This story is featured in the 4Q 2019 issue of the PitchBook Private Market PlayBook.
It took a few mistakes before Stephen A. Schwarzman skyrocketed.
Once, a single miscalculation rippled its way through an entire deal book. Decades later, he invested $330.0 million in a company that collapsed within months—which resulted in a 100% loss.
These career-defining moments now bedeck the pages of Schwarzman's memoir "What It Takes: Lessons in the Pursuit of Excellence," published by Simon & Schuster in September 2019. It traces the story of his meteoric rise from mowing lawns in a Philadelphia suburb to becoming king of a global alternative investment empire worth $554 billion. Among his many titles: CEO, entrepreneur, philanthropist, presidential adviser and multibillionaire.
Yet with all this success, Schwarzman still sees Blackstone—the firm he created in 1985—as a "work in progress," his job much the same as it ever was. And at 72, he says he has no plans of slowing down.
PitchBook spoke with Schwarzman about his perspectives on the changing private equity landscape, what he describes as Blackstone's "revolution" in the industry and what's next for the legendary dealmaker. (Hint: It's not retirement.)
The following interview has been edited and condensed for clarity.
PitchBook: You talked a lot in your book about creating Blackstone and the defining inflection points in that journey. What was the moment when you and co-founder Pete Peterson realized you were creating something big?
Stephen Schwarzman: I guess it was the moment when we got our circle, or commitment, from Prudential Insurance. We were basically fundraising and getting close to failing. We had $75 million from two commitments, but they were contingent upon us getting to $500 million— and we were trying to raise a billion. We were about out of names. We got to Prudential, and we're having a lunch, and I did the exact same presentation I gave to everybody else, which had resulted in only those two commitments.
The chief investment officer was listening, and he said, "Sounds great. I'll give you $100 million." At that point, Prudential was the No. 1 investor in terms of size and reputation in the world of private equity. I knew that if we had their prestige and knowledge base as our lead investor, the rest of the world would follow. So, that was the moment.
PB: What emotions did you have at that moment?
SS: I think it was something approximating stunned amazement.
PB: You rose very quickly in the ranks at Lehman Brothers, becoming a managing director at 31. How did your expertise in M&A inform your transition to private equity entrepreneurship?
SS: I was used to the concept of buying or selling something. Lehman, at that point, was the most active in mergers and acquisitions of any firm. Goldman Sachs had accumulated more in terms of aggregate principal deal value—they did bigger deals across the board—but Lehman did more total deals. It was an enormous amount of activity. So, you could learn how deals were put together, what valuations were. Negotiating wasn't a periodic activity—it was almost an everyday activity.
Getting business was something you had to do. So, being out and about and able to convince people to trust you with something of enormous consequence to them were skills similar to what you would need in private equity.
PB: Blackstone has evolved a lot since its creation. How have you and the firm changed your perspectives on producing returns, from financial engineering in the beginning to a focus more on operational improvements and growth initiatives today?
SS: From the 1980s to now, it's been sort of a revolution. Nowadays, you would never buy anything without developing a significant transformation plan beforehand, so owning large-scale assets isn't the type of adventure that it was in the 1980s and 90s. Now we're quite sure in terms of what needs to happen and be done at every different phase of the company's management. We own now about 200 businesses, and this is just in private equity. Private equity is only 25% of Blackstone. Real estate represents a bigger proportion of our business. We also have a huge credit business and a very good-sized hedge fund business.
When you have responsibility for hundreds of billions of dollars in assets, you have to have systems. You have to have in-house experts. It's not like a small partnership of 10 or 15 people trying to make its way. We do group buying, and because of the total scale of the firm, I'm sure we're one of the 10 largest purchasers of supplies of all types.
So, when you combine your companies doing something like that, you get enormous cost advantages. We did the same thing with healthcare costs here at the firm. It's a different type of approach than a medium size or small private equity business has.
PB: You talked a little bit about the different strategies that Blackstone has pursued, such as credit and real estate. What strategy are you most excited about looking forward?
SS: We're the largest owner of real estate in the world. I've been excited since 1991 about that area, and it's proven to be a really great thing. We now are so broad in terms of our presence around the world. Today, we like warehouses, because the digital economy needs warehouses for delivery of their products to customers. Digital sales are going up faster than brick-andmortar retailing, so warehouses turned out to be a terrific focus.
Certain kinds of residential real estate have turned out to be very good, such as apartment buildings and single-family homes. We sold almost all of our shopping malls, so we didn't get hurt like many other real estate investors did. We used to be the biggest hotel owner in the world, and that turned out to be an extremely good focus, but as the economy was peaking, we sold those assets. We go in and out of asset classes and different parts of the world. It's always interesting.
PB: One aspect of leveraged buyouts that you didn't delve into in your memoir is the cost-cutting layoffs that often ensue after a financial sponsor takes the reins. A new report from economists including Josh Lerner and Steve Davis found average job losses of 4.4% in the two years after a company is bought by PE firms. How do you respond to criticism about this?
SS: I'd say the flaw in that analysis was that it was looking at only two years. The cycle in private equity, depending on what kind of company you buy, is a function of what happens with the jobs. If you're buying a very healthy company that's expanding nicely, I think the study showed that those companies grow employees 10% to 13% in their first two years. Something like that.
On the other hand, say you're buying a carveout of a company, in other words, a part of a very big company. Or say you're buying a company that's done quite poorly—because people don't always sell wonderful companies—and that company needs to be restructured. But the seller, for whatever their reasons, doesn't want to do that. To make those companies healthy, there needs to be some changes of various types. You know that when you buy that business.
The personnel cuts for those companies are larger. And they were using a control group—I have no idea what control group they were using. What happens with those companies is once you start getting them in shape, you put them in a growth mode. In growth mode, you end up hiring more people. The average life of a private equity deal isn't just two years. In two years, you haven't established enough growth because just reducing people count does not add a lot of value.
My experience has been that there's always situations in which you get a company that has more jobs at the end of five years than you started with after the first year or two. Because that's how you make money. You should be matching the life of the investment, not cutting off the whole improvement, which is why you buy the company in the first place.
I think the methodology that was chosen is unfortunate. … I don't think, at the end of the day, private equity net fires anybody. Because if you have a holding period of three years, and they're growing in years three, four and five, you didn't net fire anyone in a given year.
PB: After many public private equity firms converted to C-Corps, we've seen their market caps skyrocket. Are the public markets finally valuing Blackstone and its competitors correctly?
SS: It's certainly been modified. I saw no reason why those historic valuations of 11x earnings made any sense. I was pretty straightforward about indicating that. Now we're being valued on a much more sensible basis.
The way you value companies is, what do you think the growth rate is? What's the yield? We were always significantly undervalued in part because the structure we were using, a master limited partnership, basically eliminated two-thirds of the typically eligible buyers from owning us.
By changing to a corporate form, a much, much bigger group of potential owners could buy us. We used to visit these people, and they'd say, "Geez, you've got this marvelous company, but we can't buy you." So, if we went to a mutual fund company, usually there was one manager that could buy us and seven that wouldn't. But now all seven can. In a way, it's the law of supply and demand—that's how we've made ourselves available to a much larger group. And that's working out with a much higher valuation.
PB: I'd also like to hear your thoughts on longer holding times for portfolio companies. We've seen a lot of firms including Blackstone raise long-dated or permanent capital funds. Do you think this will become a larger part of the industry?
SS: I think the longer holds will slowly grow as a percentage of the industry. The compensation structure now in the industry, from the perspective of the investors, is based in part on high rates of return. Longer holds typically have somewhat lower rates of return, which makes it harder to attract that capital. It may be smarter to invest on that kind of basis, but it's harder if the people who are giving you the money are incented in a slightly different direction. We pioneered this type of investment. It's increasing in popularity.
It's a smart type of investing to do, and we're optimistic about it. But it won't challenge, in terms of aggregate scale, the more traditional private equity structure.
PB: In your memoir, you wrote that your mother had what it took to become the CEO of a major corporation, if only she had lived in another time. Private equity still has very few female executives, even compared with other segments in finance. What do you think needs to change in the private equity industry to encourage more female leaders?
SS: Well, that's a good question. What it was, interestingly, was you had very few women who ever applied to go into private equity. For some reason, they thought this industry was a difficult place to work. It's hard to hire people when they don't apply. So, what we did about three or four years ago, is we said, OK, let's find out why women aren't applying. Let's go to campuses and explain what we do. Let's start an intern program, where women can apply and just get an introduction into what we do. In our entry-level classes now, we've gone from 15% women to 40%. And we still have women applying at disproportionately low rates.
I think we've made some very forward-looking approaches to trying to rebalance Blackstone's next set of employees, and we've been unbelievably successful doing that.
PB: What was the worst investment you've ever made, and what did you learn from it?
SS: The worst investment we ever made was called Edgecomb Steel, a steel distribution business, and it's in the book. We lost 100% of our money. It was our third deal. It resulted in changing everything we did, in terms of how we looked at a potential investment, the kind of processes that we had, the focus on downside risk and how to construct an investment committee process where everybody participates. We get the virtue of everybody's thoughts. That was a seminal moment in the firm's history.
PB: You've found incredible success in your career. What more would you like to accomplish?
SS: Well, I don't approach the world that way. For me, every day is a new day, and there are two things that could happen: You could do something that's really terrific, or you can stop something from becoming a mess. Both of those require enormous immediacy and focus. I don't look backward. I don't feel that Blackstone is some kind of success. I view it as a work in progress that can always go wrong.
The job of myself and the other senior people here at the firm is to make sure that things don't go wrong and that things go right for our investors and the people who work here, as well as for society. There are always going to be wonderful things that happen in the future, and our job is to help figure them out and make sure we have the resources to execute that.
So, I don't know. I think my job sort of is the same as it ever was. I want to make sure Blackstone's lifespan is a lot longer than my own personal lifespan, because I'm getting a bit older apparently, and the firm is just getting better and better.