As markets continue to fall on worries about the ability of the EU to survive and the ability of the US to grow its GDP, investors are growingly seeking the safety of cash, selling riskier assets for the safety of both gold and, strangely, US treasuries.
This knee jerk reaction always creates opportunities for those companies or individuals who happen to be well capitalized as the market sells off, and opportunistic in buying as prices drop. This world, often dominated by wealthy professionals, is off limits to most individual investors who lack the capital or connections to enter this realm of investing. However, with units of The Blackstone Group (NYSE:BX) down nearly 30% since reporting earnings July 21, investors who are looking to gain exposure to the private equity markets are being given an opportunity.
The Blackstone Group is perhaps the best known private equity company in the world, and is likely most widely known for its buyouts of public companies. Limited partner units have been publicly traded since June of 2007, and the firm navigated the credit crisis rather well, buying up depressed assets from weaker companies, the FDIC, and out of bankruptcy.
The firm was able to do this due to the way the company operates: Blackstone starts new funds, raising amounts of $10 billion or more per fund from wealthy individuals, pension funds, and others, as the firm loads up on capital, referred to as "dry powder." The money is locked up for a few years, allowing Blackstone the ability to sit on the cash, waiting for compelling investment opportunities before pulling the trigger and deploying capital.
Dry powder at the end of the second quarter was a record $31.4 billion, meaning the firm has the ability to do large transactions even if other investors begin to shun risk. Last month Blackstone said it was looking for deals in Europe, attempting to take advantage of lowered asset values due to sovereign debt issues. Since owners of the limited partner units do best when Blackstone is able to scoop up assets at bargain prices, downward pressure on asset prices should be viewed as a positive for Blackstone's ability to make investments in future returns.
Blackstone's second quarter earnings release showed exactly how Blackstone can make transactions in times of stress that continue to pay off years later. The quarterly report showed real estate revenues tripled in the quarter, from $208.5 million in Q2 last year to $648.5 million this year. A large part of this jump was due to what are referred to as "catch-up" provisions in the way profits are distributed in the real estate funds.
These provisions state that once a fund's performance passes a certain level, Blackstone receives a "disproportionately greater share of the profits until it effectively reaches its full share of performance fees." This change in profit splits easily makes Blackstone's real estate business the largest contributor to the firm's ENI, and helps explain why the firm has been so active in buying commercial real estate in the recent past. As the "catch-up" provisions continue on for the rest of the year, investors should expect to see both earnings and distributions that easily beat last years results.
As markets continue to be strained in the wake of European troubles and a slowing US economy, investors should be looking for companies that are well capitalized, well managed, and that can continue to make money in a slow growth environment. Given Blackstone's record $31.4 billion of dry powder, seasoned management team, and knack for picking up distressed assets at favorable terms, Blackstone will be able to weather this storm.
The recent drop in unit prices is likely an opportunity for long term investors to align themselves with the investment interests of a leader in the private equity space, and its rich and powerful clients. Add in a distribution that should increase past last year's level due to increased fees in the real estate business, and units of the Blackstone Group look like long term winners.
Disclosure: I am long BX.