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Jul 22
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Stephen Schwarzman of Blackstone group, a private equity firm. Schwarzman co-founded Blackstone Blackstone in 1985, with $400,000 seed capital. As of today Blackstone group has a market capital of over $38 Billion.
How has Stephen Schwarzman made so much money? DEBT!
Stephen Schwarzman strategy of making money is to is to use other peoples money to buy companies.
The following is a standard, textbook example that Stephen Schwarzman has designed to perfection:-
Suppose a company makes an annual profit of 10 million USD and is acquired by a private equity firm for 100 million USD, that is, at a price earnings ratio of 10, meaning that the private equity firm is willing to pay 10 times the company’s annual profit. To acquire the company the private equity firm invests 30 million USD of its own capital borrowing the remaining 70 million USD.
Now suppose that three years later the company still makes a profit of 10 million USD per year. The private equity firm has used the profits to repay 30 million USD of the loan (I’m abstracting from taxes here) and decides to sell the company for the same price as it has bought it, that is, 100 million USD. This may seem like a bad deal, but take a closer look at what happens. The private equity firm uses 40 million USD to repay the remainder of the loan and is left with 60 million USD. Thus, in three years the firm has doubled its initial investment of 30 million USD!
If the private equity firm manages to reduce costs and increase the company’s annual profits to 16 million USD, to keep things simple, and sells it again with a price earnings ratio of 10, that is, for 160 million USD, the profit for the private equity firm is 90 million USD (after repaying the 70 million USD loan), three times the initial investment. If, because of the increase in profits, it can convince buyers of a higher price earnings ratio, it will earn even more.
So, in this simplified example, regardless of whether the company being acquired is “turned around”, the private equity firm makes a substantial profit on its investment. The reason? Its ability to finance part of acquisition with debt.
Source Courtesy of Ivar Hagendoorn private equity