Hi there wave

Welcome to the Weekend Read. Each Saturday, we send you something interesting. Forward it on to your friends (or enemies).

Going public can seem like the ultimate goal of a successful business. Companies are founded, they scale (or not) and hit their IPO (or not). Then the stock trades happily between investors for years to come. Shareholder capitalism in action!

But there's a whole sector of the economy that sit outside the public markets. And it's not just small firms or family businesses.

Many major companies and a lot of economic activity sit in private ownership. Sometimes they're owned by wealthy individuals or families. But a lot of the time, it'll be private equity firms.
What's private equity? 🤔

Private equity (or PE) firms work a bit like venture capital. They're investment management companies that raise funds from big investors and look for returns by taking stakes in interesting private companies. They'll take management and performance fees too. Like some VC firms, PE firms themselves often invests their own money too.

But where VC firms focus specifically on funding startups, PE firms invest in companies of all sizes, as well as alternative asset classes like hedge funds. If it can be owned, a PE firm probably does.

PE firms will even sometimes buy out entire public companies. In fact, rather than exciting innovations, PE will often acquire old well-established businesses, without much growth potential but lots of steady cash flow. Stuff like supermarket brands or hotel chains. They're often keen on declining companies that need a turnaround.

Returns come from improving the company and selling their stakes on to a larger business, another PE firm or back to the public markets.

Or the PE firm can hold their stake for the long-term, benefitting from the cash flow.

Among PE firms, one name is pre-eminent: Blackstone.
Blackstone black_circle️

Nowadays, Blackstone CEO Steve Schwarzman straddles the financial world like a greying, besuited colossus.

But back in the 1980s he was just a humble investment banker at a little firm called Lehman Brothers. That's him in the middle

"Sure hope nothing goes catastrophically wrong in 20 years, right guys?"

Schwarzman led mergers & acquisitions at the bank, overseeing huge deals for companies snapping up rivals or joining forces.

With that experience, he split off in 1985 to found his own private equity business with Peter Peterson (so good, they named him twice), Lehman's CEO and Richard Nixon's Secretary of Commerce.

At first they struggled to raise funds for deals and had to focus on the advisory business, consulting on Lehman's acquisition of smaller investment bank E.F. Hutton.

Wonder how they got that business? laughing

But the 1980s was a ripe time for corporate consolidation and within a couple of years they'd launched their first fund.

One of their first acquisitions was staid railroad freight company CNW, but they soon moved on to bigger fish. Over the years they've invested in the likes of:

    Allied Waste
    Orangina
    United Biscuits (maker of the digestive)
    Hilton Worldwide
    Nielsen Holdings
    The Weather Channel
    And Legoland

Between 1987 and their 2007 IPO, Blackstone invested over $20B in private equity deals, and even more in real estate.

Like many PE firms, one of their main tactics was the controversial leveraged buyout (LBO), Gordon Gekko's mechanism in the classic movie Wall Street.

Basically, the buyer puts up some of the money but funds the rest with debt. Crucially the loan is secured by the assets and cashflow of the target company. So the buyer can get a new company with a fraction of the necessary capital and if the company fails, they're not really on the hook.

This is a controversial tactic and some so-called corporate raiders were accused of using LBOs to force their way into a company, sell off valuable assets, cash out and leave the company to flounder with high debts.

Since the financial crisis, LBOs declined due to regulatory crackdowns and some PE firms adopted more vanilla approaches. However, in the context of historically low borrowing costs and with memories of 2008 slipping away, they may be making a comeback.
Blackstone/BlackRock black_circle️... black_circle️

In 1988, Blackstone partnered with a hotshot team led by Larry Fink   to create a fixed income management division. Called Blackstone Financial Management - though Blackstone only owned 50% - it focused on providing fixed income asset management to big institutions.

That's bonds, loans and other debt instruments, including mortgage-backed securities which Fink had helped pioneer.

"Sure hope nothing goes catastrophically wrong in 20 years, right guys?"

The division grew very quickly as institutions snapped up the innovative new securities. An IPO was considered and the division was renamed BlackRock to give it a distinct identity.

However, some seams began to open between Steve and Larry.

Fink wanted to offer company equity to new hires to attract the best of the best. But Steve didn't want Blackstone's stake diluted. Eventually, they agreed to split, with a complex series of sales and swaps eventually divesting one from the other.

As part of that, BlackRock greatly decreased its debt security business and acquired more equity asset management units.

BlackRock beat their backer to IPO, going public in 1999. They rode out the dotcom boom and focused on acquiring more asset management units. One of their most notable moves was purchasing Barclay's iShares ETF business in 2009 for only $13.5B.

With the rise of low cost, passive ETFs, BlackRock have captured a huge amount of capital in iShares.

BlackRock is now the world's biggest asset manager and a top 10 shareholder for a huge number of public companies. And Blackstone is the biggest alternative asset manager, as well as one of the world's biggest landlords via their real estate holdings.

    BlackRock assets under management: $6.5T
    Blackstone assets under management: $470B

However, with BlackRock's low-fee, high scale model and Schwarzman's larger ownership stake of Blackstone, Steve Schwarzman is still much wealthier than Larry Fink. money_with_wings
Blackstone Inc. bank

A couple of weeks ago, Blackstone completed its conversion into a corporation. While Blackstone went public in 2007, they did so as a publicly traded partnership rather than a corporation, mainly for tax reasons.

However, after the Trump corporate tax cuts, the relative advantage pretty much disappears. FYI Schwarzman and Trump are old friends and he served as head of Trump's business council until its dissolution.

Anyway, the change opens Blackstone up to new opportunities. In particular:

    It's easier for investment managers to hold Blackstone stock
    The stock can also be included in indexes (and so be bought by index funds)

After the announced change, Blackstone's stock has risen swiftly; Schwarzman, the largest individual shareholder, has seen his net worth rise 20% since April.

Amazing what a policy tweak can do.

Between them, Steve and Larry will continue battling for the world's investment capital, one selling broad index tracking, the other the unique opportunities of strategic dealmaking.

Blackstone vs. BlackRock. Steve vs. Larry.