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Why minority stakes spell trouble for private equity

It is the beginning of the end for a big Blackstone misadventure. In 2006, the U.S. buyout firm spent €2.7-billion ($3.4-billion) on a small stake in Deutsche Telekom. It has just dumped a third of its underwater investment. The tale shows why private equity and minority stakes in big public companies don't connect.

Six years ago, Blackstone even paid a small premium to the market price of Deutsche Telekom stock to secure its 4.4-per-cent stake in the German telecom group at €14 apiece. The firm borrowed some two-thirds of the funds needed. To help pay back a portion of the giant margin loan and restructure the rest, Blackstone has now sold 65 million of its shares. With the price now slouching toward €8, the private equity firm probably kissed its own investment goodbye some time ago.

The episode has given the firm led by Stephen Schwarzman an expensive refresher course on the importance of control. Blackstone took one seat on Deutsche Telekom's 20-member board, representation commensurate with its ownership stake. And though it stepped in with the blessing of the German state, the buyout firm underestimated the clout of the 10 worker representative directors. Blackstone also lobbied behind the scenes for leadership change, but it took two years to replace chairman Klaus Zumwinkel.

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Any progress was too slow. Last year's collapse of Deutsche Telekom's effort to sell its T-Mobile USA arm to AT&T was the latest setback for shareholders. The proceeds had been earmarked for debt reduction and share buybacks. The company's dividend is also now in danger of being slashed.

There are exceptions, but some of private equity's biggest busts are in the minority investing arena, with TPG's punt on Washington Mutual another example. Buyout firms work their magic effectively when they are in charge. When they are not, they can be as helpless as any other shareholder. Blackstone's fund investors could be forgiven for feeling grumpy. They don't need to pay hefty fees to own shares they could buy directly themselves.

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