Blackstone's $26 Billion Hilton Deal: The Best Leveraged Buyout Ever

The most profitable private equity deal in history was badly timed but brilliantly executed

Blackstone's $26 Billion Hilton Deal: The Best Leveraged Buyout Ever
The most profitable private equity deal in history was badly timed but brilliantly executed (Photograph by Thomas A. Kelly/Corbis)
Photograph by Thomas A. Kelly/Corbis

In the early spring of 2009, with the recession deepening, Christopher Nassetta stood alone in an empty house in Arlington, Va., surrounded by moving boxes and trying not to despair. What he hoped would be the crowning achievement of his career—executing, as chief executive officer, the turnaround of Hilton Worldwide Holdings, the legendary hotel company founded by Paris Hilton’s great-grandfather—had turned nightmarish. He’d just returned to the East Coast after closing Hilton’s Beverly Hills headquarters, and that was the least of his troubles.

Behind this week???s covers??Photograph by David Brandon Geeting for Bloomberg Businessweek; Prop Stylist: Priscilla Jeong
Behind this week???s covers??Photograph by David Brandon Geeting for Bloomberg Businessweek; Prop Stylist: Priscilla Jeong

Eighteen months earlier, in the fall of 2007, Blackstone Group had bought Hilton in a $26 billion leveraged buyout at the height of the real estate bubble. Jonathan Gray, Blackstone’s global head of real estate and the architect of the Hilton deal, invested $5.6 billion of Blackstone’s money and had big plans for revitalizing the chain, the epitome of cosmopolitan glamour in the Mad Men era. Central to Gray’s plans had been hiring Nassetta away from Host Hotels & Resorts, where he was CEO.

At Hilton, the two got off to a decent enough start, but then, as the financial crisis hit and the economy tanked, it appeared that Blackstone and its partners had paid too much, used too much debt, and couldn’t have picked a worse moment to close the deal. Some of its partners—among them, Bear Stearns and Lehman Brothers—would soon cease to exist. After Lehman’s collapse, tourism went into a severe slump, Hilton slumped, too, and it appeared that all of Nassetta’s bright ideas for restoring the chain’s luster would never get implemented. Adding insult to injury, rival Starwood Hotels & Resorts Worldwide sued Hilton in federal court, alleging that Hilton employees had stolen the plans for its successful W Hotel franchises in what it called “the clearest imaginable case of corporate espionage, theft of trade secrets, unfair competition, and computer fraud.” The Department of Justice began investigating Starwood’s charges.

“Revenue’s running down 20 percent,” Gray recalls. “Cash flow is down around 30 percent. We get a huge suit. The DOJ opens up an investigation. It was definitely a low moment in the deal.” Blackstone was in serious danger of losing the bulk of its $5.6 billion. “I promise you this is the absolute bottom,” Nassetta recalls Gray telling him that summer, bucking himself up, too. “How can it get any worse than this?”

Four years later, when Blackstone took the company public in December 2013, its timing proved impeccable. And this July, when Hilton’s stock closed at $24.80, Gray and Nassetta had officially transformed Hilton into the most lucrative private equity deal ever, with a paper profit of $12 billion.

Click to enlarge.
Click to enlarge.
Photograph by David Brandon Geeting for Bloomberg Businessweek

One key to this good fortune is obvious: the historically low interest rates maintained by the Federal Reserve. But plenty of other deals benefited from low lending rates, too, and fell apart. In fact, of the nine hospitality and lodging LBOs completed in the same time frame as Blackstone’s Hilton acquisition, only Hilton and La Quinta Inns & Suites (another Blackstone deal) weren’t forced into bankruptcy or a debt restructuring.

The full story of the richest LBO in history is actually a story of private equity working as advertised. By persuading its lenders to exercise forbearance, restructuring its debt before it had to, and practicing smart management, as opposed to indiscriminate cost cuts and pink slips, Blackstone made Hilton perform better than most thought possible.

“There weren’t many people in the room with me who still believed,” Gray says of 2009. “But the good news is we were able to say, ‘Look, we’ve got plenty of cash’—I don’t think we ever went below a billion dollars in cash on our balance sheet—and, ‘We really believe in this business.’ ” Still, he confides, he had to filter out the negativity while he waited for things to improve. “It’s no fun reading that you’re not very smart.”
While he’s familiar to some investment bankers because of Blackstone’s history of savvy real estate deals, especially the purchase of Equity Office Properties Trust, Gray, 44, is little known outside Wall Street. A billionaire (his Blackstone shares are valued at about $1.3 billion), he’s a Phi Beta Kappa graduate of the University of Pennsylvania and determinedly low-key—“annoyingly calm,” his wife, Mindy, says. He prefers philanthropy to a Hamptons manse, spending time with Mindy and their four daughters over parties and auctions. He does own a five-bedroom apartment on Park Avenue but drives a Toyota minivan and wears a plastic Timex watch.

Considered a likely successor to Blackstone President Hamilton James, Gray is certainly less flamboyant than either James or his boss, Stephen Schwarzman, whose fortune is estimated at $10.8 billion and whose lavish parties inspire urban myths. Schwarzman and Pete Peterson, a former Nixon administration Commerce secretary, founded Blackstone in 1985 following a power struggle for control of Lehman Brothers. They must be glad they lost that one: Blackstone now manages about $280 billion in so-called alternative assets for wealthy individuals, college endowments, pension and sovereign wealth funds, and corporations. The firm mainly invests in private equity deals, hedge funds, and other esoteric, and often risky, opportunities.

One reason Blackstone has been so successful is its ability to attract and rely on young talent. Gray joined the firm in 1992 right out of the Wharton School and quickly began learning from his mentors, John Schreiber, Thomas Saylak, and John Kukral.

During the summer of 2006, Gray says, there was an enormous amount of capital that was finding its way into commercial real estate. “And in response to that, we’re trying to figure out how can we find an edge. We have this simple motto where we want to try to buy hard assets at a discount to replacement cost.” In other words, he was looking for an opportunity to buy all of a company’s stock for less than it would cost to build, say, all the hotels it owns. Gray got excited, he says, when he realized that real estate assets were “cheaper on the screen than they were on the street.” He could make money on that perceived difference in value.

The lobby in the Hilton Hotel in San Angelo when it wasdecorated to resemble a corral for an event circa 1930s
The lobby in the Hilton Hotel in San Angelo when it was
decorated to resemble a corral for an event circa 1930s
Cattle Raisers Museum, Fort Worth, Texas

Gray first approached Stephen Bollenbach, Hilton’s CEO, in August 2006. Bollenbach was open-minded about a buyout, but the two men couldn’t agree on a price. In the meantime, Gray’s focus shifted to buying Equity Office from real estate mogul Sam Zell. At $39 billion, the Equity Office deal was not only huge, but also highly complex. It began with a battle for control of the company against another bidder. Then, no sooner had Blackstone bought the company, it began reselling many of Equity Office’s properties to several developers. Thanks in large part to Gray, Blackstone made a fortune, although just how large it’s not saying.

Gray called Bollenbach again the following May and told him Blackstone was willing to consider a deal closer to Bollenbach’s asking price of $48 per share. On July 3, 2007, the two sides agreed on $47.50 a share in cash, valuing Hilton at some $26 billion. Blackstone financed the purchase with about $5.6 billion in equity from two of its funds and a few co-investors, plus around $20.5 billion from a group of 26 big banks, hedge funds, and real estate debt investors. Gray says the price Blackstone paid was high, as was the company’s debt load. But Gray managed to get the banks to lend him most of the purchase price at low rates, with easy payment schedules and less restrictive terms than usual. Often, if a company has operating losses for consecutive quarters, lenders will demand immediate repayments. The loans Gray negotiated had none of these so-called covenants—and that proved prescient.

Gray’s next big move was to replace Bollenbach with Nassetta, whom he’d known since the early 1990s. They’d met in the aftermath of the savings and loan crisis when the federal government established the Resolution Trust Corp. to sell bad mortgages and other squirrelly securities it inherited from failed savings banks. A few years later, when Nassetta was CEO of Host, Blackstone sold the company some hotels from its portfolio. From Nassetta’s perspective, the decision to take on Hilton was complicated by Hilton’s main headquarters being in Los Angeles while he and his family (the Nassettas have six daughters) lived in the Washington (D.C.) area. Still, he agreed to have lunch with Gray at Occidental Grill & Seafood in Washington to discuss the job. “I definitely walked away from that lunch thinking that this is a once-in-a-lifetime opportunity with a once-in-a-lifetime partner,” Nassetta says.

While Gray says Bollenbach was a “brilliant strategist,” he found Hilton sleepy. “The company I wouldn’t say was the hardest-driving business,” he says. Based in Beverly Hills, Hilton’s executive offices closed at noon on Fridays. Nassetta, too, found Hilton’s corporate structure—with five business units strewn across the country—to be counterproductive. It was “disjointed and complacent,” says Nassetta as diplomatically as he can. Adds William Stein, a Blackstone real estate partner, “We went to all five of the offices that were corporate offices, and at every single one of those offices they would tell you, ‘We got it right. This is how the company should work. The other four places are completely wrong.’ And each one gave you the same story. We’re thinking, ‘No one’s talking to each other here. It’s unbelievable.’ ” Nassetta put an end to this Balkanization. “We’ve completely transformed the culture to one that is integrated, aligned, and performance-oriented,” he says. Bollenbach could not be reached for comment.

The Gray-Nassetta business plan also called for Hilton to expand its international presence, which had shriveled from the company’s pioneering days when Conrad Hilton opened gorgeous hotels in places such as Istanbul, Bogota, and Tokyo. “It was as if Hilton didn’t have a passport to leave the United States anymore,” Gray says. Nassetta brought back the founder’s motto: “To fill the earth with the light and warmth of hospitality.”

Blackstone’s Hilton acquisition closed on Oct. 24, 2007. A few months earlier, two Bear Stearns hedge funds had collapsed and were liquidated. In August, French bank BNP Paribas froze three mutual funds because it could no longer properly value the mortgage-backed securities in which the funds had invested. Signs of stress were everywhere, Gray says, but “we didn’t know the world was about to go through a global financial crisis. … We plowed ahead.”
In March 2008, Bear Stearns collapsed and was sold to JPMorgan Chase. As part of its deal for Bear Stearns, JPMorgan insisted that the Federal Reserve Bank of New York take $29 billion of Bear Stearns’s assets off its books. One of the assets that JPMorgan didn’t want was Bear’s $4 billion chunk of the Hilton loan. Bear and the others involved in financing the Hilton deal still owned the loan because the disruption in the capital markets had prevented it from being turned into a security and sold to investors. Gray tried not to take personally that Jamie Dimon, JPMorgan Chase’s CEO, wanted to ditch the Hilton loan. “You don’t like to see your debt tagged that they didn’t want it,” he says, “but frankly, with all the leveraged deals, people weren’t discriminating. People were just saying, ‘Look, the markets have fallen, the economy’s slow.’ Nobody wanted to buy anything at that point.”

In 2009, Hilton’s revenue declined 15 percent. That fall, Gray wrote a tough-love letter to Blackstone’s investors informing them that the value of the firm’s equity in Hilton had fallen by 70 percent, or roughly $3.9 billion. Matthew Clark, a longtime Blackstone investor and the state investment officer at the South Dakota Investment Council, which manages $12 billion, was concerned. “We knew that highly leveraged companies were very vulnerable when things are down that far, and so I was worried that if things got worse, eventually these things could go to zero,” he explains. “I was worried that all of our stocks could go to zero.”

It’s at this moment that Gray and his Blackstone partner Kenneth Caplan made the opportunistic decision—Caplan prefers “proactive”—to negotiate a debt restructuring with Hilton’s creditors. Normally, a company would do this only if it had defaulted or tripped a clause in its loan that resulted in penalties or steeper rates. In this case, no interest payments had been missed. The only catalyst for the negotiation, Caplan says, was Blackstone’s desire to buy some “insurance” with the creditors. Getting a reprieve from its creditors—by stretching out the debt repayment schedule and converting a portion of the debt to equity, meaning it wouldn’t have to be paid back at all—could buy Gray and Nassetta the precious time they needed.

It was no easy task. For the plan to work, all 26 creditors, among them Deutsche Bank, Morgan Stanley, Goldman Sachs, and Bank of America, plus hedge funds, debt funds, and the Federal Reserve Bank of New York, had to agree to the deal. “If it wasn’t an attractive proposal for everybody, it wouldn’t have gotten done,” Caplan says. “The lenders didn’t give us a discount just because they were nice guys or whatever. They were doing it in their own self-interest.” If they sold a small amount of their debt at a discounted level in exchange for greater value later, he says, “that was a positive for them. It was literally thousands of phone calls over a 9- or 10-month period. I’d say my wife knew the names of many of our lenders by the end of it.”

The toughest negotiator turned out to be the New York Fed, which ironically was being advised by BlackRock, the huge asset manager run by Larry Fink that was once part of Blackstone. The Fed, the hotel chain’s largest single creditor, was reluctant to be seen as taking a discount on a portion of its Hilton debt lest it be interpreted as giving a financial bonanza to Blackstone. “The banks were more like, ‘Let’s get this out of Dodge,’ ”—as in, take the money and run, says one participant in the negotiations—“but the Fed was tough.” The Fed also wanted a fee as part of the restructuring, since the other creditors were promised fees for future work on Hilton. In the end, the Fed sold a $320 million face amount of its Hilton debt back to the hotel chain at a loss of $180 million, though it did get an (undisclosed) multimillion-dollar payment.

By April 2010, Gray and Caplan had corralled the lenders into a new agreement. To pull it off, Blackstone also invested $819 million of new equity into Hilton, which the company used to buy back $1.8 billion of its secured debt at a discount of 54 percent from the original borrowed amount.

Jacques Brand, CEO of Deutsche Bank’s North American business and a key banker to Hilton and Blackstone, says the combination of the additional equity investment and the reputations of Gray, Nassetta, and Schwarzman made the restructuring possible. “To write a $5 billion check and then to write another [for] nearly $1 billion clearly demonstrated to the market that Blackstone was absolutely committed to this investment, and that both it and Hilton were trying to transform the business,” Brand says, kissing up to his client.

“Obviously it was a perilous time,” Gray says. “The people at the banks and the Fed—and the world at large—thought we were pretty insane.”
Critical as the debt restructuring was, Gray credits Nassetta, 51, with the rescue of Hilton. And he did it by recommitting to Hilton overseas, expanding its available rooms, and going upmarket. At the time of the acquisition, the hotel chain had 116,000 rooms under construction, 19 percent of them in international properties. Today, it has 210,000 new rooms on the way, 60 percent of which are abroad. Hilton now has more than 700,000 hotel rooms total—good for No. 1 in the world.

“That didn’t happen overnight,” Nassetta says. “It happened by grinding it out. We were making progress each year. While we were doing the restructuring, while the world was upside down, we redoubled efforts. … While we cut significant costs out of the business, we reinvested huge amounts into its growth.” He’s proud of the expansion. “It’s like taking a trans-Atlantic flight on a 747 from Kennedy to Heathrow and having three engines under repair but you’ve got to keep the plane flying,” he says.

Gray, right, brought in Nassetta as Hilton’s turnaround CEO
Gray, right, brought in Nassetta as Hilton’s turnaround CEO
Photograph by Christopher Leaman for Bloomberg Businessweek

Under Nassetta’s leadership, Hilton’s market share, profit margins, and the amount of outside capital it attracted from developers that wanted Hilton to manage their hotels increased. Like Marriott, Hilton runs hotels it doesn’t own, and for Nassetta, this was an important way to improve Hilton’s balance sheet. Hilton’s time share business also grew, attracting investor money that displaced as much as 80 percent of Hilton’s own capital in the program. And Nassetta quadrupled Hilton’s spending on its luxury brands. In 2009 he started Home2 Suites by Hilton, which now has close to 170 hotels open or in development.

Nassetta still had to contend with the Starwood lawsuit, however. In it, the rival hotel group held that two executives Hilton had hired away from Starwood had stolen more than 100,000 electronic and paper documents containing “Starwood’s most competitively sensitive information.” While preparing for a separate arbitration, also involving the poaching of employees from Starwood, Hilton executives discovered the purloined documents, packaged them into eight boxes, and sent them back, unannounced, to Starwood’s offices in White Plains, N.Y. According to Starwood’s complaint, Hilton’s general counsel had attached a note to the boxes asserting that the documents were “neither sensitive nor confidential” and that he was returning them “nonetheless in an abundance of caution.” In December 2010, Hilton settled the litigation with Starwood by agreeing to pay its rival $75 million in cash. Hilton also agreed not to develop for two years any hotel with the hip, modern feel of Starwood’s W hotels, the subject of the documents taken from Starwood. Following the settlement, the DOJ lost interest.

By the late summer of 2013, Hilton had started to hum. Companywide revenue for 2012 was $9.3 billion, up from $8.7 billion in 2011. The ratio of debt to earnings had declined. Things were going so well that Blackstone began to think about what had once been unimaginable: cashing in. Soon after a complete debt refinancing in October 2013, Blackstone, Hilton, and their bankers began working on Hilton’s IPO prospectus. Led by Brand and Deutsche Bank, the IPO trumpeted the revitalized Hilton. Investors found the story irresistible. “It’s a unique story,” says Tyler Henritze, a Blackstone senior managing director. “Most people underestimated … the degree to which the business had grown during the downturn. People were blown away.”

One of the clichés of Wall Street is a collection of exuberant executives gathering above the floor of the New York Stock Exchange to ring the bell on IPO day. As trading has become electronic, the exchange itself has become nothing more than an elaborate television set for this rite of passage. Corny or not, Nassetta, Gray, and their respective teams at Hilton and Blackstone embraced this ritual on Dec. 11, 2013. Nassetta calls it the finest moment of his career.

“When we rang the bell, Jon and I turned to each other, and I’ll never forget it,” he says. “Very few words were spoken, big smiles, a big hug.” What didn’t need saying: “We’d never lost faith in the company, never lost faith in one another.” They gave each of the floor brokers managing the stock’s trading a terry cloth bathrobe—just like the ones guests aren’t supposed to steal from their hotel room. Hilton’s stock closed at $21.50 at the end of the first day of trading, giving the company an equity value of around $20 billion and Blackstone a gain of almost $9 billion. That made it second on the list of all-time profitable deals to the $10.1 billion that Apollo Global Management earned on its investment in LyondellBasell Industries, a large chemical company. Later, as Hilton’s stock rose, it took over the No. 1 spot.

Although deal junkies rarely praise a rival, David Solomon, the co-head of investment banking at Goldman Sachs, says Hilton’s success has been good for Wall Street—good for everybody, that is, who gets big fees for pushing paper around.

“Yes, success has many fathers, and it’s easy to see in hindsight, but a lot of people didn’t get it right,” he says. “The two people who deserve an enormous amount of credit for this deal are Jonathan Gray and Chris Nassetta. They got it right, and that’s what they’re paid to do. But they are also terrific people, and I’m thrilled for their success.” Of course, he’s also got to feel pretty good about the $443 million Goldman invested in Hilton’s equity that’s now worth about $1.3 billion.

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