s they sized up each other over their dinners at Schwarzman’s apartment in 2002, one of the issues on which Schwarzman and James saw eye to eye was the state of the market. They shared a conviction that they were looking at the opportunity of a decade to buy assets cheaply.
James had cemented his reputation as a private equity investor with DLJ’s spectacularly pro table 1992 fund, raised when the economy was still in recession. Likewise, Blackstone’s 1993 fund, much of it invested early in the 1990s upturn, was the rm’s most successful to date. Blackstone was putting the nishing touches on a fresh $6.9 billion fund the summer they began talking. When the debt markets would allow it, both men wanted to dive back into the old-fashioned LBO business. What attracted them most was cyclical businesses—companies whose fortunes ebb and ow sharply with the economic tides.
Theirs was a contrarian view at the time, when most buyout firms were still nursing wounds from their mistakes of the late nineties, but Schwarzman’s conviction was visceral. “I recall Steve very early in that particular cycle [saying], ‘Look what’s going on! You’ve got to be buying,’ ” says Mario Giannini of Hamilton Lane, a rm that advises pension funds and others on private equity investments.
It would be risky. Timing is everything when you are borrowing to buy a cyclical company. Like cli diving in Acapulco, plunging in too soon or too late can be disastrous, which is why many private equity rms steer clear of cyclical businesses. Nimbly timed, however, a leveraged investment at the bottom of the cycle can magnify any earnings gains. In addition, valuation multiples for cyclical companies tend to rise at the same time that pro ts do because buyers will pay a higher multiple of cash ow or earnings when those are on the upswing. Harness both the earnings growth and the increase in valuations, and returns can shoot o the charts. The exit must be timed as deftly as the entry, however, because in a declining economy multiples can recede at the same time earnings are falling. A company that sold for seven times earnings in good times could easily trade for just six times in a down market. If earnings drop at the same time, the two factors together could slice
the value by a third, leaving the company worth less than its debt and wiping out the value of the equity, at least on paper. That is the inherent risk of leverage.
Despite the perils, instinctively Schwarzman and James wanted to pounce.
“We got very active, very aggressive, and went out and bought big, chunky, industrial assets,” says James. In 2003, the year the economy turned the corner and began expanding again, Blackstone far outpaced its rivals, signing up $16.5 billion worth of deals. Goldman Sach’s private equity unit was the only other buyout investor that came close. The totals for TPG and Apollo, Blackstone’s next closest competitors, were only half Blackstone’s.
The rst big cyclical play was the TRW Automotive deal. Neil Simpkins, one of the ve new partners promoted in 2000, was already talking to the company’s parent, the defense contractor TRW Inc., about buying the parts business in 2002 when Northrop Grumman, another defense rm, made a hostile bid to take over TRW Inc. The latter eventually relented and agreed to be absorbed into Northrop, but Northrop had no interest in the parts business and moved to sell it even before it had completed the TRW acquisition. Since Simpkins knew the business, he was able to cut a quick $4.6 billion deal with Northrop.
At the same time, Chinh Chu, another member of the new crop of partners from 2000, was chasing two other companies in the chemicals industry, which was at least as cyclical as the car business.
Chu had followed an unusual route to Blackstone. While most of his peers were the products of a uent families and Ivy League schools, Chu’s family had ed Vietnam when the United States pulled out, and he had earned his bachelor’s degree from the University of Bu alo. After a short stint as a banker, he joined Blackstone in 1990 and soon was apprenticed to the mercurial David Stockman. Chu didn’t shy from questioning his superior’s views and earned a place in Blackstone lore for an incident in 1996 when he was working with Stockman on a proposed investment in an aerospace components maker, Haynes International. When Stockman made his pitch to the investment committee, Schwarzman asked Chu what he thought about Haynes. Chu replied frankly that he didn’t think it would be a good investment. Stockman was so incensed that his underling would undercut his position that he refused to talk to Chu for weeks. Finally Schwarzman had to take Stockman aside, pointing out that it would be nearly impossible to close the deal if he wasn’t communicating with the associate who had worked on
the project from the beginning.
Chu turned out to be right about Haynes: Blackstone lost $43 million of the
$54 million it invested. With Stockman’s departure, Chu and the rest of the class of new partners from 2000 and 2001 would be put to the test as they led their first deals.
The rst buyout Chu signed up, in September 2003, was Ondeo Nalco, known as Nalco, an Illinois-based maker of water-treatment chemicals and equipment owned by Suez SA, a French water, electricity, and gas utility that was selling off peripheral businesses.
Long before he began pursuing Nalco, though, another company had caught Chu’s eye: Celanese AG, a publicly traded, Frankfurt-based chemical company. It would take two years to get it to agree to a buyout and another two years to complete the last step of the transaction, but when it was all over Celanese would generate by far the biggest pro t Blackstone had ever seen. It would prove to be a showcase for the art of private equity, a brilliant mix of nancial wizardry with a hefty dose of nittty-gritty operational improvements. Together with Nalco, which also repaid Blackstone’s money many times over, Celanese secured Chu’s position as the fastest-rising star of the buyout group.
When Chu rst began running the numbers on Celanese in 2001, the company was in a slump. With the economy ailing, demand was down for its key products: acetyl derivatives used in paints, drugs, and textiles; acetates for cigarette lters and apparel; plastics used in automobiles; farming chemicals and detergents; and food and beverage additives.
Celanese was also something of an orphan. Originally an American company, it had been acquired by the German chemical and drug maker Hoechst AG in 1987. When Hoechst agreed to merge with a French pharmaceutical company in 1999, it sold o Celanese via an IPO on the Frankfurt stock exchange. More than half Celanese’s operations and revenue were in the United States, however, and only 20 percent or so in Europe, so it was a German company in name only and never found much favor on the German market. Moreover, German stock valuations tended to be lower than those in the United States. The logical thing, it seemed, would be to shift Celanese’s main stock listing to New York. Chu gured that Celanese would trade for one multiple more there: ve times cash ow, for example, if it
traded for four times in Germany.
Beyond that, Celanese looked ripe for cost cutting. “We believed there were signi cant costs that could be taken o Celanese because Celanese was the [product] of a number of acquisitions and mergers,” Chu says.
Identifying the target was one thing; buying a public company in Germany was another. Private equity had received a frosty reception in Germany, where managements were reluctant to sell out to investors who would unload their companies again in a few years. It was a cultural matter, in part.
German rms tend to be paternalistic, guarding their workforces and preserving corporate traditions. In addition, large German companies are required by law to give nearly half the seats on the boards to employee representatives, who uniformly regard private equity rms with suspicion. As a result, private equity rms had made many more investments in Britain and France, even though their economies were much smaller.
Twice Chu approached Celanese and twice he was rebu ed, rst in 2001 and again in 2002. In May 2003 he came back a third time, this time allied with General Electric, the American industrial and nancial conglomerate.
They proposed to merge Celanese’s plastics businesses—about a quarter of the total business—into GE’s global plastics division, leaving the rest of Celanese for Blackstone. Celanese’s stock was trading for around four times its cash ow at the time, a bargain price for a company whose pro ts were sure to soar if the economy picked up speed.
With GE at Blackstone’s side this time, Celanese’s board was nally willing to grant Blackstone a hearing, and Celanese soon allowed Blackstone and GE to begin the process of due diligence, talking to managers and combing through internal records to understand the business and unearth any problems.
But no sooner was that under way than GE’s management did an about- face and decided it did not want to invest more in the plastics industry. (Four years later GE sold its plastics business.) The talks continued with Blackstone, but Celanese seemed to be dragging its heals and Chu began to worry that he was going to nd himself rejected again and back at square one. To keep up the momentum, he did an end run around management, appealing to Celanese’s biggest shareholder, the Kuwait Petroleum Corporation, which owned 29 percent. The Kuwaitis signaled to management that they supported a buyout, and the process got back on track.
Celanese’s executives were deeply divided over the idea of selling the company and working for American nanciers. “It did take some time to become comfortable with how such a deal would be structured, managed, and create value for shareholders,” says David Weidman, then Celanese’s chief operating officer.
Winning over the company was only the rst challenge. Nothing about Celanese would be simple.
The nancing and the mechanics of the takeover were complicated by Germany’s takeover laws. Like most LBOs, Blackstone’s purchase would take place via a new holding company, which would borrow money to buy the operating business and use pro ts from that to cover the cost of the debt. But German law bars a buyer from taking cash out of a company until any remaining public shareholders have approved the move—a vote that could take a year or more to arrange. Blackstone therefore had to inject extra cash into the business at the outset so there would be money to pay the interest on the buyout debt in the interim.
Scaring up the equity also proved to be a problem. Blackstone needed about $850 million of cash to close the deal, but that would amount to 13 percent of Blackstone’s new fund—far more than it was willing to risk on any single investment. Chu had assumed he would be able to bring in other buyout rms to take smaller stakes but soon found that he was alone in his conviction that the chemicals market was turning up. All six of the competitors he approached turned him down. “A lot of them thought the cycle would get worse before it got better and told us, ‘You guys overpaid,’ ” Chu recounts. Ultimately he lined up $206 million from Blackstone investors, which invested directly in Celanese in addition to their investments through Blackstone’s fund. Bank of America, Deutsche Bank, and Morgan Stanley, the lenders for the buyout, agreed to buy $200 million of preferred shares—a cross between equity and debt—to fill the remaining hole.
In December 2003 the pieces nally came together and Celanese’s board agreed to sell the company to Blackstone for 32.50 per share, for a total of 2.8 billion ($3.4 billion). It was by far the biggest public company in Germany ever to go private. The 32.50 was 13 percent above the average price of the stock in the prior three months, but it still looked good to Chu, for that was just five times cash flow.
There was still one more hurdle: getting the shareholders to agree. The Kuwaitis had committed to sell their 29 percent, but other shareholders were
free to refuse the 32.50 o er, and German takeover rules gave them a perverse incentive to do so.
In the United States and many other European countries, once a buyer gets 90–95 percent of the shares of a company, it can force the remaining shareholders to sell out at the price the other shareholders accepted. In Germany, by contrast, shareholders can hold out and insist on an appraisal, and the arcane formulas mandated for the appraisals almost always yield a far higher price—sometimes well above the stock’s highest price ever. Until the appraisal process was complete, Blackstone therefore wouldn’t know exactly what it would cost to buy Celanese.
Because of the holdout right, Chu found himself playing a multibillion-euro game of chicken with the hedge funds and mutual funds that owned most of Celanese’s stock.
Blackstone had conditioned its o er on winning at least 75 percent of the shares at 32.50. Any less than that and the whole deal was o . The hedge funds and mutual funds didn’t want that to happen, because Blackstone was paying a premium, and the stock would likely fall back well below 32.50 if the deal was scotched. However, it was in each investor’s interest to demand an appraisal so long as most of the other shareholders opted for the 32.50.
“I remember sitting in my o ce negotiating with every hedge fund who had a stake and all the mutual funds,” says Chu. “They all wanted the deal to go through, but they did not want to be part of the 75 percent.”
On March 29, 2004, the day the o er expired, the outcome still wasn’t clear, and Schwarzman was on pins and needles. “[Steve] walked into my o ce around three thirty and just sat there, because he was obviously concerned about the deal,” says Chu. “We had run up something like $25 million in expenses, which was no small matter. Steve said, ‘Chinh, how is it going?’ I’d say, ‘Steve, I’m on the phone negotiating with everybody. I don’t know how it’s going!’ ”
Schwarzman returned again with only minutes to spare till the 6:00 P.M.
deadline. “We were 15 percent short. At six o’clock, Steve asked me, ‘What is the o cial tally?’ At that point, we were 1.5 percent short, but I told Steve, ‘I think we’re going to be ne when you wake up in the morning because a lot of guys came in at the last minute, and there is still stu stuck in the computer system.’ ” The next morning Blackstone learned it had garnered at least 80 percent of the shares, and the nal tally the following day was 83.6
percent. Blackstone controlled Celanese. It would take another four months before a shareholder vote could be held, however, two additional months before Celanese’s cash ow could be tapped to service the buyout debt, and more than a year and a half to buy up the rest of the German shares. In the fall of 2004 Blackstone o ered 41.92 a share to the shareholders who had refused to sell out, but there were no takers. Two American hedge funds that owned almost 12 percent, Paulson and Company and Arnhold and S.
Bleichroeder Advisers, held out for more. Finally, in August 2005, they both agreed to sell at 51 a share. A few stragglers stuck it out and ultimately got 67 per share. Paulson and Company would later gain fame for making billions in 2007 betting that the mortgage market would crash.
Blackstone didn’t wait for the last of the holdouts before setting about to reshape the company. That began as soon as it won control in April 2004.
The rst step was to, in e ect, de-Germanize the company, both to invigorate the management culture and to make the company more appealing to American investors for an eventual IPO. Celanese’s CEO, a thirty-eight-year veteran of Celanese and Hoechst, was slated to retire, and Blackstone wanted to install a brisk American-style leader. It settled on David Weidman, the company’s chief operating o cer, an American who’d joined just four years earlier from Honeywell / AlliedSignal and thus represented fresh blood.
German companies have a reputation for being plodding and bureaucratic.
The problem was exacerbated at Celanese by the fact that the company had three power centers: the head o ce in Frankfurt and large satellite o ces in Somerset, New Jersey, and Dallas that it had inherited over the years and never bothered to consolidate. Some key executives were based in the U.S.
o ces, and the three duchies often bickered and tripped over one another.
One of the rst moves under Blackstone was to centralize power in Dallas, an action it hoped would reduce the organization’s inertia and reduce overhead.
The move to Dallas saved $42 million a year. Retooling at the North American plants sped up production and allowed more jobs cuts, saving another $81 million annually. Celanese also o -loaded a money-losing business that made glasslike plastics and sold its stake in an unpro table fuel- cell venture, two drains on pro ts. It saved another $27 million annually by shifting most of its production of acetate bers used in cigarette lters to China, where cigarette sales were rising and labor is cheaper.
To augment its business, meanwhile, in October 2004 Celanese struck a deal to buy Acetex Corporation, a Canadian company, for $490 million and the next month agreed to buy Vinamul Polymers for $208 million. Acetex brought new facilities in France, Spain, and the Middle East and made Celanese the number-one producer of acetyl products, with a 28 percent market share worldwide. That pushed cash ow up by another $60 million.
Blackstone also endorsed Weidman’s plans to increase the capacity of several plants Celanese already was building in Asia.
The rapid- re asset sales and acquisitions, the operational changes, and the switch of headquarters “would have been extremely di cult to carry out as a German public company,” says Weidman, because the costs—including payments to laid-o workers and investments in new plants—would have cut deeply into Celanese’s earnings in the short term. Celanese’s bureaucracy at the time also would have thwarted the changes, adds Weidman, who remained on as CEO long after Blackstone exited Celanese.
As the company was trimming fat and expanding through acquisitions, business was taking off as the global economy improved. Even before the deal closed in April 2004, demand had picked up enough that Celanese had begun raising prices. Over the course of that year it publicly announced thirty price increases, which helped lift its top line to $4.9 billion from $4.6 billion the year before and pushed cash ow up 42 percent. On the strength of that, Celanese was able to borrow more money in September 2004 to pay out a dividend. With that, Blackstone recouped three-quarters of the equity it had invested in April. Thereafter, most of what it would collect would be pure profit.
Two months after the dividend, in November, Celanese led papers for an IPO to go public and in January 2005, only eight and a half months after Blackstone won control of the company, Celanese went public again on the New York Stock Exchange. As Chu had predicted, American investors valued the company more highly: at 6.4 times cash ow, or 1.4 “turns” more than Blackstone had paid. Celanese raised close to $1 billion in common and preferred stock, $803 million of which went to Blackstone and its coinvestors, on top of the dividend they received earlier. Blackstone and the coinvestors had now collected $700 million in pro t on their $612 million investment, and they still owned most of Celanese. By the time they sold the last of their Celanese shares in May 2007, Blackstone and the coinvestors raked in a $2.9 billion pro t on Celanese—almost ve times their money and by far the