Stephen Schwarzman and Blackstone: Wall Street's unstoppable force

Image: Jamel Toppin for Forbes

In March 2015, Stephen Schwarzman got a telephone call from JP­Morgan Vice Chairman Jimmy Lee, one of Wall Street’s legendary power brokers. Lee, who died three months later, was helping General Electric (GE) unload $30 billion in commercial real estate assets lingering on its books. GE boss Jeffrey Immelt was uncomfortable with the massive financial services business his predecessor, Jack Welch, had slowly built up. During the 2008 meltdown, frozen credit markets put GE Capital’s $101 billion in commercial paper funding in peril, bringing the mighty industrial conglomerate to its knees. Lee told Schwarzman that the real estate sale was the keystone to Immelt’s reinvention plan for the 123-year-old company.

The hang-up: Finding a single buyer for a portfolio that included financing for everything from Mexican warehouses to Parisian office buildings to commercial mortgages in Australia. The billions in real estate and commercial mortgages were scattered across six countries, comprising all sorts of risks. Lee, Immelt and GE Capital boss Keith Sherin knew that Blackstone Group was the only firm with three key traits: The global reach to understand all the different assets, the resources to close a deal quickly and the financial firepower to swallow the entire package.

The first call went to Blackstone’s global real estate chief, Jonathan Gray, who quickly darted over to GE’s 30 Rockefeller Center of­fices in Manhattan. There Sherin offered Blackstone an exclusive look for three weeks—a minuscule period of time given the scope of the assets, but also a huge opportunity. Gray agreed, and before even getting off the elevator, he was marshalling an army of 100 Blackstone real estate professionals to tear through GE Capital’s portfolio.

Four weeks later, on April 10, Immelt announced that Blackstone would purchase $14 billion of GE’s assets, with Wells Fargo taking $9 billion of GE’s commercial real estate mortgages.

For Immelt, Blackstone was a saviour. GE’s languishing stock jumped 11 percent on the news. It was an even better transaction for Blackstone. The private equity firm had the inside track and thus more control over the deal terms and price, which was ultimately discounted.

“It was a perfect deal for us,” Schwarzman says. “No one else in the world is set up to buy both equity assets and real estate debt on a global basis.”

Indeed, Blackstone’s massive 2015 purchase, executed flawlessly, announced to the world that the bankers at JPMorgan and Goldman Sachs—who had been the premier financiers for many decades—were no longer the kings of Wall Street. There was a new pecking order that put private equity firms on top—with Blackstone at the apex and its chairman and chief executive, Schwarzman, as the most powerful banker on the planet.

Ever since the financial crisis, risk—the fuel for Wall Street’s astonishing profitability—has been forbidden fruit. The Volcker Rule, for example, means that today the mightiest trading firm, Goldman Sachs, is effectively blocked from proprietary trading. Capital restrictions have likewise limited the lending and merchant banking activities of big banks, like JPMorgan Chase and Deutsche Bank, that would have ordinarily drooled over the GE deal. The power has shifted to the so-called “buy side” to asset managers, and among them none is better positioned than Schwarzman’s largely unregulated $344 billion private equity conglomerate, Blackstone Group.

“Goldman is a really well-run bank, and so are JPMorgan and Wells Fargo, but they just can’t be in some of these businesses anymore,” says Mitch Rubin of RiverPark Funds, a Blackstone shareholder. “If Net­flix woke up tomorrow and Amazon wasn’t allowed to compete in streaming video, that’s good for Netflix.”

So while regulators wring their hands over restricting compensation at firms such as Citigroup, UBS and Morgan Stanley, Schwarz­man happily counts the $800 million in dividends and gains he personally took home in 2015, 34 times the $23 million that Goldman’s chief, Lloyd Blankfein, earned and almost 30 times the $27 million pay cheque for JPMorgan Chase CEO Jamie Dimon. Schwarzman’s net worth stands at $10.2 billion, making him one of five billionaires Blackstone has produced—more than any other Wall Street firm in history.

In the past eight years Blackstone’s footprint and influence under Schwarz­man have become nothing short of breathtaking. Since the financial crisis, Blackstone’s assets have nearly quadrupled. More than 85 percent of its 2,070 employees have joined since 2007, and the firm has introduced dozens of new products. Blackstone has major stakes in 92 companies, from Hilton Hotels and Michaels Stores to iconic brands like Versace and Leica Camera; it owns thousands of pieces of commercial real estate, including Manhattan’s Stuyvesant Town and Chicago’s Willis Tower, and more single-family homes in the US than any other private entity. In nearly every business in which it operates, including hedge funds and credit, Blackstone is the leader.

In its core private equity business, Blackstone hasn’t had a single fund lose money since it launched its first one in 1987. The average annual returns realised by its private equity funds (19 percent), real estate funds (20 percent) and credit funds (14 percent) have all trounced the S&P 500, which has delivered an annualised return of 9.7 percent over the past 30 years.

“There’s some perception that turning out great returns over 30 years is going to stop in year 31,” Schwarzman says. “I don’t know what the reason for that is. People have been saying that since the first five years we were in business. We have a system that works.”

In previous Wall Street eras, Schwarzman was known for his grandiosity. He owns a 34-room triplex on Park Avenue—John D Rockefeller Jr’s former digs—and oceanfront properties in Palm Beach, East Hampton, Jamaica and Saint-Tropez. Like Andrew Carnegie, he has been both generous and conspicuous in his philanthropy. He gave $100 million to the New York Public Library in 2008, which got his name emblazoned on its landmark main branch. Last year he gave Yale, his alma mater, $150 million to create the Schwarzman Centre, which will remake the university’s 115-year-old Commons into an 88,300-square-foot state-of-the-art complex that will include performance, dining, meeting and exhibition spaces. Blackstone’s chief has also launched the Schwarz­man Scholars programme at Beijing’s Tsing­hua University—his version of the prestigious Rhodes Scholarship—with another $100 million. And just in case his biographers don’t get it right, Schwarzman is working with a publisher on a forthcoming book.

At 5-foot-8 with an unassuming posture and a penchant for conservative, loosely fitting suits, Schwarzman is not someone you’d expect any flashiness from. But in 2007, he ignited populist anger with a $3 million birthday bash held in New York City’s Park Avenue Armory, featuring Rod Stewart, Patti LaBelle and Martin Short. He made matters worse later by comparing US President Barack Obama’s threat to end the carried-interest tax preference—which lets private equity types pay capital gains rates on their income, perhaps the most indefensible tax loophole in America—to a Nazi invasion (he later apologised).

With every US presidential candidate bashing Wall Street, being the billionaire king of finance these days is like wearing a scarlet letter. “You become a bit of a symbol or a target,” he says. “When I started in finance, it was a very high-prestige area.”

Great fortunes are often born in crises. For example, in the Panic of 1907, which caused a stock market crash and a bank run, an opportunistic banker named John Pierpont Morgan stepped in and organised a bank bailout. In return, President Theo­dore Roosevelt granted Morgan’s company, US Steel, immunity from anti-trust regulations as it bought up its biggest rival and became the dominant monopoly during a period of rapid industrial growth. Steel was one of the cornerstones of Morgan’s great fortune.

During the Great Depression of the 1930s, J Paul Getty famously bought up cash-starved oil companies. Using this foothold, he built an oil empire that made him one of the world’s richest men.

Likewise, financial crises have been great for Schwarz­man.
 
Blackstone was formed during heady days on Wall Street. It was 1985, the Mike Milken era, when savings-and-loan portfolios were brimming with his risky junk bonds. Blackstone started as a partnership of Schwarz­man and Peter Peterson, his longtime mentor at Leh­man Brothers, who had been forced out as co-CEO in 1983.

At Lehman, the duo acted almost like a father-and-son sales team. Peterson, who is 21 years older and once served as commerce secretary for President Nixon, had the contacts, while the analytical Schwarz­man was a great closer. They had what they thought was an airtight business plan. With an initial $400,000, they set up as a merger-advisory firm, with cash flow from deal assignments bringing in enough capital to keep the lights on until they could kick-start phase two: Raising a private equity fund to make their own investments. Like other buyout firms, they would use plenty of leverage and charge a management fee of 2 percent of assets and a performance fee that typically granted them 20 percent of the profits after they achieved an 8 percent “hurdle” rate.

After a carpet-bombing campaign of 488 solicitation letters, Peterson and Schwarz­man eventually raised $635 million, closing the initial fundraising the day before the stock market crashed in October 1987. As Milken’s money machine proceeded to break down, hundreds of junk-bond-laden thrifts were put into receivership. When the government’s Resolution Trust Corp started auctioning off billions in troubled assets, Schwarzman & Co was flush and ready to buy. It began snapping up dozens of apartment buildings in places like Arkansas and Texas. Blackstone’s real estate business was born out of the S&L crisis.

A decade later, there was another crisis for Blackstone to seize upon. After internet stocks crashed in 2000, Alan Greenspan’s Federal Reserve began pushing down interest rates. Money poured out of public markets into so-called alternative investments, which offered the promise of returns not correlated with the stock market. Here again, Blackstone was positioned perfectly.

Since 1990, Blackstone had been investing modest amounts of capital with hedge fund manager Julian Robertson through an entity the firm set up called Hedge Fund Solutions. This pool, which included Blackstone partners’ money, grew to more than $1.3 billion by 1999, and more clients began asking about the fund. So Schwarzman decided to ­expand the business, under the ­leadership of former M&A banker Tomilson Hill, offering a fund of hedge funds for existing clients. 

“Alts” became all the rage, even on Main Street, so the money poured in. The collapse of the Madoff Ponzi scheme accelerated the pace as investors sought out the safety of the biggest hedge funds. Blackstone’s hedge fund operation has grown from $26.9 billion under management in 2007 to $68 billion today. It has been the key partner in the most important hedge fund launches of the past few years, like Peter Muller’s quantitative superfund, PDT Partners.

Nothing has done more to bolster Blackstone’s position on Wall Street than the financial crisis of 2008. One of the Achilles’ heels of running a private equity firm or hedge fund has always been a lack of permanence in the capital structure. Partnerships raise funds and earn fees, and then are forced to exit their positions and liquidate the funds, typically within seven years.  

So on the eve of the financial crisis and the collapse in the stock market, Schwarzman decided to bolster Blackstone’s permanent capital via an initial public stock offering (IPO). On June 21, 2007, Blackstone raised $4.1 billion in capital, valuing the firm at $33.6 billion. The deal was so coveted that China’s sovereign fund invested $3 billion just prior to the offering and agreed to give up its voting rights. Schwarzman held on to 23 percent and sold $493 million of stock, and Peterson, who was set to retire, sold the bulk of his remaining position for $1.9 billion.

“I had this desire for permanent capital,” Schwarzman says. “I just felt something bad was going to happen. The markets were peaking, and I just wanted to be prepared for the nuclear winter.” Within two years, Blackstone’s new partnership units (as its shares are formally known) cratered from the $31 IPO price to $3.87. “It was a deluge which didn’t have anything to do with us.”

With plenty of dry powder, Blackstone was not only prepared but also well positioned, given the backlash from regulators toward some of the firm’s competitors, including Goldman Sachs. Schwarzman’s directive to his team of dealmakers was clear: Be smart, be entrepreneurial, but above all, don’t lose capital.

A good example: Schwarzman’s 2013 purchase from Credit Suisse of Strategic Partners, a business that raises money to buy investor stakes in existing private equity funds. The big Swiss bank had to unload the business, which managed about $9 billion, because of tightening regulations. Blackstone ran with it, doubling its assets to $19 billion today.

In hedge funds, Blackstone was already the biggest allocator in the world. But with traditional hedge funds struggling, Schwarzman & Co is innovating again, quietly building an internally managed hedge fund business called Senfina Advisors.

The relatively new unit is located a block away from Blackstone and is structured to control risk and keep managers focussed solely on picking great longs and shorts (rather than on raising money). To that end, Blackstone limits the buying power of each individual manager to $450 million, hedges risks centrally and encourages longer-term and concentrated positions. So far, Senfina has $2 billion in assets and eight managers, mostly refugees from funds like Ziff Brothers and Citadel LLC.

In a conference room connected to his 44th floor office at Blackstone’s Park Avenue headquarters, Schwarzman, dressed in his usual Wall Street pinstripe shirt with white collar, sips an espresso during a brief moment of calm. Schwarz­man’s drive is inexhaustible. At 69, he sleeps only five hours a night and travels extensively, courting new clients, meeting with current investors and consulting with foreign dignitaries and heads of state. He never misses Blackstone’s Monday meetings, where division heads provide updates on business, and an iPad app has been developed for Schwarzman and other top brass who want “real-time” updates on the firm’s active deals.

As his 70th birthday approaches, Schwarzman insists he isn’t going anywhere. “Don’t look for me to be retiring—it’s not my nature,” he says, but quickly adds, “This is not a ‘great man’-centred business,” referring to Blackstone’s deep bench. In 2002, Schwarzman brought in patrician Hamilton ‘Tony’ James, formerly the top banker at Donaldson, Lufkin & Jenrette, to run day-to-day operations. He has empowered real estate don Gray, whom he hired out of the University of Pennsylvania in 1992 and who generates 60 percent of Blackstone’s profits. Gray is being groomed as Schwarzman’s likely successor and sits on the firm’s board alongside Schwarzman, James and hedge fund chief Tom Hill, 67. Bennett Goodman, co-founder of credit unit GSO Capital, 59, was given a $200 million incentive plan and a seat on the board last year.

“I believe Steve will be the chairman until his last breath,” says Laurence Tosi, who was Blackstone’s CFO from 2008 until he left to join Airbnb in 2015, “but [CEO] succession will be a nonevent.”

By nearly all measures, business is booming. Blackstone has raised $80 billion for its funds in the past 12 months, dwarfing rivals like KKR, Carlyle Group and Apollo. Perhaps even more impressive is the fact that Blackstone’s analyst programme has become the most coveted ticket at elite schools. Some 15,000 candidates from every Ivy League school applied for just 84 positions in 2015. That’s a 0.6 percent acceptance rate, compared with 4 percent for the analyst programme at Goldman Sachs.

If there is any blemish in Schwarz­man’s impressive tenure, it’s probably Blackstone’s stock: While it has returned 63 percent in the past three years, it is still trading at less than its IPO price and sells at a steep multiple discount to the shares of other asset managers.

Public shareholders hate volatility, and Blackstone’s earnings depend on the timing of asset sales and mark-to-market adjustments. For the 12 months through March 31, Blackstone earned $899 million in economic net income, an 83 percent drop from the $5.2 billion earned a year earlier. During the first quarter, Blackstone marked its holdings down by $1.6 billion as global equity and credit markets went on a roller-coaster ride tied to oil prices and central bank actions.

Taking a page from “buy and hold” sages Warren Buffett and Jack Bogle, Schwarzman may have devised a novel solution to his earnings-volatility problem. Blackstone recently ­introduced “core-plus” funds in real estate: Essentially open-ended investment vehicles that use less leverage, have longer holding periods and offer lower returns. They also tend to lock up capital.

Core-plus funds are a great way for Blackstone to capitalise on the huge and growing demand among its clients for “safe yields”. Unlike traditional private equity “opportunity” funds, these funds charge fees of 1 percent and 10 percent, and there is no expectation that Blackstone will “fix” or “sell” the assets. The firm’s $5.3 billion purchase of New York residential complex Stuyvesant Town in 2015 is an example. “Stuytown” is a 68-year-old, 110-building apartment complex just north of Manhattan’s East Village and should generate market rents for a very long time to come. The core-plus real estate strategy gained 4.4 percent in the first quarter of 2016 alone, and it has already amassed $12 billion in assets.

Perhaps this latest financial innovation—which Schwarzman thinks could reach $100 billion within a dec­ade—will smooth earnings and finally afford Schwarzman the status he thinks he deserves among the financial greats.

“The traditional drawdown funds are such treadmills because you raise the money, you invest them and then you have to sell them and give the ­assets back,” says Blackstone’s billionaire ­president, Tony James. “The power of this business is holding the assets forever.”

(With additional reporting from Nathan Vardi)