Private equity is the new financial supermarket


Three decades ago, Jonathan Gray might have been an unlikely candidate to become Blackstone’s chairman and expected successor to its chief executive, Stephen A. Schwarzman.

Very little of Mr. Gray’s career at the private equity firm has involved leveraged buyouts – the aggressive deals, often involving large amounts of borrowed money and sharp cost-cutting, that have given capital -investment his reputation as a raptor. Instead, he spent most of his time in the relatively quiet real estate business of Blackstone, helping the company become one of the largest landowners in the world.

Mr. Gray’s rise to the post of chairman in 2018 reflected Blackstone’s growth into a juggernaut with a hand in just about everything: mortgages, infrastructure, television and film studios, stakes in entertainment companies, commodities. pharmaceuticals and even the dating app Bumble.

Blackstone is at the forefront of an industry leaving its roots far behind. Since the 2008 financial crisis, it and its private equity rivals like Apollo Global Management, KKR and Carlyle have transformed themselves into supermarkets of the financial industry. They cover areas of traditional finance long dominated by banks and investment categories typically dominated by hedge funds and venture capital.

“Private equity firms are now the financial conglomerates,” said Richard Farley, a partner at law firm Kramer Levin, who works on buyouts and leveraged loans.

As money continues to flow into their investment funds from traditional clients like pension funds and retirement plans, private equity firms are not only buying up companies with investors’ money, but are also putting their own money on the line with new business ventures.

Globally, private equity firms managed $6.3 trillion in assets in 2021, more than four times what they oversaw at the start of the financial crisis in 2007, according to the provider. Preqin data. Blackstone, the largest, told investors this year it was on track to manage $1 trillion by the end of 2022, four years ahead of its target.

Even the term private equity is a misnomer, as many large companies are public. Over the past two years, shares of Blackstone are up more than 145%, while Apollo and Carlyle are up more than 85%, and KKR is up about 130%. The S&P 500 index, meanwhile, rose more than 55%. TPG – a rare company deciding to go into an initial public offering amid a bearish and volatile market – is trading only slightly below its January offer price.

The performance of their shares is a sign of growth prospects, said Jim Zelter, co-chairman of Apollo. “Investors see the business model we’ve created as being at the intersection of businesses that need to borrow and investors that need different choices,” he said.

The industry is very different from its beginnings.

In 1982, a private equity firm, Wesray, bought Gibson Greeting Cards, a unit of RCA, for around $80 million. The two Wesray owners only contributed $1 million, using debt and the sale of Gibson’s real estate to fund the rest. A year and a half later, they took the company public for $290 million, but first paid themselves a special dividend of $900,000.

Wall Street financiers were mesmerized by the fledgling industry’s ability to create gigantic profits with very little money, and over the next two and a half decades more companies were created to rush into this type of transactions. Buybacks grew in size until the 2008 financial crisis – when many collapsed as banks withdrew their loans or produced abysmal returns. For many years, the volume of leveraged buyouts was less than half what it was before the crisis, according to Dealogic data.

But the crisis has provided the industry with two key catalysts. First, historically low interest rates for more than a decade have pushed investors to seek higher returns through riskier investments, especially after the hard hits their portfolios took during the loan crunch. mortgages. Second, as government regulations forced banks out of riskier areas, including high-interest lending, private equity firms jumped on the bandwagon.

“These are opportunistic companies,” said Patrick Davitt, principal analyst at Autonomous Research. “The big alternative asset managers took advantage of this to fill this vacuum left by the banks.”

Apollo, for example, lends to medium and large businesses, but also provides loans for aircraft and mortgages. KKR has also expanded its underwriting operation, allowing the industry to take some of the lucrative fees associated with pricing these transactions.

Mr Gray said Blackstone and its rivals could make certain lending activities cheaper and more efficient by lending directly, as opposed to the banking approach of syndicating a loan – essentially pledging the money but finding others to provide it .

But in a quest for more money to manage, private equity has done more than offer a way around the banks. Businesses have become late-stage owners, insurers and capital investors. In 2009, Apollo helped start Athene Holding, which sells retirement products such as annuities — a type of insurance designed to boost retirement savings — and reinvests the premiums Athene collects by selling those products. Other companies have followed the same path; KKR bought a life insurance company last year for about $4.7 billion.

As the real estate sector faltered after the mortgage crisis, Blackstone used its capital to buy and rent homes and other real estate, amassing $280 billion in assets, which generate almost half of the company’s profits. . As interest rates rise, Gray predicted, real estate will continue to help its performance. Rents in the United States, he noted, have recently increased by two to three times the rate of inflation.

Blackstone has also stepped up its activities by taking stakes in fast-growing companies, including women’s shapewear company Spanx and Reese Witherspoon’s media company Hello Sunshine. Its life sciences division has purchased pharmaceutical companies or stakes in them, and also pursues drug development in cooperation with major drugmakers. And it plans to spend $1 billion to acquire the rights to music from artists through a partnership with Hipgnosis Song Management, which owns the rights to songs by Neil Young, Steve Winwood, Barry Manilow and others.

But Mr Gray said the biggest change for Blackstone came when the firm realized it could attract clients outside of the typical pool of large institutional investors it historically served.

“Our industry historically catered to a fairly narrow audience of customers,” he said.

Large investors have long relied on a combination of stocks and bonds for reliable returns, and have risked only a small portion of their holdings on private equity, forcing investors to take on risk. money for five or 10 years on average. In return, companies typically aimed for returns of 15% or more over longer time horizons.

But in recent years, Blackstone has discovered that ordinary investors can be attracted by the potential for greater returns than they would get elsewhere, Mr Gray said.

The sudden and synchronous growth of private equity industries and clientele has added to concerns about the grip of the so-called shadow banking sector, which also includes hedge funds and venture capital firms. The Securities and Exchange Commission is studying new rules that would require these entities to disclose more information about holdings, fees and returns.

As banks considered important to the financial system have faced tougher lending and risk guidelines since the financial crisis – and are trying to avoid serious problems if large numbers of businesses were to suddenly default – private equity firms are lightly regulated, although they do not have the same government support. Some critics say the combination of more lending and fewer restrictions could shake up the economy if corporate bets go south.

David Lowery, head of research at Preqin, said private equity firms had been “very good” at screening companies and avoiding defaults, but during a period of relative stability. “This strength will be tested,” he said.

Unbridled expansion has been good for business so far. Consider the eye-popping windfall received by Mr Gray’s boss at Blackstone last month.

For 2021, Mr. Schwarzman’s compensation was $160 million, about 4.5 times that of the highest-paid bank chiefs, James Gorman of Morgan Stanley and David Solomon of Goldman Sachs, who each received about $35 million. of dollars. And Mr. Schwarzman’s salary package was eclipsed by the dividends he earned, which pushed his total to more than $1.1 billion.

Blackstone’s push into seemingly everything is working well for the company. “Blackstone,” Mr. Schwarzman told investors in late January, “returned the most remarkable results in our history on virtually every metric.”

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