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Peterson and Schwarzman’s new firm had sailed through the 1987 crash in good shape and they were free of nagging financial worries after raising their fund. But the stretch ahead would be rocky not just for Blackstone but for the buyout business as a whole. A treacherous turn in the capital markets and misfires on the deal front would doom some of Blackstone’s fellow start-ups and imperil even some seasoned buyout firms. Through it all, Blackstone would struggle to establish footing. It didn’t help that turnover at Blackstone was notoriously high in the early years, owing partly to Schwarzman’s mercurial and demanding personality. The young firm, too, would make some bum bets on companies and people. But it would do more right than wrong.
With its $635 million safely in the bag, Blackstone immediately ramped up its operations. Soon it spilled over with fresh hires and filing cabinets. In the autumn of 1988, the firm moved to 345 Park Avenue, a bland, hulking, cream-colored skyscraper right across Fifty-second Street from its former offices in the Seagram Building. It took a ten-year lease on sixty-four thousand square feet, twenty times the size of its original quarters. Surveying the cavernous new expanse, Schwarzman wondered if he’d been batty to sign a lease for so much more space than the firm needed at the moment.
In rapid succession, Schwarzman and Peterson recruited three high-ranking partners with imposing pedigrees. The first, Roger Altman, forty-two, the Lehman banker, joined as vice-chairman. Peterson and Schwarzman had tried hard to lure him in 1986 and 1987, but their old colleague held off until Blackstone at last raised its fund and was financially stable. Altman’s coyness irked them, but they knew the well-connected banker would be a magnet for M&A fees. Lean, with a shaggy mane and suave manner, Altman was as adept as any Wall Street banker at winning over big-ticket corporate clients. His fascination with public policy clicked with Peterson, even though Altman was a staunch Democrat who had worked on Robert F. Kennedy’s 1968 presidential campaign and had put his Lehman career on hold from 1977 to 1981 to work in Jimmy Carter’s Treasury Department.
In February 1988, Blackstone corralled Laurence Fink, thirty-five, who had helped create mortgage-backed securities—bonds backed by packages of home mortgages—and built First Boston’s successful mortgage securities unit. Securitization, as the process of making bonds out of mortgages was called, transformed the home lending business and created a huge new addendum to the debt markets. The next month, David Stockman, forty-one, a former Reagan administration budget czar, arrived.
As Reagan’s first budget director, Stockman, a former two-term congressman from Michigan, was the point man for the supply-side economics the new administration was pushing—the theory that taxes should be lowered to stimulate economic activity, which would in turn produce more tax revenue to compensate for the lower rates. With his wonky whiz-kid persona, computer-like mental powers, and combative style, he browbeat Democratic congressmen and senators who challenged his views. But he soon incurred the wrath of political conservatives when he confessed to Atlantic reporter William Greider that supply-side economics was really window dressing for reducing the rates on high incomes. Among other acts of apostasy, he called doctrinaire supply-siders “naive.” The 1981 article created a sensation and prompted Reagan to ask him over lunch, “You have hurt me. Why?” Stockman famously described the meeting as a “trip to the woodshed.”
Though the president himself forgave him, Stockman’s loose lips undercut his power at the White House, and in 1985 he left government to become an investment banker at Salomon Brothers. He was recruited to Blackstone initially by Peterson, who had known Stockman from Washington circles and, like Stockman, was deeply concerned about the federal deficit. Peterson and Schwarzman hoped to put Stockman to work with corporate clients on big-picture strategic, economic, and trade issues, but ultimately he evolved into one of Blackstone’s main LBO deal makers.
Fink, tall and engaging, with a shrinking periphery of hair and old-fashioned rimless spectacles, was a well-regarded Wall Streeter whose star had fallen. A pioneering financier and salesman, he was considered the second leading figure, after Salomon Brothers’ Lewis Ranieri, in the development of the mortgage-backed bond market. At the time, Fink was about to lose his job at First Boston after his unit racked up $100 million in losses in early 1988. But Schwarzman and Peterson had from the start hoped to launch affiliated investment businesses and thought Fink was the ideal choice to head a new group focused on fixed-income investments—the Wall Street term for bonds and other interest-paying securities. They accepted Fink’s explanation that flawed computer software and bad data inputs had triggered the stunning trading losses, and they were further reassured by a conversation Schwarzman had with Bruce Wasserstein, First Boston’s cohead of M&A, who had become a friend and frequent tennis partner of Schwarzman’s. “Bruce told me that Larry was by far the most gifted person at First Boston,” Schwarzman says. Peterson and Schwarzman offered Fink a $5 million credit line to start a joint venture called Blackstone Financial Management, or BFM, which would trade in mortgage and other fixed-income securities. In exchange for the seed money, Blackstone’s partners got a 50 percent stake in the new business while Fink and his team, which included Ralph Schlosstein, a former Lehman partner and a good friend of Roger Altman’s, owned the other 50 percent. Eventually, the Blackstone partners’ stake would fall to around 40 percent as the BFM staff grew and employees were given shares in the business. Fink also got a 2.5 percent interest in the parent, Blackstone.
The arrangement with Fink reflected the Peterson and Schwarzman approach to building up Blackstone. They wanted to recruit top talent, but they were not about to surrender any significant part of Blackstone’s ownership. The implosion at Lehman had convinced them that they should keep tight control of the overall business. This was going to be their show. Altman, who might have gotten a bigger stake if he had joined his friends sooner, received a comparatively meager ownership interest of around 4 percent. Stockman’s piece was even smaller.
By the spring of 1988, Blackstone had larded its buyout fund with an extra $200 million from investors who signed up after the original closing, pushing the fund’s total capital to about $850 million, and it was now scouring the country for investments. It was a heady time for the LBO business, stoked by Drexel’s junk-bond factory, and the larger corporate world was undergoing one of its periodic paroxysms of mergers and consolidation. There were more than sixteen hundred mergers in the United States worth nearly $90 billion in the first half of 1988, more than triple the dollar volume five years earlier and on a par with the frenzied level in early 1987. The slump in M&A following the October 1987 stock market crash was swiftly fading from memory.
Blackstone was as yet only a midsized player in a field that had become more crowded since its launch. A Wall Street bank, Morgan Stanley, had raised $1.1 billion, while Merrill Lynch would close a $1.5 billion fund later that year, and two new Blackstone-style, M&A-cum-buyout boutiques had burst onto the scene with far more hoopla than Blackstone had aroused.
The first was formed by First Boston mergers superstars Bruce Wasserstein and Joseph Perella, who jolted Wall Street when they left First Boston in February 1988 to form Wasserstein Perella and Company. They talked the cream of First Boston’s M&A bankers into joining them, and their names carried enough cachet that they quickly lined up $500 million toward a $1 billion buyout fund.
More than anyone else, Wasserstein, forty, a rumpled, paunchy figure with a chess genius’s command of tactics, had restyled the genteel M&A business into a sophisticated, high-stakes sport of aggression. He first gained wide attention in 1981 in the $9 billion takeover battle for the oil company Conoco, Inc., in which he outflanked Mobil Oil Corporation and the liquor giant Seagram Company Ltd. to win the target for E. I. du Pont de Nemours and Company, his client, despite a lower bid. (The intricate tactic he hatched to capture Conoco, called a front-end-loaded, two-tier tender offer, was later banned by the U.S. Securities and Exchange Commission.) After Conoco, Wasserstein had a hand in some of the biggest takeovers of the mid-1980s, including Texaco’s hotly contested $10.8 billion purchase of Getty Oil Company in 1984 and Capital Cities Communications’ $3.5 billion acquisition of the ABC television network in 1985. He was known for exhorting gun-shy clients to pull the trigger on topping bids, which earned him a nickname he hated, “Bid ’Em Up Bruce.” Perella, forty-seven, the diametric opposite of his partner in height, girth, and sartorial savoir faire, was more of a traditional relationship banker in the mold of Peterson and Altman.
Wasserstein Perella soon won the backing of Japan’s largest stock brokerage, Nomura Securities Company, which that July put up $100 million for a 20 percent stake in the firm. Most or all of that money ended up being funneled into Wasserstein Perella’s buyout fund. Nomura issued a press release expressing its delight at the chance to be an early investor in a firm so obviously “destined to be an international M&A powerhouse.” Wasserstein Perella looked to be halfway there already, raking in $30 million of M&A fees in its first four months. With those fees and the $100 million from Nomura, Wasserstein and Perella were spared the hand-to-mouth existence Peterson and Schwarzman endured for their first two years.
The other headline-grabbing new firm was Lodestar Group, formed the same month as Wasserstein Perella by Ken Miller, Merrill Lynch’s M&A chief and vice-chairman and its highest-paid banker. Miller was not as lionized as Wasserstein and Perella, but he had secured his reputation by making Merrill a first-tier power in M&A and shepherding several high-profile LBOs that Merrill had led, including those of truck trailer maker Fruehauf Corporation and drugstore operator Jack Eckerd Corporation. In July, a day after Nomura announced its investment in Wasserstein Perella, Lodestar unveiled a comparable deal: Yamaichi Securities Company, Japan’s fourth-largest brokerage, would put up $100 million of the $500 million LBO fund Miller was raising and separately inject an undisclosed sum in Lodestar itself for one-quarter of the firm.
Blackstone would have to vie for investors, talent, and deals with these flashier upstarts. None of the new players held a candle to KKR, though. It had recently amassed a $6.1 billion war chest—far and away the biggest buyout fund ever—and controlled about a third of the $15 billion to $20 billion of equity the buyout industry had stockpiled to date. It was no easy task to compete, for KKR was raking in profits on a scale its founders couldn’t have imagined a decade earlier. In May 1988, Henry Kravis and the other KKR partners personally pocketed $130 million in profits on just one investment: Storer Communications, a broadcaster they had bought just three years earlier, which they sold for more than $3 billion. KKR had pulled off gargantuan buyouts of namebrand companies—a $4.8 billion deal for the supermarket chain Safeway in 1986 and the $8.7 billion buyout of Beatrice Foods the same year. Late in 1988 KKR would reassert its dominance when it cinched by far the largest buyout ever, the $31.3 billion take-private of the tobacco and food giant RJR Nabisco—a bid that would define the era, crystallize the public image of private equity investors as buccaneers, and set a record that would not be matched for eighteen years.
Unlike KKR, though, Blackstone had its M&A business, which by 1988 was capturing its share of plum M&A assignments. Early that year Blackstone took in more than $15 million from two jobs alone: handling negotiations for Sony Corporation’s $2 billion purchase of CBS Records, an assignment Blackstone picked up from Sony founder Akio Morito, an old friend of Peterson’s, and from Sony’s top U.S. executive, whom Schwarzman knew; and advising Firestone Tire & Rubber when it sold out to Japan’s Bridgestone, Inc., for $2.6 billion, a deal Schwarzman guided. As Peterson and Schwarzman hoped, the M&A business gave the firm access to executives that eventually turned up LBO opportunities.
Blackstone’s first buyout developed that way. It was puny compared with KKR’s big deals—a mere $640 million—but it would have an immense impact on the young firm’s image and fortunes.
It began when Altman telephoned Donald Hoffman, a top official at USX Corporation, the parent of U.S. Steel. USX was battling for its corporate life with Carl Icahn, the much feared corporate raider. In 1986 Icahn had amassed a nearly 10 percent stake in USX and launched an $8 billion hostile takeover bid. U.S. Steel was three months into a strike that was crippling steel production and had pummeled the stock. Over the next year, Icahn hectored USX to off-load assets and take other steps to boost its share price. To back itself out of a corner and persuade Icahn to go away, USX eventually announced that it would sell more than $1.5 billion in assets and use the money to buy back some of its shares. (Companies often buy in shares to boost their share price because that increases the earnings attributable to each individual share.) Among the assets USX tabbed for full or partial sale were its rail and barge operations. The plan assuaged Icahn.
Altman, Peterson, and Schwarzman flew to Pittsburgh to meet with USX’s top brass to see if they could strike a deal for the transport business, which Hoffman headed. In addition to Hoffman, USX chairman and chief executive David Roderick and Charles Corry, the steelmaker’s president, were at the meeting. USX hoped to raise $500 million from the sale, but two conflicting goals made it tricky to structure a deal. USX wanted to sell more than 50 percent of the transport business to an outside party so that under accounting rules it could take the unit’s debt off its books. However, it didn’t want to give up too much control. More than half the railway’s business came from other shippers, but U.S. Steel was almost wholly reliant on its subsidiary’s train and barges. The system hauled all the raw materials to U.S. Steel’s Midwest plants and 90 percent of the company’s finished products passed over its lines on the way to customers. Roderick couldn’t agree to a sale if the businesses would end up in unfriendly hands.
“They told us, ‘This is our lifeline. If anything goes wrong with this, if we sold it to a buyout firm unwilling to invest enough capital or that held us up for higher transport rates, it could bankrupt us,’ ” Schwarzman recalls. Rather than focus on price at the outset, the three Blackstone partners zoomed in on USX’s anxieties and how to allay them. “The first meeting was not about price,” Peterson says. “It was about governance. We went over some major operating decisions we’d face—spending levels to maintain the equipment, how we’d set rates, a determination of what to do if either of us wanted to sell our interests and various other issues.”
That approach alone wouldn’t have won Blackstone the deal, Roderick says: “Governance was extremely important to us, but so was price.” But the attentiveness Altman, Peterson, and Schwarzman showed to USX’s concerns gave the company comfort. The trio convinced Hoffman “that they understood our problem very well,” he says. “They were head and shoulders above any other investment group that I saw. We saw probably five or six.”
Not everyone at Blackstone was keen on the deal. Back in New York, David Stockman was dead set against it. The partners agonized over doing it. The big concern was how the business would perform if there were a severe slump in the steel market—a common event in that highly cyclical industry that could ravage revenues and profits of the transport unit. It fell to James Mossman, a brilliant, twenty-nine-year-old banker Altman had lured from Shearson, to digest the patchy data Blackstone had been given. After crunching the numbers, he was enthusiastic about the deal and made his case at a staff meeting.
“James raised his hand and said, ‘We need to do this deal. We’re going to make a lot of money!’ ” says Howard Lipson, a young staffer at the time who helped Mossman draft the financial model. Mossman explained that even though steelmaking is notorious for its ups and downs, the business of shipping steel was much steadier. “We showed that most of the wild cyclicality in steel companies’ profits was due to what happened to pricing as volume rose or fell,” says Lipson. “Despite that, the railroads are affected only by steel volume, not prices, and volume is not nearly as volatile as prices.”
Mossman sketched an imaginary worst case. He assumed that steel volume tumbled to its lowest point in twenty years and stayed there for two years. He showed that, even then, the railroad and barge unit would be able to meet its costs and turn a profit. “James did a perfect analysis,” says Schwarzman.
Convincing the Blackstone partners was one thing. Persuading banks to finance the deal was another matter. Blackstone needed $500 million of loans or bonds for the spinoff, but it had no track record in buyouts, and bankers were unnerved at the prospect of lending to a highly leveraged business that was dependent on the boom-and-bust cycles in steel. They weren’t moved by Mossman’s analysis. “ Their mind-set was they didn’t want to go anywhere near a cyclical business,” Lipson says.
Schwarzman put out calls to all the big New York banks that financed buyouts: Manufacturers Hanover, Citibank, Bankers Trust, Chase Manhattan, and J.P. Morgan. All but J.P. Morgan turned him down flat. The House of Morgan, whose name radiated prestige, had been U.S. Steel’s banker since the turn of the century, when J. Pierpont Morgan bought the steelmaker’s predecessor from the industrialist Andrew Carnegie. It offered to finance the deal with USX, but it declined to give a firm commitment to come up with the money, and its proposal was loaded with conditions. “We loved the J.P. Morgan name,” Schwarzman says, but reputation alone wouldn’t get the deal done.
A sixth bank offered much better terms, however. Chemical Bank, like Blackstone’s founders, had aspired for years to break into the LBO business, but it had been a distant also-ran in the world of high finance. Mocked for its dismal lending record, Chemical deserved its popular sobriquet, “Comical Bank.” It would shed that reputation only in the late 1980s under the leadership of Walter Shipley and his successor as CEO, Bill Harrison. The two gave Chemical’s new commercial lending chief, James Lee, a thirty-something banker, free rein to invigorate Chemical’s loan operation and lead the charge into LBOs.
Chemical simply wasn’t big enough to finance large buyouts alone, but Lee got around that limitation by mustering a network of banks that would back the deals he signed up. Canvassing loan officers he’d befriended in Australia, Japan, and Canada, he assembled a corps of banks that trusted Chemical and could be counted on to ante up quickly when new lending opportunities came along. By 1984 Lee’s syndication apparatus was in place, and he conducted trial runs on a handful of high-rated, low-risk corporate loan packages before he ventured into the dicier realm of buyouts. By the time of the USX rail and barge deal, Lee had notched a handful of small loan syndications for LBOs.
To steal a march on other banks, Lee loaded Chemical’s $515 million debt package for Blackstone with seductive features. Most important, he gave Blackstone an iron-clad promise to provide all the debt, and to do so at a lower interest rate than Morgan. By contrast, Morgan had offered only to make its “best efforts” to round up the requisite funds, not a binding commitment. To sweeten Chemical’s proposal, Lee agreed to drop the interest rate by half a percentage point if the company’s profits sprang back to prestrike levels. To tide the business over if it ran into trouble, Lee further offered $25 million of backup capital in the form of a revolving credit facility—a now-conventional part of LBO financing that Lee helped popularize. This was credit the company could draw on if needed and pay back as it could, unlike the regular loans, whose amounts and due dates were fixed.
“When I walked into Blackstone’s offices, I knew I could give them what they wanted,” says Lee. “I had a firm grip on how much money” Chemical could pledge to any deal.
Schwarzman, still angling to obtain the imprimatur of the more august J.P. Morgan, went back and asked Morgan to match Chemical’s terms. To no avail.
“Steve let us know he thought J.P. Morgan was classy, and we were not,” says Lee. “But he said our offer was vastly more clever and creative,” and Chemical won the day.
First announced on June 21, 1989, the deal closed in December. That month, Blackstone and USX formed a new holding company, Transtar Holding LP, to house the rail and barge operations. As with the famous leveraged buyout of Gibson Greeting in 1982, equity was just a tiny sliver of the total financing package for Transtar. Blackstone shelled out just $13.4 million, 2 percent of the buyout price, for a 51 percent ownership stake. The new debt Chemical provided replaced much of the railroad’s equity, so USX was able to take out more than $500 million in cash. (USX also lent Transtar $125 million in the form of bonds—a kind of IOU known in the trade as seller paper because it amounted to a loan by USX to help Blackstone finance the purchase.) Roderick and USX got what they asked for: Despite holding just 49 percent, USX shared decision-making power over budgeting, financing, and strategy on equal terms with Blackstone.
The transaction was not a classic LBO at all. Strictly speaking, it was a leveraged recapitalization—a restructuring where debt is added and the ownership is shuffled. But whatever the label, it helped advertise the company-friendly approach that Peterson and Schwarzman had been touting for three years now. “ We really wanted to put meat on our corporate partnership idea, and we hoped this deal did that,” Peterson says. “It sent a signal that we were good guys who did thoughtful, friendly deals as a real partner.”
Blackstone got everything it bargained for: a sturdy business on the rebound, which it had snared for an extraordinarily low price of four times cash flow. That was one-third to one-half below the stock market valuations of most railroads.
For a buyout investor, cash flow is the axis around which every deal turns. It determines how much debt a company can afford to take on and thus what a buyer can afford to pay. Net earnings, the bottom-line measure mandated by accounting rules for corporate financial statements, factors in interest costs, taxes, and noncash accounting charges such as the depreciation of assets. Cash flow is the deal maker’s raw “show me the money” measure—the amount that remains after operating expenses are paid. The financial structure of an LBO is built upon it.
One way that buyout firms make profits is to use the cash flow to pay down the buyout debt. In the industry’s early days, deals were formulated with the aim of retiring every dollar of debt within five to seven years. That way, when the business was finally sold, the buyout firm reaped all the proceeds because there was no debt to pay off. A second way to generate a gain is to boost cash flow itself, through revenue increases, cost cuts, or a combination, in order to increase the company’s value when it is sold. Using cash flows, there is also a third way to book a gain, without an outright sale. If a company has paid down its debt substantially, it can turn around and reborrow against its cash flow in order to pay its owners a dividend. That is known as a dividend recapitalization.
In Transtar’s case, Blackstone used all three means to manufacture a stupendous profit. In 1989, in line with Mossman’s expectations, Transtar’s cash flow reached nearly $160 million, enabling it to repay $80 million of debt by year’s end. By March 1991 Transtar had pared $200 million of its original buyout debt. With substantially less debt than it had when the business was spun off and with Transtar’s cash intake growing, the company was able to borrow again to cover a $125 million dividend to Blackstone and USX. A little more than two years after the deal closed, Blackstone had made back nearly four times the $13.4 million it had invested. By 2003, when Blackstone sold the last of its stake in a successor to Transtar to Canadian National Railroad, the firm and its investors had made twenty-five times their money and earned a superlative 130 percent average annual return over fifteen years.
If this seems a bit like conjuring profits from nothing, that’s largely what happened. Transtar, like Gibson Greeting, was a prime example of buying at the right time, leveraging to the hilt, and milking every drop of cash flow for profit. Soon enough, rising prices and a floundering economy would change the rules of the game, forcing buyout firms to focus more intently on improving fundamental corporate performance to generate profits and less on financial sleights-of-hand.
That’s not to say the Transtar buyout served no purpose. It delivered a hefty profit to the pension funds and other institutions that put their money with Blackstone. The deal also assisted USX, allowing it to keep control of Transtar even as it restructured itself and sold off the subsidiary and other operations to increase the value of its stock. As to Transtar itself, the buyout didn’t particularly strengthen the company, but it certainly didn’t weaken it.
* * *
Transtar’s success showed the rest of Wall Street that Peterson and Schwarzman could excel at the buyout game. The deal also was a landmark for a second reason. It forged an abiding tie between Blackstone and Chemical Bank’s Jimmy Lee that would be of enormous consequence to both. A gregarious spark plug of a man who resembled a back-gelled Martin Sheen and was known for his spiffy silver-dollar suspenders, Lee soon emerged as a kingpin of leveraged finance, a banker’s banker to other LBO luminaries such as Henry Kravis and Ted Forstmann. Just as Drexel Burnham’s Michael Milken had created the junk-bond market, tapping the public capital markets to finance the corporate raiders and buyout shops of the 1980s, Lee reinvented the bank lending market with his syndicates, which allowed risk to be shared and thereby allowed much larger loan packages to be assembled. At Chemical and its later incarnations (Chase Manhattan Bank, the name Chemical adopted in 1996 after buying Chase, and later JPMorgan Chase, after Chase bought J.P. Morgan in 2000), Lee would go on to play as critical a role in the stupendous growth of LBO activity in the 1990s and 2000s as Milken had with junk bonds in the 1980s.
Even though Lee would do brisk business with all the major LBO shops, he would work most closely with Blackstone. Beginning with Transtar and for the next fifteen years, Lee functioned as a kind of house banker to Blackstone, financing a great many of its deals and never siding with a competing LBO firm in a deal on which Blackstone was bidding. Theirs was a truly synergetic relationship, which helped propel both Chemical/JPMorgan Chase and Blackstone to the top in their fields.
“ You could argue that Blackstone made JPMorgan Chase as much as JPMorgan Chase made Blackstone,” says one of Lee’s counterparts at another bank. “Neither would be where they are today without the other.”
Transtar also advertised Blackstone’s readiness to ally itself with corporate chieftains in the war against raiders, and just how far it would bend to accommodate corporate America’s financial and strategic imperatives. It helped establish Blackstone’s reputation as “an operating problem solver,” in Peterson’s words.
“ In every way, it was a perfect first deal for us,” says Lipson. “It was highly successful quickly, and it showed we weren’t looking to antagonize corporations but to be friends. Corporate partnerships became our calling card.” Whereas competing buyout shops typically exercised dictatorial control over their acquisitions, Blackstone was adaptable. Its openness to splitting power or even taking a back seat to a corporate collaborator bolstered its deal flow, as Schwarzman and Peterson had hoped: Of the dozen investments that Blackstone went on to make with its 1987 buyout fund, seven would be partnerships akin to Transtar.
In addition to differentiating Blackstone from the competition, Schwarzman also believed the partnerships heightened Blackstone’s odds of success. Having a co-owner intimately familiar with the business—typically one that was a major customer or supplier and therefore had an interest in its thriving—would give Blackstone an advantage over competing buyout firms, staffed as they were with financial whizzes who had never run a business or met a payroll. With the prices for whole businesses escalating in step with the stock market in the late 1980s, Schwarzman felt Blackstone “needed an edge to safely do deals in a higher-priced environment.”
“That’s really why we came up with the corporate partnership strategy. I just couldn’t figure out how to make money buying companies unless we brought unusual efficiencies to a company by way of cost improvements or revenue synergies.”
The partnership approach also fit with Schwarzman’s innate cautiousness. In some partnerships, Schwarzman went so far as to barter away some of Blackstone’s potential upside for downside insurance, in the form of a right to sell out to its partner several years later at a preset price or valuation. Some of the firm’s rivals viewed such trade-offs with bemusement. To their way of thinking, ceding power and profit to hedge the downside was downright lily-livered. “ We always thought Blackstone’s corporate model was bullshit,” sniffs one. “It was like they couldn’t stand on their own; they needed help and made a lot of concessions to get it.”
Schwarzman’s preoccupation with the possible downside was more than a reasoned response to the market dynamics of the day. It was a gut-level reflex, a kind of bête noire or obsession, former colleagues say. The rudimentary rule of investing, that one must risk money to make money, “is something Steve always had a hard time coping with,” says one former partner. For a world-class investor, “his risk-aversion was really extraordinary.”
Schwarzman acknowledges as much. “We are more risk-averse than other private equity firms, and part of it is visceral. I don’t like failure, and losing money is failing. It’s a personal thing that has turned into a strategy here.”
Over the next two decades, the corporate partnership deals had a mixed record. But the strategy was pivotal to Blackstone’s success early on, producing most of its early home runs, including investments in the Six Flags amusement parks and a second train line, the Chicago and Northwestern Railroad.
Schwarzman’s caution sometimes worked against Blackstone by denying it promising deals. But it also spared it from perpetrating some of the colossal blunders that in the 1990s would damage and doom a few bullish (or bull-headed) rivals. Call it what you will, knee-jerk trepidation or prudence, Schwarzman’s instincts would be central to Blackstone’s success.