The Structure and Business of Blackstone - Essay Example

?Chapter Four 4 The Structure and Business of Blackstone The Blackstone Group is based in New York, but it is an investment company and the companies it owns are based all across the U.S. and the world. Blackstone's private equity business has been one of the largest investors in leveraged buyout transactions over the last decade while its real estate business has been an active acquirer of commercial real estate. Blackstone is a self-described “leading global alternative asset manager and provider of financial advisory services”; at root, the Company’s business is to profitably invest other peoples’ money. It's a veritable feast for the discerning investor's eyes: 37% compound annual revenue growth, 65% operating margins, $3 million in profit per employee, returns on invested capital in the triple digits. And a cherry on top: the Blackstone Group is arguably the uber-buyout firm. Led by billionaire cofounders Steven Schwarzman and Peter Peterson, Blackstone has gone from relative obscurity to global renown in the span of roughly two decades, parlaying a penchant for deal making and a yen for competition into a war chest that now brims with billions of dollars in investment capital. Blackstone Capital has extensive expertise in structuring transactions under Regulation D, SCOR, Rule 144A, Reg. A, Reg. S, and other public or private direct offerings, as well as commercial lending, mezzanine financing, commercial paper, and subordinated debt transactions. Their structures provide an exit strategy for investors with short or long-term holding periods. Basically what Blackstone does is delivers to its client’s necessary capital, for less cost, more efficiently, and strategically structured. It operates from a style, which avails itself of the richness of a variety of investment philosophies and techniques that will ultimately provide superior returns while exposing a particular partnership to lesser risk. It is here, that Blackstone prides itself in creating the innovative financial solutions for its clients. Their primary objective is to maximize value for their clients. Blackstone’s business is organized into four segments: 1) corporate private equity, which focuses on management of the Company’s private equity funds; 2) real estate, which is responsible for management of Blackstone’s various real estate investment funds; 3) “marketable alternative asset management,” which involves management of Blackstone’s various hedge funds, mezzanine funds, and other “alternative” investment vehicles; and 4) The financial advisory group, which comprises the Company’s advisory services business that provides, for example, merger and acquisition analysis and services to other companies. These various funds are generally structured as limited partnerships that are capitalised by limited-partner investors (such as institutional investors and pension funds) and managed by Blackstone, which, through subsidiary holding partnerships, serves as general partner. Blackstone therefore does not own directly either the various portfolio companies in which it’s corporate private equity funds invest or the real estate assets owned by its real estate funds. Rather, Blackstone derives revenue from two principal sources: It earns a “management fee” equal to 1.5% of the value of the assets under management; It earns a “performance fee” or “carried interest” equal to 20% of the profits generated on the capital it invests for limited partners. Blackstone is subject, however, to having its performance fees “clawed back.” That is, the Company is obligated to return performance fees to investors if investments perform poorly. In contrast to those who invest in Blackstone’s various funds, investors in Blackstone itself acquire a stake in Blackstone’s investment management business, hoping that strong performance by the various investment funds will generate performance fees for the Company. 4.2 Southern Cross Healthcare Southern Cross Healthcare (SCH) is the fourth largest provider in the U.K. residential and nursing long-term care market for both the elderly and enduring mental health patients. The business also provides specialist healthcare services to patients suffering from acute psychiatric problems, brain injuries and learning disabilities. Southern Cross operates 160 care homes with approximately 8,200 beds. SCH being the largest provider of health and social care services in the UK, predominantly through the provision of care centres. As top dog in its field it should be in an enviable position, best but the scenario is different. It’s on the verge of its collapse. The company has had a roller coaster ride since it was founded in 1996 by British entrepreneur John Moreton. By 2002, SCH had 140 care homes. In that year came a management buyout for ?80m funded by equity groups West Private Equity and Healthcare Investments Ltd. 4.3 Blackstone Consolidation of the Home Care Sector Overview Blackstone, a company known for the provision of financial services, believed that the consolidation of the care home sector to create an industry leader, focused on quality of care and high quality operations, was a sound thing to do. Blackstone’s investment thesis was predicated on growth, investment in the management infrastructure of the business and on the creation of a company with a reputation for quality: a company viewed as a responsible operator by its local authority funders and its residents. Acquisition of Southern Cross Healthcare Blackstone acquired Southern Cross in September 2004 for ?162m. An operating company managing 162 homes, of which the vast majority (142) was leased. Blackstone invested in Southern Cross to create a high quality care home operator of scale that was professionally managed and a responsible member of its community. At the time, the UK care home sector was highly fragmented and facing more demanding quality of care requirements.  Acquisition of Nursing Home Properties Blackstone acquired care home owner Nursing Home Properties (NHP) for ?564m. NHP was a publicly listed company that owned two businesses: NHP, a securitized property portfolio and an operating company, called High field Care, which operated 192 homes. High field operated homes leased primarily from NHP under leases which were created years before Blackstone’s acquisition. Blackstone’s rationale for acquiring the NHP group was to combine Southern Cross with High field to create the UK’s largest care home operator. Before, during and after Blackstone’s ownership of the NHP group, the NHP property portfolio was held separately (and had separate stakeholders in the form of bond holders) from High field, and High field paid rent to NHP. Blackstone did not create this structure and did not create the High field leases.  In fact, just before Blackstone acquired the NHP group, the company had announced a process to sell High field Care. Southern Cross merged with High field, and several months later, Blackstone sold the NHP property portfolio in two separate sales: one to RBS and the other to a property group, Loyds. Finally, in November 2005, Southern Cross acquired the operations of Ashbourne Care, an operator of 190 care homes.  Shortly before Southern Cross’ acquisition of Ashbourne, the company’s previous owners had sold its real estate to property group, London and Regional. Acquisition of the Ashbourne Group In November 2005 it also took over the Ashbourne Group of care homes, comprising 10,000 beds in 193 homes, for ?85m. On the surface the Blackstone displayed that they believed there was scope to build a large, professionally managed healthcare services company across key market segments of elderly and specialist care, with a focus on high-quality care delivery. If they were acquiring the company, the prime goal behind it was to upgrade the services and provide maximum care for the unfortunate; the intention being to bolster its position in the private pay elderly care market and in specialist healthcare services through both organic development and acquisitions. The chief executive officer also believed that SCH had partnered with one of the best management teams in the sector. 4.4 Blackstone’s Management of Southern Cross While growing the platform through acquisitions, Blackstone demonstrated prudent management of Southern Cross in reducing the company’s debt with proceeds from the Initial Public Offering (IPO); after which Southern Cross had relatively modest debt of approximately ?65 million, or 1.5x current year EBITDA. During the period between Blackstone’s acquisition of Southern Cross in 2004 and the IPO in July 2006, the business significantly grew its revenue and profits, both organically and through acquisitions, and was widely viewed as a high quality, responsible operator.  Blackstone helped Southern Cross do what it did best – operating quality care homes. Blackstone made a positive return for its investors on this investment because it helped to create a sector leader that was successfully floated on the London Stock Exchange. After the IPO, Southern Cross’ share price nearly tripled (Fraser-Sampson, 2010).  4.5 Blackstone’s Sale of Southern Cross In July 2006 Southern Cross was floated on the London Stock Exchange, with a share price of 225p in order to raise ?423 million, they entered the FTSE 250 Index in September making it one of the UK's top companies in size and valuation. In less than 2 years, Blackstone had bought and sold SCH, making a massive profit and getting out. Essentially they had practiced a classic business strategy of buying cheap and selling high. In 2006, when Blackstone floated the stock of Southern Cross on the stock market, it was enthusiastically following a strategy of buying nursing homes, then selling them on to landlords and relying on the fees it generated to pay its rents. But like private equity's other great plan of loading businesses with high debts, this wheeze began to unravel when the credit crunch struck and Southern Cross began to be hit by a combination of falling fees, higher operating costs and rising rents. The management of Blackstone was blamed that the business it created was not built to withstand an economic downturn, but the management insisted that during its tenure "the company experienced growth and profitability and was healthy at the time of its float". But this could also be spun in another way that at one point Blackstone owned the operating company Southern Cross and the main landlord NHP. They may not have created the lease, but they for sure had the opportunity to do something about it. Blackstone sold NHP to outside investors in March 2006 for more than ?1.1b, according to analysts, doubling the firm's ?564m investment. Before floating Southern Cross in July of that year at another profit the former chief executive, Philip Scott, sold his shares for ?13m in 2007. Still not everybody was winning. Although Scott said that bad management was to blame for the company's dire state and that it should be allowed to go under, the business model he, Blackstone and previous owners West Private Equity left behind provided inadequate investment. So how was this allowed to happen? Surprisingly, experts say that nobody currently oversees the financial stability of care home providers. The health and social care bill as it stands, would give NHS regulator monitor the power to license providers of NHS-funded care and support the continuity of services, should one become insolvent. However, this does not apply to social care. Paul Saper, chief executive of LCS International, a health consultancy, said: "There was legislation giving powers to the regulator to review the financial stability of major operators, but it was not necessarily the best drawn up and the regulators never hired the staff to implement it. The regulator has since changed and nobody looks at this." 4.4 Aftermath of Southern Cross Sale Southern Cross was focused on providing high quality care in well-invested facilities, seeking to be the home of choice in each local community in which it operates. Still, as families fret about their relatives in care, the debate about Blackstone's contribution to the Southern Cross crisis, and the wider role of the private equity industry, continues. After its former boss said the entire board of the care home group should step down following years of mismanagement, Southern Cross was in the line of fire again. The world’s renowned Private equity group, Blackstone is all set to get its hands on to Southern Cross, the largest nursing home provider in the UK. Blackstone was expected to reacquire Southern Cross by buying its debt secured against Southern Cross’s careworn care homes. In 2006, the company was termed as the highest quality provider in the nursing home sector when compared to its peer companies en masse. However, the role of Blackstone group is considered to be a scape goat as they acquired Southern Cross, refurbished or redecorated its financial position and left the company with four fold returns through Initial Public Offering in 2006 (Finkel, et. al. 2009). Due to the much criticised sale and lease back agreement, Blackstone left the company with a mammoth rent bill of ?250 million. Since then the company is unable to keep its head high above troubled waters. It is quite possible to argue on the issue that Blackstone weighed down Southern Cross during 2004-2006 with an arduous leasing and rent review model. But the reality lies in the fact that during its ownership, Blackstone was only involved in only a mere three percent of the sale and leasebacks. It is also been said that in a pre 2004 scenario, the home nursing market was undercapitalised and Blackstone capitalised on it. As of today Southern Cross, which is catering it 31,000 residents in its 750 homes is on the verge of a collapse. The problem for Southern was clear – the group had little control of its own destiny. On one hand the Government reduced fees in real terms for healthcare providers; on the other, Southern was tied into unprofitable care homes and property boom-written rents. The decision by previous owners, including Blackstone, to sell the care home properties and then lease the sites on upwards-only rents built a rod for Southern’s back. 4.5 Analysis of Performance of Southern Cross 2006-2011 Southern Cross provides care services for most of the local authorities in the UK which, together with the NHS, represent circa 78% of the Group's revenues. From the company’s financial statements, we can deduce the following facts. Current ratio tells us whether the company has assets to pay off its debts. High current ratio shows that the company has lot of money tied up in non-productive way and the resources are not being used efficiently. In case of Southern, the current ratio first rose from 0.48 in 2008 to 1.05 in 2009 and then again declined to 0.73 in 2010, meaning that the company has the assets that it can use to pay off debts. The acid test ratio tells us about the more liquid assets in the balance sheet. The acid test ratio has also shown the same trend, first it raised from 0.47 in 2008 to 1.04 in 2009 and then decreasing to 0.72 in 2010. This is not a good thing as it shows that company is not in a good position to pay off its short-term debts. The debt has decreased from ?98.1m in 2008 to ?6.6m in 2010. This automatically decreases the debt ratio which is good for the company as this show that the creditors will be willing to lend money to this company because creditors prefer companies with lower debt ratio because the lower the ratio the greater the cushion against creditors loses in the event of liquidation. But the stockholders may want higher ratio because it magnifies expected earnings. The revenue has also declined from 2006 onward and the forecast for 2011 also shows a decline from ?959m to ?939m. The accounts also show a pre-tax loss of ?47.4m in 2010, which is up from ?19.8m in 2009. The operating profit has also gone into negative, being -44m pounds in 2010. If it goes on like that, the company will collapse. Southern Cross is a low margin business and there has been a progressive squeeze on its revenues in the last few years. There are many upward pressures on its costs, meaning Southern Cross is now in a critical financial position and cannot afford to meet its future rent obligations in full.  Reflecting this reality, it has taken a major book write off of its goodwill and certain other assets through these accounts. Equity investors have been all but wiped out by a 97 per cent fall in the shares since November 2007. Southern Cross’ share price stood at 225p when first floated in July 2006. Since the float the prices consistently increased right up until November 2007 when they were at an all time high of 606p, although the volume of shares was less than a third from the initial float. Thereafter they started to decline, within the last year the highest value was 32.25 on the 26th July 2010 and the lowest of a mere 4.8 on the 31st May 2011. This is a big turnaround and not a good one at that. Southern Cross' stakeholders - landlords, lenders, and shareholders, the various components of government, management and employees – are all give overriding priority to maintaining the quality of care for Southern Cross' 31,000 residents. Over the near coming period the key stakeholders will need to agree on a comprehensive package to restructure Southern Cross' financial affairs so that a new, stable and sustainable corporate and business model can be developed and introduced to underpin the continued successful operation of Southern Cross' homes. After over viewing the company’s position, there are reasonable grounds for believing that such an outcome can be secured and it is the responsibility of all stakeholders to work to that end. 4.6 Analysis of Performance of Southern Cross 2011 Gauging the financial position of the company during 1st Half FY2011, Southern Cross faced two key accounting issues while preparing its consolidated accounts. First issue was whether or not Southern Cross should prepare its books on a going concern basis; and they decided to stick to the fact that they will operate as a going concern. The second issue is whether or not the noncurrent assets depicted on the balance sheet have been reduced in value. It’s true that the carrying value of assets of the company has been considerably impaired, resulting in a non-cash right off ?293m. (?48.6 m of fixed assets, ?219.2m of goodwill and ?25.2m of deferred tax assets). Apart from these write-downs, Southern Cross would have incurred an after tax loss of ?43.1m. The Group came up with adjusted EBITDA of ?7.4m and generated a positive cash flow from operations of ?6.1m. During the discussed period, revenue decreased by ?16.4m to ?464.3m. Home payroll costs also declined from ?279.3m to a sum of ?277.6m. Home running costs were 13.3% of revenue as compared to the 12.6% during the same period last year. Rentals increased marginally and stood at ?124.2m (2010: ?124m) due to new leases completed in FY2011. Southern Cross also incurred a non-recurring, extraordinary cost of ?4.7m. Of this, ?0.6m associated to the “New Horizons” program. Other exceptional central costs amounted to ?4.1m which is primarily related to the costs incurred with regard to on-going restructuring. Since 2006 Southern Cross reiterated that Blackstone created troubles for them by buying big businesses that owned its real estate, daunting untenably high rents. Selling the real estate at huge profits to Blackstone left the company in an odd position. Although Blackstone has been denying these allegations, the fact lies since 2006 once the IPO was launched, the company faced hard times. 4.6 Analysis of Southern Cross Demise One considers that Blackstone’s public sale of Southern Cross Healthcare came at a crucial macroeconomic juncture. In 2008 the United States would experience the greatest economic recession since the 1929 Great Depression. While there were a number of inputs to the economic fallout the primary consideration was a subprime mortgage crisis that artificially inflated housing prices. This recession would spread to the United Kingdom and ultimately impact the entire Western hemisphere. The 2006 sale of Southern Cross Healthcare, within this context of understanding, occurred at an extremely fortuitous time for Blackstone. The private equity business model that they implemented upon the buyout, wherein homes were purchased and then sold to landlords, took advantage of the inflated and steadily rising housing costs that had emerged. The notion that Blackstone somehow had foreseen the collapse of this bubble seems highly unlikely considering that the true reality of the crisis evaded all but a handful of investors and government watchdog groups. Rather, Blackstone seems to have restructured Southern Cross Healthcare in accord with the best practice way of the real estate sector. While the 2006 sale was an extremely fortuitous event, it seems erroneous to indicate that the organization recognized or prepared Southern Cross for later failure. Rather the question becomes, in light of the later closure of Southern Cross, if private industry, with its risk assumptions should allowed to assume important control of health care infrastructure. 4.7 Contemporary Developments Since the IPO in 2006, Southern Cross Group was financially burdened due to sales-back lease agreements that the former acquirer Blackstone did once it bought Southern Cross in 2004. The group agreed with its lenders on an extension on its banking facilities by the end of August 2011. This further relaxation, over and above the ongoing deferral of rent from 1St June 2011, signified indispensable support for the continuance of the restructuring process that entails the transfer of homes to other care home operators, as announced on 11th July 2011. The chairman of Southern Cross, Mr. Christopher Fisher termed this agreement as a fresh breeze in a gloomy situation. He stated that, “We appreciate the ongoing support of our lenders during this period of transition. It re-affirms the commitment of those involved in the process to the continuity of care for all of our residents” However, the problems seem never ending for Southern Cross as the landlords have still not agreed on a 30% cut on rentals. The company is still in a process to settle this issue. The company still considers Blackstone as the problem creator as it bought large businesses that owned Southern Cross’s real estate, daunting indefensibly elevated rents and selling the real estate at hefty gains to Blackstone; thereby left the company inept of operating productively. Southern Cross further stated that due to the financial measures taken by Blackstone, the care home provider was unable to invest the necessary capital and management resources in the business. Southern Cross was under troubled waters with a ?250m annual rent bill after ­slicing off the majority of its freeholds. Simultaneously, local authorities were preparing to lessen the fees they pay to Southern Cross to take care of residents in the midst of a public spending cutback. Reviewing the problems of the company, Christopher Fisher also said: “Southern Cross is a low-margin business and the progressive squeeze on its revenues over the last 12 months, while facing many upward pressures on its costs, means Southern Cross is now in a critical financial position and ­cannot afford to meet its future rent obligations in full.” Alongside the rental fees problems it was reported that more than half of the company's 750 care homes were owned by landlords with accounts in places such as Guernsey and the Cayman Islands. A GMB spokesman said: 'While rental fees have gone up and these companies have a trail of cash going into offshore tax havens, the elderly are suffering. MPs and peers are calling for an investigation after the Southern Cross crisis has been resolved. John Spellar, Labour MP for Warley, West Midlands, said: 'Public money meant for the care of elderly and vulnerable people should not be siphoned tax-free to line the pockets of the super-rich, and in the case of NHP, ultimately a foreign government.’ While this is on-going it’s an area of concern for Southern Cross. Since July 2011 Southern Cross Health has announced that they will be undergoing closure procedures. The organization had found itself increasingly challenged by the annual rental bill exceeding ?240m on its 750 properties, as it had sold leases prior to the 2008 financial crisis to fund expansion. Again one recognizes that while Blackstone’s restructuring of Southern Cross during the private equity period placed the organization more exposed to risks, but without the unforeseen macroeconomic recessionary conditions it seems unlikely that such hardship would have been inflicted. The recession lead to public spending cuts that resulted in reduced home rentals, as occupancy rates dropped from 92% to 84%. In early June Southern Cross was forced to withhold rent on 30% of its homes as a means of avoiding insolvency. As stated, in July they went under. 4.8 Conclusion At the time of the July closure announcement Southern Cross had over 750 homes that were facing demise. Since this time, however, Four Seasons Health Care has stepped in and assumed control over a number of the homes. Still, more remain. The situation is a pressing one as it places demands on the U.K. government to devise a system that will prevent such occurrences from happening in the future. If the government looses faith in private care organisations it will have a knock on effect across the industry. With more and more people relying on grants and loans to fund their care needs in the current climate, it is becoming detrimental to the survival and the expansion of the care provider to take on contracts and referrals from councils and government bodies. An obvious argument would be to consider that this closure indicates that the Blackstone buyout not only was ineffective for SCH, but also placed the organization on the eventual path towards insolvency. While it would be possible to attribute this closure to poor management practices that occurred in the wake of the 2006 sale, the complete structural disintegration of the organization seems to qualitatively attest to a heuristic restructuring process. Ultimately, gaining a definitive answer on the question is challenging considering the shortened period of Southern Health Care’s existence. Indeed, the period before Blackstone purchased the organization nearly parallels in length the period following its sale. Read More