Barbarians, the aftermath: Part 3, the crescendo
[Continued from yesterday’s Part 1 and Part 2.]
[Previous posts on the proposed takeover here (newest), here, here, here, here, here, here, here, and here (oldest).]
So far we’ve seen how Blackstone won.
Or did it?
Who got what? Despite Vornado’s entry, Blackstone prevailed, albeit at a twice-raised price. As the Wall Street Journal put it:
Blackstone Group’s triumph over Vornado Realty Trust in the battle for Equity Office Properties Trust marked another big win for private-equity firms, but the pitched battle shows that the buyout firms face a tougher acquisition environment than last year.
After watching its initial bid get trumped by the surprising Vornado-led bid, Blackstone employed aggressive tactics and bold bidding to capture its prey.
Aggressive tactics? They paid up!
Just keep raising the paddle and you’ll win eventually
In the end, the buyout firm paid $23 billion and assumed $16 billion in debt to win Equity Office. The final price tag was 14.4% higher than its initial bid back in mid-November.
The buyout is a record price in several senses, not only the biggest nominal-dollar LBO ever, but also a heroic bid in terms of yield. As the pay-me-and-I’ll-show-you
Vornado Realty’s withdrawal from the battle for Equity Office Properties Trust hands Blackstone Group boss Steve Schwarzman the biggest collection of office buildings in the country. But he isn’t just buying it for cash from a seasoned investor, Sam Zell. His rival for EOP’s affections, Vornado Realty boss Steve Roth, is also a world-class landlord. Can Blackstone do better than the smartest guys in the property universe?
It’s hard to imagine the improvements will be in straight operations; the plays have to be financial.
It is certainly paying a hefty price to try. At $23 billion, as well as $16 billion in debt, the cap rate, or the yield from rents, comes in at around 5%. Once transaction fees are included, that isn’t much better than the yield on Treasury bills.
Cap rates are the inverse of yield rates, and when you buy income-producing property, you’re making a statement about the yield you’re willing to take over a long period of time.
We’ll come back to that 5% cap rate in a little while — for now, just appreciate how low it is even by LBO standards:
It is also lower than other recent deals — including by Blackstone — which had cap rates closer to 6%.
Vornado’s unwillingness to top Blackstone’s $55.50-a-share offer also raises questions. Given Vornado’s track record of extracting greater value from its properties than rivals, this was a surprise. Investors had bid EOP shares up to $56.05 on expectations that Vornado would deliver another couple of dollars.
It’s always surprising when somebody quits in an auction
They keep bidding, I keep auctioning
It isn’t clear why Vornado backed off. One explanation is that it felt the price just got too high.
What, you need another reason?
Need another reason, number six?
When KKR won RJR, it lost by winning.
In one of the biggest buyout battles before EOP, Kohlberg Kravis Roberts nabbed RJR Nabisco but its returns suffered.
Meanwhile, Equity Office’s shareholders won by selling:
It may also have been the conditions Vornado attached to its bid that EOP wanted removed.
Certainly, if one were a director of Equity Office thinking about life after the sale, one might want to demonstrate awareness of fiduciary duty by accepting whichever offer was better at the time, and simultaneously encouraging both bidders to raise their offers further.
Yet, these moves left the impression that Mr. Zell strongly favored cash over Vornado’s mix of cash and stock, which would have left him exposed to commercial real estate. During the bidding, EOP at one point recommended a Blackstone offer that — once discounted for the time value of money — was about 90 cents inferior to a competing offer by Vornado.
It all depends on your discount rate, doesn’t it?
What percentage will you use?
What scales: ownership, management, or finance? Even as the financial sector has been rapidly consolidating, does consolidation apply to the other essential functions: ownership and management?
In some ways, ownership can scale: group buying, financial control, cost efficiency, all benefit from having a larger inventory or portfolio. By contrast, property management is an infantry-level function — there is no substitute for boots on the ground. Quality varies:
EOP’s huge size wasn’t necessarily a blessing. To some tenants, the buildings’ owner was a distracted landlord that couldn’t keep tabs on property needs. Last year, EOP lost the three main tenants in its 191 Peachtree building — one of Atlanta’s prime downtown office addresses — when the tenants’ leases came up for renewal, leaving the building virtually empty.
As compared with apartments, offices are thought safer because there are longer-term leases, better credit-quality tenants, and less intrusive maintenance.
Want to buy some offices from me?
But those who tout offices forget an advantage of apartments — rolling leases mean the building is never see-through. When a building is empty, cash flow suffers, and the owner may be forced to sell at a bad time:
Cousins Properties, an Atlanta REIT, recently bought the building for $153 million, a price one research firm described as a fire sale.
Not those cousins!
“We bought it at $127 per square foot and you couldn’t build it for $350 a square foot,” says Tad Leithead, a senior vice president with Cousins.
Mr. Leithead may know something about overpaying that the rest of us don’t — check our the eerie coincidence of his leasing career:
Leithead began his career as a leasing agent with Trammell Crow and was responsible for leasing more than 3 million square feet of office space, including the corporate headquarters of RJR Nabisco
Feeling lightheaded? (Another dreadful pun)
Cousins executives are betting that their intimate knowledge of the
On what, I wonder, is Blackstone betting?
[Concluded tomorrow in Part 4.]
