King of Capital: The Remarkable Rise, Fall, and Rise Again of Steve Schwarzman and Blackstone by David Carey;John E. Morris;John Morris

Author:David Carey;John E. Morris;John Morris
Language: eng
Format: mobi
Tags: Leveraged buyouts, Investments & Securities, Financial services industry, Finance, Business, Corporate & Business History, Private equity, General, Investment advisors, Mergers & Acquisitions, Biography & Autobiography, Consolidation and merger of corporations, Business & Economics
ISBN: 9780307452993
Publisher: Random House Digital, Inc.
Published: 2010-10-05T13:30:09+00:00

James wasted no time putting his mark on the organization. “He arrived and you knew he was there,” says former Blackstone partner Bret Pearlman. “He didn’t spend six months behind closed doors” developing ideas of what he wanted to do.

His mandate from Schwarzman was to manage the entire firm, but Schwarzman wanted him to focus initially on reinvigorating the M&A business and whipping the private equity group into shape.

One of James’s first moves was to impose more discipline on the investment process. He instituted a screening regimen so that partners, who had been free to pursue investment possibilities for weeks or even months without supervision, were required to submit an outline at the outset so management could decide if an opportunity was promising enough to warrant the partner’s time.

He also pressed partners to analyze the risks of deals more rigorously. Like their counterparts at other firms, Blackstone’s partners were accustomed to producing voluminous projections, often a hundred to one hundred and fifty pages, forecasting “every item of every division, down to how many Coca-Colas they’re buying in their conference rooms and the price of Coke,” as James puts it, to come up with the base case—the minimum projected financial performance. But he insisted that they take the analysis a step farther, factoring in more carefully the possibility of fluke events that could sink a company or turn the investment into a success—what economists dub optionality.

He cites a hypothetical investment in an airline: “You say there’s a chance there’s a major terrorism event blowing up an airline, but that happens once in twenty years, so that doesn’t affect the base case because it’s one in twenty. Then there’s a chance that oil goes from $30 to a $140 a barrel in a year. It’s never happened before—the most oil has ever gone up is twenty bucks in a year. How could it go up a hundred? But there’s a probability to that.” There is a risk of labor problems, “but, geez, we’ve got good relations with the unions and we’ve got three years before [the contract is up].

“All these unlikely things are one in ten, one in twenty, one in fifty, whatever they are, so you don’t put them in your base case because they’re very unlikely.” But they are hazards nonetheless. “The chance of any one of them happening is tiny, but the chance that none of them will happen is also tiny. You multiply it out and you find that there’s [say] a 55 percent chance that one of them will happen, and it kills you.”

The same analysis worked on the upside. Some investments were like call options on a stock, which give you the right to buy shares at a fixed price at some point in the future. If Blackstone could leverage a deal enough that it had little money at risk and the freak possibilities on the downside were few and the payoff from an unlikely event on the positive side of the ledger was huge—such as Paul Allen’s grabbing up Blackstone’s U.

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