Reflections on the Blackstone IPO

There was not any choice this week but to talk about last Friday’s IPO of Blackstone (BX), the New York private equity firm. Blackstone, headed by Steve Schwarzman and former Commerce Secretary Pete Petersen, is selling 12.3% stake in the company for $4.13 billion dollars. With 5: 1 demand for the IPO, 133.33 million partnership units were priced at 31, the upper end of the range. Concurrently, Blackstone is selling almost a 10% stake to the Chinese Government at the same time.

The stock opened at 36.45, an 18% premium to the IPO price.

This is the largest IPO to hit Wall Street since CIT Group went public five years ago in 2002. After AT&T wireless, Kraft foods, UPS, CIT, and Conoco, it is the sixth richest IPO in history. .

Blackstone started with an investment of $400,000 in 1985 is now worth more than $40 billion. With only 770 employees, Blackstone was priced at a market value greater than Bear Stearns and a third of Goldman Sachs, the premier brokerage firm in the world with more than 326,000 employees. Its market value is greater than such brand names as Sears, Amazon and Nike.

Blackstone manages about $80 billion in assets. Their portfolio of companies includes Cadbury Schweppes, Celanese, Freescale Semiconductor, Houghton Mifflin, Michael’s Stores, Pinnacle Foods, Universal Orlando, and large real estate holdings. Blackstone stated in the prospectus that it has earned an annual return of 30.8% for the last thirty years.

This offering earned Blackstone many distinctions not all of them honorariums. It is the first private equity firm to take itself public. Kohlberg Kravis and Leon Black’s Apollo are slated to be next.

In addition, Blackstone is the first IPO that members of Congress have implored the SEC to stop its flotation at least until hearings could be held. Congressman Henry Waxman of the House Oversight Committee and Dennis Kucinich wrote to SEC Chairman Christopher Cox that the IPO might present investors with new and undisclosed risks while stripping them of necessary protections.

Bloomberg reported that a record number of 5 congressional chairmen had raised concerns about the IPO. British lawmakers are also looking into private equity.

Much of this has to do with the low rate that private equity firms enjoy. There is a movement underfoot to change private equity’s tax status from that of capital gain to ordinary income. This would mean that the tax rates would be raised in the United States from 15% to 35%. As one British parliamentarian asked, “Why should you be paying lower taxes than your maid or chauffer?”

Blackstone has already warned investors that the rise in taxes could adversely affect their return. I am not convinced that the raising of taxes is imminent. Last week, hedge fund billionaire Stevie Cohen hosted a fundraiser for Senate Chris Dodd, chairman of the Senate banking committee. This committee would weigh on the rise in tax rates. Show me the money works every time.

Buyers of Blackstone units need to be clear on what they are buying. Blackstone is not offering shares with voting rights or direct connection to their portfolio of their companies. If the buyer of Blackstone units does not like management, he can not vote to remove him. The only protest mechanism available is selling the stock.

What you are buying is participation in the fees and capital gains that the management company of Blackstone earns. There are plenty of profits to go around. According to Bloomberg, the firm earned $2.3 billion, 71% more than the year before. But yet Blackstone has already warned that there will be no profits in the foreseeable future. They have disclosed there Texas sized compensation costs.

Investors are still clamoring for Blackstone because it affords an opportunity to invest alongside big institutions and one of the best management teams in the business. There are very few if any investors that have sustained a 30% annual return for thirty years.

Fortress Investment Group, the hedge and private equity fund group, would be the closest publicly traded competitor to Blackstone. It went public in February and is currently trading at a 20 P/E ratio. Some of the premium afforded Fortress is due to the fact that it was the only publicly traded private equity/ hedge fund vehicle.

Compared to Fortress, Blackstone is cheap. It is trading at a 13 P/E. But the P/E gap is closing. Fortress stock has been falling for a week. But it might be more realistic to compare it to the Goldman Sachs with a P/E of 10. In that case, it is selling at a slight premium.

One of the catalysts for the explosive returns in private equity was the low interest rates of the past several years. Private equity borrowed at an average yield of 7.3% last year. Now the yield is up to 7.8%. The rise in yield could adversely affect returns.

To paraphrase the Clash song, “Should I buy, Should I stay, or Should I go?” is the topic du jour. This is one question that can be answered with a coin toss. I can not get excited about the stock. It is not a screaming buy. But I would never bet against Steve Schwarzman succeeding.

The Trader chatter was that most of the institutional demand was coming from overseas and the fast money hedge funds. The hedge funds were probably looking to sell into the pop in the IPO price.

The mutual funds were keeping their powder day and staying on the sidelines. Maybe you should too.