Is the Tide Turning for Blackstone?

Shares of The Blackstone Group L.P. (BX) have had more than their share of volatility since pricing their IPO at $31.00 in June of 2007.  At the time, the deal was surrounded by criticism as Stephen Schwarzman, the CEO, pocketed one of the largest windfall profits in business history (not to mention the fact that the gains were at a very favorable tax rate).  On top of that, the Chinese government used an investment vehicle to make a substantial purchase of the shares before they were publicly offered to the market.  As many investors cried foul, the stock began a bumpy descent eventually giving up more than half of its market value as the economy began to turn sour.

As we enter the second half of 2008 and the second year for Blackstone as a public company, the tide may be turning ushering in a better environment for owners of the stock.  To be sure, there are many cross currents and the outcome is far from certain, but a low stock price may be discounting a worst-case scenario.  

The bear case for Blackstone places an emphasis on the value of the capital already invested within the funds Blackstone manages, particularly the private equity portfolios along with the real estate investments.  Not only will the company likely take losses on its own capital invested in these areas, but it is also likely that a non-cash charge to incentive income (which is paid by outside investors in the respective funds) will be booked.  This will have an effect on reported earnings, although it is primarily a non-cash event.  The long-term bear perspective also notes that financing for leveraged buyouts will be hard to secure.  This keeps the funds from scoring outsized returns based on leveraged investments but also acts as a check to keep risk at a more reasonable level.

The positive side of the current environment is that Blackstone can put new capital to work in situations with dramatically lower price tags.  The company is actually enjoying strong capital in-flows as institutional money managers are becoming more and more aware of their need for alternative investments.  As this new capital is being put to work at lower levels, the prospect for much larger incentive allocations in the future (1 to 2 years down the road) is getting stronger.  So a situation with many attractive potential investments coupled with new capital to put to work is an exciting dynamic.

Finally, in reading a report by Morgan Stanley, I became aware that the company placed a significant amount of its IPO capital into its hedge fund portfolio.  Judging by the fact that the average fund of hedge funds is up 2.1% for the year, one can expect a decent return on investment for this capital.  Morgan Stanley goes on to say that the overall market appears to be extrapolating the current weak environment well into the future and gives little credence to the opportunities that are available to new capital.

Blackstone is certainly a volatile name with plenty of short-term risk as it approaches the earnings announcement in August.  However, long-term it appears that the shares offer significant value as the new capital grows and generates incentive income.  One possible way to profit from the long-term trend would be to buy in-the-money calls a few months out.  An investor would pay a bit more to cover the option premium, but the benefit of capping losses would also be helpful.

BX Notes

FD: Author has a long position in BX.

Comments

[RMG:]

When I read one of the recent transcripts, I got the impression that they are not honest. They claim to have good amount of capital to invest and they are purposefully not investing as they were looking for better opportunity. When I looked at their Balance sheet, the capital they were talking about was mostly intangible.

2008 Jul 29 10:37 PM

[Zachary Sch...:]

I've found it very difficult to "run the numbers" on Blackstone as the business has so many moving parts. It could be that they do not have their own capital (balance sheet) available to invest, but the funds that they manage (which include their own capital already invested in these funds) may have plenty of cash or at least undrawn credit lines. It may be a bit tough to pin down the specifics, but the overall environment and the fact they are raising new assets from investors should propel them over the long-run.

Thanks for the comment!
Zach
zachstocks.com

2008 Jul 30 08:29 AM