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Blackstone's New Playbook
Hedge-Fund Deal
May Offset Slump;
Buyback Plan Set
By MATTHEW KARNITSCHNIG and PETER LATTMAN
January 11, 2008

Blackstone Group LP, seeking to shield itself from dislocations in its core private-equity business, plans to acquire hedge fund GSO Capital Partners LP for as much as $930 million.

With leveraged-buyout activity at a near standstill amid the credit crisis, Blackstone has been keen to expand into areas that are resistant to such downturns. GSO, which has about $10 billion in assets under management, invests in distressed assets and makes leveraged loans.

It is among the hedge funds that has taken advantage of the banking sector's troubles by helping to finance private-equity deals, having agreed to help fund Hellman & Friedman LLC's $1.76 billion buyout of Houston air-conditioner maker Goodman Global Inc.

HEDGE-FUND HEDGE


Background: Buyout titan Blackstone Group has been looking to diversify as some key businesses slow down.
The News: The firm now wants to acquire a hedge fund, GSO Capital Partners, which fittingly makes a portion of its profits from investing in "distressed" assets.
What's Next: Blackstone says it's still on the hunt for more deals.Blackstone's shares, which had lost nearly half of their value since the firm's June initial public offering, rallied on word that it planned to buy back about $500 million of its own stock, or about one-fifth of the publicly traded shares, as part of the deal. At 4 p.m. in New York Stock Exchange composite trading, Blackstone was up $1.74, or 9.6%, at $19.84.

The transaction is the latest sign that the boundaries between private-equity firms and investment banks are blurring. While Blackstone and other buyout shops, including Cerberus Capital Management LP, have become prominent players in the lending business, Goldman Sachs Group Inc. and other investment banks have become more aggressive in operating funds that invest like private-equity firms.

As big banks' lending operations have turned cautious amid the tumultuous credit markets, GSO and other investment funds with lending capabilities are in demand, providing private-equity funds with an alternative financing source for their deals.

"We think the timing of going into this kind of area now given the credit crunch is really terrific," Blackstone Chief Executive Stephen Schwarzman said in an interview. "There aren't too many people out there right now with capital who are willing to lend it."

Though Blackstone's core business is buying companies through its various private-equity funds, the GSO deal is its first acquisition at the corporate level. The firm has signaled that it planned acquisitions to bolster its existing operations and said yesterday that it would continue to look for opportunities.


Under the deal, Blackstone will pay $620 million in cash and stock to GSO upfront. It will pay a further $310 million during the next five years if specific earnings targets are met.

Blackstone plans to use about $300 million of the $500 million in stock it is repurchasing to help fund the transaction. Blackstone also is buying out Merrill Lynch & Co.'s interest in GSO. That New York investment bank purchased a minority stake in the fund in May 2007.

Separately, Blackstone President Hamilton James said the private-equity firm will write down part of its investment in Financial Guaranty Insurance Corp., which insures about one-third of all municipal-bond issues in the U.S. Mr. James didn't discuss the size of the write-down. A person familiar with the matter said the firm isn't likely to write down the entire investment.

Blackstone, together with private-equity firm Cypress Group and mortgage insurer PMI Group Inc., bought stakes in FGIC in 2003, when its former parent, General Electric Co., put it up for sale. The consortium paid $1.86 billion, which gave Blackstone and Cypress each a 23% stake and PMI a 42% holding.

GSO, launched in July 2005 by former Credit Suisse Group executives Bennett Goodman, Tripp Smith and Doug Ostrover, is regarded as one of the top credit hedge funds on Wall Street. A number of Wall Street executives questioned why Mr. Goodman and his partners would sell so soon after striking out on their own with such success.

"We didn't wake up on morning and say 'Gee, let's go back to being employees,'" Mr. Goodman said. "But we believe that with Blackstone's resources, we can create a unique and powerful investment platform under the GSO brand." He added that being with Blackstone would enable GSO to expand its business internationally.

Mr. Goodman and his partners aren't taking any cash out of the transaction. In a letter to its investors, GSO said the exposure of its principals to GSO funds will increase to $520 million from about $220 million. Blackstone will fold the roughly $11 billion of assets of its existing credit business into GSO and will maintain the GSO brand.

The acquisition will reunite Mr. Goodman and some of his GSO partners with Mr. James, for whom they worked at Donaldson, Lufkin & Jenrette and then Credit Suisse First Boston.

Mr. Schwarzman said he has tried to hire Mr. Goodman for the better part of a decade. "I tried to hire him in 1999. Failed. I tried to hire him in 2004 before he went out on his own. Failed. And now here we are. The third time's a charm," he said.