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Hilton (NYSE:HLT), which was once seen as Blackstone's (NYSE:BX) worst private equity investment, went for an IPO on December 12. Hilton and its shareholders sold 117.6 million shares at a price of $20 per share, raising $2.35 billion in the IPO. In 2007, Blackstone bought Hilton for $26 billion in a leveraged buyout. Blackstone contributed $5.5 billion as equity, and it raised the remaining amount through debt. In 2010, the company again invested $1 billion in Hilton, taking its total equity investment to $6.5 billion.

Hilton's stock is trading around $22 at present, and the company has a market cap of $21.6 billion. Currently Blackstone owns around 750.6 million shares, or 76.2%, of Hilton's total outstanding shares. So, the valuation of Blackstone's share in Hilton is around $16.5 billion. This indicates that Blackstone has gained $10 billion on the $6.5 billion equity it invested. Hilton has returned 2.3 times its investment, or generated a return at a CAGR of around 17%. There is more to the story; Blackstone isn't selling its stake in Hilton at present and wants to benefit from the growth of Hilton.

Hilton has grown its total rooms by 36% since June 30, 2007, which is highest among the major hospitality companies. Rooms under the company's development pipeline have increased 60% and rooms under construction rose by 133%. The outlook for the hotel industry looks good. The U.S. lodging industry's revenue per available room, or revpar, is expected to grow at 7.2% in 2014 and 8.1% in 2015. This will have a significant impact on the revenue of Hilton since it operates 78% of its rooms in the U.S. This will drive up Hilton's share price, increasing the value of Blackstone's stake.

We will see a considerable increase in the company's management fee as well as performance fee as the value of Blackstone's stake increases. Blackstone charges around 0.65% to 1.75% on the fair value of the invested capital for its real estate and private equity investments. So, if the value of the Blackstone's stake in Hilton increases by $1 billion, Blackstone's management fee will increase by $6.5 million-$17.5 million. When it comes to the performance fee, the company charges 20% on the net capital appreciation per annum, provided the fund gives the required return. As the value of Blackstone's stake increases, there will be a significant increase in the performance fees from the Hilton investment, which in turn will increase Blackstone's revenue.

Cashing in on the recovering real estate sector

Blackstone's assets under management, or AUM, in the real estate segment grew 28% from $53.5 billion in September 2012 to $68.9 billion in September 2013, and it now forms around 27.5% of its total AUM, which is $248.1 billion. The company's AUM in the real estate sector has increased $12.2 billion in the first nine months of 2013. Around $7.8 billion of the increase was due to the market appreciation of its real estate investments, which indicates the growth of the real estate sector last year.

The company is increasing its investments in the real estate segment across the world to benefit from the recovering sector, with more focus on Asia Pacific. The Asia Pacific real estate sector is expected to show strong growth of 5.0%-5.3% annually up to 2015. To gain from the Asian market, recently Blackstone agreed to buy 40% stake in the Chinese shopping mall group SCP Co. for $400 million. Blackstone, which has around $7 billion in investments in Asia, will fund this acquisition from its Asia real estate fund, which has a target to raise $4 billion to invest in Asia. The company is also increasing its investments in Australia. The company's strategy of increasing real estate investments will pay off as real estate sector growth will drive the value of its investments.

The real estate sector values in the U.S. are also expected to grow at a rate 5% in 2014. This will increase the value of Blackstone's investments in the sector, which will increase the performance fees as well as the management fees of the company. The performance fee from the company's real estate segment in the last quarter was $440 million, up 63% from the third quarter of 2012, and formed around 36% of the company's total revenue. This increase was due to the increase in the value of its investments in the real estate segment. Going forward, I expect robust earnings from the real estate segment in 2014 as the real estate sector values across the world increases.

Conclusion

Blackstone's stock had a bull run this year; it grew more than 85%, from around $16 in the beginning to around $30 at present. The appreciation in the asset values of its investments was one of the main reasons for this stock spike. Going forward, the company will benefit from the appreciation of its investment in Hilton and its real estate sector.

The company's fund management fee and performance fee will increase as the real estate values increase. The company provides a dividend yield of 3.90% compared to the industry's 2.80%, which indicates that the company is undervalued at its current price and is bound to increase. In my view, Blackstone's stock will continue its bull run on the street.

Source: Blackstone: Betting On Hilton And Real Estate Recovery