Buyout Industry, Once Flush, Staggers Under Weight of Debt http://www.nytimes.com/2008/03/11/business/11equity.html?_r=1&oref=slogin By MICHAEL J. de la MERCED Published: March 11, 2008 With their big paydays and bigger egos, private equity moguls came to symbolize an era of hyper-wealth on Wall Street. Now their fortunes are plummeting. Celebrated buyout firms like the Blackstone Group and Kohlberg Kravis Roberts & Company, hailed only a year ago for their deal-making prowess, are seeing their profits collapse as the credit crisis spreads through the financial markets. Investors fear that some of the companies that these firms bought on credit could, like millions of American homeowners, begin to buckle under their heavy debts now that a recession seems almost certain. The buyout lords themselves suddenly confront gaping multibillion-dollar losses on their investments. On a day in which the stock market tumbled to its lowest point in two years and rumors flew that a major Wall Street firm might be in trouble, Blackstone said Monday that its profit had plunged. The firm said earnings tumbled 89 percent in the final three months of 2007 and warned that the deep freeze in the credit markets â and, by extension, in the private equity industry â was unlikely to thaw soon. âThey see the handwriting on the wall,â said Martin S. Fridson, a leading expert on junk bonds, said of buyout firms. âTheyâre staring into the jaws of hell.â It is a major turn of events for Blackstone and its chief executive, Stephen A. Schwarzman, who took the firm public last year at the height of the buyout binge. On paper, Mr. Schwarzman has personally lost $3.9 billion as the price of Blackstoneâs stock sank. Even so, Mr. Schwarzman is still worth billions, more than rich enough to pledge $100 million to the New York Public Library, as he plans to do Tuesday. In recent years private equity firms have bought thousands of companies, mostly with borrowed money. Blackstone and others argue they can run these businesses more efficiently â and therefore more profitably â than they could as public companies. Now, the bankers and investors who financed the boom in corporate takeovers are running for the exits. Loans and junk bonds that deal makers used to pay for the acquisitions â debts that must be repaid by the companies, not the deal makers â are sinking in value. The speed and ferocity of the industryâs reversal has taken even Wall Street by surprise. On Monday, Carlyle Capital, a highly leveraged fund linked to another buyout firm, the Washington-based Carlyle Group, confronted the prospect of insolvency. Carlyleâs troubles, along with rumors that Bear Stearns might be running short of cash, helped drive stocks lower. Bear Stearns denied the rumors. But companies far from Wall Street are feeling the pain of the private equity crisis. In 2006, for example, Freescale Semiconductor, which makes computer chips, found itself the object of private equityâs affection and the subject of the biggest buyout battle of all time in the technology industry. Two groups of private equity firms vied for the microchip manufacturer, a spinoff of Motorola that builds most of the computer chips for that companyâs cellphones. Ultimately, the winning group, led by Blackstone, paid a staggering $17.6 billion, most of that with borrowed money. That was then. Now Freescale is plagued by falling demand from Motorola and billions of dollars in debt related to its takeover. It replaced its chief executive nearly three weeks ago, and its junk bonds recently traded at levels that suggest the company might be unable to pay its debts. The company has said that while times are challenging, it can meet its debts. âNo one saw this kind of outcome,â Michael Holland, chairman of the New York investment firm Holland & Company, and a former Blackstone executive, said of the buyout industryâs troubles. Freescale is far from alone, as the private equity industry reels from the shocks to the credit markets and the broader economy. Since last summer, financing for the multibillion dollars deals has withered, depriving buyout firms of the headlines and, more important, the returns to which they had grown accustomed. Bonds and loans of newly private companies as diverse as the Realogy Corporation, a Minneapolis-based real estate company, and OSI Restaurant Partners, which owns the Outback Steakhouse chain, have plunged so far in value that bankers consider the debt distressed. While these and many other companies are current on their debts, their bonds now trade at 70 or 80 cents on the dollar, suggesting investors are worried about these businessesâ financial health. Some bonds are selling at even lower prices, and a few companies have gone bankrupt. As a financial firm, Blackstone is just one of many that have suffered over the past eight months. But unlike banks and mortgage lenders, Blackstone is the only major American buyout firm that is publicly traded. Its stumbles are more clearly tracked than any of its peers, as shown by a stock price that has dropped more than 50 percent since its debut. On Monday, Blackstone reported soft results in its private equity and corporate real estate businesses, its two biggest divisions. Stripped of the cheap debt that girds its deal making, Blackstone said it will now focus on smaller transactions. Yet the firm has not struck any deal over $2 billion since last July, when it announced a $25 billion takeover of Hilton Hotels. Since then, it has seen two buyouts crumble, those of PHH, a mortgage lender, and Alliance Data Systems, a credit card processor. Blackstone also took an accounting charge related to its investment in the Financial Guaranty Investment Corporation, a troubled bond insurance company. But private equity firmâs problems now extend well beyond themselves. Banks, for example, are saddled with billions of dollars of buyout-related debt they cannot sell, serving as the next possible wave of write-downs after the subprime mortgage debacle. Citigroup, Goldman Sachs and Lehman Brothers are currently holding what some analysts estimate is $130 billion in leveraged loans, or those supporting private equity deals. And the companies that private equity firms have acquired may be the next to suffer. Emboldened by the availability of cheap debt, private equity firms borrowed more and more as they paid higher prices to strike more deals. That has left many companies like Freescale to cope with more debt to pay off. Surveying junk debt offerings since 2002, Mr. Fridson found that companies taken private tended to suffer more distress than their peers. According to his firm, FridsonVision, Blackstone had the fourth most-distressed companies of major private equity firms, with nearly 34.8 percent of its holdings falling into that category compared with the average of 27.7 percent. Calling a bottom to the industryâs problems is a notoriously difficult task, even for sophisticated investors like Blackstone. Executives from the firm argue that these are times to buy things cheaply, be they stakes in companies or real estate properties. Blackstone recently raised $1.4 billion from investors for a fund devoted to buying bonds and loans at fire sale prices. But in a conference call on Monday, Hamilton E. James, the firmâs president, said the fund is â100 percent dry powderâ and so far has not been tapped for investments. âOur view is that things will get worse before they get better,â Mr. James said.