Blackstone’s leveraged buy-out of Equity Office Properties is a record breaker. Blackstone paid $23 billion for the company and assumed $16 billion of debt in a $39 billion transaction that eclipses the $25.7 billion plus $6 billion in assumed debt that Kohlberg Kravis Roberts shelled out for RJR Nabisco back in 1989 and the $21.3 billion plus $11.7 billion in debt that a consortium of funds paid for HCA last year.
Does such a huge, leveraged deal for a commercial property company flash bright red warning signals of a market top? Certainly the combination carries unfortunate echoes from those Barbarians at the Gates days. Less than two years after KKR closed its era-defining deal, the recession of the early 1990s and rising white collar unemployment threatened a systemic failure in the US financial system where commercial lenders, S&Ls and broker dealers were left horribly exposed to failing highly leveraged transaction and property loans.
Back then, as LBOs – at the time a revolutionary corporate form – started turning sour, a clear pattern emerged. Those deals where the sponsor’s plan to pay back its debts required speedily breaking up the purchase and selling off the pieces tended to hit the wall. Some of those where there was a more cushioned capital structure and a longer-term plan to fix the purchased company, raise volumes or margins, repay debt out of cashflow and then undertake an IPO, survived.
Of course, history rarely repeats itself and private equity firms today operate very differently to the way they did 20 years ago. Back then, most private equity firms were keen to proclaim themselves as company hospitals, repairing the ailing assets transferred to them from the public markets with new management, patiently restoring them to health and returning them. Private equity was the ultimate value investing game, seeking to buy low in a downturn and wait.
Today, private equity fund managers have to purchase assets that are already highly valued because of the liquidity that is raising all prices. The game is even more about financial engineering, about extracting value from the sponsors’ greater appetite and capacity for debt. It’s more about leveraged recapitalizations and churning deals to the next fund manager desperate to invest funds than it is about liberating management to fix companies away from public scrutiny.
However, these financial engineering skills are impressive and earn their own reward. Look at the speed and boldness with which Blackstone went to work on Equity Office Properties. It sold $7 billion-worth of buildings in New York on the very day it bought the company, having previously persuaded EOP to open its books and allow Blackstone to enter discussions with potential buyers for individual properties, even as the takeover battle for EOP still raged.
Blackstone’s lenders will be delighted that they are not going to be caught on any burning bridge. Investors in its funds might wonder what to call what Blackstone is doing. This is much more like trading than investing, the kind of high-velocity approach of a hedge fund or a prop desk applied to very lumpy assets. It’s undoubtedly smart and bold: endlessly sustainable it most certainly is not.
