It's been a long week for me but I really must post on some of the historical events of this week. First, Blackstone's offer to LBO Equity Office Properties marks the largest buyout in history. The public courtship of this valuable office REIT definitely turned it into a match of pride. Some critics question the viability of the deal given that bidding originally started at $48.50 per share and ended at $55.50 per share. I believe that there is value in the deal even at this high of a price. However, it is obvious that as competition in the market for private equity increases, so does the value of winning these "Trophy Deals" to differentiate the best of the best. We'll surely see if the financial wizardry of Blackstone can handle the leverage and weather any downturns in the commercial real estate market. I suspect that as the dynasty of Blackstone enlarges, this will only be a benchmark deal in a string of larger and larger buyouts.
The second event is obviously the Fortress IPO. I wrote about the S-1 previously. Since that filing, several stories have been written about how the main principals have taken out over a billion dollars in fees from the company. Despite many pundits going off on how unequal the ownership structure is of the IPO, the street rumor mill as of today is that the deal is 25 times oversubscribed. As I mentioned before, the guys at Fortress have been running a gold mine and it appears that they are about to pot it all.
If anything, this is another mere story of rags to riches, not unlike the Google or YouTube founders who have become instant billionaires. In every one of these stories, you see a handful of entrepreneurial people who have been opportunistic and caught a huge wave at the right time. Who would have guessed that a new platform for advertising on the internet would be worth hundreds of billions of dollars even as the tech downturn continued? Who would have believed that a website hosting videos would be worth billions? Who would have believed that a hedge fund could be so successful to virtually grow from few assets to a $7 billion market cap in 8 years with $30 billion under management?
What this all confirms is something most of us have already known. Private equity whether it be hedge funds, buyouts, venture capital, or real estate, is like any other business. It is about providing excellent service/products (returns) and making money (fees). And like lots of businesses that cash out by acquisition or public offering, so too can the private equity company.
The irony of course is that the business of private equity is essentially that - transacting in a non-public manner. Yet, the act of going public or hiring a public relations firm really is the opposite. Back in the old days PE partnerships didn't give a hoot who thought what of them - they had the money and the financial savvy and literally were barbarians at the gates.
What people may be overlooking is that like any other business that has a liquidity event for the founders, most of the time the founders move on and management changes. Perhaps that is why so many public companies are poorly mismanaged - the new managers don't have the incentive or the same passion as the original founders. I would argue that in private equity, more than in any other industry, the value of the firm is in the partners - their personalities, skills, experience, and connections are what make the deals happen. The main hedge fund strategist IS essentially the hedge fund. If that guy goes, so goes the fund.
We will see if the is the final act for Fortress and if their founders disappear into their billions. Hopefully, they will have too much pride and passion for their trade to let everyone down.
Blackstone's Overpaying for EOP marks the top of the commercial real estate market. Just like Time Warner overpaying for AOL marked the top of the dot com boom. Sam Zell, the self made real estate billionaire, couldn't sell fast enough. He actually has been quoted several times as saying "The reason I am wealthy is because I have bought from the pessimistic and sold to the optimistic many times in my life."
Most people don't know it but the commercial default rate is about .2% right now. The all time high in the late 80's, was 6%. That's a default rate 30x higher than right now. What's a vacant commercial property worth to a lender? Think about that. They are getting no income from it and its sitting on their books. In the past downturn's, it's worth jus the land value. I know a few investors that bought commercial buildings for land value in 1995. (meaning the structure came for free)
What will cause the default rate to rise? For one many of the investor's in California that bought commercial buildings at historically low cap rate's of 3,4,5,6%. With such a low cap rate it doesn't take just a small increase in expenses, or small increase in vacancies to make the building lose money.
Posted by: Matt Recore | February 10, 2007 at 09:14 AM