Excerpted from King of Capital by David Carey and John E. Morris © 2010 David Carey and John E. Morris. Reprinted by permission of Crown Business, an imprint of the Crown Publishing Group.
By David Carey and John E. Morris
For Chinh Chu, the first sign that something was askew came in 2005 when Blackstone was weighing a bid for Tronox, which made titanium dioxide pigments used in paints. Like most chemical companies, Tronox's cash flow had soared as the economy picked up speed. Lehman Brothers, the bank handling the sale for Tronox's parent, Kerr-McGee, was offering buyers a generous package of guaranteed financing they could take advantage of if they wished.
With the Celanese and Nalco deals, Chu had earned a reputation as perhaps Blackstone's most astute buyout investor. The $2.6 billion in gains on those deals accounted for more than a third of the profits that Blackstone's 2002 fund realized through the end of 2008. Having snagged Celanese and Nalco at the bottom of the market, Chu understood well the swings of the chemicals industry. He was dumbfounded to learn that Lehman was offering debt of up to seven times Tronox's current cash flow. He figured the chemical industry was near a crest and that if business slacked off, the company wouldn't be able to handle such a huge debt load. If earnings fell back to what one might expect at the midpoint in the business cycle instead of the peak, he reckoned, Tronox's debt could suddenly equate to fourteen times cash flow-- a perilous level.
offered on that deal was twice what I thought the company was worth," Chu says.
With Lehman's backing, Blackstone could have paid what Chu considered an absurd price, but Blackstone walked away. No other bidders took Lehman's bait either, and Kerr-McGee ultimately took Tronox public that November. After peaking that year, Tronox's cash flow nose-dived 40 percent, back to 2002 recession levels, sending it into bankruptcy in 2009. By then, Lehman itself was out of business.
Tronox was not an isolated case. Lehman's wildly optimistic package was symptomatic of the forces that were igniting a new buyout blitz that would eclipse that in the 1980s. The $10 billion and $15 billion LBO funds raised in 2005 and 2006 may have turned the ignition key, but it was the banks and the credit markets that shifted the buyout business into overdrive and jammed the pedal to the floor.
The first sign of the escalation to come was a buyout engineered by Glenn Hutchins, the Blackstone partner who left in 1998 to co-found Silver Lake Partners. In the spring of 2005, Silver Lake made headlines by leading a buyout of publicly traded SunGard Data Systems, which provides computer ser vices to financial institutions and universities. At $11.3 billion, it was the second-largest LBO ever, upstaging the old number two, KKR's $8.7 billion buyout of Beatrice Foods in 1986. Only the RJR Nabisco buyout in 1988 was bigger.
The SunGard deal was notable not only for its size but for the unusual and potentially unwieldy, seven-firm coalition that Silver Lake corralled in order to come up with the $3.5 billion of equity needed. It was a who's who of the buyout world: Bain Capital, Blackstone, KKR, TPG, Goldman Sachs, and Providence Equity Partners. Private equity firms had occasionally teamed up in twos or threes in the past, but one firm usually had a larger stake and took a lead role. SunGard set a new precedent by including so many marquee names with roughly equal shares. No other consortium ever quite matched SunGard's, but increasingly firms that competed on one deal allied on the next in order to come up with the requisite capital.
SunGard also signaled that the banks would fund deals on a scale far beyond anything in the preceding fifteen years. It was their debt packages that were pushing the envelope on deal sizes, and even the biggest private equity firms sometimes had to scramble to round up the equity.
SunGard was a turning point, but it wouldn't hold its place in the record books for long. Soon Clayton Dubilier, Carlyle, and Merrill Lynch topped that with a $14.4 billion deal to buy Hertz Corporation, the rental car company, from Ford Motor Company. It seemed every time one blinked in 2005, another house hold name was being snapped up in a buyout: the retailer Toys "R" Us ($7 billion: Bain Capital, KKR, and Vornado Realty Trust), Neiman Marcus, Inc., the tony department store chain ($5.1 billion: TPG and Warburg Pincus), and the doughnut and ice-cream chains Dunkin' Donuts and Baskin-Robbins ($2.4 billion: Bain, Carlyle, and Thomas H. Lee).
Apart from the size, the other striking thing about the rash of megadeals in 2005 was that, except for Hertz and Dunkin' Donuts, the companies were all publicly traded. The sheer scale of the new LBO funds all but dictated that their sponsors go after public companies, because there simply weren't enough big subsidiaries and private companies for sale to soak up the billions that the firms had to deploy. That meant the focus would shift heavily back from Europe to the United States, where big targets were more plentiful and there were fewer legal impediments to taking public companies private.
The take-privates, as they were known, also reflected a new social acceptance of private equity. CEOs who had once looked askance at buyout artists were now only too happy to offer up their companies. The Sarbanes-Oxley law enacted after the Enron and other corporate scandals early in the decade had imposed new disclosure obligations and new liabilities on companies and their managers, which executives groused were a distraction and a drain on their time. Offered the chance to answer only to private equity executives, and not to stock analysts and hedge funds that always seemed to think they knew better than management what to do, many CEOs found the going-private option tempting. At least as important, the private equity firms offered executives equity stakes that potentially could make them much richer than they could ever hope to become collecting stock options in a public company. "Sign me up!" CEOs said.