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Will Blackstone Sink Like One?


The leveraged rise and possible fall of private equity's one-time "it" firm.


The tale of how private equity's Golden Age came to an end this year has to start on June 22, 2007. It was the day Blackstone Group (BX), the private-equity giant, went public on the New York Stock Exchange. Its stock ended the day at slightly more than $35. Riches were bestowed on CEO Stephen Schwarzman and the rest of his employees.

The very smart people at Blackstone had to have seen the writing was on the wall for private equity - for what other reason was there to go public? The window to cash out was closing quickly. Today, Blackstone's stock price is around $7. The S&P 500, then above 1500, has sunk alongside.

The Golden Age lasted for 3 or 4 years. Blackstone's initial public offering, or IPO, signaled the end of cheap debt and excessive liquidity. The question now is: Will private equity make it through this crisis? Probably not in its current form and maybe not at all.

Leveraged buyouts, or LBOs, are the bread and butter of private equity - and they are set to unravel. Highly leveraged deals fueled private equity's boom, meaning only a small amount of equity was necessary to take on mountains of debt. Leverage is already a thing of the past; because of the credit crisis, banks have no appetite for risky lending.

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"There will certainly be dozens of LBOs that won't make it and it doesn't take a lot of imagination to get into the hundreds," John Moulton, founder and managing partner of Alchemy, a London-based private equity firm, told Canada's Globe and Mail recently.

The credit crisis has exposed several bad bets by private equity. Six months ago, J.C. Flowers bought a significant stake in Germany's Hypo Real Estate Holding. Flowers paid €22.50 per share; today the price is below €5.

Apollo Management, one of the giants, completed its buyout of Realogy, formerly Cendant, in the spring of 2007 at the height of the bubble. Realogy's debt is trading at $0.75 on the dollar, meaning it has a good chance of defaulting. Apollo and TPG Capital's buyout of Harrah's Entertainment, the casino operator, looks much the same. TPG lost all $1.35 billion of its investment in Washington Mutual.

In the past, private equity would simply take those companies public again and cash in. Today, that would be tantamount to suicide since most of the companies are saddled with debt. It also doesn't help them that an Obama administration may raise the capital gains tax.

Blackstone was the best of the best and at least one of its investors thinks it will survive. China's sovereign fund, the China Investment Corporation, is doubling down. Less than 2 weeks ago, Blackstone said in a regulatory filing that it has agreed to raise the ownership limit for the fund, from 9.9% to 12.5%. Last year, it paid $3 billion for a stake in Blackstone's IPO, the value of which has sunk by roughly 75%. Government officials and citizens in China have been angry and confused.

I guess they didn't see the writing on the wall last June.

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No positions in stocks mentioned.

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