Blackstone's $26 Billion Hilton

Deal: The Best Leveraged Buyout

Ever
In the early spring of 2009, with the recession deepening, Christopher Nassetta
stood alone in an empty house in Arlington, Va., surrounded by moving boxes and
trying not to despair. What he hoped would be the crowning achievement of his
careerexecuting, as chief executive officer, the turnaround of Hilton Worldwide
Holdings (HLT), the legendary hotel company founded by Paris Hiltons greatgrandfatherhad turned nightmarish. Hed just returned to the East Coast after
closing Hiltons Beverly Hills headquarters, and that was the least of his troubles.

Eighteen months earlier, in the fall of 2007, Blackstone Group (BX) had
bought Hilton in a $26 billion leveraged buyout at the height of the
real estate bubble. Jonathan Gray, Blackstones global head of real
estate and the architect of the Hilton deal, invested $5.6 billion of
Blackstones money and had big plans for revitalizing the chain, the
epitome of cosmopolitan glamour in the Mad Men era. Central to
Grays plans had been hiring Nassetta away from Host Hotels &
Resorts (HST), where he was CEO.
At Hilton, the two got off to a decent enough start, but then, as the
financial crisis hit and the economy tanked, it appeared that
Blackstone and its partners had paid too much, used too much debt,
and couldnt have picked a worse moment to close the deal. Some of
its partnersamong them, Bear Stearns and Lehman Brothers
would soon cease to exist. After Lehmans collapse, tourism went
into a severe slump, Hilton slumped, too, and it appeared that all of
Nassettas bright ideas for restoring the chains luster would never
get implemented. Adding insult to injury, rival Starwood Hotels &
Resorts Worldwide (HOT) sued Hilton in federal court, alleging that
Hilton employees had stolen the plans for its successful W Hotel
franchises in what it called the clearest imaginable case of

corporate espionage, theft of trade secrets, unfair competition, and

computer fraud. The Department of Justice began investigating
Starwoods charges.
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Revenues running down 20 percent, Gray recalls. Cash flow is
down around 30 percent. We get a huge suit. The DOJ opens up an
investigation. It was definitely a low moment in the deal.
Blackstone was in serious danger of losing the bulk of its
$5.6 billion. I promise you this is the absolute bottom, Nassetta
recalls Gray telling him that summer, bucking himself up, too. How
can it get any worse than this?
Four years later, when Blackstone took the company public in
December 2013, its timing proved impeccable. And this July, when
Hiltons stock closed at $24.80, Gray and Nassetta had officially
transformed Hilton into the most lucrative private equity deal ever,
with a paper profit of $12 billion.
One key to this good fortune is obvious: the historically low interest rates maintained
by the Federal Reserve. But plenty of other deals benefited from low lending rates,
too, and fell apart. In fact, of the nine hospitality and lodging LBOs completed in the
same time frame as Blackstones Hilton acquisition, only Hilton and La Quinta Inns
& Suites (another Blackstone deal) werent forced into bankruptcy or a debt
restructuring.

The full story of the richest LBO in history is actually a story of

private equity working as advertised. By persuading its lenders to
exercise forbearance, restructuring its debt before it had to, and
practicing smart management, as opposed to indiscriminate cost
cuts and pink slips, Blackstone made Hilton perform better than
most thought possible.
There werent many people in the room with me who still believed,
Gray says of 2009. But the good news is we were able to say, Look,

weve got plenty of cashI dont think we ever went below a billion
dollars in cash on our balance sheetand, We really believe in this
business. Still, he confides, he had to filter out the negativity while
he waited for things to improve. Its no fun reading that youre not
very smart.
While hes familiar to some investment bankers because of
Blackstones history of savvy real estate deals, especially the
purchase of Equity Office Properties Trust, Gray, 44, is little known
outside Wall Street. A billionaire (his Blackstone shares are valued
at about $1.3 billion), hes a Phi Beta Kappa graduate of the
University of Pennsylvania and determinedly low-keyannoyingly
calm, his wife, Mindy, says. He prefers philanthropy to a Hamptons
manse, spending time with Mindy and their four daughters over
parties and auctions. He does own a five-bedroom apartment on
Park Avenue but drives a Toyota minivan and wears a plastic Timex
watch.
Considered a likely successor to Blackstone President Hamilton
James, Gray is certainly less flamboyant than either James or his
boss, Stephen Schwarzman, whose fortune is estimated at
$10.8 billion and whose lavish parties inspire urban myths.
Schwarzman and Pete Peterson, a former Nixon administration
Commerce secretary, founded Blackstone in 1985 following a power
struggle for control of Lehman Brothers. They must be glad they lost
that one: Blackstone now manages about $280 billion in so-called
alternative assets for wealthy individuals, college endowments,
pension and sovereign wealth funds, and corporations. The firm
mainly invests in private equity deals, hedge funds, and other
esoteric, and often risky, opportunities.
One reason Blackstone has been so successful is its ability to attract
and rely on young talent. Gray joined the firm in 1992 right out of
the Wharton School and quickly began learning from his mentors,
John Schreiber, Thomas Saylak, and John Kukral.

During the summer of 2006, Gray says, there was an enormous

amount of capital that was finding its way into commercial real
estate. And in response to that, were trying to figure out how can
we find an edge. We have this simple motto where we want to try to
buy hard assets at a discount to replacement cost. In other words,
he was looking for an opportunity to buy all of a companys stock for
less than it would cost to build, say, all the hotels it owns. Gray got
excited, he says, when he realized that real estate assets were
cheaper on the screen than they were on the street. He could make
money on that perceived difference in value.
Gray first approached Stephen Bollenbach, Hiltons CEO, in August
2006. Bollenbach was open-minded about a buyout, but the two
men couldnt agree on a price. In the meantime, Grays focus shifted
to buying Equity Office from real estate mogul Sam Zell. At
$39 billion, the Equity Office deal was not only huge, but also highly
complex. It began with a battle for control of the company against
another bidder. Then, no sooner had Blackstone bought the
company, it began reselling many of Equity Offices properties to
several developers. Thanks in large part to Gray, Blackstone made a
fortune, although just how large its not saying.
Gray called Bollenbach again the following May and told him
Blackstone was willing to consider a deal closer to Bollenbachs
asking price of $48 per share. On July 3, 2007, the two sides agreed
on $47.50 a share in cash, valuing Hilton at some $26 billion.
Blackstone financed the purchase with about $5.6 billion in equity
from two of its funds and a few co-investors, plus around
$20.5 billion from a group of 26 big banks, hedge funds, and real
estate debt investors. Gray says the price Blackstone paid was high,
as was the companys debt load. But Gray managed to get the banks
to lend him most of the purchase price at low rates, with easy
payment schedules and less restrictive terms than usual. Often, if a
company has operating losses for consecutive quarters, lenders will
demand immediate repayments. The loans Gray negotiated had
none of these so-called covenantsand that proved prescient.

Grays next big move was to replace Bollenbach with Nassetta,

whom hed known since the early 1990s. Theyd met in the
aftermath of the savings and loan crisis when the federal
government established the Resolution Trust Corp. to sell bad
mortgages and other squirrelly securities it inherited from failed
savings banks. A few years later, when Nassetta was CEO of Host,
Blackstone sold the company some hotels from its portfolio. From
Nassettas perspective, the decision to take on Hilton was
complicated by Hiltons main headquarters being in Los Angeles
while he and his family (the Nassettas have six daughters) lived in
the Washington (D.C.) area. Still, he agreed to have lunch with Gray
at Occidental Grill & Seafood in Washington to discuss the job. I
definitely walked away from that lunch thinking that this is a oncein-a-lifetime opportunity with a once-in-a-lifetime partner,
Nassetta says.
While Gray says Bollenbach was a brilliant strategist, he found Hilton sleepy. The
company I wouldnt say was the hardest-driving business, he says. Based in Beverly
Hills, Hiltons executive offices closed at noon on Fridays. Nassetta, too, found
Hiltons corporate structurewith five business units strewn across the countryto
be counterproductive. It was disjointed and complacent, says Nassetta as
diplomatically as he can. Adds William Stein, a Blackstone real estate partner, We
went to all five of the offices that were corporate offices, and at every single one of
those offices they would tell you, We got it right. This is how the company should
work. The other four places are completely wrong. And each one gave you the same
story. Were thinking, No ones talking to each other here. Its unbelievable.
Nassetta put an end to this Balkanization. Weve completely transformed the
culture to one that is integrated, aligned, and performance-oriented, he says.
Bollenbach could not be reached for comment.

The Gray-Nassetta business plan also called for Hilton to expand its
international presence, which had shriveled from the companys
pioneering days when Conrad Hilton opened gorgeous hotels in
places such as Istanbul, Bogota, and Tokyo. It was as if Hilton
didnt have a passport to leave the United States anymore, Gray
says. Nassetta brought back the founders motto: To fill the earth
with the light and warmth of hospitality.

Blackstones Hilton acquisition closed on Oct. 24, 2007. A few

months earlier, two Bear Stearns hedge funds had collapsed and
were liquidated. In August, French bank BNP Paribas (BNP:FP) froze
three mutual funds because it could no longer properly value the
mortgage-backed securities in which the funds had invested. Signs
of stress were everywhere, Gray says, but we didnt know the world
was about to go through a global financial crisis. We plowed
ahead.
In March 2008, Bear Stearns collapsed and was sold to JPMorgan
Chase (JPM). As part of its deal for Bear Stearns, JPMorgan insisted
that the Federal Reserve Bank of New York take $29 billion of Bear
Stearnss assets off its books. One of the assets that JPMorgan didnt
want was Bears $4 billion chunk of the Hilton loan. Bear and the

others involved in financing the Hilton deal still owned the loan
because the disruption in the capital markets had prevented it from
being turned into a security and sold to investors. Gray tried not to
take personally that Jamie Dimon, JPMorgan Chases CEO, wanted
to ditch the Hilton loan. You dont like to see your debt tagged that
they didnt want it, he says, but frankly, with all the leveraged
deals, people werent discriminating. People were just saying, Look,
the markets have fallen, the economys slow. Nobody wanted to buy
anything at that point.
In 2009, Hiltons revenue declined 15 percent. That fall, Gray wrote
a tough-love letter to Blackstones investors informing them that the
value of the firms equity in Hilton had fallen by 70 percent, or
roughly $3.9 billion. Matthew Clark, a longtime Blackstone investor
and the state investment officer at the South Dakota Investment
Council, which manages $12 billion, was concerned. We knew that
highly leveraged companies were very vulnerable when things are
down that far, and so I was worried that if things got worse,
eventually these things could go to zero, he explains. I was worried
that all of our stocks could go to zero.
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The people at the banks and the Fedand the world at largethought we
were pretty insane.
Its at this moment that Gray and his Blackstone partner Kenneth
Caplan made the opportunistic decisionCaplan prefers
proactiveto negotiate a debt restructuring with Hiltons
creditors. Normally, a company would do this only if it had
defaulted or tripped a clause in its loan that resulted in penalties or
steeper rates. In this case, no interest payments had been missed.
The only catalyst for the negotiation, Caplan says, was Blackstones
desire to buy some insurance with the creditors. Getting a reprieve
from its creditorsby stretching out the debt repayment schedule
and converting a portion of the debt to equity, meaning it wouldnt

have to be paid back at allcould buy Gray and Nassetta the

precious time they needed.
It was no easy task. For the plan to work, all 26 creditors, among
them Deutsche Bank (DB), Morgan Stanley (MS), Goldman Sachs (GS), and Bank
of America(BAC), plus hedge funds, debt funds, and the Federal
Reserve Bank of New York, had to agree to the deal. If it wasnt an
attractive proposal for everybody, it wouldnt have gotten done,
Caplan says. The lenders didnt give us a discount just because they
were nice guys or whatever. They were doing it in their own selfinterest. If they sold a small amount of their debt at a discounted
level in exchange for greater value later, he says, that was a positive
for them. It was literally thousands of phone calls over a 9- or 10month period. Id say my wife knew the names of many of our
lenders by the end of it.
The toughest negotiator turned out to be the New York Fed, which
ironically was being advised by BlackRock (BLK), the huge asset
manager run by Larry Fink that was once part of Blackstone. The
Fed, the hotel chains largest single creditor, was reluctant to be
seen as taking a discount on a portion of its Hilton debt lest it be
interpreted as giving a financial bonanza to Blackstone. The banks
were more like, Lets get this out of Dodge,as in, take the money
and run, says one participant in the negotiationsbut the Fed was
tough. The Fed also wanted a fee as part of the restructuring, since
the other creditors were promised fees for future work on Hilton. In
the end, the Fed sold a $320 million face amount of its Hilton debt
back to the hotel chain at a loss of $180 million, though it did get an
(undisclosed) multimillion-dollar payment.
By April 2010, Gray and Caplan had corralled the lenders into a new
agreement. To pull it off, Blackstone also invested $819 million of
new equity into Hilton, which the company used to buy back
$1.8 billion of its secured debt at a discount of 54 percent from the
original borrowed amount.

Jacques Brand, CEO of Deutsche Banks North American business

and a key banker to Hilton and Blackstone, says the combination of
the additional equity investment and the reputations of Gray,
Nassetta, and Schwarzman made the restructuring possible. To
write a $5 billion check and then to write another [for] nearly
$1 billion clearly demonstrated to the market that Blackstone was
absolutely committed to this investment, and that both it and Hilton
were trying to transform the business, Brand says, kissing up to his
client.
Obviously it was a perilous time, Gray says. The people at the
banks and the Fedand the world at largethought we were pretty
insane.
Critical as the debt restructuring was, Gray credits Nassetta, 51, with
the rescue of Hilton. And he did it by recommitting to Hilton
overseas, expanding its available rooms, and going upmarket. At the
time of the acquisition, the hotel chain had 116,000 rooms under
construction, 19 percent of them in international properties. Today,
it has 210,000 new rooms on the way, 60 percent of which are
abroad. Hilton now has more than 700,000 hotel rooms totalgood
for No.1 in the world.
That didnt happen overnight, Nassetta says. It happened by grinding it out. We
were making progress each year. While we were doing the restructuring, while the
world was upside down, we redoubled efforts.While we cut significant costs out of
the business, we reinvested huge amounts into its growth. Hes proud of the
expansion. Its like taking a trans-Atlantic flight on a 747 from Kennedy to
Heathrow and having three engines under repair but youve got to keep the plane
flying, he says.

Under Nassettas leadership, Hiltons market share, profit margins,

and the amount of outside capital it attracted from developers that
wanted Hilton to manage their hotels increased. Like Marriott,
Hilton runs hotels it doesnt own, and for Nassetta, this was an
important way to improve Hiltons balance sheet. Hiltons time

share business also grew, attracting investor money that displaced

as much as 80 percent of Hiltons own capital in the program. And
Nassetta quadrupled Hiltons spending on its luxury brands. In
2009 he started Home2 Suites by Hilton, which now has close to
170 hotels open or in development.
Nassetta still had to contend with the Starwood lawsuit, however. In
it, the rival hotel group held that two executives Hilton had hired
away from Starwood had stolen more than 100,000 electronic and
paper documents containing Starwoods most competitively
sensitive information. While preparing for a separate arbitration,
also involving the poaching of employees from Starwood, Hilton
executives discovered the purloined documents, packaged them into
eight boxes, and sent them back, unannounced, to Starwoods
offices in White Plains, N.Y. According to Starwoods complaint,
Hiltons general counsel had attached a note to the boxes asserting
that the documents were neither sensitive nor confidential and
that he was returning them nonetheless in an abundance of
caution. In December 2010, Hilton settled the litigation with
Starwood by agreeing to pay its rival $75 million in cash. Hilton also
agreed not to develop for two years any hotel with the hip, modern
feel of Starwoods W hotels, the subject of the documents taken
from Starwood. Following the settlement, the DOJ lost interest.
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By the late summer of 2013, Hilton had started to hum.
Companywide revenue for 2012 was $9.3 billion, up from
$8.7 billion in 2011. The ratio of debt to earnings had declined.
Things were going so well that Blackstone began to think about what
had once been unimaginable: cashing in. Soon after a complete debt
refinancing in October 2013, Blackstone, Hilton, and their bankers
began working on Hiltons IPO prospectus. Led by Brand and
Deutsche Bank, the IPO trumpeted the revitalized Hilton. Investors

found the story irresistible. Its a unique story, says Tyler

Henritze, a Blackstone senior managing director. Most people
underestimatedthe degree to which the business had grown
during the downturn. People were blown away.
One of the clichs of Wall Street is a collection of exuberant
executives gathering above the floor of the New York Stock
Exchange to ring the bell on IPO day. As trading has become
electronic, the exchange itself has become nothing more than an
elaborate television set for this rite of passage. Corny or not,
Nassetta, Gray, and their respective teams at Hilton and Blackstone
embraced this ritual on Dec. 11, 2013. Nassetta calls it the finest
moment of his career.
When we rang the bell, Jon and I turned to each other, and Ill
never forget it, he says. Very few words were spoken, big smiles, a
big hug. What didnt need saying: Wed never lost faith in the
company, never lost faith in one another. They gave each of the
floor brokers managing the stocks trading a terry cloth bathrobe
just like the ones guests arent supposed to steal from their hotel
room. Hiltons stock closed at $21.50 at the end of the first day of
trading, giving the company an equity value of around $20 billion
and Blackstone a gain of almost $9 billion. That made it second on
the list of all-time profitable deals to the $10.1 billion that Apollo
Global Management (APO) earned on its investment in LyondellBasell
Industries, a large chemical company. Later, as Hiltons stock rose,
it took over the No.1 spot.
Although deal junkies rarely praise a rival, David Solomon, the cohead of investment banking at Goldman Sachs, says Hiltons success
has been good for Wall Streetgood for everybody, that is, who gets
big fees for pushing paper around.
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Yes, success has many fathers, and its easy to see in hindsight, but
a lot of people didnt get it right, he says. The two people who

deserve an enormous amount of credit for this deal are Jonathan

Gray and Chris Nassetta. They got it right, and thats what theyre
paid to do. But they are also terrific people, and Im thrilled for their
success. Of course, hes also got to feel pretty good about the
$443 million Goldman invested in Hiltons equity thats now worth
about $1.3 billion.