Dealbook The Biggest Buyout Ever Could Have Been Bigger By ANDREW ROSS SORKIN Published: February 11, 2007 http://www.nytimes.com/2007/02/11/business/yourmoney/11deal.html IS Samuel Zell the hero in the epic battle for Equity Office Properties? Mr. Zell, the raspy-voiced deal maker who built Equity Office into the nationâs biggest office landlord, appears to have played the Blackstone Group and Vornado Realty Trust like two fiddles. Applying pressure at just the right moment, he coaxed higher and higher bids from each side, ascending to a multibillion-dollar crescendo. Shareholders of Equity Office have praised Mr. Zell for his ability to extract an additional $3 billion over Blackstoneâs original takeover proposal in November. âYou have to hand it to him,â said James Corl, who oversees real estate investments for Cohen & Steers Capital Management, Equity Officeâs largest shareholder. âHe ran a fantastic process. Thatâs how you sell a company.â So, bravo, Mr. Zell? Wait. Hold your applause. Has anyone stopped to think that just three months ago, Mr. Zell had been prepared to sell his company for $3 billion less â to the exact same buyer? Was he such a masterly negotiator then? Blackstone, the same firm that agreed to pay $55.50 a share this week, almost walked off with Equity Office for considerably less. When Blackstone agreed to buy the company for $48.50 a share in November, Barry S. Sternlicht, the chairman of Starwood Capital who later teamed up with Vornado on its bid, called the deal âthe greatest heist of all time.â For Mr. Zell, it was a stroke of luck that his good friend, Steven Roth of Vornado, showed up to crash the deal and start a bidding war. It may seem churlish to find fault in a bidding war as rapid-fire and intense as this one was. Still, Mr. Zell may have made a couple of flubs that prevented him from obtaining an even higher payout. One of the more fascinating tactics in this fight was the use of the break-up fee as both a carrot and a stick. When Blackstone reached its original agreement, Equity Office offered a relatively tiny break-up fee of $200 million, far below the usual fee, which can run as high as 3 percent of the entire value of the deal. It was a shrewd move that allowed another bidder to emerge without having to clear too high a hurdle. But once the battle commenced, that carrot turned into stick â to the ultimate advantage of Blackstone. After Vornado bid $52 a share, Blackstone countered with $54 a share but at the same time pressed Equity Office to agree to raise the break-up fee to $500 million. That was when Mr. Zell started to hit some wrong notes. By agreeing to the higher fee, he began to make it increasingly difficult for Vornado to fire back with a credible offer. Still, Vornado came back with a bid of $56 a share, disappointing analysts and investors who had expected a counter of more than $57 a share. Then Mr. Zell broke a string. When Blackstone countered with an offer worth $55.25 a share, Equity Office asked for 25 cents a share more â offering in return to raise the break-up fee further, to $720 million. The break-up fee meant that Vornado had to pay the equivalent of almost $2 a share more than the underlying value of its bid to shareholders. âThat chess move chilled the bidding from our side,â said a person involved in Vornadoâs bidding group who spoke on the condition that he not be identified because he was not authorized to speak for Vornado. âWe wanted to go higher, but the break-up fee killed us.â Perhaps, but that might just be jealousy talking. Thereâs no guarantee that Vornado would have come back with a new bid even if the break-up fee had been lower. And Blackstoneâs bid still had advantages â it was all cash and could be completed immediately â that Vornado might never have been able to overcome. O.K., but would Blackstone have continued to raise its offer without the incentive of a higher break-up fee? Blackstone executives deny it, but it seems likely that the firm would have kept on going. For one, Blackstone already had the right to match whatever price another suitor offered, effectively giving it the last word and making the break-up fee less meaningful to it. And there were other factors â none of which had much to do with Mr. Zellâs negotiating skills â that created powerful incentives for Blackstone to keep bidding. Beyond the egotistic thrill of holding the trophy for âlargest buyout ever,â Blackstoneâs partners get paid a fee of one-half of 1 percent of the value of any acquisition they make. That means that Blackstone will receive about $200 million just for winning the auction. The higher the price, the higher the fee. A perverse incentive indeed. The other thing that might have motivated Blackstone was that it is in the process of raising a new real estate fund, worth $8 billion to $10 billion, giving it good reason to deplete the current fund. BLACKSTONE, of course, played its hand brilliantly, too. By pushing so hard for those break-up fees, the firm was able to shut Vornadoâs effort down. Blackstone also locked up nearly all of Vornadoâs potential real estate partners, like Brookfield and Macklowe, by entering into negotiations to offload some office properties even before it had won. Those talks surely made it harder for Vornado to pull together a clinching bid. Still, even Mr. Corl, the investor, conceded that Blackstone âhad the wherewithal and willingness to go higherâ with its bid. Mr. Zell, an aspiring poet and lyricist, should have known that. In his holiday e-mail card sent to friends, he included a link to a song he wrote about the state of the financial markets, parodying the Burt Bacharach song, âRaindrops Keep Falling on My Head.â The parodyâs lyrics, in part: âCapital is raining on my head/Everything is liquid; weâre awash with cash to spend.â DealBook also has a newsletter and a Web site, nytimes.com/dealbook, that is updated continuously when markets are open.