Calling a Turn in Blackstone Group

Blackstone (BX) is quite possibly one of the most misunderstood companies trading on the US exchanges. The company is listed as a “global alternative asset manager,” but few people adequately grasp the manner in which the company creates value for shareholders. Reported earnings do very little to paint a picture of shareholder value as the company holds investment portfolios that may grow in asset value for considerable periods without ever actually being converted to earnings.

Furthermore, the assets that the company owns are to a large degree unpriced and very difficult to value. It is not until part each individual holding is sold to the public markets that the company can confidently predict what the current value of the individual holding might be.

Part of the reason Blackstone’s shares have declined is due to fear over the company’s exposure to the liquidity crisis. This crisis has been a vicious phenomenon for many financial institutions and at this point appears to have taken down at least one brokerage (Bear Stearns). The environment calls into question how adequately Blackstone is funded and how much risk they have to redemptions.

However, the company is extremely well capitalized and at this time is not employing leverage. Investors in the firm's multiple strategies are for the most part required to give adequate notice before pulling their capital out and in some cases are not allowed to redeem their investment for years. This allows the company to invest with a long-term value creation mindset without worrying about short term disruptions in the credit market.

As far as earnings are concerned, the company receives management fees for the capital it manages for investors in its various funds. The company also invests its own capital alongside investors. The management fees are helpful in paying salaries and carrying on the day to day business of Blackstone as a whole, but they do not add significantly to the profitability of the firm. The key to the company’s success are incentive allocations which are essentially profit sharing arrangements with investors in the company’s funds.

When a position is sold for a gain, Blackstone recognizes a gain on its book for the portion of its own capital it invested as well as a portion of the gain its investors received (usually 20%). These gains can amount to tens and even hundreds of millions of dollars and are vital in the company’s reported earnings. The problem is that due to market conditions, these earnings have been largely absent for the last two quarters.

Looking at today’s environment, there are some interesting dynamics lining up. Firstly, the company continues to accumulate assets under management [AUM]. This supplies Blackstone with ample cash to be able to purchase investments during a time when such investments are very cheap. Investments made today could result in huge incentive allocations in the next 18 to 36 months. Secondly, the IPO market is likely to pick up now that Visa (V) has successfully launched its IPO.

Investors should be more confident in purchasing new issues in the coming months, which will likely result in Blackstone being able to turn out some of its portfolio of private investments resulting in incentive allocations.

Finally, the stock is incredibly depressed, offering investors a chance to pick up shares for less than half of their IPO price. While timing is difficult and volatility will likely cause some major swings, the shares are in a range that should prove to be a strong support area and one with less risk compared to the potential reward. Beginning to build a position in BX at this time could yield significant gains throughout the next year or two.

Full disclsoure: Author has a long position in BX

Comments

[texalope]

I've been thinking about the government regulations that are a pretty good bet bet following the IBanks' borrowing from the Fed. The beneficiary could be the Private Equity firms like Blackstone , since they can be more aggressive.

[WAGSTAFF]

NO MENTION OF DIVIDEND ??? IT IS MY UNDERSTANDING THAT THE COMPANY IS ON RECORD FOR THE PRESENT $1.20 TO CONTINUE THROUGH 2009. LOOKS PRETTY GOOD TO ME. AM I MISSING SOME-
THING ???

[Kanganomics]

The assets that the company owns are to a large degree unpriced and very difficult to value? Stock price has been cut in half since IPO?

I have serious doubts that this is stock offers anything other than highly risky speculation, especially seeing as the market has not been a fan. I assume you bought in at the IPO, are you adding to your position at half price?

[zenalgorithm]

The Blackstone IPO was simply a Ponzi scheme. Too bad so many people fell for it.

Why invest in so much risk when you could buy a safer, big bank like BofA, JP, WF, or Citi, which are all protected by the FED?

[venividivici]

Oh I understand Blackstone perfectly. It is a river of gold for the people who run it, no matter what happens. Those other geniuses on Wall Street must be green with envy.
And what an investment it's turned out to be for the Chinese and those who invested in the IPO. But you have got to hand it to those masters of the Universe at Blackstone, there timing as usual:PERFECT

[Bindaas]

What an article !

Give us some decent numbers to support your claims Mr. Scheidt. After all, you are LONG on BLK, and have possibly done a good deal of analysis.

Or do the numbers tell a different story than your article !?

[syndicat]

Blackstone has little debt on its balance sheet because it is an asset manager. Blackstone's deals do need large amounts of debt to work.

Think about the Hilton Hotels buyout that was done last year.
BX paid $26 billion for Hilton and borrowed more than $20 billion.

Last month, Lex, a writer in the Financial Times, suggested that the
Blackstone equity in Hilton was now worthless.

[Burlcouch]

Good Article. I would just add 2 points. (1) I put my investment in BX not in my stock portfolio, but in my fixed income portfolio, my dividend return based on my average cost is 7.5% (2) With fll ownership in Hilton, other Motel chains & other companies, I look at BX also as a conglomerate, which should add appreciation in value. Until that time 7.5% return on my investment is not bad.

[BBurkhart]

All I can say is BUY BUY BUY. Yes, it takes a certain maverick mentality to like the BX offering, but seeking alpha is all about smart decisions and BX certainly has it's share of smart people. I like the company and I love the current buying opportunity!

[mmuribi]

What I do not understand is why management seems to have lost all ability and/or interest to alter the seemingly one way path for its stocks. Downward!

[Zachary Scheidt]

Kang, I sold my position from the IPO when the deal went south (damage control) but yes, I have begun building a position with a much lower average price

All, Thanks for the comments. Many are right in that the numbers are difficult to come up with. Management's guidance gives little concrete to work with simply because there must be assumptions as to the value of holdings for which there is no current market. However as sentiment begins to turn and the market begins to find its feet (even if temporarily), Blackstone should get a strong trade-able lift.

[Stephen Egan]

Good article