Stephen Schwarzman of Blackstone Feels the Agony of Victory
By LANDON THOMAS Jr.
SEPT. 4, 2015
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Stephen A. Schwarzman, Blackstone’s chief executive, has spent at least half of each year since 1985 flying around the world, wooing clients. Credit Todd Heisler/The New York Times
Stephen A. Schwarzman ought to be a satisfied man.
The Blackstone Group, the investment firm he helped found 30 years ago, is hauling in cash at a dizzying pace. His name graces the New York Public Library building at 42nd Street and Fifth Avenue as well as a new complex to be built at Yale. And last year he made $690 million, one of the biggest paydays ever for a chief executive of a public company.
But instead of taking a victory lap, Mr. Schwarzman, who will turn 69 in February, has spent countless hours over the last year struggling to convince investors that Blackstone’s shares are drastically undervalued when compared with those of its peers. His message: Blackstone’s extraordinary run of asset growth and profitability is no mere fluke.
“It is ridiculous empirically, but psychologically, people want to believe that it might never happen again,” Mr. Schwarzman told an investment conference in New York this spring, making little attempt to disguise his frustration over Blackstone’s stock price. “Is it a miracle when LeBron James scores 37 points? Not really, he is the best basketball player. The guy scores more than anybody. Each shot is unique, but over time, some teams win and they score and that’s like performance fees for us.”
LeBron James? Well, no one has ever accused Mr. Schwarzman of selling himself short.
Mr. Schwarzman, Blackstone’s chief executive, was speaking before a packed conference hall at the Waldorf Astoria, surely not unaware that he commanded the coveted 9 a.m. speaking slot ahead of Michael L. Corbat, the chief executive of Citigroup.
The scheduling could be seen as a sign of how profits — and power — on Wall Street have shifted from the global banking giants to asset-gathering machines like Blackstone. Since the financial crisis, Citigroup and other large commercial banks have had their profits and ambitions shrink, while nimbler investors like Blackstone have generated sky-high returns by cashing in on investor demand for riskier investments.
Nonetheless, Mr. Schwarzman seemed to be on the defensive. He had gone to the Sanford C. Bernstein Annual Strategic Decisions Conference to dispel doubts that Blackstone could keep up its great performance. Those concerns have only increased since the recent stock market slump. Private equity firms need buoyant stock and real estate markets to sell off their holdings and earn performance fees.
But as he responded to investors’ questions, Mr. Schwarzman took offense at the suggestion — put to him by the conference moderator — that Blackstone’s profits may not be repeatable.
“I don’t accept that observation or that conclusion, which is based on nothing, actually,” he said, a slight edge creeping into his voice. “It’s the same thing as a basketball player who is great, taking a shot and never going to the basket again. That’s not how it works.”
From Mr. Schwarzman’s childhood in suburban Philadelphia to his years at Yale and through all his professional conquests, he has been driven to accumulate more. More money, more power, more status. But one ambition has trumped them all: to create a financial enterprise that will stand the test of time.
Since Mr. Schwarzman started out as a junior analyst at Donaldson, Lufkin & Jenrette in 1969, roughly 25 Wall Street names have disappeared (D.L.J. among them), having either imploded or been swallowed up in various financial mergers.
Blackstone, in turn, has survived and prospered, and now Mr. Schwarzman is demanding respect in the form of a higher stock price. Of course, the fight may be futile. One of the core principles of investing is that, over the long term, the stock market is supremely efficient in terms of incorporating all that needs to be known about a company’s worth.
Conceived as a buyout shop that lived from one big deal to the next, Blackstone in recent years has broadened its business mix. While the bulk of the company’s profits still come from leveraged bets, Blackstone is pushing hard to present itself to investors as a fast-growing asset manager and not a boom-and-bust deal maker.
Through its stakes in luxury hotels, office buildings and rental homes, Blackstone owns more real estate than any other private-sector entity. It has also emerged as a dominant shadow banker, extending loans or buying up the distressed debt of a wide range of companies through its credit division. And the $68 billion in hedge fund assets that it oversees makes it one of the biggest players in the sector.
From these business units, Blackstone collected more than $7 billion in revenue last year, with the majority coming from profits recouped from home-run investments in the Hilton hotel chain and the timely offloading of real estate positions.
Few companies have raised as much money in as short a time or been as profitable as Blackstone has.
Since 2007, when the company sold shares to the public, Blackstone’s assets under management have soared to $330 billion from $102 billion, and profits have leapt to $4.3 billion from $348 million. In the last 12 months alone, it raised close to $100 billion — an amount that roughly equals all the assets under management of its archcompetitor, the private equity company Kohlberg Kravis Roberts & Company.
But the real secret to Blackstone paydays comes from those LeBron-like performance fees that the company collects when it unloads private equity and real estate stakes.
Consider this: Of the $4.3 billion Blackstone earned in 2014, 71 percent came from performance fees. That sum equals the combined net income of the asset management giants BlackRock and T. Rowe Price, which together preside over $5.4 trillion in assets, more than 15 times the size of Blackstone’s.
It also exceeds the $3.6 billion earned last year by the investment banking giant Morgan Stanley, which employs 55,000 people, compared with Blackstone’s 2,300.
Blackstone’s profits, it should be said, are flattered by a minuscule tax rate of 4.3 percent. That is because the bulk of these performance fees is so-called carried-interest gains, which — with much political controversy — are taxed at a much lower rate than standard corporate profits.
Charles D. Ellis, a longtime financial consultant and the author of a comprehensive study of Goldman Sachs, pinpoints two elements that set Blackstone apart: a laser focus on raising capital and Mr. Schwarzman’s obsessive drive.
Indeed, when it comes to banging on the doors of wealthy institutions for money, be it a major pension fund in California or Abu Dhabi’s enormous sovereign wealth fund, there is arguably no one on Wall Street who rivals Mr. Schwarzman.
Since 1985, when the firm was founded, Mr. Schwarzman has spent at least half of each year flying around the world, wooing clients. Even now, pushing 70, he spends the majority of his time meeting with large institutional investors.
And while it may well be that Blackstone’s next generation, like the real estate guru Jonathan D. Gray and the head of private equity, Joseph Baratta, are doing much of the work, at the root of it all is Mr. Schwarzman’s refusal to be satisfied.
“It is the Steve phenomenon,” Mr. Ellis said, “his unrelenting push for more and better.”
While he can be a punishing micromanager when the firm’s capital or reputation is at stake — on one occasion he cursed out an investment partner over a bet gone bad, according to the book “King of Capital” — for years he has given top executives the space to build and run their businesses.
Blackstone executives compare their brand on Wall Street to Goldman Sachs’s. Mr. Schwarzman likes to brag about the 15,000 job applications the company gets each year for 100 analyst spots, and there is no doubt that from the client’s perspective, investing in a Blackstone fund carries a cachet similar to that of a company board’s hiring Goldman to advise it on a merger.
But Mr. Ellis stops short of saying that Blackstone has reached the point at which its culture of success has become institutionalized, like that of Goldman Sachs. He wonders whether the company can sustain its pace without Mr. Schwarzman at the helm.
“Can they continue without him?” he asked. “I just don’t know.”
Although he has ceded the operating reins to the company’s president, Hamilton E. James, and has a line of succession in place, with Mr. Gray the early favorite, Mr. Schwarzman has no plans to retire anytime soon and continues to work full time as Blackstone’s cheerleader in chief.
But skepticism over the company’s stock price continues to haunt him. And the burning issue now is whether Blackstone can keep generating the profit-pumping performance fees once interest rates go up, as they are expected to this year or next.
The fee bonanza of the last few years has attracted the attention of regulators concerned that the secrecy in private equity deals is masking hidden fees. Blackstone and other private equity companies have disclosed that government officials are investigating how they charge their clients for their services.
In Blackstone’s filing, it reported that the Securities and Exchange Commission was investigating practices “relating to the application of disparate vendor discounts to Blackstone and to our funds.”
Even without regulatory inspection, investors have started to become wary of the opaque and pricey fee structure of hedge funds and private equity firms.
“The real question is whether the Blackstone business model will hold up in the future,” said Roy Smith, a former Goldman Sachs partner and professor of finance at New York University.
“Returns on hedge funds and private equity have been disappointing, and as such, the fee structure is hard to justify.”
“Returns on hedge funds and private equity have been disappointing, and as such, the fee structure is hard to justify.”
“Investors don’t have to buy alternative assets — they can go back to the old ways and maybe do just as well with E.T.F.s, but save a lot of money on fees,” he said, referring to exchange-traded funds.
For now at least, the cumulative returns on Blackstone’s main private equity and real estate funds have been impressive — around 20 percent.
And while the recent bout of market volatility may hit short-term profits, Blackstone, unlike mutual and hedge funds, has an advantage: The majority of its capital is locked up for 10 years.
It’s a point that Mr. Schwarzman hits on time and again when making the case that Blackstone deserves a stock market premium.
Take a look at the travails of the bond giant Pimco, he said at the investor conference, referring to the mass exodus of investor cash from its funds last year because of management turmoil.
“I feel sorry for these people,” he said. “But they had the largest bond fund in the world. And what happened? Somebody decided to take their money out and then somebody else decided and then lots of people.”
With most of Blackstone’s funds, he continued, “you can’t take your money out.”
In Mr. Schwarzman’s pitches to investors, he frequently reminisces about the firm’s early days as a start-up. Mr. Schwarzman and the company’s now retired co-founder, Peter G. Peterson, had their desks, a couple of secretaries and about $400,000 in the bank between them.
Now Blackstone presides over companies generating close to $90 billion in sales and effectively employing 616,000 people through its private equity operations.
Perhaps its biggest bet is on the notion that Americans will move from owning homes to renting them. Since 2011, Blackstone has spent close to $10 billion buying nearly 50,000 homes in beaten-down real estate markets, including Arizona, Florida and Nevada.
Through its newly formed company, Invitation Homes, it fixes up homes and rents them to families. The idea is to create a nationwide landlord by providing better service than local alternatives.
Blackstone executives have said that they plan to take Invitation Homes public next year, although that could change if markets continue to decline.
As Blackstone’s profits have grown, so has Mr. Schwarzman’s compulsion to secure the company’s legacy. This cannot be truly achieved, in his view, until it rids itself of its “doggy multiple,” as Mr. Schwarzman has taken to describing Blackstone’s valuation on the stock market.
What bothers him is that Blackstone has a price-earnings ratio of just 8.5, compared with a multiple of around 13 for BlackRock and T. Rowe Price, despite sitting on more substantial profits. That is because the market considers so-called alternative investment companies like Blackstone to be riskier, given the volatility of their performance fees. While the profits of classic money managers may be lower, they are seen as more consistent, and thus deserving of a higher rating.
Blackstone’s stock certainly has not been stagnant. Over the last five years, the share price is up over 200 percent, more than double the return of mutual fund firms.
But for Mr. Schwarzman, that is not enough.
In a way, an undervalued stock undervalues him — which is an unacceptable state of affairs for a man who, in 2007, gave himself a 60th birthday party in which a part of the vast Park Avenue Armory was redesigned as his living room.
This year, Blackstone reported its most profitable quarter ever. As he usually does, Mr. Schwarzman led off in presenting the company’s highlights during its earnings call with Wall Street analysts.
He touched on the company’s growth (few other large businesses in America were growing as fast) as well as its cachet (getting a job at Blackstone was six times as hard as getting into Harvard).
Perhaps, he suggested, the company might even have a higher calling than minting money for its partners.
“Blackstone is not really a business per se,” Mr. Schwarzman said. “It’s a mission to be the best.”
And with that, he turned the call over to his chief financial officer.
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