A red bicycle with an ice cream cooler mounted in front is parked in the middle of an empty room in an uninhabited mansion in the Santa Ynez Valley, about 120 miles northwest of Los Angeles. On the back of the cooler, written in script, are the letters “MJJ.”
The bicycle, like the house and the 2,680 acres (1,085 hectares) it sits on, once belonged to Michael Jackson, the pop singer who died a year ago this month. It was a gift from actress Elizabeth Taylor, who celebrated her eighth marriage at Jackson’s Neverland Ranch in 1991.
Neverland is now controlled by private-equity firm Colony Capital LLC, whose chairman and founder, Thomas J. Barrack Jr., has a spread 5 miles (8 kilometers) away. Acquiring the ranch in 2008 by taking over a $23.5 million loan may seem like a tiny investment for Barrack, who oversees a $30 billion empire that includes a stake in Europe’s largest hotel company, buildings from New York to Beijing and a Las Vegas casino operator that filed for bankruptcy last year, Bloomberg Markets reports in its August issue. That he bought it suggests the 63-year-old billionaire, who got his start rummaging through the debris of the 1980s savings and loan crisis, may be getting back to his roots in distressed debt after gorging on leveraged buyouts.
“We’re always trying to find places that people haven’t gone before,” Barrack says of his first distressed-celebrity deal, sitting in Colony’s New York office on Madison Avenue, above Barneys department store, dressed in jeans and a crisp button-down shirt, his head cleanly shaven. “We’re going to fight, scratch and claw our way to every cent of capital that we can get back. We also know from history that the best funds come out of an abyss like this.”
Rising from the abyss is the biggest challenge facing Barrack and other private-equity managers who spent a record $1.6 trillion on buyouts from 2005 to 2007 before a credit market crash led to the worst financial crisis in 70 years. Now, firms need to persuade investors they have more to offer than wanton dealmaking, piles of debt and meager results.
Megafunds managing more than $4.5 billion were the worst performers of those tracked by London-based research firm Preqin for the 12 months ended in July 2009, with an average loss of 31 percent of their value. Colony Investors VIII LP, a $4 billion fund launched by Barrack in 2007, had paper losses of about 60 percent as of the first quarter.
“It’s tough emotionally,” says Barrack, whose firm has delivered an average annual return of 21 percent since its founding in 1991. “In 17 years, the investors have never experienced something like this.”
For Barrack, getting out of the hole involves going back to his playbook of pursuing unlikely deals, most of them involving buying or restructuring debt -- including that of celebrities. Earlier this year, he helped photographer Annie Leibovitz, who was facing the loss of four New York properties and the rights to her work, by refinancing a $24 million loan.
“It’s a small part of the business, but it’s interesting and lucrative because it’s complex,” Barrack says.
Lucrative would be a welcome development for Colony’s investors, who have poured $10.6 billion into the Santa Monica, California-based firm’s funds during the past decade, placing it among the top 10 private-equity real estate companies in the world, according to Preqin. Over that time, they’ve watched Colony pursue ever-larger, highly leveraged and ultimately unsustainable buyouts.
Barrack’s biggest misstep was the $8.5 billion buyout in 2007 of Station Casinos Inc., which operates 18 casinos in Nevada and is the largest U.S. gaming company to go bankrupt. In New Jersey, the $2 billion Meadowlands Xanadu retail and entertainment complex Colony acquired in 2006 -- “Xana-don’t,” Barrack calls it -- sits empty and unfinished after one of Colony’s lenders, Lehman Brothers Holdings Inc., went bankrupt during construction.
“The question for private equity is, What do you want to be when you grow up?” says Barrack, who was raised in Culver City, California, the son of a Lebanese grocery store owner. “Are you making money from investing or managing assets? That’s the dilemma that everybody’s facing.”
It’s a predicament shared by a handful of elite managers, many of whom Barrack has known for decades.
Starwood Capital Group LLC -- headed by Barry Sternlicht, who competed with Barrack during the S&L crisis -- has raised new private-equity funds, which will allow it to earn more management fees and pursue buyouts.
David Bonderman, who founded TPG Capital after working with Barrack in the 1980s buying assets of failed thrifts for Texas billionaire Robert Bass, is doing smaller deals while adding distressed-debt and credit funds.
Apollo Global Management LLC, which Leon Black started in 1990 after making his own fortune buying distressed debt, is following Blackstone Group LP and KKR & Co. into businesses such as capital markets as it prepares to tap equity markets through a public offering.
All of them are becoming what Colin Blaydon, director of the Center for Private Equity and Entrepreneurship at Dartmouth College’s Tuck School of Business in Hanover, New Hampshire, calls “the new, broad-based asset managers.”
Barrack has chosen the opposite path, staying focused on investing and keeping Colony closely held. He says he has given up, at least for now, on the equity funds that drove the leveraged-buyout boom, postponing a planned multibillion-dollar fund in favor of raising a more modest distressed-debt pool and floating a real estate investment trust that has tapped public markets for $250 million.
He’s also gone back to his original playbook with a familiar partner, the U.S. government, pursuing deals to buy loans with assistance from the Federal Deposit Insurance Corp., which has $37 billion of assets seized from failed banks. He has already completed eight, including one in January in which Colony bought a 40 percent stake in a company set up with the FDIC to hold $1.02 billion of unpaid commercial real estate loans for 22 cents cash on the dollar.
Barrack’s choices reflect idiosyncrasies that have defined him personally and professionally. He says he got his work ethic from his father, who would come home for dinner and then go back to his store. His mother gave him a metaphor for his personality.
“My mom had this idea that you could either be a miner or a jeweler,” Barrack says. “A miner is going and digging one sort of thing, but a jeweler is collecting and harvesting all sorts of jewels.”
Barrack, who went to Jesuit-run Loyola High School in Los Angeles and to the University of Southern California, where he earned a bachelor’s and a law degree, started harvesting jewels soon after.
His first job, working with Herbert Kalmbach, former President Richard Nixon’s personal attorney, led to an assignment in Saudi Arabia helping construction company Fluor Corp. negotiate a contract. He opted to stay for three years to advise two sons of the Saudi king. After a stint in President Ronald Reagan’s administration, he was recruited by Bass.
Barrack and Bonderman made so much money for Bass buying the assets of some of the more than 740 thrifts that failed during the S&L crisis, including those of Stockton, California-based American Savings Bank, that the Texan gave each of them a stake to get a private-equity firm off the ground.
Since founding Colony -- he named it after Malibu Colony, the beachfront community where he was living at the time -- Barrack has collected other gems, including the Chateau Lascombes vineyard in the Bordeaux region of France, the colonial-era Raffles Hotel in Singapore, the Savoy Hotel in London and the Paris Saint-Germain soccer team.
A love of athletics led Barrack to USC, where he talked his way into a tryout with the football team. Trojans coach John McKay watched him run a few patterns and then told him to go out for rugby, which he did, playing varsity for three years and touring with the national Eagles team.
At 6 feet 3 inches (1.9 meters) tall, he now cuts a trim figure. He lifts weights for about an hour a day and runs or spins on a stationary bicycle for another 30 to 60 minutes.
“Athletics has a lot to do with everyday life,” Barrack says, sipping a cappuccino one evening in April in Toscanova, an Italian restaurant in the Century City section of Los Angeles. “I surf; I ride horses -- to stay on that edge.”
Keeping an edge has Barrack in almost perpetual motion. He says he spends a week in Europe, a week in Asia and a week in New York each month. He’s also in constant contact with his lieutenants, at all hours of the day, throwing out ideas.
“I drive them nuts,” he says. “I end up being the information transfer element within the firm.”
Barrack posts his thoughts about investing on the Chairman’s Corner of Colony’s website. After an April surfing trip to Mexico’s Baja peninsula with two of his three sons, he wrote a 4,300-word treatise that included 32 ethical and business guidelines, including “Call your Mom often,” “Debt is the new equity” and “Seek mispricings and inefficiencies -- stay away from crowds.”
Barrack’s current approach reflects some of those principles. The firm is eyeing investments that aren’t the typical targets of private-equity or real estate investors.
“He’s unconventional, and he’s looking where no one else is,” says Eli Broad, 77, the billionaire founder of KB Home who was among Barrack’s first backers.
‘Worst Investment Ever’
Barrack says Colony is focusing on smaller, unconventional deals after getting caught up in leveraged buyouts.
“If you were to pick the hour, the minute that it could have been the worst investment ever, it was,” he says of the timing of his November 2007 Station Casinos buyout.
Colony joined brothers Frank and Lorenzo Fertitta, part of the family that founded the company as a bingo hall in 1976, in making the deal, which valued Station at $8.5 billion. The company filed for bankruptcy last July, with $6.5 billion of debt, after failing to reach agreement with creditors.
“The LBO certainly couldn’t have occurred at a much worse time than it did, immediately preceding the crash in the Las Vegas market, which has gone on since the transaction,” says Grant Govertsen, a Las Vegas-based analyst at research firm Union Gaming Group LLC.
Colony is currently backing two bids by the Fertittas, who also own Ultimate Fighting Championship, a mixed-martial-arts league, to retain ownership of Station’s assets and allow the company to exit bankruptcy by year’s end.
A Nevada judge will oversee an auction of most of the casinos in early August, with the existing owners opening bidding with $772 million of new equity. Five other casinos, the company’s most profitable, would be taken over by the Fertittas, Colony and their banks without an auction in exchange for a cash payment and the cancellation of some debt.
Colony has also struggled with two Atlantic City, New Jersey, casinos. One of its affiliated companies forfeited the deed to Resorts Atlantic City, and another is in talks with creditors after defaulting on a loan tied to the Atlantic City Hilton.
The most glaring emblem of Colony’s miscalculations rises 800 feet above the New Jersey Turnpike, not far from the new stadium for New York’s Giants and Jets football teams. It’s the shell of an indoor ski slope, a main attraction at Xanadu.
The 2.3 million-square-foot (214,000-square-meter) mall, named after the summer capital of Mongolian emperor Kubla Khan, was taken over by Colony and Steven Mnuchin’s Dune Capital Management LP in 2006, after the original developer, Mills Corp., ran out of money. It also features an indoor sky-diving facility and a theater for live concerts.
Frozen Ski Lift
Plans called for visitors to be schussing down Xanadu’s ski slope by mid-2009. The collapse of Lehman in September 2008 brought work to a halt seven months later.
On a visit in April, not a single worker could be seen. Cardboard covered carpeted floors, and signs indicated where retailers H&M, Forever 21 and Cabela’s have staked out stores. The ski lift’s four-person chairs were frozen still.
“We had a great team together and started leasing,” Barrack says. “Even the downturn was OK. What killed us is, Lehman went broke. We never envisioned our bank going bankrupt.”
One potential lifeline is developer Stephen Ross’s Related Cos., which is in talks to partner with Colony on restarting construction, leasing and raising fresh capital. Even if Barrack can renegotiate the debt, it will be at least a year before Xanadu can open.
Albatrosses such as Station and Xanadu have changed the economics of the firm, since those projects are unlikely to produce profits for investors, or for Colony, anytime soon. In early 2009, Barrack scrapped Colony’s compensation plan and replaced it with one that gives every employee, including those charged with minding struggling investments, a chance to make money.
“We’ve reset our targets,” Barrack says. “People need a future to look forward to. They need an offense.”
None of that has dampened Barrack’s zeal for deals. Last October, Colony joined General Atlantic LLC in an 18-day sprint to buy First Republic Bank, a San Francisco-based firm that caters to wealthy individuals, from Bank of America Corp.
“It was just the most incredibly intense thing,” says Richard Nanula, a Colony principal and former chief financial officer of Walt Disney Co. “We knew this was a wonderful bank, not a troubled asset.”
Barrack and Nanula, both banking clients of First Republic, moved into gear after Charlotte, North Carolina-based Bank of America signaled that talks with Carlyle Group had stalled. The two men worked the phones to find other investors. In the end, they agreed to pay about $1.85 billion for the bank.
Nanula also negotiated the deal with Leibovitz, after getting an e-mail from his boss asking, “Can we help her?” Leibovitz, who photographed John Lennon for the cover of Rolling Stone magazine on the day of his death in 1980, was unable to keep up on payments on a $24 million loan from Art Capital Group, a New York firm that provides financing to artists and that sued Leibovitz to seize her assets.
Nanula says he’s talking with Leibovitz about a national tour to showcase her work. He says he envisions similar deals with other celebrities.
“If all we did was one Neverland, or one Annie, it wouldn’t make too much sense,” he says.
As for Neverland, Nanula says it will remain a Colony asset, at least for now. Barrack has converted Jackson’s former amusement park into a series of gardens and is renovating other parts of the estate. He says he’ll sell it as the real estate market recovers, possibly for more than $100 million.
Legion of Honor
In May, Barrack was in Paris to receive the French Legion of Honor, the highest award bestowed by the government on citizens and foreigners. About 120 people attended the ceremony in an 18th-century building on the Rue du Faubourg Saint-Honore near the Elysee Palace.
Gilles Pelisson, chief executive officer of Accor SA, the Paris-based hotelier that owns the Novotel and Motel 6 chains and is 29 percent owned by Colony and its partners, was among those looking on as a red-ribboned medal was pinned on Barrack’s pinstriped suit.
Barrack has had a long and sometimes stormy relationship with France since he first visited in his twenties. Colony helped oust the previous CEO of Accor, as well as the top executive at Carrefour SA, the world’s second-largest retailer, in which Barrack had invested. Two presidents of the firm’s Paris soccer club were sacked in two years. Colony’s stakes in Carrefour and Accor, which at one point had a $1 billion paper loss, are getting close to parity, Barrack says.
None of that stood in the way of the festivities. Barrack was praised by a French deputy minister for establishing his firm’s European headquarters in Paris rather than London and for being “affable, accessible and enthusiastic.”
Speaking in French and English, Barrack talked about his “passionate relationship” with France, comparing it to “falling in love with a young girl.”
Then, after drinks and petits fours, he was gone -- heading to Asia on his Gulfstream V early the next morning.