A Look Back At the Blackstone IPO

Amidst the detritus of today's broken markets, I felt compelled to look back and review some of my thoughts around the Blackstone (BX) IPO. Why? Because I had thought their filing had pretty much signaled a frothy equity market, and certainly a top for the private equity business, due both to the "perfect" environment for raising debt capital (e.g., savvy, opportunistic issuers coupled with liquidity-rich, brain-dead investors) and that some of the smartest money in the business wanted to take chips off the table and raise permanent capital. And were willing to take this step even in the face of much criticism and consternation from their LPs and others. Cries of hypocrisy came from every direction. But still Mr. Schwartzman pressed on.

Here is an extract from a post I had written 3/17/2007 titled Blackstone Going Public? Watch Your Wallet, Brothas:

But really, what does this mean? Mostly that Steve is calling the top. Not an absolute market top, but a valuation top for his firm. Why?

• PE is just getting so big. Too big. Too much liquidity. At some point in the not-too-distant future returns will degrade. He knows this. He is sitting the catbird's seat. He's smart. We're dumb. He's the deci-billionaire, remember?
• "The real and perceived growth of the Blackstone business will slow, so let's monetize it while we can extract the momentum from the market (read: dummies like us), right? And besides, guys, it's mostly my money, anyway."
• The public scrutiny of PE returns, its place in the market, and its adverse PR will only intensify. There is a real issue with the tax treatment of management fees - logic and reason implies that this may well change. Why not monetize these on a capital gains-tax rather than a ordinary income-tax basis? This is worth billions of capitalized market value.
• That whole issue of Steve's saying for the last 20 years "Being public sucks because of costs, complexity, scrutiny, etc." applies to everybody but him because, hey, now we're talking about his money and he wants it - now.

Looking back, I'd say that I was pretty much spot on from a motivation perspective. I expanded on this thought process in an editorial I penned for the Financial Times that was published 3/27/2007 titled Why the Blackstone Offer May Signify a Bubble:

My assessment is that we are in a private equity bubble of sorts. However, it is not one that has ghastly implications for the overall market but, instead, will have negative outcomes for those invested in private equity funds - and certainly for those buying into the public shares of private equity management companies such as Blackstone.

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As long as the debt markets co-operate, all is well. But when debt investors wake up to the fact that they are systematically underpricing risk, the highly leveraged deal structures simply will not work. Deals will still get done because private equity firms need to deploy their capital to build franchises and justify their fees but leverage ratios will fall and returns will decline. Bad for the overall market? Not really, because competition for doing deals in general will remain strong owing to liquidity considerations. But bad for private equity investors? Certainly, and now there will be one more constituency at the table: investors in the public equity of these private equity firms. Here is the rub.

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Mr Schwarzman knows this full well, as do his colleagues at Kohlberg Kravis Roberts, Texas Pacific Group, Apollo and others thinking about following in Blackstone's footsteps. They understand that the risk/reward calculus of the private equity business (largely being borne by debt holders in today's frothy environment) could shift rapidly, closing a historically attractive window for them to monetise their franchises. They see the private equity bubble and want to extract value before it pops. But where does that leave the rest of us? Unhappy, indeed.

Let's take a quick look at the data:

GSPC S&P 500 Index

3/17/2007 (date of my first post): 1386.95

6/22/2007 (date of BX IPO): 1502.56 (+8.3% from 3/17 post)

3/28/2008 (last close): 1315.22 (-5.2% from post, -12.5% since BX IPO)

BX

IPO price: $31.00

6/22/2007 close: $35.06 (+13.1% from IPO price)

3/28/2008 close: $15.28 (-56.4% from first day close)

I think we can all look back at the Blackstone IPO as one of the definitive signs of the troubles yet to come. Mr. Schwartzman and his PE colleagues all saw the same thing, the possibility of a sea change in the debt and equity markets, but only he had the guts and the intestinal fortitude to get a deal done - fast. And his decisiveness certainly paid off in spades - for Blackstone insiders, that is.

In the future we should be more aware of the signs the top tier of "Money People" are sending us. Because it was all right there for us to consider. But few people wanted to believe the end was near. Sadly, this is a fixture of the human condition, particularly as it relates to investing.

Comments

[fxtrader07]

nice call back then, but your article, unfortunately is not more than bragging about that earlier call and offers nothing for the future.

[p.minaud.paris]

YOU DESERVE BRAGGING RIGHTS...YOU WROTE WHAT SO MANY THOUGHT...AND FEARED

[Plasticman]

So, is it time to buy back in now that we have gone from extreme optimism to extreme pessimism and now that BX is down 56%? The day that it becomes public record that Schwarzman has started buying back his own stock, it will be too late to get the big returns. There is one big positive here. It makes me feel warm inside knowing that the Chinese were such big investors.