October 17, 2017

SeaWorld Puts Stephen Schwarzman Under Glass

The Lisbon Oceanarium

Blackstone is about to take SeaWorld public - putting Stephen Scwarzman under a microscope.

This week’s big IPO was an interesting one. After a dearth of offerings following Facebook’s, the private equite firm, Blackstone is taking SeaWorld public. The theme park’s parent, Busch Gardens, was acquired three years ago by Blackstone for $2.3 billion. Since then the firm has increased revenue at the parks while paying itself $610 million in dividends. Not bad for the $1 billion in equity Blackstone put up in the deal. This deal at SeaWorld puts Stephen Schwarzman under glass.

The CEO has been under the microscope for years. A year before the SeaWorld deal, The New Yorker did a brilliant profile on Schwarzman. In a 23-page story, James B. Stewart shed some light on one of the biggest personalities in the business. Luckily, I’m here to summarize the piece for you. It starts by introducing the firm and the private equity business model.

Blackstone, the partnership that Schwarzman founded, in 1985, with Peter G. Peterson, Secretary of Commerce under Richard Nixon and a former chairman and C.E.O. of Lehman Brothers, was a new type of financial institution: a manager of so-called alternative assets, such as private-equity, real-estate, and hedge funds—esoteric vehicles that barely existed when Blackstone began but now accounted for trillions in assets. Most of the investments came from corporate and public pension funds, endowments of universities and other nonprofit institutions, insurance companies, and rich people. Blackstone was the world’s largest manager of these alternative assets, with $88 billion. Its investors included Dartmouth College, Indiana University, the University of Texas, the University of Illinois, Memorial Sloan-Kettering Cancer Center, and the Ohio Public Employee Retirement System. It had taken control of a hundred and twelve companies, with a combined value of nearly $200 billion. It had just completed what was at the time the largest private-equity buyout ever, the purchase, for $39 billion, of Equity Office Properties, and was on the verge of acquiring Hilton Hotels.

Schwarzman’s friend James B. (Jimmy) Lee, Jr., a vice-chairman at J. P. Morgan Chase, sent him a congratulatory e-mail:

You were like Indiana Jones over the last few weeks. . . . They rolled giant boulders at you . . . fired poison darts at you . . . threw you into that giant snake pit . . . and yet you still found the grail, and got the blonde. . . . Bravo.

Whatever his indulgences, Schwarzman has always drawn a strict line between personal expenses and Blackstone’s business operations; colleagues say that he keeps a close watch on office spending.
Partners pay for their own lunches; there is a twenty-five-dollar limit on dinner expenses for employees working at night. Even subscriptions to the Wall Street Journal are deemed personal expenses. One exception has been anniversary dinners, often at the Four Seasons. Still, until recently Schwarzman had trouble getting a prime table in the Grill Room at lunch. When Schwarzman asked Peterson why, his co-founder replied, “It takes more than just money.”

Schwarzman’s philanthropic activities have received wide notice. With a hundred and fifty million dollars from the public-offering proceeds, Blackstone established the Blackstone Foundation. Schwarzman has contributed to or raised money for a long list of nonprofit institutions, including the Frick Collection, the Whitney Museum, Phoenix House, the Red Cross, the Inner-City Scholarship Fund, the American Museum of Natural History, New York City Outward Bound, the Asia Society, and the Central Park Conservancy.
Jimmy Lee jokes that his friend has received more accolades and raised more money for the Catholic Archdiocese of New York than any other Jew. (Schwarzman has also raised money for the American Jewish Committee.)

For someone of Schwarzman’s wealth and business prominence, affiliations with boards—which are stocked with the lawyers, bankers, and business executives who are Blackstone’s clients, potential clients, or advisers to them—are all but essential. A board member is expected to make contributions that roughly correlate to the size of his personal fortune. Richard Beattie, a prominent lawyer who is also a longtime friend, told me, “Steve laughs about the old Wasp image—he doesn’t buy into that old-money standard. He thinks it’s ridiculous.”

Late last year, we met in the Blackstone offices. Half of his desk is crowded with family photographs. Behind his chair, along the windows facing Park Avenue, are scores of photographs of him with prominent people, including President Bush and Laura Bush, the German Chancellor Angela Merkel, Cardinal Egan, Michael Bloomberg, Colin Powell, President Hu Jintao of China, Bruce Wasserstein, and the 2006 honorees at the Kennedy Center—Andrew Lloyd Webber, Zubin Mehta, Dolly Parton, Smokey Robinson, and Steven Spielberg.

“My father was very bright,” Schwarzman says. “My mother had enormous drive. Put that together, and that’s my gene pool…By working and training harder than anyone else you gain an advantage at the margin.”

The summer before his sophomore year, while recovering from a touch-football injury, Schwarzman decided to study classical music, a subject about which he knew almost nothing. He started with Gregorian chants and worked through the repertoire chronologically, listening to recordings and reading related texts. He studied every major work and every major conductor, often spending, he claims, eight to ten hours a day listening to the stereo system. By late summer, he had reached Tchaikovsky. He was especially captivated by the ballet music from “The Sleeping Beauty.” “I’d close my eyes and listen, and I could see dancing.”

Schwarzman applied to several law and business schools. He was accepted at Harvard Business School. Feeling that he needed a break, he asked to defer his admission for a year.
To earn some extra money, Schwarzman worked for the Yale alumni office and then the admissions office. Larry Noble, a 1953 graduate who worked in the alumni office, introduced Schwarzman to others in Yale’s extensive alumni network, including his classmate Bill Donaldson, who was running an investment-banking firm, Donaldson, Lufkin & Jenrette. When Donaldson asked him why he wanted to work at the firm, Schwarzman replied, “Mr. Donaldson, I don’t even know what you do. But if you have such great-looking girls and intense guys then I want to do it.” Schwarzman was hired. He quickly realized that he was unqualified. He left after six months.

Schwarzman met his first wife, Ellen Philips, during his second year at Harvard Business School, where she worked as a researcher and helped grade essays. They were married in 1971 and had two children. Looking for a job after graduating, Schwarzman was shocked when both Goldman Sachs and First Boston turned him down, but he had offers from Lehman Brothers and Morgan Stanley. He claims that he was only the second Jew to get a job offer from Morgan Stanley, but he chose Lehman. One former Lehman banker describes the firm, “It was survival of the fittest. You produced the business and then you fought over the proceeds. It was every man for himself.”

Tropicana, an important Lehman client that was merging with Beatrice Foods, asked Schwarzman to represent the company in the sale, even though Schwarzman had never worked on a merger. (A Tropicana executive had been impressed by a bond presentation Schwarzman made, and felt that, despite his inexperience, he could explain complicated aspects of a merger to a relatively unsophisticated board.) The $488-million deal, in 1978, marked Schwarzman’s emergence as a lead banker in M. & A.

his work habits and his competitive drive impressed clients and other bankers and lawyers in that tightly knit world. A former Lehman colleague recalls a concert at Carnegie Hall that he and Schwarzman attended with their wives. As soon as the lights dimmed and the music began, Schwarzman opened his briefcase, pulled out a sheaf of papers, and began working. Though his wife chastised him at intermission, he resumed working as soon as they returned to their seats. He typically was awake by 4:30 or 5 a.m., and often worked until 10 p.m.—a habit that continues today.

In 1983, Schwarzman, accurately gauging the ambitions of Peter Cohen, the chairman of American Express, to expand into the potentially lucrative field of investment banking, approached Cohen (a neighbor in East Hampton) and delivered a persuasive assessment of the benefits to American Express of buying Lehman. In 1984, just nine months after Peterson’s departure, Lehman was sold for $360 million. To many, it was Schwarzman’s most brilliant deal yet: he had enriched himself and his mentor while turning the tables on Glucksman and freeing himself to join Peterson in launching a new partnership.

“My job was to bring in business,” Peterson explains. He launched a direct-mail campaign, targeting a hundred chief executives, in which he declared that Blackstone would not back hostile deals and would have no conflicts of interest with investment-banking clients, since Blackstone had no investment-banking clients. According to Peterson, the effort resulted in retainer agreements with E. F. Hutton, Firestone, Union Carbide, Bristol-Myers, and Sony.

Schwarzman and Peterson had bigger ambitions than a boutique firm. Combining a merger-advisory business with a buyout fund was bold.

Shortly after they formed the company, a cautionary scandal involving Dennis Levine, who had been a Schwarzman protégé in Lehman’s M. & A. department, became public. In 1986, Levine, was charged with insider trading. This launched the biggest insider-trading scandal in Wall Street history. Levine pleaded guilty. Among those implicated in the ensuing investigation were the arbitrager Ivan Boesky and the junk-bond financier Michael Milken. In short order came the collapse of Drexel Burnham.

The nineties were the beginning of a golden age for private equity. As with leveraged buyouts, the power of private equity, and the wellspring of its remarkable profits, is leverage—the use of borrowed money. The private-equity fund raises capital from rich investors, often pension funds or large institutions. (The fund is “private” in that only invited investors are allowed to participate.) It uses the capital to buy an asset, typically a publicly traded company or a unit of a publicly traded company; restructures it financially to add layers of debt; manages it aggressively to cut costs and boost cash flow; then, after five to seven years, pays off the debt and resells the company or relaunches it on the public markets at an enormous profit. The power of leverage is vast: if you invest ten dollars in an asset and sell it a year later for twelve, you have earned twenty per cent. If you invest one dollar, borrow nine, pay a dollar in interest on the debt (an eleven-per-cent rate), and sell the asset for the same twelve dollars, your return is one hundred per cent.

This isn’t a difficult concept, which raises the question of why public companies don’t embrace the same high-leverage, high-profit model. The reason is that private-equity funds exist to generate capital gains, which are taxed at fifteen per cent; public companies focus on earnings, which are taxed at a much higher rate. Public companies are typically valued at a multiple of earnings, and the interest payments associated with high leverage may all but eliminate earnings. Private companies don’t report earnings. Freed from any preoccupation with quarterly earnings reports, private-equity firms like to praise their long-term perspective, but “long term” means between five and seven years, at which point they sell the asset to realize a capital gain and move on to new conquests.

Even so, in recent years public companies have added huge amounts of leverage to their balance sheets, often by buying back their shares or taking on debt for acquisitions.
In addition to the turbocharging effects of leverage, private-equity operations like Blackstone benefit from an exceedingly generous compensation structure. The private-equity manager takes a management fee—two per cent is common—of the capital raised from the firm’s investors and twenty per cent of all gains (a stake known as “carried interest”), under the formula known on Wall Street as “two and twenty.”

Several early Blackstone deals illustrate the firm’s strategy of combining high-leverage buyouts with M. & A. advisory work for established clients. In 1987, USX (the former U.S. Steel) was under pressure to raise its stock price in order to fend off the corporate raider Carl Icahn. To raise cash for a stock buyback, USX decided to sell its transport subsidiaries, which hauled iron ore and other raw materials into USX’s factories and finished steel out of them. It was an unglamorous, low-growth business, but it had a captive customer in USX and predictable cash flow to service debt. Peterson argued that Blackstone was friendly, whereas other bidders might prove little better than a raider, like Icahn. His argument prevailed, and USX sold the subsidiaries, for $640 million, to a company owned fifty-one per cent by Blackstone and forty-nine per cent by USX and the company’s managers. Blackstone invested just $13 million, with the rest in debt financing. USX used the cash to buy back shares, and Icahn eventually went away. According to Blackstone, the project ultimately generated a return of more than two thousand per cent.
Leverage greatly magnifies gains, but it exacerbates losses in equal measure. Recessions are especially treacherous.

In 1993, Schwarzman hired another refugee from Lehman Brothers, J. Tomilson Hill, the former co-chief executive, to run Blackstone’s fledgling offerings in the world of hedge funds, the third major prong in Blackstone’s expansion strategy. Hedge funds have been the fastest-growing financial vehicles of the past five years—there are some eight thousand—and are fuelled by the same quest for higher returns and low volatility that has driven the private-equity boom. Hedge funds got their name from investment strategies that sell stocks short, or “hedge” against a declining market, thereby generating high returns in both bull and bear markets, but they embrace many investment strategies. The only thing they have in common with private-equity partnerships is the two-and-twenty (or higher) fee structure. Only recently has Blackstone launched its own hedge funds; its focus had been on what is known as a “fund of funds” approach, meaning that it steered clients’ money into suitable hedge funds. In return, Blackstone takes a fee of one per cent of the assets. The combination of private-equity, real-estate, and hedge funds has given Blackstone a presence in all three of the major alternative-asset classes.

The severe decline in stock prices between March, 2000, and October, 2002, during which the S. & P. 500 dropped forty-nine per cent and the technology-heavy Nasdaq composite an astounding seventy-eight per cent, was devastating for the large financial companies, pension funds, and nonprofit institutions that depended on equity gains to finance their operations and to fund their obligations to retirees. Suddenly, the most desirable investments among institutions were those which, like hedge funds, private-equity, natural resources, and emerging-market funds, don’t necessarily track the stock market—so-called non-correlated assets.

One banker explains, “Steve gets the credit, but it was Pete’s Rolodex that built that firm.”

Schwarzman recognized that if he was to remain immersed in deals and larger strategic initiatives Blackstone needed a manager. In early 2002, he approached Hamilton (Tony) E. James, the head of the investment-banking arm of Donaldson, Lufkin & Jenrette, which had recently been acquired by Credit Suisse First Boston. Schwarzman courted him over a series of dinners at his apartment, and every meeting, James told me, “was more intriguing.”

In June 2006, Michael Klein, the chairman and co-chief executive of markets and banking at Citigroup, came over for lunch. Klein unveiled a detailed plan for taking the Blackstone Group public. This wasn’t the first time someone had broached the idea of going public—Goldman Sachs had been raising the issue for some time, especially after its own successful offering, in 1999. Schwarzman, who had taken so many companies public, had often pondered the possibility. Still, at that point no private-equity or other alternative-asset managers had taken their firms public. It was one thing for full-service investment banks like Goldman Sachs and Morgan Stanley to be publicly owned; they were closer to commercial banks than to private partnerships, and much of their income was fee-driven. But private-equity firms like Blackstone had long argued that their financial interests and incentives were identical to those of their investors: Blackstone partners, by investing in the same partnerships and having a carried interest, prospered when their clients did. If Blackstone was a public company, it would need to consider its shareholders’ interests along with those of its investors.

Still, Michael Klein convinced Schwarzman that Blackstone could retain many of the benefits of private ownership. Public ownership would generate capital for investment and expansion and a currency—common stock—that could be used for acquisitions. “Michael understood the earnings power and the growth potential,” Schwarzman says.

Despite Peterson’s advice to avoid personal publicity, Schwarzman began planning the party for his sixtieth birthday, which fell on February 14, 2007. Weeks before the event, the Times ran an article, by Landon Thomas, previewing the plans and speculating about the guest list: “more rumors about his party than his deals.”

In the event, the scale of the party disappointed no one. Part of the cavernous Park Avenue armory was transformed into a large-scale replica of the Schwarzmans’ Manhattan apartment by Philip Baloun, the party planner who designed the Prince Charles gala at Lincoln Center. Replicas of Schwarzman’s art collection were mounted on the walls, including, at the entrance, a full-length portrait of him by Andrew Festing, the president of the Royal Society of Portrait Painters. Dinner was served in a faux night-club setting, with orchids and palm trees. Guests dined on lobster, filet mignon, and baked Alaska, and were offered an array of expensive wines. (Schwarzman himself doesn’t drink.)

Although Blackstone avoided the mortgage and credit debacles, the resulting credit freeze caused asset values to plunge, credit to disappear, and leverage to decline, all of which affected Blackstone’s core businesses. Its earnings for its first two quarters as a public company disappointed investors, and its stock went down. Early last month, Blackstone couldn’t raise the financing for the buyout of the mortgage unit of PHH Corporation, which it had agreed to buy in 2007. Blackstone’s proposed buyout of Alliance Data Systems, for $6.8 billion, also collapsed, and A.D.S. is suing Blackstone to force it to complete the deal.

When I was talking with Schwarzman in his office, I asked him how it felt to be the focus of so much negative attention.
He paused, and his look hardened.
“How does it feel? Unattractive. No thinking person wants to be reduced to a caricature.” He continued, “Why did this happen? We went public in June, 2007, at the top of a giant bull market, with a society undergoing rapid change. Globalization. Job dislocation. Middle-class anxiety. Private equity is seen as a symbol of the people who are prospering from a world in flux. That’s a lightning-rod situation.”

Schwarzman told me that in 1993, at forty-six, he was found to have a rare blood-protein deficiency that put him at risk of a blood clot or embolism, a condition that had killed his grandfather at the same age. He is tested every few weeks and takes a pill each day, which he says should help guarantee him a normal life span. Still, “it’s a reminder that life is fleeting,” he said. “Every day should be a good day. People fool themselves that they’ll be here forever. I get a daily wake-up call that that’s not true. We have limited time, and we have to maximize it. Live life intensely—I’ve always believed in that. I’m happy to be here. I was happy to make it to sixty. That’s the simple reason for the birthday party.”

That last paragraph may have been the best anecdote I’ve ever read in a profile. I hope you enjoyed the abridged article as much as I did. Some deals like SeaWorld puts Stephen Schwarzman under glass to take a look at the larger-than-life personality. But he’s been doing advisory work, public equity, and hedge fund investing for some time. He’ll probably only draw more scrutiny as time passes.

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