In Greek mythology, King Midas is popularly celebrated for his ability to turn everything he touched into gold. Tap a twig, stroke a stone and, presto, gold.
Legend has it that the Midas touch was a gift bestowed on him by Dionysus after the hospitality the king showed the god of wine and pleasure’s foster father, who had one day, as the story goes, wandered off drunk and got lost before amiably intercepted and provided for.
In real estate lore, Midas is Blackstone, the private equity titan with more than $900 billion of assets under management, around a third of which is real estate. That ranks Blackstone as the largest real estate investment manager in the world, where everything they touch seemingly turns to gold.
And as sure as Midas drew his power through the endowment of hospitality, Blackstone has made a fortune through its deft investment in the hotel space. Its most rutilant deal—one that 15 years later has gained even further fame and study—was the $26-billion acquisition of Hilton in 2007. The structure of it is the stuff of legend—a case study for first-year MBA students aspiring to become the next Jonathan Gray, the man who orchestrated it, and today is president and COO of Blackstone, with a net worth of $6.3 billion, according to Forbes.
Blackstone had hooked an icon. Hilton spans more than 100 years, founded by the Stetson-wearing Conrad Hilton, who died in 1979, but was reanimated in the hit TV drama series "Mad Men" as one of the few men who could tweak the phlegmatic Don Draper.
Hilton's storied history includes names such as Waldorf Astoria and DoubleTree, but by the 2000s, it lost some of its luster and needed a new coat of paint. Blackstone saw an opening and took a shot. Swish.
The transaction was a resounding success, but not without hardship. The question is: Was Blackstone's acquisition of Hilton a once-in-a-lifetime deal? Is there a circumstance, a scenario, that would allow it to be duplicated?
Blackstone's acquisition of Hilton was achieved through an all-cash leveraged buyout, or LBO, which is an acquisition of another company completed almost entirely through debt. In the case of Hilton, $20.5 billion, or 78.4 percent, was financed through debt with the remaining $5.6 billion in equity. It was Blackstone’s first megadeal since its $39-billion buyout of Equity Office Properties, in February 2007, and made without a partner, unlike some of its more recent hospitality acquisitions, such as its 2021 pick up of Extended Stay America, with Starwood Capital as wingman. At the time of the deal, the Wall Street Journal called it “one of the group’s more aggressive forays,” and “at a time when the market is full of talk about tightening conditions for leveraged deals.”
The deal, which could have easily gone sideways since it was made just prior to the Great Recession of 2008, bagged Blackstone a hefty sum. The firm netted a $14 billion profit when it fully cycled out of it in 2018. The use of LBOs began to wane post-2008.
Whether or not a deal of the magnitude of Hilton can ever be replicated is undetermined and relative to factors including need, circumstance and timing. Blackstone's highly leveraged acquisition of Hilton was done in a much higher rate environment than even today. In 2007, the federal funds target rate was above 4 percent. As of May 2022, the target range is 0.75 percent to 1 percent.
Blackstone began its pursuit of Hilton in 2006, furtively naming the transaction internally "Project Murphy," a nod to actor Eddie Murphy, who played the lead role in the 1984 film "Beverly Hills Cop." (Hilton at the time was based in Beverly Hills, Calif.)
Blackstone's acquisition of Hilton figuratively set off fireworks within the industry: the deal was announced on July 3, 2007. Weeks later, the economy started to spasm and a year later Lehman Brothers collapsed. Gray concluded he needed new stewardship for Hilton and turned to Chris Nassetta, then the chairman and CEO of Host Hotels & Resorts, a real estate investment trust that owns hotels. But it took convincing: Hilton at the time of the deal was not the Hilton of today. The company was headquartered in Beverly Hills, Calif., where existed a milieu of lassitude and insouciance among the top brass. Further, Hilton did not act as a unified company, but a Balkanized collective of regions and hotels with no central accountability.
Ultimately, Gray cajoled Nassetta into the position, but dark days lay ahead. Beyond the vast organizational changes Nassetta set out to make (one industry insider said Nassetta was persona non grata at Hilton offices and hotels in the early days), including moving the headquarters to the Washington, D.C., area, there was a huge debt cloud hanging over the company with loans maturing in 2013. It was still years away but the economy was souring, Lehman's demise was on the horizon and, with it, the Great Recession, which did not augur well for travel.
Blackstone and Hilton worked fast to restructure the debt. According to Washington Post reporting, in subsequent months they negotiated with the banks who held the notes and were able to work out new terms that not only pushed the maturity of the loans out to 2015, but forced the banks to take a loss of some $1.2 billion after Blackstone bought back $2 billion worth of debt for $800 million. On top of that, the consortium of banks that held the loans removed another $2 billion off the debt by converting it into Hilton preferred stock.
In the end, Blackstone's bet on Hilton paid off: A few years of hardship ensued but a long lodging upcycle emerged thereafter. Blackstone was able to refinance some $14 billion left of debt and push out the maturity on it even farther. Hilton was profiting under Nassetta's leadership and emerged as not just a domestic purveyor but a global force. In late December 2013, Blackstone took Hilton public with a valuation $7 billion higher than what Blackstone bought the company for. It began to wind down its investment beginning in June 2014 and took its last profit on it in 2018.
Private equity has a lineal timeline: It enters an asset, effects value enhancement, then exits. The longer the hold term, the more it reduces its fund's return. For example, holding a developing asset that earns a yield of 20 percent versus a stabilized asset at 8 percent. As soon as you are done enhancing its value, the return degrades over time.
Like a good comedian, timing is everything in the world of private equity, where when you get in is as important as when you get out. For private equity, risk is temporal. Blackstone’s acquisition of Hilton was the antithesis of good timing, having been bought just prior to the Great Recession. The timing could not have been worse, but, as Sean Hennessey, president of Lodging Advisors, a New York-based advisor for hotel investments, and Clinical Assistant Professor at the Jonathan M. Tisch Center of Hospitality at New York University, said, Blackstone made all the right moves. Above all, installing Nassetta CEO. It was a wise decision, according to Hennessey: “It was not apparent how screwed up [Hilton] management structure was,” he said. “Nassetta made it a vibrant company.”
Blackstone's Hilton play was like a broken play in football: a fumbled snap that ended in a touchdown. The quarterback of Hilton's success today says large-cap private equity deals are unlikely, especially given the fluid rate environment and the likelihood of the Fed continuing to raise rates. Most private equity deals depend on leverage, and when debt rates increase, it impacts the cost of capital.
"When rates go higher, and probably are, private equity is less active traditionally because they tend to rely on higher leverage," Nassetta told me in New York recently, adding most are also shorter-term owners, a two- to five-year frame. "I think there will be fewer deals done out of private equity as a result, but things shift around. Everyone is hopeful the Fed is successful in taming inflation and they do that by slowing down the economy. When that happens, there is pressure the other way on rates and it is harder to do some of the real big stuff because the debt markets aren't as conducive to it."
Nassetta believes that deal activity will percolate given, as he said, strong demand, strong pricing and very little capacity. "On the other side," he said, "money costs a lot more."
"It makes it a little less attractive now to buy,” said Hennessey. “When underwriting a new deal, it’s cash flow that pays debt service and not asset appreciation.”
In contrast, Sloan Dean, CEO of Remington Hotels, is not convinced of any material slowdown in private equity activity. In fact, investment in hospitality, he said, could grow as asset classes such as multifamily and industrials lose appeal. "I thought that as the Fed stepped up rates we'd see deal activity fall off," he said recently at the NYU Hospitality Industry Investment Conference. Remington is a hotel management company with partners that include private-equity firms. He notes that the returns in those asset classes have waned as the cost of debt has gone up, encouraging investors to seek yield elsewhere.
"Rising interest rates present a problem for certain investor types, but there's so much money that has been raised by private equity," he said. "Deal activity is going to be very frothy. If you're a seller, you're going to get full value in most cases. That's going to continue for some time even with rising interest rates."
Despite debt becoming more expensive, the reality is that rates were much higher years ago. Not only was it costlier 15 years ago, hotel companies were structured differently. Today, the vast majority of public hotel companies follow an asset-light model that rewards companies through fees generated from operations and franchising, rather than hotel ownership, which carries with it a slew of risk factors that include leverage and depreciation. Close to 100 percent of Marriott and Hilton hotels today are either brand-managed or franchised, leaving asset ownership to the likes of institutional investors, from private equity to pension funds and sovereign wealth funds to REITs.
This dynamic was not the case prior to the Great Recession when hotel company balance sheets were far more crowded. One could argue that Blackstone's deal for Hilton ushered in the asset-light strategy that is de rigueur today, carving out the operating company from the property company. More likely, it was byproduct from the global financial crisis, whose culprit was the bursting of the U.S. housing bubble. Like a subprime mortgage, hotel companies have grasped the risk and understanding that real estate could go belly up, so it decided to get out of the "own" game and into the "owe us" game—stable cash flow minus the risk.
The global financial crisis was misery for many. It was a boon for Blackstone. Starting around 2012, the firm began buying up foreclosed homes, sprucing them up and renting them out, a bet that the rental market would boom as home ownership waned. Blackstone spent around $10 billion, of which around 80 percent was debt, and put the assets under a company called Invitation Homes, which it took public in 2017, before divesting its shares in 2019, and exiting with a reported $2 billion in profit.
Some saw Blackstone's tactics as preying on the misfortune of others. Others saw it as a brilliant move by one of the preeminent prognosticators in the business. It saw an opening and, like Hilton before, threaded the needle.
Blackstone has as solid a pedigree as Secretariat: It’s a proven winner, but like any pedigree, it doesn’t end with one sire, one dam or one foal. The lineage continues and it’s up to the new breed to carry on the quality and success. Just getting a job at Blackstone is next to impossible: the acceptance rate is around 0.4 percent and employees are covered in ivy.
One of them is Michael Swank, who, despite being at Blackstone for more than decade, doesn’t look a year out of Wharton, where he graduated. He lives in London and still speaks reverentially about the Hilton deal. He almost misses having the company around. “It's a fantastic business,” he told me over Zoom recently, "that you wish you could own forever."
Private equity deals in the ephemeral. Swank admits that it will be difficult to replicate the Hilton deal since there are not many opportunities out there of that size. But if anyone can do it, it would be Blackstone: It has the firepower to do deals of that magnitude.
Blackstone invests on behalf of the world’s largest institutional investors, from pension funds to endowments, and on its Q4 earnings call outlined its expectation over the next 18 months to raise $150 billion in fundraising, a 25-percent increase over the prior cycle.
“One of our advantages is the scale of our funds that allows us to make large acquisitions like Hilton,” Swank said. “That gives us a competitive advantage because there aren't many that can bring such scale of capital.”
As it stalks its next deal, Blackstone has been active in all spaces of commercial real estate. It’s been a premier buyer of late in logistics (which accounts for 40 percent of Blackstone's current portfolio), rental housing and industrials. The company recently took a large position in student housing with the $13-billion acquisition of American Campus Communities and is finalizing a $21-billion recapitalization of European warehouse business Mileway.
Other Buyers Beware
According to Swank, Blackstone will be a net buyer over the course of the next 12-plus months, but its method of acquisition and divestment within the space could change. Private equity raises money from outside investors or limited partners for funds that it then uses to invest in different types of assets. These funds are typically closed-end, meaning they have a fixed term. That approach has been the bulk of Blackstone’s hospitality investments, where success is measured on the financial return at exit. Swank said that the last handful of years have seen new pools of capital raised that are targeting more core-plus assets, or assets that have a bit higher risk profile than core assets, which could be included in open-ended funds that don’t have a specific expiration date.
“Relatively newer pools of capital, including on the core-plus side, allow us to look at more income-focused-type hotels than we have historically,” Swank said. Core-plus owners typically have the ability to increase cash flows through small property improvement plans (PIPs) and operational tweaks that are focused on the bottom line.
Swank said that it is particularly available in Europe, where "the challenge we have had historically, is that a lot of the hospitality sector is often leased to operators,” he said, “Which, if there is a 20-year lease, is not particularly opportunistic. Now that we have these different buckets of capital, we have a bit more flexibility to be more active in the space.”
Deploying the Dough
Blackstone is famous for its Monday morning meetings. They are not so much ‘how was your weekend?’ but, rather, ‘how is your business?’ But friendly, naturally. On those manic Mondays, a global assemblage of Blackstone employees dish on industry and investment and leaders are given airtime to summarize their business lines. In that sense, Blackstone is large (more than 3,000 employees), but tightly knit. When investment decisions are made, they are made in assembly, not autonomously.
On the real estate side, Blackstone has a Global Investment Committee that analyzes and approves deals. Swanks calls them “super coordinated” when it comes to dealmaking. Unsurprisingly, Blackstone creates and consults a surfeit of data points, which it shares globally. “We have global calls where we talk about everything going on—what’s happening in the U.S., Europe, in Asia," he said. They inform what we do.”
Investment in today’s environment from an inexpert perspective could be characterized as a crapshoot. From inflation to interest rates, it’s an investment gauntlet. Private equity shops do not exist in a vacuum, susceptible to the whims and fancies of global markets.
In the Crosshairs
The term private equity itself sometimes carries with it a slight stink, perceived to exist solely out of avarice—buying companies, whittling costs down to the bone, then selling for a tidy profit. This came to the fore in the U.S., in 2012, during President Barack Obama’s reelection campaign against Mitt Romney, the Republican nominee who also founded Bain Capital in 1984. Though the campaign railed against Bain for one particular acquisition and disposal, it also insisted it wasn’t maligning private equity in its totality. But the implication was that private equity was evil, greedy and out for itself at the expense of the working class.
It's far less nefarious than some politicians will have you think. Though profit is their motivation, private equity simply fills a void left by other publicly traded entities that are more risk averse. "The function of private equity is investing in and enhancing assets that have some sort of need, whether that’s changing management or making other upgrades,” said Hennessey. “Private equity takes advantage where public markets don’t want to play in.”
Some watchdogs, however, believe private equity takes too much advantage. In May, Jonathan Kanter, head of the U.S. Department of Justice’s antitrust unit, told the Financial Times this: “Sometimes [the motive of a private equity firm is] designed to hollow out or roll up an industry and essentially cash out. That business model is often very much at odds with the law and very much at odds with the competition we’re trying to protect.”
Should the DOJ elect to come down hard on private equity, it could have a cooling effect on deals. The aim is to prevent these so-called “buy-out firms” from controlling large swaths of industry.
But for every Houdaille Industries, there is a Hilton, which went through the private equity wash and came out cleaner on the other side. Like many PE deals, Blackstone loaded Hilton up with debt, took it private and with its resultant tax shield effects, delivered it back to the public markets at a higher multiple. On the day Blackstone announced it was acquiring Hilton, the stock closed at $73.97. The next trading day it closed at $93.14.
Blackstone returned Hilton to the public markets in late 2013, raising $2.35 billion as part of its initial public offering—the biggest share sale by a hotel company ever and besting the public share sale of Twitter, which had gone public in November.
Blackstone had won the money game, sure, but Hilton arguably came out a stronger company, structurally for shareholders and better for consumers, offering more choice in hotels across myriad travel segments. As of 2006, a year prior to Blackstone, Hilton was the world's fifth largest hotel company by number of rooms. Today, it's number three (trailing Marriott International and Jin Jiang) and ended 2021 with more than 6,800 hotels across 18 brands in six continents.
Despite today's market volatility, Blackstone was sunny on its first-quarter earnings call. Blackstone Chairman Stephen Schwarzman, who founded Blackstone in 1985, with partner Peter Peterson, called the company’s performance “proof of concept that we grow rapidly even in a risky world.”
Real estate accounts for around $300 billion of Blackstone’s business. “Owning hard assets has provided a strong hedge to inflation,” he said.
Gray, who also serves as chairman of Hilton, continues to be bullish on the travel space despite the headwinds and called the recovery “robust.”
Recent travel-related acquisitions include U.K. holiday company Bourne Leisure, a large portfolio of extended-stay hotels under the WoodSpring brand and the aforementioned Extended Stay America deal. (The extended-stay segment, as Swank put it, is not as mature in Europe as it is in the U.S.)
In late June, Blackstone completed the acquisition of Australia's Crown Resorts for a reported $6.3 billion—the largest transaction to date for the firm in Asia Pacific. Blackstone previously owned just under 10 percent of the gaming company. Crown, which reported USD$1.1 billion in revenue for full-year 2021, a 31.3% YOY decrease, had been belabored by accusations of money laundering and links to organized crime.
Gaming is a space Blackstone has previous exposure to, having acquired The Cosmopolitan in Las Vegas for $1.7 billion in 2014, before selling it for more than $5 billion in 2021.
Blackstone’s hotel-related portfolio could increase as the year continues. Speaking at the Hunter Hotel Investment Conference, in Atlanta, earlier this year, Tyler Henritze, senior managing director of Blackstone, said that Blackstone’s overall exposure to the hospitality space is at a “historically low” rate. “When we got into COVID, it was around 12 percent. Today, we wish our hotel portfolio was bigger.”
Blackstone has largely concentrated of late on the industrial and logistics spaces, along with the residential housing market, while eschewing sectors such as malls. Blackstone, Henritze said, has always looked to invest by identifying “large-scale shifts.”
Turning its back on hospitality toward other asset classes was a function of the times. “We saw supply picking up, cost pressures picking up and stagnating cash flow,” he said. “We thought there were better asset opportunities elsewhere.”
The script has flipped in the time since COVID and with Blackstone capital on the sidelines, the behemoth could be primed for a big splash. “Supply has slowed down and capital has pulled out,” Henritze added, though conceding that the distressed assets they thought would materialize have not come to fruition. “It is scarier to invest now, but less capital gets us excited,” he said.
Speaking three months later at the NYU Hospitality Investment Conference, in New York, his sentiment had not changed. “The fundamentals around hospitality are incredibly strong. We are looking at how we can invest more in hospitality," he said.
Blackstone isn’t frightened by much and its limited partners, from whom it raises capital from, are not afraid to keep Blackstone’s funds flush. According to Swank, further investment into the travel space is only a matter of time. “We are thematic, high-conviction investors and leading up to COVID, travel and hospitality was certainly one of our high-conviction sectors and themes,” he said. “Our view now, as we look at the world, is that those broader mega trends or macro themes that were supportive of the sector pre-COVID, they never fundamentally disappeared, they were just interrupted and are starting to come back.”
The post-COVID world is a new and complicated one for investors—a labyrinth of risk forged by seismic shifts, alterations and trend changes that have happened in a short period of time. At its core, investment in the hospitality sector is simple: the more people travel, the better it is for business. One of the truths that came out of the pandemic is the degree to which the global collective takes free movement for granted. For the past two-plus years, restriction on movement squeezed the ability to travel. When that was revoked, the notion that travel and vacations were discretionary became less accurate. In Expedia’s Super Bowl commercial, Ewan McGregor asks: “Do you think any of us will look back on our lives and regret the things we didn’t buy—or the places we didn't go?” Blackstone is betting on the latter. “There is a desire for experience—spending money on experiences versus goods,” Swank said.
The way customers choose their experience, vis-à-vis the type of accommodations they choose, is changing, as traditional hotels compete head-on with alternative accommodations, from short-term rentals to serviced apartments. Blackstone has yet dipped its toe squarely in the space. “It’s clear that some consumer preferences and the expectations that they have around how they travel and how they vacation and what they expect from where they're staying are changing,” Swank said. “We intend to follow that.”
One of the larger themes picking up more steam and awareness within the hospitality landscape is ESG, which stands for Environmental, Social, and Governance. Investors are increasingly applying these non-financial factors as part of their analysis process to identify material risks and growth opportunities. It’s the same for Blackstone as it tries to make sense of the future of investment.
“Hotels historically have not always been extremely efficient from an environmental perspective, so that focus will come,” Swank said. “As we manage our portfolio, we’re investing meaningful time and capital into sustainability initiatives because it’s important for building better businesses for the long-term and we think that perspective is changing.”
As customer preferences change, investment fundamentals remain fairly static and traditional. Investment should be unemotional; it’s never wise to get that cute. And though institutional capital for long has chased some of the more prized, trophy assets, sometimes the best investments are vanilla. More and more capital is flowing downfield into the extended-stay and even budget territory, where exist more favorable margins.
“The fundamental demand trends underlying extended stay or budget are strong,” Swank said. Of the former, which tend to have longer stays, it starts looking a little bit more like residential in a sense that the income streams are more stable. “One of the things that we've always liked about limited service is that they are more efficient in terms of staffing, and so the margins tend to be better from a cash-flow-generation perspective.”
Blackstone could continue to play in the sandbox, with Swank citing low supply and the ability to still buy assets below replacement cost. “It’s a pretty unique proposition,” he said.
All That Glitters is Not Gold
Most people know how King Midas’ story began. They don’t know how it ends. Hearsay or real, his power turned into a plague and he ended up hating his gift. Of course, not everything touched should be turned to gold. It makes life very difficult—eating, for instance. In one version, Midas pleaded to Dionysus, beseeching him to extinguish his hunger. But according to Aristotle, legend holds that Midas did end up dying of starvation—his power becoming his ultimate curse.
Despite its reputation, Blackstone does not have superpowers we know of and is constantly at watch for any imminent threats or swings in the market that can be harmful to its business. Vigilance is one thing, but Blackstone’s bold and intrepid investment strategy is not compromised.
“We are high-conviction investors," Swank said. "We don't diversify for the sake of diversifying. By identifying these handful of themes, and investing in them significantly, it has been one of the big drivers of our performance historically.”