Wanna Buy a Bridge To Big-Time Debt?

It's the happiest of New Year's on Wall Street, which is positively awash in money. No, I'm not talking about the jaw-dropping eight-digit bonuses at Goldman Sachs or the even bigger unpublicized paydays for heavy hitters at some hedge funds and private equity houses. Rather, I'm talking about the money sloshing around the Street chasing deals.

You can see this by reading recent filings involving the biggest leveraged buyout in history: the pending $36 billion takeover of Equity Office Properties, a big commercial-property owner, by the Blackstone Group buyout firm. There's such hunger to put money to work that three financial institutions--Goldman Sachs, Bear Stearns and Bank of America--have agreed not only to lend almost $30 billion to the Equity Office LBO, but to also invest more of their own cash in the deal than the $3.2 billion Blackstone has committed. The three firms are putting up $3.5 billion of so-called bridge equity to get the deal done. What's bridge equity? Good question. It's a steroidal version of the short-term bridge loan you take out when you have to close on the purchase of a new house before you've finished selling your old one. The difference: bridge equity in deals involving borrowed money (what financial types call "leverage") is a higher-risk, higher-reward game than lending you money on a house.

The idea is that Blackstone will quickly round up investors to take out Goldman, Bear and B of A. If things go well, the lenders will get a fee of maybe $35 million (though I think their major incentive isn't the fee, it's getting the LBO done). But should something go wrong, they could lose lots of money and lots of face.

I'm certainly not saying this deal won't work--Blackstone's a smart outfit. But for those of us who worry about financial excesses, bridge equity sets off alarm bells because it means buyers and lenders are taking more-than-normal risks. I don't know how much bridge equity exists, but such deals apparently started a few years ago and are spreading rapidly.

Blackstone, Equity Office and the lenders all declined to comment, citing SEC rules about pending deals. So I'm relying on my reading of various documents, supplemented by background discussions with people who would talk about the deal only if I agreed not to identify them.

Blackstone needed this bridge work because that was the only way it could get a deal done with Sam Zell, Equity Office's founder. Zell--a tough, funny, profane guy who calls himself the Grave Dancer--had been talking with various suitors since at least November of 2005, but nothing had come of it. When Blackstone came sniffing around, Zell pushed for a quick decision with minimal weaseling-out possibilities. So, even if the financing somehow falls through or there's a "material adverse change" in the stock or real-estate markets, Blackstone's still on the hook.

But boy, will the firm get paid if things go well. For starters, it will get a $360 million fee for doing this deal. In addition, it will knock down about $100 million of annual fees from its investors, if all goes as planned. (Blackstone will reduce some of its fees to offset $180 million of its deal fee, but I'm not sure how that works.) Then there's the Street's fee festival for placing and selling $29.6 billion of debt; for redeeming Equity Office's current debt; for advice (including $30 million to Merrill Lynch for helping Equity Office), and who knows what else. My guesstimated fee total: north of $1 billion. That doesn't include Blackstone's 20 percent of its investors' profits. If any.

OK. Many people think that commercial real estate is in a froth, if not a full-fledged bubble. So how does Blackstone think it can pay a top-of-the-market price to a shrewd seller like Zell and still hope to make a profit for its investors? By loading up Equity Office with debt. The company currently carries debt of $15.4 billion, and its stock is worth $19.8 billion (at the deal's $48.50 per share). The post-buyout company would have about $30 billion of debt and stock worth $6.7 billion. If it covers the interest payments on this new debt, investors will do nicely. If not, look out.

Although this deal may well prove successful, it's a symbol of how lending standards are falling, and will continue to fall as more money searches for more deals. Someone--maybe a lot of someones--will go under before this is over. Given how many public and private pension funds and endowments are in this game, some of that lost money may indirectly be yours.

Debt and bridge equity are like financial Jet Skis. If you get it right and you're not unlucky, you'll have a great ride. But get it wrong, and the next great market will be for lifeboats. And bankruptcy lawyers.