Grave dancer knew when to step back

If you revisit the Blackstone – EOP deal today after the Housing market collapse, Sam Zell wouldn’t have timed his exit better.

In February, Zell sold his flagship Equity Office Properties (EOP) and its portfolio of 540 prime office buildings to the Blackstone Group for $39 billion. Large PE firms that benefited from absurd leverages, were offering premium prices to publicly held Real Estate firms. Later the subprime crisis followed and the resultant credit squeeze and risk aversion would never have allowed that kind of a deal to go ahead. In Zell’s own words “today, you would never be able to replicate the Blackstone deal”.

Interesting feature on the great mogul here.

Wharton Real Estate professor Peter Linneman notes that Zell is known by the nickname "the grave dancer." According to Zell, the term grew out of the headline of an article he wrote describing his strategy of profiting off distressed real estate following the inevitable bubbles of investment enthusiasm. Zell said the article shows how "I was dancing on the skeletons of other people's mistakes."

Zell, however, also pointed out that the last sentence of the article reads: "He who dances closest to the graves, always has to be careful he doesn't fall in."

Zell clearly knew when to step back. Does that leave Blackstone in the grave then? Stephen Schwarzman knew how to look for greater fools. He did the unthinkable – of taking a PE firm public - Blackstone went public in June…!

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The end of leverage ?

Blackstone Group units, ever since its debut at the US markets on June 22nd, had been closing below the $31 price the private equity giant fetched in its IPO, as investors fretted the private equity boom may have peaked. Some observers attributed the recent weakness to concerns about Blackstone's (Charts) lofty valuation, and a bill in Congress that would raise the tax rate on the profits of publicly traded PE firms to 35 percent from 15 percent.

Normally many in the PE industry would dismiss these concerns as unfounded. In fact the industry had grown exponentially even as its critics were working overtime. For them availability of cheap credit by way of leveraged debt to finance those buyout deals and infuse funds into the working capital of portfolio companies was what mattered. But now the worry is precisely that – cheap credit has been drying up owing to rising interest rates.

Sensing a shift in the economics of the industry, creditors around the world have started questioning the easy money offered to PE firms, which feed off risky types of debt. The prospect of dwindling returns makes buy-out firms reluctant to club together to buy the big companies they covet; banks, meanwhile, are growing wary of offering their own capital as “bridge” finance.

Well, it’s not yet time to sing a requiem to PE boom. But if interest rates keep heading northwards, it could soon be a contagion. PE is inevitably a “feast and famine” business: when one fund can raise a lot of capital, they all can. It helps turn illiquid bank-dominated debt markets into highways for delivering cheap credit. But the key word is “cheap credit”… something that’s drying up fast.

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