Blackstone inked a deal to buy the hotel operator Hilton Worldwide for $27 billion just as the stock, debt and real estate markets were peaking in the summer of 2007, tapping its corporate private equity and its real estate funds each for $3 billion in equity to finance the deal — the most capital it has ever invested in a single deal.

Two years into the deal, in 2009, it looked like it might be a terrible mistake, as travel fell off in the recession and property prices plummeted. Blackstone wrote down the value of its investment by 70% on its books.

Fast forward to 2011 and the deal is in the money again, according to a Feb. 2 Wall Street Journal story — not least because the banks that had lent for the buyout and had never been able to syndicate (sell on) the loans agreed to negotiate the total owed down from $20 billion to $16 billion if Blackstone kicked in some extra cash. With business up, property values on the rise and a smaller mortgage, Blackstone now reckons that the stake is, at last, worth more than it was in 2007, the Journal reports.

The Journal story gives a good overview of the history of Blackstone’s real estate group. A fuller account, naturally, can be found in King of Capital.

Blackstone’s stake in an oil field off Africa’s west coast has turned into a gusher.

In 2003 Blackstone and another buyout firm, Warburg Pincus, plunked down $300 million initially to form a new company to drill for oil in the waters off Ghana. The venture they created, Kosmos Energy, wasn’t your typical, debt-driven leveraged buyout. Instead it more resembled a venture capital start-up, with successive rounds of investment as Kosmos needed more capital. (Kosmos did, however, borrow $1 for each $1 of equity its backers had sunk in it.)

They chose a fabulous place to drill. In 2007, Kosmos and other energy companies made one of the biggest oil discoveries of the past decade: the Jubilee field. Kosmos owns 23% of Jubilee, which holds an estimated 1.8 billion barrels of oil. The stake is Kosmos’s only major asset.

Oil fields off Ghana

Now, Blackstone and Warburg have set the stage to reap profits.

On January 13, Kosmos announced plans to raise up to $500 million in an IPO. Oil industry analysts believe Kosmos might command a market value of $6 billion to $8 billion. That’s 6 to 8 times the roughly $1 billion that Blackstone and Warburg have pumped into it over the past seven years.

So rich a value would validate their decision to spurn a $5 billion offer for the Jubilee stake late last year from the state-controlled Ghana National Petroleum, which owns 14% of the field. A deal Blackstone and Warburg struck in 2009 to sell the interest to Exxon Mobil for $4.5 billion was blocked by the Ghanese government.

Blackstone has made growth investments before — with mixed results. Some of the biggest, including a German cable system build-out and an investment in Sirius, the satellite radio broadcaster, were flops.

None has delivered the high-octane returns that Kosmos surely will.

The New York Times ran a provocative piece Jan. 4 about the values private equity firms put on the companies they own – companies that are not publicly traded and thus do not have market prices. There are surprising discrepancies between the values (so-called “marks”) placed on these holdings by different PE firms that own stakes in the same companies, the story pointed out.

Given the incentive PE firms have to paper over their problems in order to placate investors, the story invited readers to ask if the numbers are simply being fudged.

One of the most striking cases the Times cited is a deal Blackstone led at the peak of the market — one of its largest investments ever. Three other co-investors now put markedly lower prices on the troubled investment:

“Freescale Semiconductor, for instance, was taken over by a pack of private investment companies in 2006 for $17.6 billion, of which $7 billion came from the firms. That $7 billion is now said to be worth $3.15 billion. Or $2.45 billion. Or $1.75 billion. The owners — the Blackstone Group, the Carlyle Group, Permira Advisers and TPG Capital — disagree on its value…. Blackstone calculates that each dollar of its initial stake in Freescale is now worth 45 cents. Carlyle and Permira value their portions at 35 cents on the dollar, and TPG at 25 cents, according to investors in the buyout funds.” (Freescale took its hits when one of its biggest customers, Motorola, had problems selling cell phones and auto sales collapsed, killing demand for the chips that go into cars.)

Is Blackstone taking too rosy a view because Freescale was its deal and the other three investors only came on board after Blackstone had been working on the investment for months? (How the deal came together is covered in detail in King of Capital.) It’s a fair question to ask.

TXU (aka Energy Future Holdings), the largest leveraged buyout ever at some $48 billion in 2007, was also cited: “K.K.R. now values its investment at 20 cents on the dollar; TPG values its stake at twice that, 40 cents.”

The Times pointed out that some of the difference is attributable to timing: As a publicly traded company, Blackstone’s financial reporting must be more up-to-date than that for non-public PE firms like Carlyle and TPG, so the difference on Freescale may be due in part to the rebound in the chipmaking industry last year.

It didn’t explain, however, just how strongly Freescale has bounced back. In the first nine months of 2010, sales soared 28%. “Adjusted Ebitda,” a measure of cash flow, meanwhile, nearly doubled: $1.06 billion in the 12 months ended Oct. 31, 2010 versus $579 million in 2009.

With a trajectory like that and a rising stock market, a fair estimate of the value of the equity becomes a rapidly moving target. If the calculations of one firm lag another’s by a quarter or more, the valuations are bound to differ. Because of the leverage, any increase or decrease in the overall value is magnified several fold in the equity.

Even without such swings in the underlying business, estimating the value of the stock of a highly leveraged company can be tricky. Take a hypothetical company that was bought for $10 billion with $3 billion in equity from a PE firm and $7 billion of debt financing. Even if the business holds steady, if the stock market falls 30% and the price of similar companies falls by that amount, in theory the PE firm’s equity is obliterated: If it were forced to sell the company, there would get only enough to pay off the company’s debt and there would be nothing left for the PE firm. The equity in theory would be worth nada.

Except that it isn’t. So long as the company doesn’t have debt coming due that it can’t pay and there is no other to force a sale now, there is value in the equity – option value, in economic terms – because the equity may regain value in the future.

What is that worth? Pity the people who have to justify a number. It hinges on how the company does in the future, what the market (and hence valuations in general) do and how the performance coincides with debt maturities (which could sink the company if they come too soon).

When you understand what’s being calculated, it’s a little easier to see why different firms come up with different figures. Indeed, if PE firms reported the same numbers, it would be downright suspicious.

Want to compare the numbers yourself? Good luck if you’re not a pension plan or other institutional investor who receives financial reports from a PE firm. There is precious little public information about individual portfolio companies.

KKR Private Equity Investors, an investment fund traded in Amsterdam, used to disclose the cost and current (estimated) value of each of its holdings. But since it was merged into KKR & Co. in 2009 and the stock was listed in the U.S., those details have been dropped. Blackstone doesn’t report detail at that level.

For information about the current marks on major buyouts, the only remaining public source is SVG Capital, a publicly traded investment fund listed in London that puts most of its money into Permira funds. SVG still regularly reports in gory detail who well and badly its holdings are doing.

Kudos to New York Magazine for crashing Blackstone’s holiday party, even if the festivities only rated 1 out of 5 for debauchery.

The good news for private equity firms is that deals are coming back as financing is easier to obtain. A statistical report this week by Thomson Reuters highlighted that. That snapshot mentioned the $3 billion buyout TPG and Leonard Green & Partners plan for the J. Crew clothing chain, but came before KKR struck a $5.3 billion agreement to buy Del Monte.

Not so lucky was Blackstone, whose $4.7 billion deal for the energy firm Dynegy fell apart in the face of resistance from shareholders, including activist investor Carl Icahn.

Trust Dealbreaker to have dug this up:

Anna and Karl? (aka Christine and Steve Schwarzman)

Though the economy is still in the dumps, the leveraged buyout market has reverted to pre-recession form.

That’s not to say $20 billion-plus deals, which proliferated in 2006 and 2007, are back in vogue. Still, in recent months the LBO market has mounted an impressive comeback. Lenders have opened their purses, bidding battles have picked up and deal values have soared.

Too high, in the estimation of Blackstone president and chief operating officer Tony James.

“We’re routinely priced out of the market” nowadays, said James in a late October earnings call with the media. “There are some good companies that are being sold, but we just can’t get to the prices that are required.”

That’s exactly what befell Blackstone at the peak of the buyout market in 2007, when more aggressive private equity firms often outbid it.

James blamed the high prices on the “hot” debt markets. Even though it remains hard to get a mortgage to buy a house, yield-hungry lenders are “fueling a feeding frenzy” for debt tied to LBOs, he said. For bidders, that’s powerful ammunition. (Buyouts are financed with a combination of debt and equity.)

“It’s hard to believe” how swiftly the debt markets have stormed back, James observed.

On the flip side, the lofty valuations favor sellers, James said. Accordingly, Blackstone, which has sold down $1.3 billion of its holdings this year, is in talks to sell several companies it owns, including United Biscuits, the U.K.-based maker of Jaffa Cakes and Carr’s Crackers it bought in 2006 for just over $3 billion. It also aims to exit some holdings via initial public offerings.

Deal values edged into nose-bleed territory this spring, with TPG Capital’s purchase of American Tire Distributors for $1.3 billion — about 12 times cash flow. Valuations of other recent buyouts have topped 8 times. That compares with 4 to 7 times for many deals in 2008 and 2009.

Blackstone hasn’t sat on the sidelines entirely. In August it agreed to buy power-generator Dynegy for $4.7 billion, and last month it struck a $400 million deal to buy chemicals maker Polymer Group.

Even so, James remarked, Blackstone likely will commit a total of just $3 billion to $3.5 billion of equity in 2010 to buyouts.
That’s in line what it invested in 2008 and 2009, when the debt markets were stingy and it was hard to finance deals.

See Blackstone’s third quarter earnings announcement.

So who are these guys who wrote this book? Check out our videos:

John talking about the book on CNBC’s Power Lunch.

David discusses Blackstone and the book with The Deal’s Vipal Monga.

John discusses Blackstone and the book with’s Gregg Greenberg

Shortly after Blackstone raised its first buyout fund in 1987, it made what proved to be a disastrous investment in a company called Edgcomb Steel. A month after the deal closed and Blackstone acquired the company, Edgcomb was unable to make its first interest payment to its creditors. A wipe-out so early on could have been crushing Blackstone, which had yet to establish its credibility with investors.

Steve Schwarzman told CNBC in an interview recently about the ill-fated investment, and what he learned from it.

For entertaining commentary on the interview, check out

Anyone looking for signs that the commercial real estate market has turned the corner should take note: Blackstone has been snapping up properties in recent months.

In real estate Blackstone has been an adroit market timer. It offloaded tens of billions of dollars of properties shortly before the bubble burst in 2007-2008, then stood pat for two years as values plunged. Now, it has jumped back in with a vengeance. It is even buying properties it once owned.

In mid-October Blackstone and two other investment firms, Paulson & Co. and Centerbridge Partners, bought hotel chain Extended Stay out of bankruptcy for $3.9 billion and then inked a deal to take over a portfolio of 180 industrial warehouses from their over-extended owner, ProLogis, for $1 billion. Weeks earlier it snapped up $300 million of junk bonds in struggling Kentucky hotel operator Columbia Sussex. Those deals followed other two other recent investments by Blackstone in ailing property businesses.

Extended Stay and Columbia Sussex were familiar targets. Blackstone bought the former in 2004 and unloaded it for $8 billion in 2007, and it sold a group of 14 hotels to Columbia Sussex for $1.4 billion in 2006. Both sales fetched high prices — so high that the buyers got burned when the real estate market tanked. Now Blackstone is picking up the leavings.

Jonathan Gray: Blackstone's co-head of real estate

Those weren’t Blackstone’s only deftly timed sales. In 2007 it bought the country’s biggest office-building owner, Equity Office Properties, for $39 billion. It then swiftly dealt away two-thirds of EOP’s assets at wildly high prices, thus shielding itself when property values tumbled soon after. Many of the buyers took a bath when the market turned.
Considering its record, Blackstone’s plunge back into commercial real estate is maybe as good a sign as any that the worse is over.

Blackstone watchers meanwhile are waiting to see if it will train it sights on other familiar prey: the wreckage of its EOP sell-off. So far it isn’t known to have targeted those leftovers. But if the past is any guide, chances are that it will.

Columbia Sussex hotel - St. Louis Airport