In Real-Estate Battle,
Titans Awash in Cash

Last July, Steven Roth called fellow real-estate titan Sam Zell with a secret proposal: a merger that would put the two longtime friends atop a company that would dwarf anything else in the real-estate world.

Mr. Roth, chief executive of Vornado Realty Trust, knew that Mr. Zell's Equity Office Properties Trust was in play. EOP -- the nation's biggest office landlord, with more than 590 buildings -- had been a disappointment on Wall Street. Mr. Zell thought he could get efficiencies from owning big buildings en masse, but had ended up paying too much for some buildings and owning in too many weak markets. With its stock trading at less than the value of its assets, EOP had become likely prey for cash-rich private-equity firms that could carve it up and sell it off.

But Mr. Zell's company looked like a boon for Vornado. With successful investments in real-estate and beyond, it was drowning in capital. A combination with EOP would give Vornado a myriad of choice properties in one swoop, at a time when competition has never been more fierce for commercial estate. Mr. Roth thought Mr. Zell, 65 years old, would leap at the chance to keep his empire intact, married to Vornado's powerful financial machine.

Mr. Roth guessed wrong. In November, after negotiations bogged down over price, Mr. Zell agreed to sell his company for $20.1 billion to the giant private-equity firm, Blackstone Group. Mr. Zell declined to be interviewed.

Now, Vornado is scrambling to get back into the deal. Last week the New York-based real-estate investment trust teamed with two partners to top Blackstone's bid by 7%. If its bid succeeds, Vornado will cherrypick from EOP's markets, and take Mr. Zell's throne as the nation's largest office-building landlord.

Vornado and Blackstone are squaring off in a giant takeover battle, fueled by a huge wave of cash washing through global markets. Low interest rates, a strong global economy and high commodity prices have flooded coffers around the world with cash that investors have increasingly sought to put in stable assets such as office buildings.

After suffering a deep slump after the dotcom crash in 2001, the office market has seen steady recovery since the end of 2004. With relatively few new buildings, rental rates in existing buildings have jumped, and that trend is expected to continue over the next year or two, even in some laggard markets.

The feverish interest in commercial real estate -- with sale prices for office buildings in particular climbing almost daily -- stands in stark contrast to falling or stagnant prices in much of the residential real-estate market over the past year.

In a presentation to shareholders last June, Mr. Roth, 65 years old, expressed regret at the many deals Vornado had passed up as too expensive, only to see their valuations soar. "The simple answer is in this environment over the last 10 years, every single deal we didn't do was a mistake," he said.

In its higher bid -- $52 a share, compared with Blackstone's $48.50-a-share offer -- Vornado and its partners are offering 40% in Vornado stock and the rest in cash. Blackstone's all-cash bid is scheduled for a shareholder vote Feb. 5, and it has the right to make a counteroffer.

The 'Gravedancer'

Mr. Zell founded EOP in 1976 with a college friend. He soon earned the nickname "Gravedancer" by buying distressed properties, rehabilitating them and selling them for huge profits. He stood out in a pinstripe world by wearing blue jeans and driving a motorcycle with fellow travelers he called Zell's Angels. He dispensed dollops of wisdom each year through custom-made music boxes, such as last year's "Capital is Raining on My Head" -- about a world awash in cash, sung to the tune of "Raindrops Keep Falling on My Head."

The Gravedancer's dance card broadened over time. He took Chicago-based Equity Office public in 1997 with the plan to put together a string of skyscrapers that stretched from coast to coast, and from Ohio to Texas. His strategy: bring economies of scale to the business of owning office buildings -- everything from spreading borrowing risk over many properties to buying light bulbs in bulk for tenants. After going public, EOP acquired three real-estate companies in five years, and, along with other acquisitions, tripled its square footage to more than 100 million square feet.

But Mr. Zell's plan fell short. Investors complained that EOP overpaid for those companies. A particular lightning rod: its 2001 acquisition of Spieker Properties with a strong concentration of buildings in Silicon Valley, for $4.5 billion, plus debt. The deal closed in July 2001, just as the implications for the office sector from the dotcom bust were looming.

The bust, along with the slowing demand for office space that came with the economy's downturn, hit other weaker office markets where EOP was a landlord and exposed a fundamental flaw in the company's philosophy. "I think the last real-estate cycle demonstrated that you don't necessarily benefit from having a national footprint unless your properties are located in very strong markets," said Keven Lindemann, director of the real-estate group at SNL Financial, a research group based in Charlottesville, Va.

EOP's huge size wasn't necessarily a blessing. To some tenants, the buildings' owner was a distracted landlord that couldn't keep tabs on property needs. Last year, EOP lost the three main tenants in its 191 Peachtree building -- one of Atlanta's prime downtown office addresses -- when the tenants' leases came up for renewal, leaving the building virtually empty. Cousins Properties, an Atlanta REIT, recently bought the building for $153 million, a price one research firm described as a fire sale.

"We bought it at $127 per square foot and you couldn't build it for $350 a square foot," says Tad Leithead, a senior vice president with Cousins. Cousins executives are betting that their intimate knowledge of the Atlanta market will allow them to fill the building with tenants in a way that the national chain could not.

As EOP's stock continued to lag behind its competitors, Mr. Zell became increasingly outspoken, lashing out at analysts -- sometimes by name in public forums -- who he believed didn't fully appreciate the value of EOP's portfolio. Though EOP's stock had a strong run-up in 2006, the company's total return to shareholders over the previous five years had been the lowest of the 12 office REITs followed by Merrill Lynch. EOP stock -- trading at about $36 a share when Vornado first approached the company in July -- closed at a 52-week high on Friday at $52.51 on the New York Stock Exchange.

Yet, the company looked poised for a comeback in 2006 after giving up on the idea of bigger is better. Through a series of restructuring initiatives over the past couple of years, EOP abandoned its weakest markets, pulling out of Dallas and Atlanta and reducing its presence in Denver and Chicago. It sold off weaker properties and acquired some top-quality buildings such as the Verizon building in New York. When the deal with Blackstone was announced, EOP had outperformed the industry for the year.

Vornado has been a darling of analysts and investors since it went public in 1993. In total shareholder returns over the past six years, Vornado delivered 377%, significantly besting the industry. It won praise for paying top dollar to hire stars -- from the executive office to local facilities managers -- and won a reputation for keeping its buildings full of satisfied tenants.

The son of a clothing manufacturer in the Bronx, Mr. Roth helped form shopping-center company Interstate Properties in 1968 and took control of Vornado in 1980. Mr. Roth's companies acquired control of retailer Alexanders Inc., which filed for bankruptcy-court protection, in 1995 to get at its real estate. In 1997, Vornado entered the office market, buying Mendik Co., which owned seven midtown Manhattan properties. Vornado, now one of New York City's largest office landlords, also has a significant presence in Washington, D.C.

In a presentation to shareholders in June, Mr. Roth said that the two most important aspects of his company were brand name and the ability to pull off big acquisitions. Turning to Vornado's President Michael Fascitelli, he added: "We walk in in the morning, Mike and I, and we never know what is going to walk in the door in terms of a spectacularly interesting transaction that we may do. The rich get richer? Thank God."

Even if it acquires EOP, Vornado intends to add only three more cities -- Boston, San Francisco, and Los Angeles -- all coastal markets that meet the company's strategy of owning in cities that benefit from international trade and where it's difficult to build, which limits competition, according to a company statement. Its two private-equity partners in the deal -- Starwood Capital and Walton Street Capital -- would divvy up EOP's hundreds of other buildings and are expected to sell off at least some of them.

At times, Vornado has acted more like an investment fund than a landlord, participating in the privatization of Toys "R" Us Inc. in 2005. The company has also invested heavily at times in McDonald's Corp. and Sears Roebuck & Co. "They're allowed to do a lot of things that if just about any other company did they'd be roundly booed by the marketplace," says Jim Corl, a representative of Cohen & Steers, a real-estate investment firm and a major shareholder of both EOP and Vornado. "They're able to go out and raise a billion dollars of equity because Steve Roth says, 'I need a billion on my balance sheet,' and the market says, 'OK, here's a billion in equity.' Everyone else would have to explain why."

But in the last year as Vornado built up cash reserves and issued more equity, analysts began to wonder how it might put its war chest to work. When Reckson Associates Realty Corp., a Uniondale, N.Y., real-estate investment trust with six valuable New York City buildings, was in play last summer, Vornado was a bidder. But Vornado eventually lost out to SL Green Realty Corp., another New York REIT, when it refused to go higher than its initial price.

Biggest Trophy

In hindsight, it's clear why Vornado wouldn't budge beyond the price it thought Reckson was worth. While bidding for Reckson, Vornado was simultaneously negotiating for the biggest trophy of them all: Equity Office.

In an interview with The Wall Street Journal last summer, Mr. Zell emphasized that EOP had no defenses, such as a poison pill, that would keep a bidder from approaching him. If the offer maximized shareholder value, he had an obligation to consider it. "I believed that the moment I took money from the public," he said.

Over 18 months, five firms approached EOP about a possible merger, according to the shareholder proxy issued Dec. 29. (Only Blackstone was identified by name. Vornado was called "Company C.")

Vornado executives argued that the two companies could enhance the best in each other, perhaps in a stock-for-stock merger, the proxy said. Equity Office would bring its vast portfolio; Vornado would bring its powerful balance sheet and cachet with Wall Street, according to sources close to the negotiations. And, in an era in which dozens of real-estate companies have been taken private, EOP -- or at least some of its assets -- could remain available to public investors through the capital markets, an avenue frequently championed by Mr. Zell.

After EOP and Vornado started their discussions, Vornado signed a confidentiality agreement and was allowed to perform due diligence on EOP's assets, the proxy says.

Yet, by October, discussions with Vornado were deteriorating. Mr. Zell met with Mr. Roth and indicated "he was highly skeptical that the two companies could agree on a transaction that would be beneficial" to EOP shareholders, according to the proxy -- an indication that price was the obstacle.

Nonetheless, Mr. Roth pressed on, asking that the company executives continue to meet, the proxy said. At least one more meeting was held Nov. 3.

But by that time Blackstone was already feeling out EOP's bank, Merrill Lynch, about the price it would take to get the deal done. Merrill Lynch suggested a price close to $50 a share. Two weeks later, Blackstone clinched the deal.

The decision surprised Vornado executives. They simply didn't anticipate Mr. Zell's willingness to sell to the highest bidder and walk away, according to people close to Vornado.

As soon as the deal was announced, however, Mr. Corl, of investment firm Cohen & Steers, announced that Blackstone's price was too low and predicted other bidders would come in.

Mr. Zell had left an opening: Merrill Lynch made clear to Blackstone that the termination fee -- the amount that Blackstone would receive if another unsolicited offer should be accepted by EOP -- had to be low, the proxy says. The amount got whittled down during negotiations from Blackstone's original request of $275 million to $200 million, setting the stage for Vornado's second chance.

-- Ryan Chittum contributed to this article.

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