Buyout Giant Goes Shopping in California

Times Staff Writer

The current corporate buyout boom is leaving its mark on California, and one name that seems to be popping up all over the state is Blackstone Group.

Last July, the Manhattan-based investment firm bought Legoland in Carlsbad and three other Lego Group theme parks for $457 million. It is advising the Albertsons supermarket chain on an auction to sell the company, a deal that is roiling the Southern California grocery industry and has caught the attention of the Los Angeles City Council.

In December, Blackstone joined a group that is trying to buy San Jose-based Knight Ridder Inc., the nation's second-largest newspaper chain. It's familiar territory for the firm. In 2003, Blackstone bought a piece of Freedom Communications Inc., owner of the Orange County Register.

And just last week, the firm was reported to be mulling over a joint offer with Silicon Valley icon Hewlett-Packard Co. for El Segundo-based Computer Sciences Corp.

For years, so-called private equity firms like Blackstone were the U-boats of the financial world, managing secretive, lightly regulated investment funds that mostly kept out of public view, and surfacing abruptly now and then to buy a company, often in an out-of-favor industry.

But lately, the stealth has gone out of the game. With more than $100 billion of private equity money on the prowl, deals are coming fast and big, involving such familiar brands as Hertz, Lego and Dunkin' Donuts.

"The world is awash" in cash looking for profitable investments, said David J. Brophy, a University of Michigan finance professor who studies venture capital and private equity.

Among the flurry of transactions was Blackstone's teaming with four other firms in November to buy TDC, Denmark's biggest telecom company, in a $15.6-billion leveraged buyout surpassed only by 1988's spectacular RJR Nabisco deal.

Leveraged buyouts -- known as LBOs -- are a favored vehicle for Blackstone and other private equity firms, which deploy funds invested by institutions and wealthy individuals looking for market-beating investment returns.

In an LBO, the buyer puts up a third or less of the purchase price in cash and finances the rest of the deal with loans. The hope is that after being restructured, the acquired company will generate enough cash flow to cover the debt payments as well as pay dividends to the equity investors.

Blackstone and other buyout firms have been criticized for weakening the companies they acquire by loading them with debt and taking excessive fees and dividends. Blackstone spokesman John Ford said that because the firm's ultimate goal was to resell its companies at a profit it was motivated to keep them financially healthy.

The carping isn't deterring investors. Blackstone's latest buyout fund, at nearly $13 billion, is the largest private equity fund ever raised, although in the current climate, it's a record that's unlikely to stand for long.

Investment returns for private equity funds are difficult to pin down, but one expert puts Blackstone's average annual return over its two-decade lifespan at 20%. At a time when the stock market is barely eking out single-digit gains, investors are clamoring to get in.

"Twenty percent for 20 years -- everybody's in their waiting room," Brophy said.

It's an exclusive club, however. Blackstone's minimum investment of $15 million limits the field to institutions -- pension funds, insurance companies and the like -- and very well-heeled individuals.

Two of the firm's biggest investors are the California State Teachers' Retirement System and the California Public Employees' Retirement System, which have put more than $500 million apiece in Blackstone partnerships. Both have been well rewarded. CalPERS, for example, has notched a 37.5% average annual gain on its $84-million investment in a Blackstone fund that opened in 1994 -- almost quadruple the gain in the benchmark Standard & Poor's 500 stock index over the same period.

"They're incredibly smart investors with an extremely good network," said Panda Hershey, who oversees CalPERS' $10-billion private equity portfolio. "Their younger people are very, very hungry."

Top Blackstone executives declined to be interviewed for this article.

Blackstone's rise to a place beside venerable Kohlberg Kravis Roberts & Co. at the top of the private equity heap has largely been the story of the alliance of its two founders. Peter G. Peterson and Stephen A. Schwarzman formed Blackstone in 1985 after leaving Lehman Bros. , where they had been, respectively, chairman and head of mergers and acquisitions.

The firm's name was a play on their surnames -- "schwarz" means "black" in German, while the name Peter comes from the Greek word for "stone."

Peterson, 78, is famously well connected, not only on Wall Street but in Washington, where he served as Commerce secretary in the Nixon administration. His circle of high-level contacts also extends overseas, thanks to his chairmanship of the Council on Foreign Relations, the prestigious New York think tank whose board of directors includes half a dozen former U.S. Cabinet members and whose international advisory board includes foreign business leaders and two former heads of government.

Schwarzman, 58, has the reputation of a sharp strategic thinker and tough negotiator. He is said to be a collegial but demanding boss, capable of intense focus.

"I've seen him when he's like that, and you'd better not get in his way," said Jonathan E. Colby, a former Blackstone general partner now with rival Carlyle Group.

In Manhattan social circles, Schwarzman is known for his spectacular, 35-room apartment at 740 Park Ave., an address so noteworthy it is the subject and title of a gossipy new book that calls it "the world's richest apartment building." Among Schwarzman's neighbors there are Henry Kravis of Kolhberg Kravis, Revlon Inc. tycoon Ronald O. Perelman and developer Steve Ross.

When they started Blackstone, during an era of hostile takeovers and "greenmail" raids, Peterson and Schwarzman made the strategic decision not to participate in hostile deals, figuring it would help potential corporate clients feel more comfortable with the new firm.

Initially, Blackstone offered itself as an M&A; advisor, but within a couple of years it had raised its first buyout fund. It has since plunged into real estate investing and prospered as an advisor in corporate restructurings -- most prominently in the bankruptcies of Enron Corp. and Global Crossing Ltd.

Blackstone minimizes competition with Wall Street investment banks by avoiding trading and securities underwriting, which also keeps it largely off the radar of the Securities and Exchange Commission. In fact, Blackstone does so much business with Wall Street that some experts regard it as the No. 1 generator of investment banking fees.

That status also ensures that Blackstone will at least get a look at any deals in the Wall Street pipeline.

An early Blackstone deal was the $1.6-billion leveraged buyout of CNW Corp. in 1989. CNW, then the nation's eighth-largest railroad, was under attack by a dissident shareholder group. Blackstone brought in Union Pacific Corp. as a co-investor to take the company private, leaving existing management in place to turn things around. CNW subsequently went public again, allowing Blackstone to cash out in 1993, reportedly having more than tripled its initial $82-million investment.

The deal had all the elements of what continues to be Blackstone's style: It acted as a white knight for a besieged company in an unglamorous industrial sector, brought in a major corporate partner, stayed around for a few years and made a bundle.

Critics said the LBO overburdened CNW with debt, but Union Pacific was happy enough with the results that in 1995, it paid $1.2 billion for the 70% of the company it didn't already own.

The CNW deal also was typical of Blackstone in that it later paid a different kind of dividend. One of the investment bankers who provided financing for the buyout was Hamilton E. "Tony" James.

Blackstone hired him three years ago to run the firm's private equity and corporate advisory businesses. James, 54, has since been named president and is considered a likely successor to Schwarzman as chief executive.

A Blackstone connection also provided Freedom Communications with its CEO.

Scott N. Flanders, a longtime outside director of Irvine-based Freedom, took over from former CEO Alan J. Bell on Jan. 1. Flanders, 48, was head of Columbia House when Blackstone bought the music and video marketer from Sony Corp. and Time Warner Inc. in 2002. He worked with the buyout firm on the deal, and stayed on as chairman.

It's too early to tell whether the 40% stake that Blackstone and its co-investor Providence Equity Partners acquired in Freedom will work out for all concerned. But the early returns are promising.

When his higher offer for Freedom was rejected in favor of the Blackstone-Providence bid, newspaper mogul William Dean Singleton predicted: "I'll be back in three years, buying the company from Blackstone, for a lot less."

"Over my dead body," Flanders retorted in an interview last week.

Flanders said that cash flow at the flagship Register had doubled to roughly $80 million from $40 million since 2003, putting the paper's once-lagging operating margin on a par with those of its peers.

He said the improvement stemmed in part from increased employment and real estate advertising thanks to a strengthening Orange County economy; from cost cutting, including layoffs that have occurred mainly outside the newsroom; and from a lull in the battle with the Los Angeles Times for Orange County readers.

But the single biggest factor was that the Blackstone-Providence deal settled a long-running conflict within the owning Hoiles family, allowing dissident family members to cash out. That left management free to return its sole focus to business, Flanders said.

"Blackstone did not come in and dictate stronger results," he said. "They helped eliminate the noise that, in spite of management's best efforts, was creating a distraction."

Flanders said he had been pleasantly surprised that Blackstone had encouraged Freedom to think creatively and put money into projects that might not bear fruit for years.

"They've pushed us to invest aggressively in innovation," such as launching new magazines and zoned newspaper editions, he said.

Blackstone's touch hasn't always been golden. Its communications fund, launched in 2000 near the peak of the technology bubble, has lagged its other funds.

An early investment in Sirius Satellite Radio, for example, was disappointing. Blackstone exited before the company generated some positive buzz by announcing an alliance with shock jock Howard Stern.

Blackstone is hoping for better things with its bid for Knight Ridder, in which it is joined by Kohlberg Kravis and Providence Equity. At least one competing bid was placed by Texas Pacific Group, and other private equity shops are thought to be preparing offers.

Within the newspaper industry, Singleton; Gannett Inc., the nation's largest newspaper chain; and McClatchy Co., publisher of the Bee newspapers in Sacramento, Fresno and Modesto, all are thought to be weighing bids.

Judging by Freedom's experience, Blackstone's plan for Knight Ridder could involve trying to kindle growth rather than breaking up the company and selling the pieces.

Said Flanders: "If I thought this was a strip-mining, harvesting strategy, I wouldn't be here. That's not what they do."


Staff writer Joseph Menn in San Francisco contributed to this report.

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