Senior Managing Director David Blitzer of the Blackstone Group (NYSE: BX) believes negative comments made by Warren Buffett about LBO firms and the companies they own at an October investment conference were self-serving. In my opinion, Blitzer couldn't be farther from the truth. In fact, if anyone's comments are self-serving, it's those of the Blackstone principal. Buffett simply stated he didn't buy companies whose managers were in it solely for the money, preferring those who also loved their businesses. Quite rightly, he recognizes that firms like Blackstone buy businesses for the sole purpose of selling them. Blitzer believes private equity adds value and there are statistics that bear this out. I'm here to say he's way off the mark, and I'll provide several examples to make my case.
IN PICTURES: Baby Buffett Portfolio: His 6 Best Long-Term Picks

Orbitz Worldwide (NYSE: OWW)

The background on Orbitz is a case of following the bouncing balls. Orbitz went public December 16, 2003, at a price of $26 a share. Less than one year later, Cendant Corp. bought Orbitz for $27.50 a share, bringing together the Galileo global travel distribution system with Orbitz.com and its other travel-related websites. Then in August 2004, Blackstone Group, along with Technology Crossing Ventures and OneEquity Partners, bought Cendant's Travel Distribution Services division (renamed Travelport) for $4.3 billion, with just a $900 million investment from the partners and the rest financed with debt. A half-year later, Travelport borrowed an additional $1.1 billion to pay Blackstone and company a special dividend. In less than a year, Travelport accumulated $4.5 billion in debt while Blackstone investors had recouped their original investment and then some while retaining 70% of the privately held company.

Fast forward to 2010, and Travelport was contemplating an IPO (scrapped in February) that would value the company at about $3 billion, meaning Blackstone investors would have made over $2 billion off their $630 million investment, or a 356% return in less than four years. How has Orbitz' stock done since its IPO in July 2007? It's down 64% from its $15 offering price. That's not surprising given what it has done with Travelport. Where's the value-added part?

Celanese (NYSE: CE)

Blackstone bought the industrial chemicals company in April 2004 for $3.8 billion with just $641 million of its own funds. Nine months later, it took the company public for the third time in Celanese's 98-year history. A big part of the $1.1 billion raised from the offering went to Blackstone in the form of a special dividend. The book King of Capital: The Remarkable Rise, Fall, and Rise Again of Steve Schwarzman pegs the Blackstone profits at $2.9 billion or roughly five times its initial investment in just three years. In comparison, investors in the January 2005 IPO have seen annualized returns of 16.4%, which I'll admit is far superior to the S&P 500 in the same period. In the book, it suggests that much of the operational improvement in Celanese after the takeover, and before the IPO, was due to Blackstone changes implemented to fix the malaise that existed prior to its involvement. I find it hard to believe that Blackstone's actions were worthy of an $803 million dividend. I'm sure Warren Buffett would agree. This is just another example of the financial shell games that private equity firms play.

Alpha Natural Resources (NYSE: ANR)

Blackstone and partners bought the American coal assets of RAG Coal International AG on July 30, 2004, for $975 million. It invested approximately $68 million in the venture for a 42% ownership stake, and thanks to the much-used dividend recapitalization, recovered its initial investment plus around $85 million in profits when Foundation Coal went public five months later. A secondary offering in September 2005 netted Blackstone additional profits of $149 million. But Blackstone wasn't done there. On January 25, 2006, it distributed the remaining shares held to its limited partners. Those who held on to the stock would receive 1.084 shares of Alpha Natural Resources in May 2009 when it bought Foundation Coal for around $1.5 billion. The deal valued Foundation's shares at $31.28, which meant an additional $131.4 million in profits for Blackstone's limited partners. All told, I'd guess total profits for Blackstone and its partners from Foundation Coal were in the neighborhood of $350 million, with most of it coming in a brief 13-month period. That's value-added, but not for the coal company.

Bottom Line

The Blackstone Group has talented paper shufflers. The value they add for their clients is obvious, but what's less clear is why Blitzer and the rest of his cronies feel tactics such as leveraging for dividend recapitalizations does anything beneficial for the businesses they acquire. Robbing Peter to pay Paul is exactly why Mr. Buffett avoids private-equity-owned companies. They have greed written all over them. (For related reading on LBOs, check out Corporate Kleptocracy At RJR Nabisco.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  2. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  3. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  4. Investing News

    Is Buffett's Bet on Oil Right for You? (XOM, PSX)

    Oil stocks are getting trounced, but Warren Buffett still likes one of them. Should you follow the leader?
  5. Investing News

    Chipotle Served with Criminal Probe

    Chipotle's beat muted expectations and got a clear bill from the CDC, but it now appears that an investigation into its E.coli breakout has expanded.
  6. Stock Analysis

    Analyzing Sprint Corp's Return on Equity (ROE) (S)

    Learn about Sprint's return on equity. Find out why its ROE is negative and how asset turnover and financial leverage impact ROE relative to Sprint's peers.
  7. Stock Analysis

    Why Alphabet is the Best of the 'FANGs' for 2016

    Alphabet just impressed the street, but is it the best FANG stock?
  8. Investing News

    A 2016 Outlook: What January 2009 Can Teach Us

    January 2009 and January 2016 were similar from an investment standpoint, but from a forward-looking perspective, they were very different.
  9. Mutual Funds & ETFs

    3 Vanguard Equity Fund Underperformers

    Discover three funds from Vanguard Group that consistently underperform their indexes. Learn how consistent most Vanguard low-fee funds are at matching their indexes.
  10. Investing News

    Alphabet Earnings Beat Expectations (GOOGL, AAPL)

    Alphabet's earnings crush analysts' expectations; now bigger than Apple?
RELATED FAQS
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
COMPANIES IN THIS ARTICLE
Trading Center