NEW YORK (TheStreet) — When American International Group (AIG) got into trouble more than two years ago, it turned to Blackstone (BX) as one of the few Wall Street players it trusted to help steer it onto more solid ground.
Now that relationship is in tatters — the result of a sharp shift in management approach when current CEO Robert Benmosche seized the reins from the wilting management team of predecessor Ed Liddy.
In November, AIG began selling off its long-term investment in Stephen Schwarzman’s storied firm. The move came in tandem with an agreement to end the business relationship with Blackstone after months of often acrimonious negotiations that forced the insurance giant back into the arms of Goldman Sachs(GS), TheStreet has learned.
But even as Blackstone became shut out of its role as a lead adviser for AIG’s restructuring process, it continued racking up fees because of a contract inked under a previous AIG management team. In the end, AIG paid four firms this year — Blackstone, Goldman, Rothschild and Citigroup (C) — to do the work that Blackstone alone had been contracted to perform, starting in late-2008.
“They hadn’t been doing anything, even though they had been billing us monthly,” says a high-level source intimately involved in AIG’s negotiations who wasn’t authorised to speak on the record. “We just wanted to get them out of our offices; we wanted to get them out of here; we just couldn’t stand them being here anymore. But they were still charging us.”
A source siding with Blackstone disputes that characterization, describing the firm’s services as “a bargain” and noting that some AIG executives who have “been hurt in the pocketbook” due to the company’s stock decline or bonus restrictions have ample reason to gripe about Blackstone’s fees.
Robert Goldberg, a former investment banker who now teaches finance at Adelphi University, points out that for more than two years, taxpayers have been indirectly footing the bill.
“If AIG had gone into bankruptcy, the contracts would have been tossed in with all those other liabilities,” says Goldberg. “They avoided that with a government bailout.”
In any case, the relationship has come to a close — and Blackstone is only the latest in a string of high-level corporate casualties that AIG has endured since its initial bailout woes. What follows is the story of AIG’s forced restructuring, through three different management teams, based on interviews with several parties directly involved in negotiations.
Spokespersons for Blackstone and AIG both declined to comment on their business relationship or the stock sale.
‘Behind the Scenes’
Blackstone has remained largely in the shadows of AIG’s bailout saga — by the nature of its advisory role, and by design.
The firm was initially hired as an “independent” adviser to AIG’s board as the insurer’s capital problems were mounting. AIG’s counterparties were demanding payment on tens of billions of dollars’ worth of specialised derivative products — known as credit-default swaps — which protected against default on subprime mortgages. At the same time, its creditors were worried that, if AIG ran out of money, debts wouldn’t be paid.
Because AIG owed money to nearly every major Wall Street firm, its options were limited in selecting an adviser whose interests weren’t against AIG’s. “You had Lazard (LAZ), and you had Blackstone,” says a source involved in AIG negotiations. “There were just a couple.”
The board ultimately went with Blackstone, partly because the two firms had a longstanding relationship of another sort: AIG was one of the first outside investors in Blackstone, in 1998, when the firm was still a private-equity partnership.
In fact, Blackstone’s role was eventually expanded into a lead restructuring adviser, working closely with management and government representatives on divestiture and capital strategies.
There was another good reason to consider Blackstone the best among the few: It had just hired Thomas Stoddard, a 44-year-old investment banker who had a strong reputation as an insurance dealmaker. A lawyer by training, Stoddard had spent more than a decade at Credit Suisse (CS) and Donaldson, Lufkin & Jenrette and a brief time as partner of a private-equity firm that didn’t get off the ground before joining Blackstone.”Tom really knows the business,” says John Vasily, co-chair of Debevoise & Plimpton’s financial services M&A group, who worked closely with Stoddard on a number of the AIG dispositions. “Tom can interact with an actuary, or he can interact with a CEO or an outside counsel — and you know that he understands the issue backwards and forwards.”
Vasily, Stoddard and others involved with the AIG-Blackstone relationship declined to comment for this article but had spoken with TheStreet for a separate article last year. In those earlier interviews, several sources emphasised Stoddard’s role as an objective adviser and downplayed tensions that had been brewing.
“At Blackstone, we pride ourselves on giving independent, professional advice, and I think that’s what we did all through this process,” Stoddard said in an interview on Dec. 22.
Vasily echoed those comments, giving the banker credit for standing his ground during tough negotiating sessions.
“Blackstone was given an important mandate, in effect, to be objective,” Vasily said. “But as you might imagine, the impact of that was that Blackstone from time to time was under a lot of pressure because if you’re the neutral arbiter of a situation, people are going to try to influence you.”
Vasily also noted that Stoddard’s primary role wasn’t to market and sell AIG’s businesses on Wall Street or haggle over minutiae; instead, he was advising on broad strategy, then sealing deals with top-level government representatives and acquirers.
“Tom was behind the scenes if you will,” Vasily said in an interview last year. “He was not the person who was out negotiating up front — that was another investment banker.”
A top-level source at the firm, who did not want to be identified to protect business relationships, indicates that this was partly by design: “I wouldn’t want Blackstone taking the limelight here. In fact, we worked pretty hard to stay in the background.”
As an outsider from the typical investment banking league ranks, the stakes were high. Success could have significantly bolstered Blackstone’s reputation as an M&A adviser and brought in new clients, but failure could have hurt it just the same. And, as a firm representing a company in which the federal government would ultimately own a 92% stake, that success or failure could resound on Wall Street and Main Street alike.
In a sense, Blackstone was being offered a voluptuous fruit: Spearheading the effort to change AIG from the country’s biggest bailout case to a slimmer, profitable venture for both investors and taxpayers.
Yet, under former CEO Ed Liddy, Blackstone fell under a mandate to sell assets quickly, at whatever price, to get the chore done.
‘We’re Going to Have to Sell Everything Off’
Ed Liddy was selected by federal officials to lead AIG after the Federal Reserve granted the firm an $85 billion bailout in the fall of 2008. He had a mandate to create a smaller, deleveraged AIG as soon as possible, chiefly by selling assets to repay the federal government.
Liddy had stepped down as head of Allstate (ALL) the previous year to join private-equity firm Clayton, Dubilier & Rice; he only accepted the AIG role for $1 per annum at the behest of the federal government.
Though management had barely begun to get its arms around AIG’s problems, Liddy planned to get all of AIG’s work done within a year.
“Ed Liddy came in and said, ‘We’re going to have to sell everything off; I’m here for one year and we have to do it in a year,'” says a source who sat in on initial meetings with Liddy. “I said, ‘Ed, I understand why you want to do that, but I don’t think it makes sense. … If you go down this path, I can assure you, it will be disastrous.’ He said, ‘I don’t care; I want a plan; get it done.'”
Liddy hired Paula Reynolds as chief restructuring officer in December 2008. With a $1 trillion balance sheet that included items like the Stowe Mountain ski resort, it wasn’t difficult for the restructuring team to come up with a long list of noncore assets.
The company announced one deal after another in rapid succession; there seemed to be a daily press release on one subsidiary or investment — from consumer banking businesses in Thailand to stakes in Spanish solar parks — that no longer belonged to AIG, with an effervescent statement about the company moving closer toward repaying taxpayers.
While the restructuring team was executing sales of dozens of those smaller assets it was also shopping crown jewels like Alico, AIA and International Lease Finance Corp. At the time, the credit markets were frozen, the equity market was about to reach a 10-year low and M&A was effectively at a standstill.
It was a buyer’s market, and AIG was on sale.
“It was a disaster — it was a complete disaster,” says the source who debated Liddy in early negotiations. “This company was in utter chaos and disarray. Having spent so many years of my life here, then seeing this poorly conceived strategy with even worse execution was one of the most difficult things in my professional career.”
By May 2009, Liddy announced his departure. He was apparently worn out by both enormity of his task and the public furor that had boiled up over AIG’s post-bailout boorishness. The CEO decided to throw in the towel and return to his private equity post after a tense hearing on Capitol Hill. Reynolds, his restructuring deputy, decided to part ways with AIG, too.
Blackstone continued in its advisory capacity, but its relationship with the new management regime was contentious almost from the start.
‘Goldman Was Running Around Doing Its Own Thing’
As Liddy shrunk out of the spotlight, former MetLife (MET) CEO Robert Benmosche came out of retirement to try to guide AIG back onto solid ground.
Benmosche, a self-described “bull in the china shop,” immediately announced plans to halt divestitures until he could review assets up for sale personally. He also focused on stabilizing AIG’s core insurance businesses and improving morale.
Unlike his predecessor, who had sidelined top executives, Benmosche listened to what insiders had to say. Some of those longtime executives were hostile toward Blackstone, viewing the firm as an outsider that came in and stole the show.
“At first, Blackstone had been helping out a little bit here and there because we just needed help setting up a stream of 20 or 30 divestitures,” says a source involved with the deals. “They were just simply arms and legs at first, but then it turned out to be more. When Paula [Reynolds] came in, she tried to outsource the management to Blackstone — and they didn’t care what values we got for our businesses. They didn’t care that they negotiated lousy terms in contracts. They didn’t appreciate what they didn’t know about our businesses.”
Yet those on the other side of the table who are supportive of Blackstone dispute that characterization.
“Our advice was contrary to what certain individuals wanted to do at certain times, but I think the results sort of speak for themselves,” says a high-level source who spoke to TheStreet on the condition of anonymity.
Indeed, while the anti-Blackstone contingent is griping about shoddy advice, AIG did ultimately follow through on Blackstone’s key recommendations: To recapitalize and extend the Fed’s loan term, to sell Alico to MetLife and to divest AIA in a public offering.
It seems that Blackstone’s relationship went sour with AIG mainly because it crossed Benmosche, who didn’t agree with the firm on a key divestiture strategy. His chief advisers were either longtime AIG executives who had a bone to pick with Blackstone or outside executives who came in to make a name for themselves.
The first 16 months of the CEO’s tenure have been a bumpy ride, which cast out far more key players than Blackstone.
General Counsel Anastasia Kelly and her deputy, Suzanne Folsom, quit a year ago over a high-profile pay dispute. They were replaced by Thomas Russo, a former top lawyer at Lehman Brothers.
Additionally, Benmosche brought a handful of Wall Street veterans into AIG’s executive ranks while promoting several AIG veterans to help steer the company onto more solid ground. Peter Hancock, who had top positions at JPMorgan Chase (JPM) and KeyCorp (KEY), was hired in February to oversee AIG’s turnaround internally. In November, the CEO also promoted Brian Schreiber and Robert Gender to oversee certain capital markets functions while naming Sid Sankaran to replace Robert Lewis as chief risk officer.
There also have been management shake-ups at key subsidiaries on the auction block, including the departure of Steven Udvar-Házy, ILFC’s founder, who left the subsidiary to start his own aircraft-leasing firm. He was replaced by Airbus veteran Henri Courpron. While AIG hasn’t yet decided to sell ILFC, the management teams of AIA, AIG Star and AIG Edison were replaced as well, ahead of their divestitures.
In fact, Benmosche himself has threatened to resign at least three times during his short tenure. The culmination of one of those threats, less than six months ago, resulted in the resignation of AIG’s then-chairman, Harvey Golub.
Until recently, the management turbulence didn’t help investor confidence.
Between board room brawls, major divestitures kept hitting snags, and it was unclear how much of the remaining company the federal government would own. Therefore, private investors had no clear rationale for plunging money into AIG shares.
While AIG’s stock nearly doubled in 2010, much of that surge came in the last few months of the year. By June 30, AIG shares were up less than 15%.
“People had us written off for dead even six months ago,” says one high-level AIG insider.
In a transaction structured by Stoddard’s team in early 2009, AIG had placed two valuable subsidiaries, Alico and AIA, in special purpose vehicles to prepare them for sale. For the next 10 months, though, not much happened. Whether that’s due to market conditions, bungled divestiture strategy or managerial incompetence depends on whom you ask.
MetLife, which ultimately bought Alico on Nov. 2, had been sniffing around the life insurance business for nearly two years before committing to the deal. According to sources close to the deal, MetLife CFO Bill Wheeler had concerns about certain provisions, particularly over cross-border tax liabilities.
Blackstone, one of them said, was about to make another proposal that “would have basically put the nail in the coffin of the deal” before Benmosche and his deputies seized control of the negotiations.
According to several sources involved with the deal, Brian Schreiber, a senior AIG executive, reached out to Christopher Cole, head of U.S. investment banking at Goldman Sachs, who had a close relationship with Wheeler. They circumvented the Blackstone proposal by offering their own and, ultimately, got the deal done.
A source supportive of Blackstone’s role describes Stoddard as “one of the leading architects of the sale of Alico to MetLife” but acknowledges “there’s no question that Chris Cole at Goldman Sachs was kind of running around on lots of AIG projects sort of doing his own thing.”
A source close to Cole indicated that he supports AIG’s version of events, though he referred an inquiry from TheStreet to a spokeswoman who said he wasn’t willing to comment on the matter. Spokespeople for MetLife, AIG and Blackstone declined to comment.
Meanwhile, as the Alico drama was playing out, the AIA divestiture was falling apart.
AIG’s leadership was split over how to proceed with AIA. Blackstone advised the board that an IPO would be the best path while Benmosche’s team preferred selling AIA in a cash transaction to Prudential PLC (a London-based insurance firm not related to the U.S. company).
Blackstone argued that AIG would get more value from an IPO. However, top AIG executives insisted that the market risk was too great and were hesitant about AIA management’s experience running a publicly traded company.
When Prudential shareholders balked at a $35.5 billion price tag for AIA, and the bid was revised to $30 billion, Blackstone’s argument seemed even more solid. Then-Chairman Harvey Golub and other directors agreed that an IPO strategy was best, leading Benmosche to threaten to resign over the dispute.
A compromise of sorts was forged: AIG would offer a majority stake in AIA to the public in Hong Kong, but only after a management shuffle. Benmosche booted AIA CEO Mark Wilson, replacing him with Prudential PLC veteran Mark Tucker in July; shortly before its IPO, he also appointed as director Edward Tse, who had spent years building out AIG’s Asian life insurance businesses.
Golub resigned in deference to Benmosche, to be replaced by restructuring guru Steve Miller. Blackstone met a similar fate.
In May, a special board committee named Rothschild, a boutique investment bank, as its independent adviser on restructuring and bailout repayment. Blackstone had effectively been serving in that role for 18 months.
After Cole’s negotiating tactics paid off, Goldman Sachs took over the reins as lead adviser on both Alico and AIA with assistance from Citigroup; the two firms are advising AIG on pending deals as well.
AIG sources say Blackstone failed to impress the board with presentations to retain its position as independent adviser and, ultimately, gave poor advice. Blackstone sources argue instead that its role as a neutral arbiter simply rubbed too many people the wrong way. After all, AIG followed its advice.
“Blackstone advised the board of AIG not to cut the price of AIA and instead to revert to the IPO path,” says the high-level source who sides with Blackstone. “That was not what others were advocating. Management’s counsel was in favour of trying to preserve the sale of AIA to the London Pru even at a lower price, So Blackstone’s advice was contrary to management’s recommendation. There’s a theme here of advising on some successful deals but also advising against transactions — and, ultimately, AIG pulled off a very successful IPO of AIA.”
In any case, both management and the board fired Blackstone quite some time ago. But, like all things pertaining to AIG’s restructuring plan, there were complications.
‘Everything at AIG Is Large’
AIG didn’t have just one contract with Blackstone; it had many. There were contracts for individual deals, along with a long-term contract that covered Blackstone’s broader advisory role.
Sources familiar with the contracts describe them either as typical or extraordinarily expensive, depending on their respective points of view.
One source says that, under Liddy’s reign, Blackstone’s contracts were expanded tremendously and came with “very onerous cancellation terms.” AIG was required to pay so-called “fee tails,” even 18 months after Blackstone’s services had been terminated. According to that source, AIG refused to pay Blackstone after verbally notifying the firm that its services were no longer needed and then spent a year haggling over an appropriate exit fee.
“They would still get fees even if they didn’t do anything,” says the source. “They were fired, we got the deals done months later, and have been negotiating with them about what kind of fees it would take to basically get them out of our hair. That went on for a year.”
Another source supportive of Blackstone’s role argues that the contracts were not atypically expensive and that AIG got tremendous value for its fees, given the amount of work that Blackstone performed.
“If you look at all this in terms of the value that was created at AIA and Alico and the success of the restructuring program and the role that Blackstone played, you’d think Blackstone was a bargain,” says the source. “But everything at AIG is large.”
The source adds: “I think if you talk to people at AIG where this has hurt them in the pocketbook because of their stock, bonuses, etc., they may have a different view.”
Neither AIG nor Blackstone will disclose specifics of fee agreements and it’s hard to tell how much, exactly, Blackstone received for its various advisory roles.
Goldberg, the associate professor at Adelphi, says fees for debt and equity offerings might be a fraction of a percentage point, where as M&A transactions could range as high as 5% of deal value, perhaps capped at a dollar amount.
“It’s typical for fees to be percentage-based, and with all the due diligence work, the paperwork, it could be greater for the larger deals,” says Goldberg. “That’s why people joke around — you might do the same amount of work raising $100 million or $500 million but you’re going to get paid a lot more.”
All told, AIG has divested $50 billion worth of noncore assets to repay the government in more than two dozen deals since October 2008. Throughout 2010, AIG was involved in nearly $120 billion worth of capital markets transactions — from M&A to debt restructurings to stock and bond offerings.
Blackstone’s broader advisory fee likely would have been a fixed, periodic payment over the life of its contract. And, whatever its varius fee structures, AIG likely faced punitive fees and interest charges for having refused to pay anything for an extended period of time.
Although Blackstone may not have been leading the AIA and Alico transactions when they closed, it still ranks as lead adviser in league tables in terms of fees.
High-level sources have told TheStreet that, effectively, Blackstone was doing little to move the AIA and Alico transactions forward after Goldman and Rothschild took over its duties. Yet if that’s the case, AIG was effectively paying an array of parties for the same job — with the same outcome as Blackstone had advised.
In the midst of the disagreement over an exit fee, the insurance giant began selling its large equity stake in the company, in what one source describes as a pressure tactic.
On Nov. 15, AIG transferred 10 million of its “partnership units” into common stock and immediately sold them. The rest of its 35.7 million units, which represent a 12% stake in Blackstone, will be delivered on Feb. 9.
The news, reported by Blackstone in a regulatory filing on Dec. 17, came just as the two parties agreed on terms to exit their advisory contract. It also seems to represent a tragic coda to a long-standing relationship: In 1998, AIG became one of the first outside investors in Blackstone, which was then still a private-equity partnership.
From AIG management’s point of view, the Blackstone drama may represent another deal gone bad. Still, there’s a sympathetic case to be made for Blackstone, a relative newbie to the big investment banking league tables; and for Stoddard, who took on an enormous task in unprecedented times — perhaps a bigger task than anyone could tackle on his own.
The insurance investment banker who has worked with Stoddard in the past characterises the Alico and AIA deals as mind-bogglingly complex on an individual basis, never mind executing both concurrently, along with other advisory duties.
“From what I understand, talking to those who were involved, it was very, very complex,” says the banker. “A lot of different issues had to be resolved relating to the business itself, extricating it from all the interrelationships within AIG. And, at the same time the Alico deal was going on, AIG was negotiating to sell AIA to Prudential — and then that fell apart. So, keeping the Alico deal together and on-course while that other transaction was falling apart, I’m sure, was not an easy task.”
When asked why he thought Blackstone had been unsuccessful, a source close to the AIG restructuring who was harshly critical of Blackstone’s performance offered the first hint of geniality: “To be perfectly honest I think they were just in way above their heads,” he said.
When asked why he thought Blackstone had been replaced, a source on that side of the table suggested AIG had simply reverted back to business as usual.
“AIG’s back, it’s healthy, so they’re using lots of different firms, lots of different advisers, lots of banks that have balance sheets and have been extending credit to AIG and using that to their advantage,” he said. “This is sort of a natural evolution here and, frankly, we’re off doing other things at this point. If other people want to take credit for it, then God bless them.”
This article originally appeared at TheStreet.com.