Sloan: When Private Equity Goes Public

You've got to be kidding me. That may be the only appropriate response to the news that the kings of "private" equity, Blackstone Group, may soon take their own company public.

Private-equity houses, you see, always talk up the joys of being private, about how you can manage for the long term as a private enterprise rather than having to tailor your business to Wall Street whims. Private companies don't have to tell anybody anything about what they're doing. Forget having to give quarterly guidance to Wall Street. Stop sweating Sarbanes-Oxley. And no more of those embarrassing disclosures about how many zillions of dollars top executives make.

So if being private is such a good thing for the companies that Blackstone buys on behalf of its clients, why would going public be a good thing for Blackstone itself? Blackstone — still a private company — declined to comment, as usual. So I'll have to answer that question myself.

No, I don't think the answer is "hypocrisy." I think it's opportunism. Blackstone chief executive Steve Schwarzman and senior chairman Pete Peterson, who co-founded the firm in 1985, know that markets are cyclical. They saw the cycle turn against them in the late 1980s and early 1990s. Back then, Blackstone and others, such as Kohlberg Kravis Roberts, were known as leveraged buyout houses because they used tons of borrowed money — what financial types call "leverage." LBOs became deeply unpopular because of the messy RJR takeover battle, which was followed by Chapter 11 filings by a clutch of companies that had gone the LBO route and choked on their debt.

The cycle has turned in favor of LBO houses, which now call themselves "private-equity firms." Large investors, especially public pension funds, are pouring money into private equity because it has had a great track record the past few years. LBO houses frequently cash in profits by taking their portfolio companies public — so why not expect Blackstone and other buyout firms to take themselves public at a high price while they can?

By going public, the owners of Blackstone's management company — as opposed to the investors in its funds, which will still be private — can cash in some of their holdings. And there's one final benefit. When Blackstone's owners themselves cash out — co-founders Schwarzman and Peterson are 60 and 80, respectively — they would have a marketable asset with which to pay estate taxes.

One reason Blackstone will show great financial performance in its IPO documents is that the demand for name-brand LBO investments seems to be endless. As a private-equity blue chip, Blackstone can pick and choose among potential investors and charge them immense fees.

Consider, if you will, the fees that Blackstone got on the recent $39 billion takeover of Equity Office Properties, the biggest leveraged buyout in history. (The pending $45 billion buyout of TXU by Texas Pacific Group and KKR would be bigger, but it's a long way from completion.)

By my reading of documents filed by a Blackstone investor, Blackstone got a $390 million deal fee — 1 percent of the transaction — for buying Equity Office, the nation's biggest holder of office buildings. That fee went to Blackstone's partners, not to its investors. Blackstone will also get 20 percent of any profit its investors make on the deal but will subtract half its deal fee from its piece of the profits.

In previous years, Blackstone would have collected a 1.5 percent annual fee on the cash that its investors put into consummated deals. But now, it collects that 1.5 percent on all the money investors have committed, rather than just on what they've invested.

And get this: Blackstone has sold (or is selling) more than $20 billion of the Equity Office properties it just bought. Somehow, I doubt that it's going to give back the $200 million of deal fees that it collected on the properties that it's flipping.

Please note that I'm not criticizing these fees — I'm just pointing out how high they are. If large, presumably sophisticated investors choose to pay them, it's their business.

Some day soon, we may actually get to see how much Blackstone is knocking down and how much people like Schwarzman and Peterson and their partners are worth. And who knows? Maybe in a few years, when the market inevitably turns its back on LBO management companies, Blackstone can complete the cycle by going private again. You gotta love it.

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