Stephen is an alumnus of HBS and is on the School’s visiting committee. He came to visit class last Friday and we managed to catch up with him for a few minutes beforehand to ask him a few questions about the industry, his firm and his personal life.
The Harbus: Sir, thank you for sparing the time to speak with us.
SS: It’s my pleasure.
The Harbus: We live in tough times; the economy on the brink of recession, the collapse in the markets and all the issues of national security following September 11th. How has this affected Blackstone over the last couple of years and how have you coped?
SS Well, we have exposure to a whole array of different industries and it affects us directly in terms of our travel sensitive businesses. Some of our hotels were adversely affected, particularly in the first few months after 9-11. Some of our manufacturing businesses were adversely affected which supply the aerospace business. It’s also resulted in lower overall equity values which, perversely, are good for us in terms of buying new businesses. The overall uncertainty and caution has created a variety of issues including exacerbating the credit crunch which has forced companies to sell quality businesses to raise cash, and that’s also an advantage for us.
The Harbus: So, it’s depressing the returns of your existing investments, but it’s creating lots of opportunities for new buyouts. Is that why you went after such a large fund?
SS: Well what we’ve learned is that it’s very difficult to predict the future and that having a large amount of capital in an uncertain time is usually a very good place to be. We’ll see in another 5-10 years whether that was wise or not.
The Harbus: Some would argue that since a lot of funds have not even managed to invest the capital that they have, raising such a large fund means that there is even more capital chasing fewer targets and therefore you are depressing returns even further because of the supply demand balance.
SS: Well, returns are depressed not because of the supply and demand for money per se. Returns in private equity are basically keyed to a spread over the S&P and most people may well have noticed that in the last three years or so there has been no return to the S&P. In fact it has been strongly negative. Since 1997 in fact, there has been no return to the S&P. So in a world where the average equity investor has received no return, to not expect a diminished return from private equity would be absurd on the face.
When returns on the S&P, even thought this sounds almost quaint, were for 5 years compounding around 18%, the return on private equity went up to a huge spread. Most good firms were making 40-50% compounded on a gross basis so that would be more than 2000-3000 basis points over the S&P. If the S&P is flat, to be earning 1000 basis points over would be a 10% return and you’d say that that is gravely diminished. It’s still 1000 points over. If you were 2000 points over, that would be 20% and that would be not dissimilar in terms of its spread to the S&P in the good times. So I think that people who believe that the private equity business is an absolute return business per se are wrong. As much as they would like to be right, they are wrong.
The Harbus: Do you think that private equity firms will now search more overseas, since there is an excess of funds in the United States?
SS: Well I think that’s a bit cyclical. When the US was experiencing over the last 2-3 years, a declining economy and declining stock prices, most intelligent people weren’t buying assets to have them be worthless every day. At that point the European economic cycle was out of phase, Europe looked better and firms sensibly looked to Europe to put money there. That cycle is modifying so that the US economy is now slowly increasing. You’ll be seeing more deals in the US as a result. Europe, which has been very active, will continue to be active but will be, I believe, somewhat muted in the sense that the Euro zone this year is expected to only have GDP growth of 1-1.5%. The US growth will probably exceed that by 50-100% so activity levels will swing back to the United States. There’ll also still be activity in Europe but the disparity will not be as visible as you have observed.
The Harbus: What do you think will happen in the private equity industry over the next 5-10 years? Will there be a shakeout and what’s your vision for Blackstone in 10 years time?
SS: Well I think there’ll definitely be a shakeout over the next 5-10 years, in large part because there’ll be differential performance.
Also, as the size of their portfolios have significantly shrunk, public pension funds and other asset managers will no longer have their alternative asset category growing as rapidly. In some cases it’ll be shrinking, along with all of their total assets, and they’ll have to be much more selective in terms of who they give money to. I think that firms like ourselves, to the extent that we continue to have a strong record in all of our various products, will be a major beneficiary of that trend. As individual asset allocators become more risk averse they’ll go with branded names of firms with very good performance. And we’re experiencing that now. That’s one reason that enabled us to raise a very large private equity fund.
The Harbus: On a more personal note, as an alumnus of the school what’s your most vivid memory of being at HBS?
SS (laughing): The miserable food at Kresge was one of the more vivid memories.
The Harbus: We’re thankful for Spangler
SS: Well, Spangler is so astonishingly beautiful that it’s veritably unrecognizable as a part of Harvard Business School. The other vivid memory that I have is how cold it was walking across that bridge to Harvard Square.
The Harbus: Well that hasn’t changed.
SS: Academically my strongest memories were how little I knew about accounting and how much I enjoyed production, which was a course I thought I inherently had no interest in. I enjoyed understanding the ways in which businesses would marshal resources. I went into finance so I basically didn’t follow up that interest, but since we own so many companies I always take an interest in how they actually work.
The Harbus: Obviously you are a very busy man, but if you were to spend a lot more time doing anything you liked, apart from work, what would you spend it doing?
SS (laughing): Uh, what would I do? I’d read more books.
The Harbus: What are you reading at the moment?
SS: I’m reading the biography of Robert Maxwell, Israel’s super spy, which is actually quite astonishing and it’s hard to figure out whether it’s really fact or fiction.
The Harbus: Mr. Schwarzman, thank you very much for your time.
SS: It was my pleasure.