March 26, 2008 - 4:32PM, Bloomberg
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Credit-market gridlock has trapped Stephen Schwarzman, who relies on lenders to fund acquisitions, while leaving Warren Buffett free to pursue the debt-free deals that have helped make him the world"s richest person.
Buffett, chairman of Omaha, Nebraska-based Berkshire Hathaway Inc., has $US59 billion ($65 billion) in cost-free money from insurance premiums to invest. Schwarzman"s New York-based Blackstone Group LP, manager of the biggest private-equity fund, is being forced to bypass Wall Street banks after they stopped financing most leveraged buyouts.
Buffett and Schwarzman each takes a different approach to the same goal: finding companies they consider undervalued. Investors are betting Buffett"s model will prevail, at least for now. Berkshire climbed 5.4% since the subprime-lending crisis sent the Standard & Poor"s 500 Index tumbling as much as 19.7% from its Oct. 9 peak. Blackstone dropped 43% in the same period.
""There"s a massive, massive advantage for Buffett in this kind of market,"" said Guy Spier, chief investment officer of New York-based hedge fund Aquamarine Capital Management LLC. ""All the leveraged finance has dried up, so he"s going to have a much better time finding things to buy.""
Blackstone"s vulnerability was underscored March 10, when the company said fourth-quarter profit plummeted 89% amid what Schwarzman called a ""severe financial crisis."" Banks started pulling back from most LBO lending last June after as much as $US400 billion in debt sat unsold on their books and losses from the subprime-mortgage market increased.
Without new loans, LBO firms struggled to complete deals, while declining bond prices forced Blackstone to write down the value of some of its holdings. The company is now contacting hedge funds and mutual funds in search of new financing, which usually accounts for as much as two-thirds of the price of an LBO.
Buyout firms such as Blackstone and New York-based Kohlberg Kravis Roberts & Co. relied on free-flowing debt to announce a record $US745 billion of transactions last year, according to data compiled by Bloomberg. The pace has stalled in 2008, with $US56 billion of announced deals through yesterday, a 71% drop from a year earlier.
The retreat by investors from all but the safest government debt has driven up LBO financing costs. The amount of extra yield investors demand to hold speculative-grade bonds over US Treasuries more than tripled to 7.97 percentage points yesterday from 2.41 percentage points at the start of June, according to indexes compiled by Merrill Lynch & Co.
""When both equity and credit markets go down in concert, it"s not unfair for people to expect our near-term earnings to suffer,"" Blackstone President Tony James said in a March 20 interview.
Blackstone led some of the biggest deals last year, including the $US39 billion purchase of Chicago-based Equity Office Properties Trust, then the largest LBO, and the buyout of hotel-operator Hilton Hotels Corp. of Beverly Hills, California, for $US20 billion.
This year, its $US1.8 billion takeover of PHH Corp., a Mount Laurel, New Jersey-based mortgage and auto-leasing company, with Fairfield, Connecticut-based General Electric Co. fell apart after banks reneged on a financing agreement. The $US6.6 billion buyout of Dallas-based credit-card processor Alliance Data Systems Corp. has been stalled by a dispute with regulators.
Schwarzman, 61, raised an industry record $US21.7 billion fund last year. Yet without access to the debt markets, Blackstone and other LBO firms may not be able to produce the annual returns of 20% to 30% or more their investors demand.
Buffett, meanwhile, is swimming in capital. Berkshire"s float, or insurance premiums collected by General Re, Geico and other Berkshire divisions, reached $US59 billion at the end of 2007, according to company"s annual report.
""This float is "free" as long as insurance underwriting breaks even, meaning that the premiums we receive equal the losses and expenses we incur,"" Buffett, 77, wrote in the February report. ""If we do that, our investments can be viewed as an unencumbered source of value for Berkshire shareholders.""
Berkshire has invested in shares of Atlanta-based Coca-Cola Co. and Procter & Gamble Co. of Cincinnati, and in the Brazilian real. It owns more than 75 companies, including paint supplier Benjamin Moore & Co. based in Montvale, New Jersey; Fruit of the Loom Ltd., the Bowling Green, Kentucky-based underwear maker; and NetJets Inc. of Woodbridge, New Jersey, which leases private airplanes.
Buffett, whose personal fortune was estimated at $US62 billion by Forbes magazine, agreed Dec. 25 to buy 60% of Marmon Holdings Inc., the Pritzker family"s collection of 125 companies, for $US4.5 billion. He"ll buy the rest of the Chicago- based company by 2014, and depending on the final price, it may be his largest purchase outside the insurance industry.
In all, the companies Berkshire owns employed 233,000 people at the end of last year. Berkshire"s market value has climbed to $US202 billion, making it the 14th-biggest company in the world.
Blackstone, formed in 1985 by Schwarzman and Peter G. Peterson, went public in June, raising $US7.1 billion through an initial public offering and sale of a 9.4% stake to China Investment Corp., a sovereign wealth fund. It was the peak of the LBO boom.
In addition to Equity Office and Hilton, the company"s biggest acquisitions include Freescale Semiconductor Inc., the Austin, Texas-based maker of chips for mobile phone, cars and consumer electronics; New York-based market researcher Nielson Co.; and Michaels Stores Inc. of Irving, Texas, the biggest arts-and-crafts retailer in the US.
Blackstone"s corporate buyout funds own 48 companies that employ about 560,000. Now, it is increasingly looking outside private equity for profits as large buyouts wane.
Assets at Blackstone"s hedge-fund division reached $US44.5 billion in the fourth quarter. The unit"s operating profit rose 58% to $US110.3 million in the final three months of 2007, while the private-equity unit had an operating loss of $US37.2 million.
""As time goes on, we get a more balanced revenue stream,"" Blackstone"s James, 57, said in last week"s interview.
The firm is also pursuing smaller deals, such as the $US1.2 billion purchase of Richmond, Virginia-based Performance Food Group Co. announced in January, and companies in regions including Asia, where credit still is available, James said.
Schwarzman thrives when he can use cheap financing to buy struggling companies. Blackstone then revamps their operations and resells them for relatively high returns because the acquisitions were funded with borrowed money.
Today, with more bargains in equity markets, Blackstone is unable to sell the bonds and loans needed to buy big companies like Hilton that can boost returns at a firm with almost $US100 billion in assets under management.
Schwarzman ""just won"t do any of these deals for a few years,"" said Whitney Tilson, founder of New York-based T2 Partners LLC, which holds Berkshire shares.
""Blackstone still has a great business model. Buffett just has a much better one.""
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