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Paulson's Capital May Bring Blackstone, Carlyle Back (Update1) 

By Jason Kelly

Oct. 17 (Bloomberg) -- The U.S. Treasury's pledge to inject $250 billion into banks may coax private-equity leaders Stephen Schwarzman, David Rubenstein and Henry Kravis to resume investing after more than a year spent mostly on the sidelines.

The founders of Blackstone Group LP, Carlyle Group and KKR & Co. LP told investors in Dubai this week that the biggest government intervention in the financial system since the 1930s will help attract private capital to lenders. The U.S. plan, following similar steps by Britain and other nations, may lead to investments of tens of millions dollars, not the $20 billion- plus deals that capped the leveraged-buyout boom of 2006-2007, they said.

Private-equity firms have been hunkered down since the onset of the credit crisis about 16 months ago, scarred by broken deals and frustrated by the evaporation of debt financing crucial to buyouts. The efforts to shore up the credit system may pave a slow road back to deploying the almost $500 billion in uncommitted cash they have raised from pension funds, endowments and foreign governments.

``There's a crying need for capital, and now there's a chance that the government will invest alongside,'' said Rubenstein, the 59-year-old co-founder of Washington-based Carlyle, whose $80 billion in assets rank it second in the buyout industry after Blackstone and ahead of KKR.

The three executives were among more than 100 speakers at the three-daySuper Return Middle East conference, where about 750 attendees gathered to discuss the industry's future. The region has become increasingly important to large buyout firms as a source of capital, with governments including the United Arab Emirates, Qatar and Kuwait pouring treasury surpluses -- fueled by soaring oil prices earlier this year -- into their funds.

A Different World

Participants described a buyout world that differs markedly from its peak, when debt-laden deals such as the $43 billion acquisition of power producer TXU Corp. and the $26 billion takeover of Hilton Hotels Corp. brought the once quiet industry into the public spotlight. There have been $194 billion in announced buyouts this year, a decline of 70 percent from the same period in 2007, according to data compiled by Bloomberg.

The hiatus has left private-equity firms sitting on a record amount of cash. New York-based Blackstone, founded by Schwarzman and his former Lehman Brothers partner Peter G. Peterson in 1985, last year announced a $21.7 billion buyout fund, still the industry's largest. Blackstone has $113.5 billion in assets.

Minority Stakes

With those sorts of commitments, private-equity firms need to put that money to work or risk angering investors with returns well below the 20 percent or more they are accustomed to. Buyout firms typically use cash from their funds and debt to take companies private, improve results and sell them three to seven years later.

Unable to rely on record-low rates for debt from Wall Street banks, they are now considering more minority transactions.

``Instead of looking to buy high-quality businesses, we're looking at financing high-quality businesses,'' said TPG Inc.'s Philippe Costeletos, who runs the Fort Worth, Texas-based firm's European operations. ``The highly leveraged deals are no longer an option.''

The three biggest buyout firms have worked during the LBO freeze to diversify and prepare for a resumption of more normal markets.

Schwarzman bought GSO Capital Partners LP in March, paying as much as $930 million for the New York-based hedge-fund manager that focuses on debt securities. The deal made hedge funds Blackstone's biggest business by assets.

Real Estate

GSO also gives Blackstone an alternative financing source, which it tapped to help fund the $3.5 billion purchase of the Weather Channel with Bain Capital LLC and NBC Universal.

``Private-equity firms do not want to be completely dependent on one business any longer,'' Rubenstein said when the industry gathered in Florida in June.

Carlyle has increased its real estate investing, buying a Manhattan building in April for $650 million and raising $3 billion for a U.S. property fund last year.

KKR, the 32-year-old firm run by cousins Kravis and George Roberts, is developing a capital-markets business to sell debt for some of its acquisitions. That puts KKR, which is planning to list shares in New York by the year-end, in direct competition with the Wall Street banks that had funded LBOs.

Banking Woes

Some of those banks either no longer exist, in the case of Lehman Brothers Holdings Inc. or Bear Stearns Cos., or are hoarding cash to protect their balance sheets. The struggles extend to banks far from Wall Street, which face liquidity problems as they try to shore up deposits and keep lending to small businesses.

That's an area where private-equity may be equipped to step in, Rubenstein said.

``Banks in places like Texas, Oklahoma and California -- these are the more attractive opportunities,'' he said.

J.C. Flowers & Co., the New York firm run by former Goldman Sachs Group Inc. banker J. Christopher Flowers, last month won approval to buy the First National Bank of Cainesville in Missouri, which has assets of about $14 million. The deal may provide a template for other private-equity firms.

Flowers told regulators he may expand the Missouri bank through acquisitions of troubled financial institutions, according to a regulatory filing.

Early Setbacks

Bets on struggling banks that proved premature may make private-equity firms more skittish. TPG, managed by David Bonderman, lost more than $1.3 billion on Washington Mutual Inc. in less than five months after regulators seized the thrift.

Flowers similarly saw the value of his minority stake in Germany's Hypo Real Estate Holding AG plunge after the government was forced to bail the lender out.

Those investments came before the latest government actions, which include a pledge by U.S. Treasury Secretary Henry Paulson to invest $125 billion in nine banks. An additional $125 billion may be used to buy preferred shares in other institutions.

``The financial crisis has left the system woefully undercapitalized,'' KKR'sKravis, 64, told the audience in Dubai. His New York-based firm manages $61 billion.

``It will be well beyond the capacity of public markets,'' he said.

Restoring Trust

Those markets, stoked by fears of a deep U.S. recession, may be among the factors that give Kravis and his cohorts pause. After initially rising on news of the government actions, the Standard & Poor's 500 Index has shed 5.7 percent and is down 36 percent this year.

``Investors have yet to regain their own trust and confidence,'' Kravis said.

Schwarzman told the Dubai audience dealing with a slumping economy is manageable and may ultimately be more lucrative for his investors than the buyout boom.

``We'll have a slower economy in some places, a recession and others,'' Schwarzman, 61, said.

``The best returns in private equity have come in a period like the one that we're just entering,'' Schwarzman said. ``This is an absolutely wonderful time.''

To contact the reporter on this story: Jason Kelly in Dubai atjkelly14@bloomberg.net