Finance: BUYOUT FIRMS
BLACKSTONE: NICE IS FOR SUCKERS
Its good cop-bad cop team grabs the No. 2 spot in LBOs
It has been an exciting week for Stephen A. Schwarzman, chief executive of the Blackstone Group. He and real estate developers Mortimer B. Zuckerman and George Klein just won the last two development sites on New York's red-hot 42nd Street. Price: a sky-high $330 million. And splashed all over the London press are reports that Blackstone has bid more than $800 million for the Savoy Group, a group of London five-star hotels. "According to my competitors, I'm this young turk with this great advantage who is unfairly buying up the world, but I can't touch Blackstone's price," says Barry S. Sternlicht, CEO of Starwood Hotels & Resorts Worldwide Inc., who also is involved in bidding for the Savoy.
When it comes to being aggressive, Schwarzman stands out even by Wall Street standards. And his aggressiveness isn't limited to bidding top dollar. His abrasive and imperious management style has earned him enmity from former partners, some of whom have left over the years. One ex-employee says Schwarzman goaded him by saying, "You're dog meat," which Schwarzman denies. Schwarzman, 51, also inspires an unusual number of derogatory comments from competitors. Among the milder ones: "He's a control freak. He thinks he's intellectually superior.""ANCIENT HISTORY." Yet Schwarzman and Peter G. Peterson have built Blackstone into one of the most successful small investment banks around through smart hiring and good timing. They own or have major stakes in 23 companies with revenues totaling $14 billion, including cellular provider CommNet Cellular Inc. and auto parts supplier American Axle. And Blackstone is a major investor in commercial real estate. One former partner, Henry R. Silverman, CEO of Cendant Corp., says: "In spite of interpersonal issues, we were able to make a ton of money for our investors." Says Schwarzman: "I was probably too tough on people, but that's ancient history in the firm's evolution."
Founded by Peterson and Schwarzman in 1985 with $400,000, Blackstone has climbed to No.2 behind the reigning buyout kings, Kohlberg Kravis Roberts & Co. In 1997, Blackstone raised $3.8 billion for its third buyout fund--in large measure because its second one had annual returns of more than 52% through December, 1997, net of fees, says Schwarzman. "At this point in the fund's life, they've been one of our superior performing private equity funds," says H. Carl McCall, New York State comptroller. Now, Schwarzman must demonstrate that his LBO team, which includes former Budget Director David A. Stockman, can invest the billions it has raised when the LBO market has never been frothier. Indeed, in a $1.9 billion deal in March, Blackstone was outbid for Safety-Kleen Corp., an environmental services provider.
And Schwarzman must keep his partners happy. "He and Pete suck off a disproportionately large percent of the economics," says one banker. For example, if the real estate fund makes $100 million, investors would get $80 million while Blackstone would get $20 million. The 25-person real estate team, in turn, divvies up $10 million, while 13 Blackstone partners split $5 million, with about $5 million going to the top two. Schwarzman says the two unequivocally control Blackstone, but insists tight control eliminates infighting while allowing employees a voice. Says Schwarzman: "A lot of places have blown up because control was not centralized."
Schwarzman knows this from bitter experience. When Lehman Brothers Inc., was ripped apart in a nasty power struggle in 1983, Peterson was ousted as CEO. Schwarzman, a Lehman mergers-and-acquisitions banker, brokered Lehman's sale to American Express Co.'s Shearson. But right after the deal closed, he shocked Shearson top brass by saying he wanted out, leaving them with a deal that he initiated.
After some lean early years, Schwarzman and Peterson transformed themselves from deal advisers to far more lucrative dealmakers. Schwarzman's M&A skills, joined with Peterson's gentlemanly way, extensive corporate Rolodex, and credentials as a former Commerce Secretary, helped reel in blue-chip pension funds and corporations to the LBO fund.
The two men created a strong niche: doing LBOs with companies that temporarily warehouse an acquisition with Blackstone. In 1996, for example, Loewen Group, a Canadian funeral home consolidator, faced a cash crunch and couldn't issue debt to buy funeral home chain Prime Succession Inc. The two created a new vehicle to buy Prime Succession that was 24% owned by Loewen and 76% owned by Blackstone. This let Loewen make a $300 million purchase off-balance sheet, since minority stakes don't have to be consolidated in its financials.
A complicated agreement stipulates that before Loewen can buy back all of Prime Succession in 2001, Loewen must first pay Blackstone at least a 25% annual return on the $52 million Blackstone invested. This built-in exit strategy and pre-carve-up of returns greatly reduces Blackstone's risk, which holds great appeal to Schwarzman. "Steve is driven by insecurity, which helps them, since he is always worried about the downside," says a colleague.
Loewen's performance has been disappointing recently, but Schwarzman says it won't affect Blackstone. But the firm's most profitable buyout, UCAR, may haunt it. Blackstone owned UCAR International, a graphite-electrode maker, from 1995 to April, 1997. In late 1997, the Justice Dept. launched an industrywide price fixing inquiry and is looking at the period when Blackstone owned UCAR. And four Blackstone directors have been named in a lawsuit by UCAR shareholders.
The outlook is rosier for real estate, which Schwarzman timed just right. In 1992, as the boom began, he hired three real estate pros who raised $350 million and bought such properties as New York's Worldwide Plaza, which is now for sale. The fund had annual returns of 50% through 1997, says Schwarzman, and in 1997, the group raised $1.2 billion in a second fund.
Now Schwarzman seems intent on being recognized as a major financier. His biggest rival is Henry Kravis. Schwarzman believes Blackstone is slighted in the press because, unlike KKR, it doesn't own companies with household names, such as Duracell International Inc., and hasn't done multibillion-dollar deals. Blackstone bets on reliable returns from dull, industrial companies. And it has only bought companies for less than $1 billion. Schwarzman also thinks he deserves credit for building five lines of business (table), compared with KKR's focus on LBOs. He snipes: "KKR is a one-trick pony."
Schwarzman, whose father owned a Philadelphia dry goods store, has little reason to feel slighted. He attended Yale University, where he launched the Yale Ballet Society as a clever way to meet women, and Harvard business school. An inveterate name-dropper, when asked for a few friends' names, he supplied a two-page memo listing 20 "old friends," including dealmaker Bruce Wasserstein and Reed E. Hundt, ex-Federal Communications Commission chairman.
Schwarzman rebounded from a devastating 1991 divorce, where he had to pay his first wife, Ellen Schwarzman Katz, more than $20 million, estimated to be half of his then-net worth. Still, Financial World calculated that he made $45 million in 1996 alone. Schwarzman was remarried in 1995 to Christine Hearst, an attorney. He gets around in a helicopter he owns with Peterson, and has homes in Manhattan, East Hampton, and Jamaica.
The booming markets will provide riches enough to keep Blackstone's 250 employees happy. Schwarzman says that its LBO fund will have no trouble generating 25% to 30% annual returns without taking more risk. He says Blackstone can add staff to maintain its 1997 investing pace of $700 million. Says Blackstone partner J. Tomilson Hill: "Pete and Steve have built an institution of permanence." If so, it would be a triumph of ego over charm.By Leah N. Spiro in New York, with Kathleen Morris in Los AngelesReturn to top