Updated from 1:06 p.m. ESTIt's not easy to beat out private equity giant Blackstone Group on a buyout deal. But Cerberus Capital, a major competitor of Blackstone, provides just the amount of muscle needed on the debt side to provide a higher bid for Equity Office Properties Trust ( EOP). Press reports say that a consortium of private equity firm Cerberus Capital, billionaire real estate investor Neil Bluhm with Walton Street Capital, and Barry Sternlicht with Starwood Capital are eyeing a competing bid to top the $48.50-per-share offer that Equity Office accepted from Blackstone Group in November. Sources say Vornado Realty Trust ( VNO) could be eyeing a piece of the deal as well, perhaps through a mezzanine debt investment or the purchase of some of Equity Office's properties. The $36 billion Blackstone/Equity Office deal is the most expensive real estate transaction ever. Any competing offer faces two major issues: Will the new bidders have a fundamental strategy for Equity Office's assets that differs from Blackstone's, and can they find a cheaper cost of capital? The first question is more difficult to answer. But Cerberus plays a vital role in raising the more than $30 million of low-cost debt needed to buy Equity Office. In an interview with The Wall Street Journal, a Cerberus executive said the firm had no intention of submitting a bid, but would be willing to provide the debt financing.
"Cerberus is doing a very high value-added role being in on the debt side, actually more than being on the equity side," says an industry source. "The only way the deal works is if Cerberus gets the debt." Cerberus didn't return a call seeking comment for this story. The reason that Blackstone, Kohlberg Kravis Roberts and other huge private equity firms tend to rarely get topping bids for their buyout deals is that they manage to involve practically every bank lender on syndicated loan deals, sources say. "This makes it virtually impossible to tie up a syndicate," says one source. Blackstone pays hundreds of millions of dollars in fees each year, so the firm holds considerable sway. Banks not involved in a Blackstone deal don't want to upset the private equity giant by arranging loans for a competing bidder, sources say. And Blackstone is said to make this point very clear to bankers. Merrill Lynch ( MER), Bank of America ( BAC) and Bear Stearns ( BSC) are the lead banks on practically every syndicated loan deal for Blackstone's real estate deals. Besides these banks, Morgan Stanley ( MS), Goldman Sachs ( GS), and Deutsche Bank ( DB) are also involved in the Equity Office deal. Major lenders remaining are JPMorgan ( JPM), Lehman ( LEH) and Wachovia ( WB). But Cerberus is big enough by itself that it can be the lead banker on the deal. The private equity shop owns a significant piece of GMAC, General Motors' ( GM) financing arm.
Even if Cerberus makes the debt piece doable, there are several other hurdles to a competing deal for Equity Office. "I still think it is very tough for someone to challenge Blackstone with the same strategy that Blackstone has, which is to buy and flip most of the assets," says one real estate investment banker not involved in the deal. Blackstone's typical plan when buying REITs is to immediately sell the highly-valued properties for a profit and then keep other assets for the long haul to service the debt. Blackstone has likely already shopped the Equity Office assets and lined up several buyers, the banker says. Thus, any competing bidder also looking to flip some of the properties could have a hard time doing so. Blackstone's advantage is that it also has favorable matching rights on any competing bid, the banker says. Basically, any bid by a competitor could be topped by Blackstone by just a penny. Blackstone would have three-day increments to view any competing bid, the source says. So to be credible, the competitor needs to come up with a substantially higher bid for Equity Office. Any competing buyer also will have to pay Blackstone a $200 million breakup fee. The original deal valued Equity Office at a 5.25% to 5.5% cap rate, or initial rate of return, which some felt was aggressive.
Bluhm, Sternlicht and Cerberus are all well-respected real estate investors. Bluhm's Walton Capital teamed up with Whitehall, a real estate fund operated by Goldman Sachs, on a losing bid for office owner Trizec Properties last year. They lost out, however, to Blackstone and Brookfield Properties ( BPO), one source says. Rival bids, even if higher, are far from always successful. A lot of noise surrounded a topping bid from Carl Icahn for Reckson ( RA) late last year. At the end of the day, SL Green's ( SLG) original bid for the New York REIT won. Nonetheless, it is a mistake to think any of the parties mentioned in the Equity Office competing bid are being irrational or emotional in trying to trump Blackstone. If they can find a deal that makes sense without being too risky, it will get done. The power of Cerberus allows them to do so.