Monday, June 28, 2010

CRE Cracks Exposed: Tom Barrack's Colony Capital Sees Neverland Redemption as Colony Fund Shows 60% Loss

By Jason Kelly and Jonathan Keehner - Jun 27, 2010


Rising from the abyss is the biggest challenge facing Barrack and other private-equity managers who spent a record $1.6 trillion on buyouts from 2005 to 2007 before a credit market crash led to the worst financial crisis in 70 years. Now, firms need to persuade investors they have more to offer than wanton dealmaking, piles of debt and meager results.
Megafunds managing more than $4.5 billion were the worst performers of those tracked by London-based research firm Preqin for the 12 months ended in July 2009, with an average loss of 31 percent of their value. Colony Investors VIII LP, a $4 billion fund launched by Barrack in 2007, had paper losses of about 60 percent as of the first quarter.
“It’s tough emotionally,” says Barrack, whose firm has delivered an average annual return of 21 percent since its founding in 1991. “In 17 years, the investors have never experienced something like this.”
Barrack’s biggest misstep was the $8.5 billion buyout in 2007 of Station Casinos Inc., which operates 18 casinos in Nevada and is the largest U.S. gaming company to go bankrupt. In New Jersey, the $2 billion Meadowlands Xanadu retail and entertainment complex Colony acquired in 2006 -- “Xana-don’t,” Barrack calls it -- sits empty and unfinished after one of Colony’s lenders, Lehman Brothers Holdings Inc., went bankrupt during construction.
“The question for private equity is, What do you want to be when you grow up?” says Barrack, who was raised in Culver City, California, the son of a Lebanese grocery store owner. “Are you making money from investing or managing assets? That’s the dilemma that everybody’s facing.”
It’s a predicament shared by a handful of elite managers, many of whom Barrack has known for decades.
Starwood Capital Group LLC -- headed by Barry Sternlicht, who competed with Barrack during the S&L crisis -- has raised new private-equity funds, which will allow it to earn more management fees and pursue buyouts.
David Bonderman, who founded TPG Capital after working with Barrack in the 1980s buying assets of failed thrifts for Texas billionaire Robert Bass, is doing smaller deals while adding distressed-debt and credit funds.
Apollo Global Management LLC, which Leon Black started in 1990 after making his own fortune buying distressed debt, is following Blackstone Group LP and KKR & Co. into businesses such as capital markets as it prepares to tap equity markets through a public offering.
All of them are becoming what Colin Blaydon, director of the Center for Private Equity and Entrepreneurship at Dartmouth College’s Tuck School of Business in Hanover, New Hampshire, calls “the new, broad-based asset managers.”
He’s also gone back to his original playbook with a familiar partner, the U.S. government, pursuing deals to buy loans with assistance from the Federal Deposit Insurance Corp., which has $37 billion of assets seized from failed banks. He has already completed eight, including one in January in which Colony bought a 40 percent stake in a company set up with the FDIC to hold $1.02 billion of unpaid commercial real estate loans for 22 cents cash on the dollar.
Barrack says Colony is focusing on smaller, unconventional deals after getting caught up in leveraged buyouts.
“If you were to pick the hour, the minute that it could have been the worst investment ever, it was,” he says of the timing of his November 2007 Station Casinos buyout.
“The LBO certainly couldn’t have occurred at a much worse time than it did, immediately preceding the crash in the Las Vegas market, which has gone on since the transaction,” says Grant Govertsen, a Las Vegas-based analyst at research firm Union Gaming Group LLC.
The most glaring emblem of Colony’s miscalculations rises 800 feet above the New Jersey Turnpike, not far from the new stadium for New York’s Giants and Jets football teams. It’s the shell of an indoor ski slope, a main attraction at Xanadu.
The 2.3 million-square-foot (214,000-square-meter) mall, named after the summer capital of Mongolian emperor Kubla Khan, was taken over by Colony and Steven Mnuchin’s Dune Capital Management LP in 2006, after the original developer, Mills Corp., ran out of money. It also features an indoor sky-diving facility and a theater for live concerts.
Plans called for visitors to be schussing down Xanadu’s ski slope by mid-2009. The collapse of Lehman in September 2008 brought work to a halt seven months later.
“We had a great team together and started leasing,” Barrack says. “Even the downturn was OK. What killed us is, Lehman went broke. We never envisioned our bank going bankrupt.”
One potential lifeline is developer Stephen Ross’s Related Cos., which is in talks to partner with Colony on restarting construction, leasing and raising fresh capital. Even if Barrack can renegotiate the debt, it will be at least a year before Xanadu can open.
To contact the reporters on this story: Jason Kelly in New York at jkelly14@bloomberg.net;Jonathan Keehner in New York at jkeehner@bloomberg.net