Blackstone Is A Dog

In today’s (8/6/2007) broad based rally in the financial sector, every major investment bank and broker dealer was up tremendously. Fortress Investment Group, the other large publicly traded PE shop, was even up 6.67%, despite having sunk some 39.1% nearly straight down since its February 2007 IPO. They were all up that is, except Blackstone (BX).

While the average financial player advanced 3.51% BX only advanced a meager .57% despite BUY ratings from every major brokerage on Wall Street and a 281 point rally in the Dow. This behavior belies that there is little investor support for the BX “stock”. I use the term “stock” loosely to describe the BX non-voting units representing the limited partner interests that Schwartzman & Co shilled onto the market.

Yet another contrarian indicator appears on the first page of the BX OM: “We have entered into an agreement with an investment vehicle established by the People’s Republic of China … we will sell to it $3 billion of non-voting common units at a purchase price per common unit equal to 95.5% of the initial public offering price in this offering.”. Is there anyone who’s investment lead should be more avoided than government of COMMUNIST China. The country is literally anathema to making profit. Schwartzman saw these guys coming a mile away and their participation is just one more sell signal.

Taking a closer examination of exactly what one receives for his share in Schwartzman’s magical money machine uncovers the beauty of the Blackstone IPO (as a vehicle for cashing out the senior partners):

1)”The Blackstone Group L.P. is managed by our general partner, which is owned by our senior managing directors. Our common unitholders will have only limited voting rights and will have no right to elect our general partner or its directors.”
Translation: We’re in charge no matter how poorly we perform as managers or whether we decide to take your money and blow it on Beanie Babies

2) “Immediately following this offering, our existing owners will generally have sufficient voting power to determine the outcome of those few matters that may be submitted for a vote of our limited partners, including any attempt to remove our general partner”.
Translation: Don’t even think of trying to get rid of us, we already thought of that.

3) “The partnership agreement of The Blackstone Group L.P. limits the liability of, and reduces or eliminates the duties (including fiduciary duties) owed by, our general partner to our common unitholders and restricts the remedies available to common unitholders for actions that might otherwise constitute breaches of our general partner’s duties.”
Translation: We can and will screw you at our digression, and don’t think about suing over your rights as a Shareholder, you bought “units”… remember, units are not governed by the rules of fiduciary responsibility, “units” are governed by the rules which we have just made up… right now.

4) Potential conflicts of interest may arise among our general partner, its affiliates and us. Our general partner and its affiliates have limited fiduciary duties to us and our common unitholders, which may permit them to favor their own interests to the detriment of us and our common unitholders.
Translation: (See above section on unit holders being screwed)

I could go on but the general idea has become apparent. Blackstone’s unit holders have no rights. The OM does make mention cash disbursements to the unit holder which one must assume will be the only value of these “units”. While it is unclear as to the size of these disbursements at present, clearly BX’s $26.6bn market cap, a value nearly equal to that of Lehman Brothers ($30bn… and their share holders have rights) is far too high.

As much as I am tempted to say these units are completely worthless the trade for my portfolio will be the purchase of the March 2008 $17.5 puts. While certainly unscientific, until the amount of the distribution is known, I will use the trajectory of Fortress Investment Group’s fall from $31 a share in February 2007 to $18.87 today as a proxy. A similar slide seems inevitable once BX’s underwriters are no longer vigorously supporting the price.

All of this being said, Blackstone remains an excellent business and a true leader of its field. The firm hires many of wall street’s best and brightest. However, one has ask to ask one’s self “Would Blackstone ever invest in the “units” of a company where it had no input on management decisions, no legal rights and management had not fudiciary obligation to protect Blackstone’s investment?” The answer is a simple, NO.

Disclosure: Author is short BX

Comments

[omooc:]

No one puts a gun at one's head to ask one to invest in China -- or invest in securities doing business in China. You are not BX management; how do you know how its decision-making process. March 2008 put is cheap; so all you can lose are a few pennies. But the PR value? Wow! We'll wait until March and see how all this works out. omooc

2007 Aug 07 08:47 AM

[James Lecato:]

You can't be for real!! If you think your going to stay short forever, your crazy. I can not see how you can not buy this stock, they have the bank of china (1.5 trillion cash) in their pocket? No deal is out of reach for them!

2007 Aug 07 11:30 AM

[Andrew:]

I agree with you that the limited partner common unit holders will have very little right in affecting operations. I'll go a step farther and say that common unit holders are the tick on a dog's butt. But, if that dog is very well fed, then the tick will get fed well.....no illusions here about being invited to board meetings. If your concern is that common unit holders will get screwed on future distribution of profits, then don't worry. Existing owners still own 78% of BX. So, it is in their interest to maximize the open market value of the common unit shares.

You focus should be on how BX has grown their assets mgmt at 34%+ per year for the past 10 years, without a single down year (even through '97 global liquidity crises and bursting of tech bubble). This rate of growth is 60% faster than peers (20%+ per year growth by avg private equity).

good luck.

BTW, there's no "t" in Schwarzman.

2007 Aug 07 01:47 PM