Investors have focused on market volatility and negative commentary around Blackstone (NYSE:BX) in recent months and this has reflected in the firm's stock performance. One could say the world's largest alternative asset manager's quarterly results also did little to calm market concerns. Poor ENI, weak short-term public market driven fund performance, and a challenging near-term outlook are a few of the concerns that investors focused on in the quarterly results.
But I believe all this is noise. Blackstone's long-term thesis remains intact. The firm has the best network to source deals and the best network of CEOs and advisors to make companies stronger and more valuable once it buys them. Despite a relatively volatile market backdrop, fundraising prospects remain robust, deal flow is picking up reflecting a broad-based step up in investment activity across segments, and outlook for distributable earnings remains healthy.
The pace of growth of EBITDA at BX's portfolio companies may temporarily slow down if the global economy slows. Similarly, if interest rates rise, it may become more expensive for BX to borrow. To the extent that the company does use leverage to finance its deals, which could in theory reduce private equity returns. Weak stock market also means that BX will probably have one less exit opportunity than would otherwise be the case. Despite these concerns, BX's latent earnings power and growth prospects remain robust.
While a sustained challenging and volatile market backdrop could tamp down public sales, accelerating strategic sales are expected to pick up much of the slack. Stepping back, long-term fund structures mean managers are never forced sellers into declining markets. Rather PMs can simply hold investments and compound value.
But Long-term Story Intact
Blackstone's fee-related earnings got a hit in the December quarter, but it was largely due to the fact that the company spun-off its advisory business last year. The spun-off left BX with reduced advisory revenues compared with the fourth quarter of 2014. A change in the accounting policy with respect to accounting for deferred compensation also affected the Y/Y comparison. But other than that, there hasn't been much change in the Blackstone story. BX's long-term fundamental drivers remain solid, the secular backdrop remains strong, and valuation is attractive.
BX has a massive amount of dry powder to take advantage of the current environment. BX raised additional $15.5 billion in 4Q15. The diversified asset manager has some $80 billion in total which includes the untapped $18 billion PE funds, a $5 billion untapped energy fund, and $13 billion of the new $16 billion real estate fund. Moreover, BX has $250 billion of performance fee eligible assets. Putting aside ongoing pressure on ENI, fundamental trends continue to strengthen, with BX's best-in-class scale/diversity better insulating the franchise from more PE-centric concerns around narrowing exit/financing windows, in particular.
A slowdown in growth in global economies is a cyclical issue. It is not something that would permanently hurt the value of BX's portfolio companies. These companies may see a reduction in their near-term growth rates. But the value-creation process, consisting of cost-cutting and other margin improvement, which is Blackstone's signature, will continue regardless of the pace of economic growth.
Distributions Potential In 2016
Putting aside ongoing pressure on ENI, BX continues to have strong underlying operating momentum and the potential to have a healthy rate of distributions into 2016. It might not be at the levels of 2015, but a healthy rate of distributions nonetheless. 2015 was a stellar year for Blackstone. The asset manager expanded positions across businesses. It raised more capital ($94 billion) than the next four of its largest public competitors combined and invested $32 billion, with $43 billion of realizations returned to LPs (Source: Sandler O'Neill & Partners).
Distributions to BX unit holders reached $2.73 in 2015, translating into slightly over 10% yield based on the current stock price. It's true that challenging public markets are likely to continue to pressure near-term ENI trends. But this mark-to-market noise is not indicative of the firm's fundamental value. BX's long-term distribution outlook remains strong with record asset levels, no slowdown in industry leading asset raising, and solid levels of accrued carry. Moreover, there is nothing to indicate that the recent weakness in performance is anything but temporary.
Strong Capital Formation
BX reported economic net income [ENI] of $0.37, below the Street estimates of $0.46. The miss was driven largely by performance marks, particularly in the credit segment, which drove reversals in accrued carry and limited investment income. Fee related earnings were stronger than anticipated, driven by stronger real estate transaction fees and well controlled base compensation (Credit and Hedge Fund Solutions). Results also included a tax benefit in the quarter (+$0.04).
Capital formation during the quarter continued at a strong pace with $15.5 billion of gross capital raised in 4Q. BX raised $94 billion in 2015. While capital formation will slow into 2016 as BREP VIII and BCP VII have reached their limits, there will be plenty of opportunity to grow the asset base as the firm has significantly expanded its product set. BX's management indicated on the call that another year of solid double-digit growth in fee-paying AUM is expected.
The argument that Blackstone's quarterly results reflect a challenging environment for private equity based asset managers is not completely ill-founded. But these firms are active in all different environments. The weak equity markets thus far in 2016 may pressure economic net income for 1Q16, but I would not put much stock in that because ENI is non-cash and inherently volatile.
Despite weak recent stock performance, I believe BX continues to have strong underlying operating momentum and the potential to have a healthy rate of distributions into 2016, although perhaps not at the level of 2015. BX's latent earnings power and growth prospects remain robust. As I said earlier, fundraising prospects remain robust, deal flow is picking up reflecting a broad-based step up in investment activity across segments, and outlook for distributable earnings remains healthy.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.