Immense Opportunity in Blackstone Group

I spent some time last week and over the weekend finding stocks that would benefit most from the rate cut and found myself looking at alternative investment managers. I have already written an article about Fortress Investment Group (FIG) so I decided to profile Blackstone Group (BX).

Blackstone is an alternative investment manager that participates in private equity, real estate investment, hedge funds and related alternatives, and also acts as an investment advisory as a fourth business division. The diversification of revenue helps smooth the total income stream for the company and offers BX multiple channels to employ their expertise. Lehman Brothers lists the company’s competitive advantages:

• Diversification of investment products
• Positive brand recognition
• Attractive long-term track record
• Access to investment banks for deal participation
• International presence
• Permanent capital base

The company raised some of the permanent capital mentioned above through its initial public offering this summer. The offering was met by unprecedented political scrutiny as company founders reaped windfall gains for their portion of company ownership, most of which would be taxed at very attractive rates. The company’s structure allows most of earnings to be taxed at a low 15% rate due to the long-term investment nature of its revenue stream. This has Washington up in arms and one of the largest overhangs in the stock right now is the concern over how earnings will be taxed going forward. It seems most likely that a bill will be passed that requires the company to pay taxes at a rate similar to traditional asset managers but it is likely there will be a grandfather clause that will allow the company to have 5-7 years before the new rates kick in.

A second issue overhanging the company is the deterioration in the financial markets and the lack of liquidity and availability of funding for transactions. Since Blackstone often enters transactions from a LBO perspective, borrowing money to buy other companies and putting up only a small portion of the capital needed for the transaction, this funding is necessary and an important part of the overall business. A bright side of this constraint is that most competitors are facing similar struggles and BX has more flexibility in securing funding because of their financial strength and track record of successful investments. Furthermore, the price necessary to take many of their target companies private will likely be lower as fewer investment firms are competing to engage in such transactions.

It appears at this time that the market is concentrating on the negative issues of taxation and financial liquidity right now, while the opportunities presenting the company, and the positive operating metrics may be overlooked. Last month, Blackstone reported Q2 distributable earnings per share of $0.63 which blew away analyst expectations. During the conference call, management acknowledged the difficult financing environment for private equity, but stated that its hedge fund business and real estate business were in good shape so far for the year. Blackstone is expected to open 7 new hedge funds between now and the end of next year, raising $15 to 20 billion in assets under management which will significantly increase fee based revenue, not to mention the potential for large incentive fees if the funds produce attractive returns.

Another exciting opportunity for BX is its relationship with the Chinese government. Before the IPO, the Chinese government bought approximately 9% of the company in a move that signified the expansion of investment from US treasuries to a broader assortment of US equity investments. The relationship with the Chinese should allow BX to participate in deals that would previously been unavailable to US based investment firms. Since the Chinese economy is expanding so rapidly, and the government restricts foreign investment in national companies, this could open very attractive doors for Blackstone and investors in funds managed by Blackstone. Already the investment advisory arm of BX has been retained by the China Development Bank to advise them on a stake they are taking in the Barclays (BCS) / ABN Amro (ABN) merger.

While earnings are almost certain to be difficult to analyze and volatile, the opportunity in BX is immense. Even if the funds are taxed at a higher rate, the growth in this portion of asset management should still make it an attractive investment. Any positive news from Washington should benefit the stock very quickly and if BX is able to find funding for one or two important deals, investors will begin to look past the current liquidity crisis towards the value BX is able to create in its investment strategies. The stock has begun to trade better the past week and I believe that is a direct response to the interest rate cut and the improving outlook for the company as well as the industry.

Disclosure: Author has long position in BX

Comments

[Hirsch Frie...:]

It is much too early to tell just what BX will give to (or take from) the investment world. Let's wait amd see what happens after all the smoke settles.

2007 Oct 13 09:28 PM