The triumph of Blackstone on Wall StreetDecember 20, 2011: 5:00 AM ET
The private equity giant has soared by obsessing about danger - and by becoming more than a one-man show.
FORTUNE -- The last time Blackstone's Steve Schwarzman was featured in the pages of Fortune, it was March 2007, and private equity firms were reveling in their moment of maximum glory. A frenzy of buying and bidding was pushing takeover deals into the tens of billions. Blackstone's founders, Schwarzman and Pete Peterson, already zillionaires, had taken home hundreds of millions more as the firm held a richly priced initial public offering. The $3 million party that Schwarzman threw for himself on his 60th birthday earned him notoriety as a tuxedo-wearing symbol of excess. This magazine crowned him "The New King of Wall Street."
In that 2007 article, a former Blackstone employee sounded a cautionary note about Schwarzman and his firm: "Never be the poster boy. The era changes, and the poster boy gets ripped off the wall." Well, the era certainly changed. The financial crisis and the grinding slowdown that followed have humbled even the buyout princes. Cerberus's audacious buyout of Chrysler and Apollo's acquisition of Linens 'n Things both ended with humiliating trips to bankruptcy court. Blackstone's top competitors, KKR (KKR) and Carlyle Group, had to repeatedly postpone IPO plans. And Carlyle was forced to close a hedge fund that it had launched to take advantage of the boom.
For all the turmoil, though, the poster boy didn't get ripped from the wall. Today Blackstone (BX) is bigger than ever. The firm had $157.7 billion in assets under management as of Sept. 30, up from $88.4 billion in May 2007. With Blackstone earning a steady 2% management fee on the vast majority of those dollars, the firm has seen its fee revenue rise 60%. So prosperous is Blackstone that average compensation was about $810,000 per employee in 2010. By comparison, the staff at Goldman Sachs (GS) had to get by on a relatively paltry $430,000 per head.
You wouldn't know those gaudy numbers if you read Blackstone's public filings, which the firm has released since going public in 2007. Those filings have consistently shown losses. That's because Blackstone is a partnership, and its goal is to generate cash for its partners rather than reporting earnings.
The firm is now more diverse than ever. Its private equity business, which oversees $43 billion, accounts for just over a quarter of the assets the firm manages, and Blackstone has three other lines of comparable scale. Its real estate and hedge fund businesses (the latter creates individualized funds of funds for clients and invests in startup hedge funds) manage $41 billion and $40 billion, respectively. Its credit unit, which buys pieces of loans and distressed debt, oversees $34 billion. Blackstone's fifth line, its advisory group, has become a top choice for complex deals and restructurings.
Returns for all of Blackstone's funds consistently rank in the top quartile of their peer groups, according to data firm Preqin. Blackstone's private equity funds, for example, have averaged 22% annual returns to investors, after fees, since the first buyout fund was raised in 1987.
Though it suffered large writedowns in 2008, Blackstone avoided a cataclysm. That's largely because Schwarzman has always been obsessed with being "alert to danger," as he puts it, instilling a caution that borders on paranoia. Blackstone anticipated the mortgage meltdown, the fall in equities prices, and the end of easy credit, and pushed hard for an IPO before the collapse. (That was good for Blackstone -- not so good for its shareholders.) Blackstone's hedge fund group wisely directed some of the hedge fund managers it worked with to bet against subprime mortgages. And in 2006 and 2007, Blackstone sold 81% of its private equity portfolio as prices were rising. Those decisions left the firm awash in cash when opportunities emerged in 2009.
Another key reason Blackstone has been able to grow: its chief operating officer, Tony James. Though overshadowed by Schwarzman, James is an adroit manager who has insulated his staff from Schwarzman's perfectionism and relentless demands, positioning Blackstone to be that rare Wall Street creature: a firm that can thrive even after its founders (eventually) depart.
Not smarter - more aware
Steve Schwarzman really, really wants to know what you think. He craves information, and he'll seek it from anybody, anywhere, anytime. Over Easter weekend this past spring Schwarzman started hearing from people he bumped into that $4-a-gallon gasoline was crimping their lives, forcing them to carpool and cancel vacations. "They were scared," Schwarzman recalls. He began asking everyone he encountered -- waiters, gas station attendants, his dentist's assistant -- what they thought.
Soon after, he put aside his planned agenda at Blackstone's management meeting. "Something's wrong with the economy," Schwarzman told his partners. Some disputed him, citing solid economic numbers. Then they began sniffing around for signs of a slowdown -- and found them. By summer Blackstone was prepared, with its portfolio companies trimming debt and lining up credit in advance of another squeeze.
A similar thing occurred on a bigger scale in 2006. Members of Blackstone's real estate teams in the U.S., Spain, and India recognized that residential real estate prices were exploding in all three countries, far outpacing growth in income. Blackstone found itself priced out of deals. The firm's partners concluded that the real estate bubble was about to burst and began selling. All told, Blackstone sold $60 billion in real estate assets from 2005 to 2007, including the $27 billion it flipped in the Equity Office Properties deal.
To hear Schwarzman tell it, the firm's footprint is the secret of its success. With a long-established presence in four asset classes vs. only one or two for rivals, Blackstone gets daily feeds of information that give the company a competitive edge. "We're not smarter than anyone else," Schwarzman says. "We just see more."
Schwarzman is so detail-oriented that this explanation stretches over 20 minutes, a not uncommon duration when he digs into an interview question. Another query, about Occupy Wall Street, sparks its own 18-minute dissection of a decade's worth of economic history, only to conclude with the bland observation that the protests are an understandable response to the economic slowdown.
Whatever the reason, Blackstone's businesses seem to be humming. After Lehman Brothers went under and GE Capital (GE) retreated, Blackstone's real estate group, led by Jon Gray, became the last giant left in the forest. Gray's team came out of the crisis with $12 billion to invest and has returned an annualized 28% to investors since inception in 1992. Blackstone's hedge fund division, run by Tom Hill, has delivered 10% annualized returns since 1990 vs. 8% for the S&P, and has enjoyed net inflows every year between 2007 and 2011, while the industry suffered net outflows.
Blackstone's fastest-growing business is credit investing, run by Bennett Goodman. The division's flagship fund has averaged 17% annual returns since inception in 2007. And its advisory group, led by John Studzinski, has handled marquee transactions, such as representing Bank of America (BAC) when Warren Buffett made his $5 billion investment in it, and handling complex bankruptcies, such as that of the Tribune Co. Overall, Blackstone's fee-related revenues increased by about 9% from 2009 to 2010.
Blackstone is underrepresented in Russia, Africa, Australia, and South America outside of Brazil. "We believe that the United States and Europe will grow more slowly," says Tony James, "but we won't expand globally for the sake of saying we're everywhere." The firm's chief expansion initiative for now: It's raising a new fund to invest in energy.
Blackstone refuses to start a business unless it has the right person to lead the effort. "Most firms would jump into an attractive business and then, when there were problems, replace people who didn't work out," says Mario Giannini of Hamilton Lane, which helps select private equity opportunities for institutional investors. Tony James points out that Blackstone got into LBOs, real estate, hedge fund investing, and credit long after its rivals. Yet it still climbed to the top. As James puts it, "There isn't much first-mover advantage if it means throwing a lot of things at the wall and abandoning what doesn't stick."
A leader delegates
It often feels that Steve Schwarzman's philosophy infuses every inch of Blackstone. Employees high and low preach the need to operate with a "zero defect" mentality. They all express an intolerance of error, a willingness to challenge one another, and constant vigilance against the prospect of losing money.
Perhaps surprisingly for a CEO, and one who is not lacking in ego, Schwarzman was able to apply the zero-defect approach to himself. He came to recognize that in some ways he was a major impediment to the firm's long-term future. Beginning with the firm's founding in 1985, Schwarzman seemed to make every decision, big or small, at the firm while his co-founder, Pete Peterson, served as its outside face until he retired in 2008.
Schwarzman wasn't a screamer, but he was impatient and a legendary micromanager. He wanted to know what everybody was doing at every minute and would sometimes proofread letters before employees sent them out. Schwarzman says he treated people "like they were deals, trying to instantly change whatever was wrong."
As a result, Blackstone struggled to keep its biggest stars, who would go on to greater renown at their own firms -- Evercore's Roger Altman, BlackRock's Larry Fink, Cendant's Henry Silverman, and Silver Lake's Glenn Hutchins. Only a handful of early employees at any level stayed on over the years. Schwarzman knew his firm would need to retain talent to thrive over the long haul.
Ultimately he realized he could give up much of his responsibility and be the happier for it. So, in 2002, Schwarzman hired James away from Credit Suisse to be Blackstone's COO. "Tony is a better manager than me," he cheerfully acknowledges. The result, with James in charge of the firm's day-to-day responsibilities, has been both a happier and more liberated Schwarzman -- James has let Steve be Steve -- and a happier and more liberated team.
James is the virtual antithesis of Schwarzman. Schwarzman is emotional; James, calm. Schwarzman is 5-foot-6; James, 6-foot-1. Schwarzman is an outspoken Republican; James, a Democrat. James doesn't share Schwarzman's love of the spotlight, and he has a New England Yankee's sense of thrift (as much as any centimillionaire can). He takes the subway and buys all his dress shirts at Costco.
Schwarzman and James diverge even in their snacks. As I interviewed Schwarzman one day, he ate mixed berries and cantaloupe on a porcelain plate, slicing his strawberries efficiently and quickly with a knife and fork. By contrast, James munched on peanut butter sandwich crackers when I spoke with him, leaving a fluorescent orange residue on his long fingers.
James reorganized Blackstone's management to take pressure off Schwarzman. He not only created a 16-member executive committee made up of the heads of Blackstone's business units, he also persuaded Schwarzman to let it decide -- by consensus -- everything from strategy to new initiatives to personnel issues. Not incidentally, membership on the committee exposes division chiefs to other parts of the firm, an important step in grooming someone to eventually run Blackstone.>
James also masterminded the 2008 acquisition of asset manager GSO Capital Partners, which doubled Blackstone's credit division. GSO became an early-warning system, giving Blackstone insight into the debt markets at their most perilous time. And GSO made money for Blackstone during the downturn by buying up discounted debt in Blackstone's portfolio companies. Given that Blackstone owned the companies, GSO knew they could service their debt.
Then there were cultural changes that might seem almost laughingly touchy-feely for a firm of alpha financiers, but that lightened what was once a dark and intense place. To combat the terror many employees had of challenging Schwarzman's ideas -- challenges that Schwarzman actually welcomed -- James required junior analysts to present once a month at investment committee meetings, to make them speak up. In part because of such measures, and because of James's calming presence, meetings once dominated by Schwarzman have given way to almost Socratic cross-questioning.
James has also nurtured employees, setting expectations and providing tools to meet them. He implemented an anonymous, 360° employee review program, and made sure that those with technical problems got training and those with behavioral problems got coaching.
Blackstone's turnover rate is now half that of the average Wall Street firm, and it has nurtured a cadre of stars who could some day lead the firm. The candidates include Gray in real estate and Goodman in credit, either of whom could ultimately become James's greatest legacy. "There's a shortage of great managers and a shortage of people with a broad knowledge of finance," says Peterson. "I have never seen anyone who combines the two the way Tony does."
Learning from mistakes
James's success has allowed Schwarzman to aspire to the statesman-like role that Peterson played for many years. These days Schwarzman hobnobs at Davos, submits editorials about policy, and raises money for presidential candidate Mitt Romney. Schwarzman donated $100 million to the New York Public Library, whose main building is now named after him.
But the feisty and blunt Schwarzman occasionally stumbles, such as when, at a board meeting for a nonprofit last year, he blasted the Obama administration's attempts to raise taxes on private equity firms. "It's a war," he said. "It's like when Hitler invaded Poland in 1939." Schwarzman apologized and declines to discuss the episode today. But he noted in a recent speech, "As a result of Blackstone's success, I find some of the things I say get a lot more scrutiny than they used to. And sometimes I say things I wish I could take back," adding that "sometimes a bad analogy can get in the way of a good argument."
He made those comments in October at the Alfred E. Smith dinner in New York, a Catholic charity fundraiser known for its speeches over the years by presidential candidates -- everybody from Ronald Reagan to Barack Obama -- rather than for appearances by Wall Street potentates. But at a moment when many fellow financiers, cowed by the furor surrounding Occupy Wall Street, were keeping a low profile, there was Schwarzman, who is Jewish but married to a Catholic. ("Frankly, you never know when you're hedged enough," he quipped.) Schwarzman helped raise more than $2 million that night, and he has contributed heavily to Catholic schools. He's been known to write letters to parochial students who benefit from his largesse, congratulating them on their achievements and inquiring about areas that need improvement.
During his speech, Schwarzman cracked topical jokes and made a plea for a return to American greatness. Mostly, though, he skewered himself, mocking his infamous birthday party and the fact that he remains a regular guy who checks out library books and leaves his name "carved into marble at the entrances to the building." Schwarzman managed to make it through the speech without putting his foot in his mouth. At the table where I was seated with Blackstone executives and Schwarzman's joke writer, there was a palpable sigh of relief. A Blackstoner pulled me aside and said, "See? Steve learns."
Indeed, friends say that Schwarzman's outsize persona conceals a man who continues to learn from his mistakes. At 64, he seems more engaged and content than ever. Schwarzman loves the intellectual stimulation, the connections, the speaking engagements. He likes being king. (The money ain't bad either.) He says he has no plans to retire. As one of his closest friends, J.P. Morgan Chase (JPM) vice chairman Jimmy Lee, puts it, "Steve doesn't have hobbies." James jokes about his partner's hypercompetitiveness: "Pete worked here until he was 83, so that means Steve will probably be here until he's 84."
It's not impossible to see him in some sort of government role if Mitt Romney becomes President. If that were to happen, it would be possible for the first time to imagine a Blackstone without Steve Schwarzman.
Reporter associate: Doris Burke.
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This article is from the December 26, 2011 issue of Fortune.