference in June.

Schwarzman co-founded Blackstone in 1985. He now oversees companies with annual revenue of $85 billion and 380,000 employees. Schwarzman began his career at Lehman Brothers Holdings Inc. and worked primarily in the firm's mergers and acquisitions department before co-founding Blackstone.

Cost of Capital

Blackstone's real estate group is among the world's most active, having made 181 transactions with a total value of more than $43 billion, including debt.

``Our cost of capital now is typically lower than a strategic's cost of capital,'' Schwarzman said at a conference in Philadelphia on Jan. 19. ``Historically that's not been the case. The risk premium of lending has just about disappeared. Money is so cheap, so plentiful.''

Blackstone's negotiations have been led by Jonathan Gray, co- head of the firm's real estate team. Gray, a 15-year Blackstone veteran, has led the buyout of 10 public real estate companies valued at more than $32 billion, according to the firm's Web site.

Starwood, Walton

Greenwich, Connecticut-based Starwood Capital and its affiliates have invested about $6 billion of equity in assets valued at more than $30 billion, including apartment complexes, hotels, offices and recreational properties. These include a $365 million controlling stake in California's Mammoth Mountain Ski Area.

Walton Street Capital LLC, based in Chicago, has received $3.4 billion in equity commitments from investors, according to the firm's Web site.

Lehman Brothers Holdings Inc., JPMorgan Chase & Co. and UBS AG advised the Vornado group and will provide debt financing as will Royal Bank of Scotland Group Plc and Barclays Plc.

Goldman Sachs Group Inc., Bear Stearns Cos. and Bank of America Corp. committed to provide $31.4 billion of debt financing, according to a Securities and Exchange Commission filing today. That is up from $29.6 billion that the banks planned to arrange.

Citigroup Inc., Morgan Stanley, Wachovia Corp., and affiliates of Credit Suisse Group and Deutsche Bank AG are also part of the lender group, the filing said.

Blackstone will sell bonds secured by office buildings and also receive real estate mezzanine loans to finance the purchase. Mezzanine loans rank behind senior debt in claims for repayment in the event of a bankruptcy.

Blackstone's Equity Contribution

Blackstone will contribute about $3.65 billion of equity financing, today's filing said. That is up from $3.2 billion that Blackstone planned to provide. Bear Stearns, Goldman Sachs, Bank of America and Morgan Stanley will also provide $3.5 billion of equity bridge financing. Bridge financing is typically interim funding.

Merrill Lynch & Co. advised Equity Office.

Also today, Blackstone bought the manufacturing unit of Cardinal Health Inc., the second-biggest U.S. drug distributor, for about $3.3 billion in cash, Cardinal said in statement distributed by PR Newswire. The unit develops, manufactures and packages medications and other products for pharmaceutical and biotechnology firms, generating about $1.8 billion in annual revenue, Cardinal said.

To contact the reporter on this story: Brian Louis in Chicago at blouis1@bloomberg.net.

Last Updated: January 25, 2007 17:50 EST