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.
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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.
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.)
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