Lending Where Banks Can’t, Blackstone Cashes In in Ireland

Bankers have been blanketing Ireland in search of cheap assets and lucrative deals, and few firms have been as aggressive as the Blackstone Group.

From snapping up hotels to advising the government on what to sell and when, Blackstone deal makers seem to be everywhere.

Yet the private equity giant’s biggest bet in the country has been one cooked up largely in the shadows: an unorthodox arrangement awarding Blackstone 25 percent of Ireland’s telephone giant, Eircom, in return for more favorable terms on its punishing debt burden. The deal is a vivid illustration of shadow banking, when private equity and hedge funds replace banks as the main creditors to companies.

And as far as Bennett J. Goodman, the Blackstone executive who led that financing, sees it, that’s a good thing.

Companies are in trouble; they come to Blackstone because they can’t get a loan from a bank; a deal gets done and jobs are saved. He asks: What is so shadowy about that?

“What we do also helps improve the resilience of the financial system,” said Mr. Goodman, a former junk bond specialist who cut his teeth under Michael R. Milken at Drexel Burnham Lambert in the 1980s. “Why would you want to be dependent on just five banks?”

But being reliant on a financial outfit like Blackstone carries risks as well, not least in Ireland, a country that was undone by the excesses of bankers and where suspicions of the species run deep.

The firm’s ability to don such a variety of financial caps â€" adviser, investor and lender â€" has created a stir of sorts and politicians as well as investors have questioned Blackstone’s ability to avoid conflicts of interest.

Outside its complexity and daring, the Eircom deal also underscores how European banks, crippled by bad loans and regulatory restraints, are ceding ground to firms like Blackstone and others that can lend money like a bank but are not scrutinized as such.

In the last few years Mr. Goodman’s team has been one of the more innovative financiers in Europe, securing outside-the-box lending arrangements with desperate borrowers in Spain, Germany and Britain as well as Ireland.

They are not the only ones of course: financiers such as Kohlberg Kravis Roberts & Company and the Fortress Investment Group are also big operators in Europe. But Mr. Goodman’s unit, called GSO Capital Partners, has committed 25 percent of its $65 billion in funds to Europe, making it one of the leaders.

And while the intricacies of each deal vary in complexity, one factor unites them: the promise of a big-time payday â€" with Eircom potentially becoming one of the more profitable.

Eircom’s default in 2012 was the largest in Irish history.

Saddled with more than $5 billion in debt and suffering from intense competition, Eircom absorbed the full force of Ireland’s financial troubles in 2010 and 2011 and as the value of its loans plummeted on the secondary market, Blackstone began accumulating them at prices as low as 65 cents to the euro.

Intent on amassing as large a stake as possible, Blackstone even bought a Dublin-based debt fund, Harbourmaster Capital, which was also a large creditor to Eircom.

By the time Eircom threw in the towel in 2012, Blackstone had acquired about $825 million worth of discounted bank loans and as the largest creditor it was in a good position to strike a deal.

In exchange for a 15 percent debt write-off and a credit line of $205 million that has not yet been used, Blackstone’s GSO Capital Partners received quite the prize in return: a quarter stake in a revamped Eircom that, shorn of much of its debt, thousands of employees and retaining its monopoly grip, is now set for a lucrative public offering or strategic sale.

“This is what these guys do,” said Tom Hunersen, a senior banking executive who has worked with Blackstone in Ireland. “They take a situation that is complicated, political and disastrous and they figure out a way to make it work. It really was a perfect deal.”

Eircom spent just a few months in receivership in spring 2012, and with its debt cut nearly in half and under new management it took immediate steps to reshape itself, among them a plan to lay off 2,000 workers.

The company has also since made $1 billion in investments â€" a large sum for any corporation in Ireland’s still-weak economy.

By 2013, Eircom was in good enough shape to raise $480 million in the high-yield bond market, the proceeds of which were used to buy back its bank loans (most of which are owned by Blackstone), increasing the value of Blackstone’s position all the more. And just last month, the company’s bonds were upgraded by Moody’s. Analysts now value Eircom at around $3.3 billion, which means that Blackstone’s profits â€" at least on paper â€" stand at about $1.4 billion. And while the risks of a financial setback can never be ignored, those winnings will compound all the more if Eircom is sold or taken public.

Such a gain may not rise to the level of Blackstone’s $10 billion payday from its Hilton investment. But it is a pretty impressive return on a company that was effectively bankrupt a few years ago.

Mr. Goodman declined to discuss the specifics of Blackstone’s position only to say that Blackstone would prosper if the company does.

The Eircom deal also speaks to the recent transformation of Blackstone, which came to fame as a buyout firm under Stephen A. Schwarzman and is now a financial colossus overseeing $265 billion.

More so than its competitors, the firm has been quick to branch out into other businesses, including hedge funds, real estate and corporate and government advisory work. And in such a small country as Ireland, with the government under pressure to offload more than $150 billion of distressed assets, it was not surprising that Blackstone’s full-court press raised a few hackles.

For example, just after the Blackstone deal for Eircom closed in early 2012, one of the junior bond investors who lost an entire investment in the transaction went so far as to write a letter to the Irish finance ministry.

In effect, the deal seemed too good to be true and the question was asked if Eircom had been discussed when Mr. Schwarzman met with Ireland’s prime minister in late 2011, just a few months before Eircom defaulted.

“The whole way the transaction went down â€" we have never seen anything like it,” said Lars Fetterlein, a Danish hedge fund manager.

Then and now, Blackstone officials say that Eircom’s status did not come up and that the purpose of Mr. Schwarzman’s visit was purely introductory, similar to the courtesy calls he pays to heads of government in countries where Blackstone is conducting business.

And when the prospect arose that Blackstone bankers â€" in their headlong rush to win business in Ireland â€" might end up advising a government agency selling real estate assets and bidding for them at the same time, a small uproar ensued.

Gerry Adams of the opposition Sinn Fein party called Blackstone vulture capitalists on the parliament floor. And public remarks by Mr. Schwarzman in 2010 suggesting that government authorities “barely know what they own” in terms of real estate assets and would eventually unload them at a “clearing price” were widely circulated in financial circles.

“When there is a carcass on the desert sands, usually the behavior of those moving toward the carcass is not all that praiseworthy,” said Peter Mathews, one of the politicians in the Irish parliament who raised questions about Blackstone’s activities.

In the end, it was all very much of a tempest in an Irish teapot. (Blackstone was never a bidder and adviser at the same time.)

Still, the controversy highlights the sensitivities involved when a large firm like Blackstone descends upon a small country like Ireland.

To be precise, Blackstone’s Eircom transaction is less of a pure shadow banking transaction than others the firm has concluded in Britain and Spain, where it lent money directly to companies in question.

And the type of shadow banking that most concerns regulators â€" short-term borrowing involving broker dealers, hedge funds and money market funds â€" does not apply to Blackstone.

But, there is no doubt that its fast-growing credit business is breaking new financial ground.

“If the fund in question knows right up front what the risks are and its exposure is quasi-equity in nature that can be beneficial,” said Adair Turner, formerly Britain’s top financial regulator and co-chairman of a comprehensive study of the shadow banking industry.

“But we also know that the financial industry is forever innovating and when it does it tends to put more leverage in the system so we have to watch this very carefully.”