Barbarians, the aftermath: Part 1, the overture
It ain’t closed until it’s closed, as the business sage Yogi Berra said:
“I never said half the things I said.”
… but now it’s closed. And now that the Equity Office sale to Blackstone is closed, and the fog of financial war is slowly lifting, we can take stock of who did what to whom, and what it means.
Let’s see … was it worth $39 billion?
A market milestone any way you look at it. The tussle set records all around.
· Largest (nominal-dollar) LBO ever.
· First time a public REIT has gone private.
· Fascinating exhibition of deal tactics, including the full array of M&A tricks.
For our previous posts on the proposed takeover, click here (newest), here, here, here, here, here, here, here, and here (oldest).
How Equity got itself noticed. As profiled in a lengthy Wall Street Journal article some weeks back, Equity originally hoped to be acquired by Vornado, but that large REIT proved slow-moving.
Last July, Steven Roth called fellow real-estate titan Sam Zell with a secret proposal: a merger that would put the two longtime friends atop a company that would dwarf anything else in the real-estate world.
Mr. Roth, chief executive of Vornado Realty Trust, knew that Mr. Zell’s Equity Office Properties Trust was in play. EOP — the nation’s biggest office landlord, with more than 590 buildings — had been a disappointment on Wall Street.
The public markets grade on only a few things: earnings and immediate earnings growth.
Public markets have little appreciation for heterogeneous assets clustered in a large vehicle, they are notoriously incapable of properly evaluating income-producing real estate, and they tend to penalize volatility very severely.
Short my stocks!
Why then did anyone go REIT in the first place? Mainly because, when the REITs re-emerged onto the scene in 1994-95, the slow-moving large institutional investors in major real estate were even more conservative. So by moving assets from stodgy private institutions to the public markets, owners made money.
Mr. Zell thought he could get efficiencies from owning big buildings en masse, but had ended up paying too much for some buildings and owning in too many weak markets.
The capital markets were unable to apply different cap rates to assets in different real estate markets. So they all got marked down.
With its stock trading at less than the value of its assets,
Pause on that throwaway comment. Assembling the property into a public vehicle was by now subtracting value from Equity Office.
EOP had become likely prey for cash-rich private-equity firms that could carve it up and sell it off.
Why did you wreck this company?
Because it’s wreckable!
When in doubt, get mad:
As EOP’s stock continued to lag behind its competitors, Mr. Zell became increasingly outspoken, lashing out at analysts — sometimes by name in public forums — who he believed didn’t fully appreciate the value of EOP’s portfolio.
When getting mad doesn’t work, what then is a body to do?
But Mr. Zell’s company looked like a boon for Vornado. With successful investments in real-estate and beyond, it was drowning in capital. A combination with EOP would give Vornado a myriad of choice properties in one swoop, at a time when competition has never been more fierce for commercial estate. Mr. Roth thought Mr. Zell, 65 years old, would leap at the chance to keep his empire intact, married to Vornado’s powerful financial machine.
Mr. Zell has always been about value and its dedicated servant earnings; his ego gains its satisfaction in ways other than top-of-the-pyramid visibility.
Mr. Roth guessed wrong. In November, after negotiations bogged down over price, Mr. Zell agreed to sell his company for $20.1 billion to the giant private-equity firm, Blackstone Group.
Lacking a date for the prom, Mr. Zell went with the boy who had the corsage and the Corvette:
Ready to be bought, Sam?
As I’ve previously posted, Mr. Zell believes that we are in a transitory environment with unprecedented and temporarily low yield rates; he wanted to monetize those rates by selling:
[The] giant takeover battle [is] fueled by a huge wave of cash washing through global markets. Low interest rates, a strong global economy and high commodity prices have flooded coffers around the world with cash that investors have increasingly sought to put in stable assets such as office buildings.
The feverish interest in commercial real estate — with sale prices for office buildings in particular climbing almost daily — stands in stark contrast to falling or stagnant prices in much of the residential real-estate market over the past year.
Well, not quite. Single-family homes aren’t income-producing. Apartments are. As I’ve said from the beginning, apartment REITs [Gee, does Mr. Zell own one of those? — Ed. Why, yes! — Auth.] may be next.
In a presentation to shareholders last June, Mr. Roth, 65 years old, expressed regret at the many deals Vornado had passed up as too expensive, only to see their valuations soar. “The simple answer is in this environment over the last 10 years, every single deal we didn’t do was a mistake,” he said.
Yet, thinks Mr. Zell, my good friend Mr. Roth seems reluctant to commit.
How can I get him to commit?
Perhaps he’ll show more enthusiasm if I date his classmate.
“Why, we had so many gentleman callers we had to send out to the church for extra chairs.”
Why Equity preferred Blackstone. Zeal and enthusiasm are charming attributes in a beau, and from the beginning, Blackstone’s breathing was heavy and passionate:
Even Blackstone’s original $48.50-a-share bid was a shock to Chicago-based Equity Office. “It started to get at a price that even exceeded our own estimates,” Chief Executive
Unlike Vornado, Blackstone appeared to have none of those Peter-Pan doubts about whether it wanted to move forward. With Equity’s share price lingering in the high 20’s only a year ago, its management saw the Blackstone offer as desirable:
Mr. Kincaid said its board favored the quick closing promised by Blackstone’s all-cash bid over the uncertainties of Vornado’s stock-and-cash bid, in part because of Equity Office’s own uncertainties about how long the office-building market would enjoy falling vacancies and rising rents. “We weren’t going to necessarily assume that the market was going to stay like this forever.”
Logical, and strategic.
From an emotional perspective, the ideal closing moment is when the seller thinks the buyer overpaid and the buyer thinks he got a rare and special jewel with hidden value. Throughout the transaction, Blackstone demonstrated ardor:
Raise your offer just a little more, darling.
To protect its downside as the price tag rose, in a key tactic, Blackstone insisted on increasing the fee it would be paid if it didn’t win. By the end, Blackstone had secured a $720 million “break-up” fee to share with investors.
In a previous post, I grumbled that I couldn’t understand why Blackstone needed or Equity agreed to a big breakup fee; what date gets a refund if the girl gives him a handshake instead of a kiss? That last clause at least hints at a reason: Blackstone, to be able to offer so much money on such immediate-closing terms, probably had to make commitments to its own capital sources, and the breakup fee would flow through Blackstone back to them and minimize its downside.
Meanwhile, downside-minimizing Vornado proceeded more cautiously:
Vornado’s response to each salvo from Blackstone was to raise the price of its part-cash, part-stock bid only slightly or not at all and then tinker both with the formula of its offer and the timing.
One man’s hesitant caution is another man’s prudence — and don’t forget, Blackstone came in at $48.50 when it quite obviously was prepared to go a lot higher. The first salvo was lobbed in by Vornado.
That was consistent with the style of Steven Roth, Vornado’s chief executive, who built his firm by hunting for bargains and moving carefully to close on targets. It took him nearly 10 years, for example, to secure the space opposite Bloomingdales department store, then occupied by Alexander’s, a one-time retailer, which was one of Mr. Roth’s great coups. But that sort of pace doesn’t work when private-equity firms enter the fray.
In exploring the unusual and awkward dance between capital and property (the fastest asset and the slowest), I have also observed that quicker response time (known in military jargon as the OODA loop) is a force multiplier. Here it translated into competitive bidding advantage:
Vornado first embarked on talks with Equity Office over the summer, at which point the company could be had for a price per share in the mid-$40s, according to regulatory filings. But Vornado hesitated, allowing Blackstone to pounce in mid-November.
Yet, however reluctantly, by mid-January Vornado had jumped into the fray.
Are you ready for REIT-o-mania?
How did Blackstone sustain its advantage and eventually win the prize?
[Continued tomorrow in Part 2.]
