Q&A: PE Authors Talk Dividend Recaps, Blackstone, and Future of AM
Fellow Monkeys, I have a very special Q&A to share with you all tonight!
I had the pleasure of sitting down with John Morris and David Carey to discuss their book- King of Capital: The Remarkable Rise, Fall, and Rise again of Steve Schwarzman and Blackstone. I highly recommend King of Capital to anyone interested in the private equity industry- the book not only provides an extensive look behind Blackstone's deals, but also delves into many of the prevailing issues surrounding the private equity industry.
In this Q&A we touch on topics like the economic value of dividend recapitalizations, the future of the private equity industry, and much more. So, please, enjoy our discussion, and make to pick up a copy of King of Capital.
Without naming names, there are many equally prominent, or flashy, players in the asset management (AM) industry. What gravitated you to write about specifically about Schwarzman and, or, Blackstone? What did you initially find interesting about Schwarzman or BX?
Morris: David had once mentioned to me – probably in 2005 or 2006 -- that he thought Blackstone could make a good topic for a book. KKR and Carlyle had received much more attention historically, yet Blackstone was bigger and had a better track record with its investments.
In 2007, he was approached by an editor about writing some kind of broad-brush book about private equity and he asked me if I'd like to collaborate with him. The publisher had originally envisioned a book that we could turn around quickly. When we sat down with the editor and her boss, David mentioned the idea of the Blackstone book – one that would take much longer to write and report than a primer. They said, "Why don't you write that book?"
Carey: It was 2007, and Blackstone was front-and-center in the news after Schwarzman's extravagant birthday party and the firm's splashy IPO. Making Blackstone the centerpiece made perfect sense. In the end, for a variety of reasons, we ended up working with another publisher.
The acknowledgements at the end of the book notes that Schwarzman "gave more of his time than anyone else." What is Mr. Schwarzman's personality like? He clearly hates losing money- but how does his Blackstone persona translate into everyday life, if ever? What do you see as Schwarzman's biggest weaknesses or strengths?
Morris: He's a paradoxical character. He was pretty testy with us in the early stages. He can be arrogant and clueless about how he comes across. But – and this is the surprising side – he's also quite self-reflective, and that fear of losing money and obsession with succeeding also makes him reflect on his and the firm's mistakes. He also doesn't have to be the smartest guy in the room.He's the boss, but he definitely listens to other people – even junior people in the organization. Investors told us that he comes across as much less arrogant with them than the heads of Blackstone's competitors.
That's not to say that the public image of him – the wealth-displaying, tactless side – is without basis. But it's not the only facet to his personality.
With Romney as the GOP front-runner, an insider's account of the industry appears more relevant than ever. You seem to believe the industry is publicly misunderstood- on the list of goals for the book, was it ever a priority to quell some of the pervading misconceptions about the industry?
Carey: We didn't set out to write an apologia for private equity. We wanted to explain how private equity works, while cutting through the common stereotype that buyout artists profit by plundering what they buy. There have been takeover artists - the crook Victor Posner comes to mind - who live by looting. But they tend not to last long. Blackstone and other top firms are bent on bettering companies' operations, margins and productivity so as to elevate shareholder value and maximize their investment gains.
Far from occupying the economy's deviant and rapacious fringe, PE epitomizes U.S.-style capitalism. It's a very different style than in continental Europe, where shareholder value isn't worshipped with the same fervor.
We did see ourselves as contrarian, as we had in our reporting at The Deal for years. We definitely thought that private equity had been caricatured. Are these guys heros? No. They're out to make money. But we believe that in many cases they fulfill an important economic function and they aren't a threat to the economy or even, over all, to jobs, even if they push change at particular companies.
When Blackstone (and others) bought during the troughs of the business cycle, they won big. When they bought at peaks, they almost always lost out. Nonetheless, the partners could not resist in dabbling in the recent buyout craze.
Talk about some of the motivations you saw first hand behind their deals prior to the recession, Is it irrational exuberance, ego, or a mixture that drives these deals? How important is it to understand the fundamental truths of the business cycle to the PE business?
Morris: Blackstone became much more cautious a year or so before the peak, and didn't do that many deals after September of 2006. But it was hard to fight the momentum. Tony James, Blackstone's COO, summed up to us the human emotions driving that era very well -- the drive of these Wall Street guys, and the pressure not to lose out to competitors:
"It's hard when everyone around you is bidding on things and buying a lot of things to stick to your guns and say, 'No, no, I think that's overpaying.' Your people start pushing back. They're deal people; they want to do deals. We allowed ourselves -- the pull pressures from our own people and the push pressures from the market -- to be dragged along. We had the brakes on but the car was still being pushed."
Carey: I wouldn't say ego was the main propellant behind the mid-decade megadeal binge. Sure, it was a factor. But PE players have wised up a bit since the 1980s, when bidding wars like that for RJR Nabisco drove prices to crazy levels and triggered heavy losses.Nowadays the big PE firms vet deals laboriously before buying, doing computer modeling to gauge downside risk versus upside potential. Of course, they can get it wrong. Just look at how miserably the $25 billion-plus LBOs of TXU, Harrah's and Clear Channel have done.
The last buyout boom was a byproduct of the unprecedented amounts of capital that PE firms had at their disposal. Surprisingly, some of the biggest deals done at the peak have been big winners. TPG made a killing on Alltel, a cellphone operator flipped to Verizon Wireless in a year or so. That was a deal from the spring of 2007. KKR has already raked in profits on Dollar General, a discount chain, and HCA, a hospital operator. And Blackstone's big bet on Hilton -- signed in July 2007, as the market was already cracking -- looks like it will be quite profitable over time.
With Bonderman, Kravis, Schwarzman, and Rubenstein all pushing into the retirement age, would you care to make any predictions of how the PE or AM landscape will change without these heavy hitters?
Carey: Good question. Those guys are charismatic entrepreneurs whose talents can't be cloned. But they are grooming younger stars to take over eventually who, from what I know, are more than capable. Whoever leads their firms will have to have imagination and moxie to keep pace in a fast-evolving industry. All the big players have gone global and are launching new products like debt, hedge and sector funds. KKR's new real estate unit just struck its first deal in the U.S. As the Volcker Rule forces banks to curtail some riskier activities, PE may step into the breach. It's a brave new world.
Morris: I would just add that it's bound to change the cultures of these firms when the founders are gone. The institutions have been so dominated by their personalities. But the top tier of firms are large enough now that they've become much more institutionalized than they were even a decade ago. Going public has forced firms to mature along those lines, too, with more processes and management.
The book goes into a lot of detail on how Blackstone raised its first fund (one of my favorite parts!). The book talks less about the capital raising process of later funds- how has the process changed since Blackstone first started? Is there a reason you chose not to delve deeper into how BX raised its later funds?
Morris: Yes, the story of the first, arduous fundraising was comical. That's a good example of the surprising side of Schwarzman that I mentioned. He enthusiastically recounted the humiliations he and Pete Peterson endured trying to get banks and pension funds to open up their wallets.
After the success of a few early investments, it was much easier to raise funds a few years later. Frankly, no one ever talked very much about the process after that and I'm not sure readers would have found that so scintillating. But maybe we missed out on something. Hmm.
Could you touch on dividend recapitalizations and its role in the PE business? How important are dividend recaps to the PE industry? Do dividend recaps serve any social or economical benefit?
Carey: Debt-funded dividends -- dividend recaps -- may not heal the sick or raise the dead, but they're not devoid of social or economic value. Like selling shares in an IPO, they're a way to capture investment gains, and the bulk of the money goes to PE firms' outside investors. These are pension funds for the most part. In that sense, dividend recaps fatten the retirement accounts of teachers in Texas, or policemen in New York.
On the flip side, they do at times inflict misery on the currently employed. This occurs when the recap piles on too much debt, causing a company to fail and forcing layoffs. That happened a handful of times on Romney's watch at Bain. But such cases are rare. Most companies that undergo dividend recaps have sturdy balance sheets and steady cash flows and can handle the added debt. The historic overall default rate is remarkably low for recapped companies.
Morris: It's just like remortgaging your house if you've paid down your old house. There's nothing wrong with that if your monthly payments don't run you into bankruptcy. In the private equity context, a recap allows firms to realize part of their gains sooner than they would if they waited for a sale or IPO of the company. Suppose the company has increased substantially in value, but you think it will improve a lot more. You may decide not to wait two or three years to collect the first gains. You can recapitalize the company and take some of your money off the table now. There's nothing wrong with that in principle.
Do you have any plans for upcoming books, together, alone, or with others?
Carey: I don't have a book in the works. I'm fishing for ideas. It was great to work with John on the book. It helped that we saw eye to eye on the subject. A future collaboration is not out of the question.
Morris: I have a terrific idea for a title. It's bound to be a best seller. Now I just need to come up with the book to go along with it.
private equity coverage. Before joining The Deal, he was the editor of Corporate Finance magazine and wrote for Adweek, Fortune, Institutional Investor, and Financial World. Carey has appeared often on CNBC. He holds two masters degrees: one in French literature from Princeton and a second in journalism from Columbia. He earned his bachelor's degree at the University of Washington. DAVID CAREY is the senior writer for The Deal and leads its
JOHN E. MORRIS, edits Bloomberg's Merger's newsletter. He was previously Deputy Managing Editor with Dow Jones Investment Banker and Assistant Managing Editor at The Deal in New York and London. Before that he was an editor and writer at The American Lawyer magazine. He has made frequent appearances on CNBC and BBC. He earned his undergraduate degree at the University of California, Berkeley, and a J.D. from Harvard Law School. He practiced law in San Francisco for six years before becoming a journalist.