Friday, June 22, 2007

Blackstone, Schwarzman, & The Tax Code

The current flap over: Blackstone's IPO; Steve Schwarzman's ostentatious lifestyle, and; Congress' intent to modify the tax code to "get" Schwarzman and his ilk, has many interesting aspects on which to comment.

Regarding the Blackstone IPO, my thoughts have not changed since I wrote a multi-part series, part three of which is found here, and this later piece. You can also simply click on the "Blackstone" topic under the Labels list, and read all of my pieces about this firm and its recent activities.

Basically, I suspect Schwarzman is selling at the top. More on this when I discuss Schwarzman's personal issues in the media of late.

Next, as I have frequently said to my partner recently, regarding the Blackstone IPO,

"Why in the world would you be buying, when one of the smartest private equity shops on Wall Street is selling?"

I also said this at the time of Goldman's IPO.

Then there is the little issue of 'fair value' for many of Blackstone's components, as discussed in one of my earlier, linked posts, above.

In summary, the Blackstone IPO essentially amounts to selling investors a limited interest in a blind investment pool. Once I put it that way, most intelligent investors realize that the Blackstone brand name is the only thing that gives this IPO any value whatsoever.

With that observation, let's turn to Steve Schwarzman's lifestyle. The Wall Street Journal and CNBC have run countless articles recently discussing Schwarzman's wealth, income from the IPO, his dietary habits (the expensive stone crabs), his birthday party, that he has a chauffeur and butler, and what tax rates those employees pay, relative to Schwarzman (allegedly higher than their boss).

Rather than comment on Schwarzman's lifestyle, let me try another tack.

Since an investor is buying a non-voting interest in a blind pool, s/he has to trust the judgment of the CEO and senior management of Blackstone. Does Schwarzman's recent behavior cause you to trust his judgment?

Here's a guy who is rapidly becoming the John D. Rockefeller of his era- obscenely wealthy, seemingly arrogant, aloof, and insensitive to the opulent and decadent life he is perceived to lead.

Hardly the poster-boy you want for your brand new equity asset.

Years ago, former Treasury Secretary, former Salomon partner, former WesRay partner Bill Simon was similarly featured in the media as being distant and obscenely wealthy for, come to think of it, being an early leveraged buyout king. Fairly rapidly, (I assume) his publicist set to work showcasing Bill and family's Christmas Day stint serving food at a local Morristown, New Jersey soup kitchen, as well as his many philanthropic activities. Rather than remaining demonized, Simon became more human and caring.

Not so, Steve Schwarzman. He seems to have this 'thumb in your eye' attitude. The comments about not having the slightest idea how expensive his and his wife's lunch of fresh stone crabs was. His frequently-quoted comments about wanting to 'win' at private equity, be the best, beat everyone else.

I think it's relevant that Schwarzman seems to have lost, assuming he had some to start with, any common sense regarding appearing as 'obscenely rich public enemy number one.' Personally, I would not want to own interest in a company led by someone whose judgment is now seeming so clouded.

Think Dennis Koslowski, Michael Millken, Ivan Boesky, et al. Things just seem to go badly when corporate titans wander into the public eye too prominently. None of those companies fared well as their leaders came under scrutiny.

Pete Peterson plans to retire as Chairman of Blackstone. Nobody really knows Larry Fink. Maybe they should gently nudge Schwarzman aside and let Fink become the lower-key, more kindly persona of the firm?

Finally, we come to the tax code aspect. This article describes the current tax situation for private equity partnerships, and proposed tax code changes.

My business partner and I discussed this yesterday over lunch. The reality of the tax code is that it is a collection of special-interest loopholes. Various industries get pilloried, or coddled, depending upon the year, the party in power in Congress, and economic conditions. Think about pharma, oil, 'high tech,' now private equity.

It's understandable that private equity partnerships should enjoy a capital gains treatment of their carried interest in risky buyout-and-turnarounds. However, if that includes paying lower rates on fairly quick payouts of 'special dividends' and operating profits of their owned operating units, then it's less clear that this is 'fair' to begin with.

It's unclear to me, as I write this post this morning, whether or not such special cashflows are shared by limited private equity 'partners,' i.e., investors, or only by the master partners. If it's the latter, then I would have less of a problem with the particular taxation of such income at shorter-term rates.

I don't condone Congress using Schwarzman's personal lifestyle and financial situation as a reason to "get" all private equity firm partners and their wealth. That's capricious, confiscatory, and symptomatic of class warfare. We don't need that. It is, in fact, antithetical to the whole basis of the American Dream- work hard, get rich.

For Congress to decide this month that some people who have succeeded must now be penalized, is extremely discomforting.

By the way, while I'm on the topic, does anyone else recall the last time Congress legislated its righteous indignation at another corporate excess? CEO compensation?

Remember when Congress became so critical of CEOs who earned large cash compensation that they imposed a special tax rate for salaries above $1MM?

The result was to pay CEOs with ....... stock options! Yes, the now-discredited compensation scheme that was spawned by Congressional ineptitude and jealousy.

Fact is, as Lloyd Blankfein, Goldman Sachs CEO, opined on CNBC this morning, tax code changes should be carefully considered by Congress before being enacted. Knee-jerk, envy-based changes will have serious consequences.

What Blankfein didn't explicitly say, but implied, was this. Who do you think is, on average, smarter- the average Wall Street/private equity partnership CEO, or a US Congressman or Senator?

Right. Nobody really smart stays in politics for long. So you have a bunch of basically mediocre, average-intelligence, at best, Congressmen and Senators enacting legislation, to be subsequently outwitted by some of America's most intelligent, best-educated and experienced minds.

The same thing happens every election cycle with campaign finance so-called "reform."

The ill-considered changes in the tax code for private (equity) partnerships will be no different.

Will such changes in the tax code trigger a private equity pullback, and, correspondingly, a public equity market value meltdown? The next market collapse, with attendant domino effect on asset values, buying behavior among average Americans, and, finally, economic recession?

Possibly. If it does, figure on a radical change in the political landscape in the runup to the 2008 Presidential and Congressional elections.

However, my guess is that it won't trigger such apocalyptic consequences. More likely, it will result in a higher hurdle rate for deals, a slowdown in their pace, and a gradual cooling off of the private equity deal frenzy.

However, nobody really knows. This particular focusing event, the Blackstone IPO, is fast becoming the transformational event in the longish journey of private equity firms as they emerge from their shadowy world of truly private activity, into the glaring light of publicly-traded interests.

One final observation. It's noteworthy that, despite the enormous financial and political stakes involved, pretty much everyone is fated to behave in their 'real' fashion, despite how it plays out in public.

Schwarzman is seen as a callous, ruthless financial titan, insensitive to how his actions affect public and political reactions to them. He is fast-becoming the lightning rod for legislative action to punish wealthy capitalists like him.

Henry Waxman appears as the power-hungry socialist he is, attempting to interject himself into the Blackstone IPO process, via an appeal to the SEC, with no basis for it. With any luck, his antics will attract sufficient attention to shift control of either or both Houses of Congress in two more years.

Investors are, even now, at 9:36am, feverishly bidding to own an uncontrollable, non-voting share of a pig in a poke. Sometime further down the road, when the nth private equity partnership sells public interest shares, there will be a fiasco of some sort, and perpetrators will be accused and convicted in the press and Congress long before anyone is indicted and brought to trial.

Some things never change, do they?

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