Friday, June 22, saw the stock market debut of The Blackstone Group, the biggest and splashiest of the private equity funds that have pretty much dominated the financial scene for the past several years. Investors poured $4 billion into the firm, buying stock that would give them no voting rights in the hope of getting a piece of the profit-spinning energy that Blackstone and its colleagues have created in recent years.
They should be so lucky.
Over the years, hedge funds have gotten a lot more press than their private equity (PE) counterparts, but Blackstone’s initial public offering (IPO) has changed that. There are considerable similarities between hedge funds and PE. Both consist of pools of capital contributed by institutional investors, like pension funds and university endowments, as well as some very rich individuals, and are run by a relatively small group of very highly paid money managers. But their investment styles are generally rather different. Hedge funds move in and out of positions often with lightning speed. PE operates on a longer time scale. Their typical modus operandi is to buy up whole companies (public companies, whose shares trade on the open markets), take them private, slim them down and sell them–either to other companies, or to float their stock on the markets afresh, after having worked their magic on them.
The numbers surrounding PE are huge. There are more than 170 funds with $1 billion or more in assets. They collectively raised $221 billion last year from outside investors, up sevenfold from a decade ago, and did $475 billion in deals, thirteen times as much as just five years ago. This flood of money has helped drive the stock market back past its 2000 highs, first reached at the peak of the dot-com mania.
Who has benefited from all this? Apologists like to say all of us, since it’s made our economy more efficient and our pension funds fatter. But the economy of the past several years has been lackluster, with GDP growth unimpressive and wages barely growing. Half of us don’t have a pension plan, and most of those who do don’t have all that much in their retirement accounts. Even the institutional investors who’ve poured all those billions into PE funds (and hedge funds) haven’t done spectacularly well. Most people who study the matter conclude that the returns aren’t all that great, especially considering the risks involved.
But there’s no doubt that some people have made out like bandits from the PE racket: the fund managers. They pay themselves huge fees at every turn. There are management fees (deducted from the outside investors’ returns), as well as fees billed to the companies that the funds own (consulting fees, monitoring fees–even termination fees when the firms are sold or go public). And there are the (typically huge) profits when the managers sell the firms they’d bought only a few years earlier.
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And how do the companies in the PE portfolios raise the cash to pay all these fees? Here’s how former hedge fund manager Andy Kessler put it in the Wall Street Journal: “Cut spending, workers, offices, factories and advertising, and with tech companies now in play, cut R&D, their lifeblood. Don’t mistake financial engineering for company building.”
Aside from Blackstone, other big names in the PE business include The Carlyle Group (famous for its connections to the national security state), Bain (the place that made Mitt Romney rich) and Kohlberg Kravis Roberts (KKR, which was big in the 1980s, faded in the 1990s but has made a comeback over the last few years).
But Blackstone’s IPO has made it the star. Founded in 1985 by Peter Peterson (Nixon’s Commerce Secretary, famous for his gloominess about the future of Social Security) and Steven Schwarzman, Blackstone now has almost $90 billion under management. It owns all or part of some forty companies, among them Freescale Semiconductor, ACNielsen, TRW, Orangina, Equity Office Properties (the biggest commercial landlord in the United States) and Madame Tussaud’s Wax Museums. Last year Schwarzman “earned” $398 million; Peterson, $213 million.
So why did Blackstone go public, given those fat paychecks and the lack of scrutiny enjoyed by private partnerships? To make even more money, of course: Schwarzman will pocket $677 million from the offering (while retaining a quarter of the firm’s shares); Peterson, $1.9 billion. But that payday may come at a high cost. Inspired in part by the Blackstone IPO, some members of Congress would like to put an end to the industry’s favored tax status, under which it pays a rate of just 15 percent, less than half the standard corporate rate. (Prospects for passage are murky, and a presidential signature is unlikely.) CNBC is now full of hysterical worry about a war on the rich–nay, a war on prosperity itself.
While it’s easy to parse Blackstone’s motives for going public, why were the shares such a hit on opening day? The inner circle of the firm retains all the voting rights. The inner circle will pay itself what it deems appropriate, and the public shareholders will have to be content with leftovers. If there’s ever a conflict of interest between the Blackstone managers and the public shareholders, the managers are free to resolve it in their own interest, and the shareholders will have no recourse.
The IPO itself has a sound of last call about it. There’s little doubt that Schwarzman and Peterson are among the craftiest capitalists on earth, and if they think this is a good time to cash in, then they may be telling us something. What that something might be is an interesting question. At the very least, they’re suggesting that the PE boom is about to go bust. Or, more broadly, many of the adventures in financial innovation contrived in the exuberant markets of the past several years are about to follow the subprime mortgage sector into crisis. The investment bank Bear Stearns is bailing out a couple of its in-house hedge funds that made some bad bets on murky financial instruments; this could be a taste of things to come, especially if interest rates continue to rise around the world.
There’s an old saying on Wall Street that they don’t ring a bell at a market top. But the Blackstone IPO sounds a little like a tintinnabulation.
