In July 2007, Blackstone took Hilton private for $26 billion. On Monday, Hilton IPO’d at $20 a share. Using the same measure to value the company as when Blackstone acquired it, Hilton’s enterprise value is now $32 billion. That’s $6 billion above Blackstone’s takeover price.So it’s a bit confusing to read that Blackstone has an made an $8.5 billion profit on its investment in Hilton.
Here’s how Blackstone, in Matt Levine’s words, “made more on Hilton, in dollar terms, than Hilton has made itself”.
Step 1: Acquire using some equity, and a lot more debt
Blackstone and its investors bought Hilton for $5.7 billion in equity. They also borrowed $13 billion and agreed to take on $7 billion of Hilton’s already existing debt. Equity plus debt minus cash held by the company, what’s called enterprise value, is how you get that $26 billion takeover cost.
This is the essence of the private equity model: buy a company with some equity, and a lot more debt; Blackstone owns the equity, and the lenders own the debt.
Step 2: Restructure, and survive some very bad years for the hotels business
Almost as soon as Blackstone bought Hilton, pretty much everything started going bad. First came the financial crisis, which arguably started one month after the acquisition. Then the hotel business tanked.
Hilton was making a lot less money. And because the hotel business was so bad, Hilton was simply a less valuable company. In 2009, Blackstone wrote down the value of its equity stake in Hilton by 70%.
Blackstone negotiated new terms with the company’s lenders. Levine explains this excellently: In 2010, Hilton paid $819 million to buy back $1.8 billion in debt and Hilton’s lenders agreed to convert $2.1 billion of the debt they were owed into equity. The debt buyback was funded by $819 million in new equity investment from Blackstone. Then, over the next two years, Hilton bought back another $1.7 billion of debt.
After Blackstone’s 70% write down of its equity stake, and using the 54% discount to full value used in restructuring the debt, we can estimate Hilton’s enterprise value in 2010 as around $12 billion. That’s made up of $2.6 billion in equity (5.4% owned by the lenders; 82% owned by Blackstone; the remainder by management and the company); $8.4 billion in debt at market value; around $800 million in cash.
At this point, the lenders were looking at substantial losses: they had locked in $1.8 billion in losses by selling debt below its initial value, and those sales pegged the value of their remaining loans at around half of what they had been. Blackstone’s losses were, on a percentage basis, potentially larger, but still totally unrealized. Instead of selling any of Hilton’s assets, they had invested more into the company.
In return, Blackstone got to reduce Hilton’s debt load. It also pushed out the maturity of the rest of the company’s debt by two years, decreasing its refinancing risk. In return, the lenders got some money back, and received 49 million equity shares, or just over 5% ownership in the company.
Step 3: IPO when things are better
Fast forward to September 2013, and debt markets are better than they were, so Hilton borrowed $10 billion to refinance its debt at lower interest rates. Hilton’s business is much stronger than it has been (revenue was up 39% in 2012), and the IPO market is relatively strong.
As a result, Hilton is now has an enterprise value of $32 billion. Blackstone’s equity stake is worth $15 billion, for which it paid $6.5 billion. And that’s where its $8.5 billion profit comes from.
Step 4: Wait for things to get even better (or worse)
Blackstone didn’t actually sell any of its shares in Hilton in the IPO. Perhaps this is because they think the company is worth more than $20 a share, or because investors tend to frown on the idea of buying shares that a private equity firm is selling (it still happens though), or some combination of the two. Regardless, Blackstone still owns 76% of Hilton’s shares. For every dollar Hilton’s shares move up, Blackstone makes another (unrealized!) $750 million. And for every dollar that Hilton’s shares drop, Blackstone loses the same.