The Blackstone Group L.P. (BX) CEO Steve Schwarzman Presents at 2018 Goldman Sachs US Financial Services Conference (Transcript)

The Blackstone Group L.P. (NYSE:BX) 2018 Goldman Sachs US Financial Services Conference Call December 4, 2018 12:40 PM ET

Executives

Steve Schwarzman - Co-Founder, Chairman and CEO

Unidentified Analyst

Okay. Great thanks everybody for joining us today. It is my pleasure to introduce Steve Schwarzman, Co-Founder, Chairman and CEO of Blackstone. 2018 marked another successful year for the firm with record $460 billion in assets under management as of the end of last quarter. With over $120 billion in fundraising just over the last 12 months. Growth and accrued incentives, despite $45 billion in realization since a year ago. In addition, Blackstone continues to develop new strategies with expectations for nearly double its AUM over the next five years or so, as we heard from you guys at your Investor Day. So we look forward to getting an update from Steve today on the business and really as well as the economy and where things are going in the market. So as always, thank you so much for being with us today.

To kick things up, I was hoping to just start with your outlook on 2019. Clearly, there are concerns of the marketplace that the pace of growth for the economy is starting to slow, but given your expansive view on the portfolio companies, really across the world, I was hoping we can start off today's session with really your view on what you see is going on in the real economy.

Steve Schwarzman

Well, welcome everybody. You're better off here than actually investing today. So congratulations for a wise choice. In terms of 2019, we see a pretty good momentum with our companies. In real estate, we have and other exposures, it’s slowing a bit, which should not be unnatural. I mean, you were at 4.2% for economic growth two quarters ago. Gee whizz, so we were like a huge developed economy. That's pretty out there on the curve. And last quarter it was 3.5%, and it'll be -- nobody ever knows what next year will be. But consumer confidence is really high and business confidence is high, markets are in high. But you'd expect to be somewhere around 3% next year. And people forget that for eight years we averaged 1.8% and we kept being told that was good. And so I don't see the feds, particularly trying to induce an economic slowdown that's certainly not what Jay was saying as I happened to be at the speech that he gave last week at the Economic Club here in New York. So we look forward to a reasonably good year. But a year whether it's sort of mid-to-upper single digits for growth, that kind of approach for companies.

Unidentified Analyst

In terms of some of the risks that are out there, obviously, consensus calling for slower growth, but obviously still positive GDP growth. It sounds like that's your view as well. In terms of what the public markets might not be focusing enough on today in terms of some of the risks that are out there, what are on your radar?

Steve Schwarzman

Well, I just mentioned the interest rate risk. And I don't think that's a big risk. You've got trade stuff assuming that Mexico and Canada agreement goes through Congress, just assuming that. That gives you the China situation and steel and aluminum and cars. There are a lot of these things to keep track of. But I think, as I was driving down here I saw that -- as a results of the meeting over the weekend that the Chinese have just implemented a whole variety of things in terms of the theft of intellectual capital within China with all kinds of sanctions for people who do that and so forth. So that was one of the first outcomes of that meeting. But if things really go awry, with China, I think that would be a potential triggering point. And you have some other issues with the tariffs that were introduced, each of which have the objective of trying to normalize trades, which has been a longer-term problem. And you’re seeing that friction now. In the best case, those things work out over the next year or so. In the worst case, if they all go wrong, we’ll have significant dislocations. I think that’s one of the things that you could worry about. But most people aren’t trying to have significant dislocations who run countries...

Unidentified Analyst

In terms of capital deployment, public asset value obviously has pulled back and obviously you mentioned today being one of those days, both in equities as well as credit. Has that significantly improved the deployment opportunity that you see for the firm? And I guess, what are the best pockets of opportunities you see across either industries or asset classes where you guys are deploying capital today?

Steve Schwarzman

Yes, what happens as you know, when markets go down, people become unhappy. And they don't rush out to sell their assets at the lower price, which is very disappointing. But since I've been doing this for over 40 years, this is what happens. There's a period of adjustment when people long for their own old values and are inclined not to do anything for some period of time and then they give up more or less, and sell you things. And at the moment we don't have distress for the most part in the economy and financial markets because economy has been so good. But we will have these valuation shifts. This year there's close to net nothing in terms of appreciation for indices. Certain areas have suffered more than others. And for people like ourselves, it results in some mark-to-market decline in some of the things we own. But as you say, it sets up really a good cycle. And the next time you have something that goes up somebody says, you know what, maybe we should take this price. And so it ultimately results in a lot of opportunity for us. You just have to be patient enough. We’ve lots of things going on now. And today, it would be easier to buy those than it was yesterday because sentiment changes.

Unidentified Analyst

One of the areas of risk that we’ve been getting lot of investor questions on over the last 12 months has really been around private credit. And the fact that there’s been so much money that’s poured into the space over the last several years now, we continue to hear that credit terms and underwriting terms have gone a bit looser. And companies that are getting those perhaps should not be getting those today. What are some of the areas within private credit you see where there's an excessive buildup of risk? And with your geo-self platform and really the broader credit platform, how are you guys navigating?

Steve Schwarzman

Yes, we’re very big in this area. And I thought that would be a question that you would be asking. And as it works out somewhere in my papers that I had to prepare for this, we had the ratios of what things were a few years ago and what they are today. And actually, we have the same amount of private credit that has good covenant package, I think it's around 76%, something like that from memory. And the attachment point of risk is actually more conservative for us than it was several years ago, which was not the right answer that you were looking for. And so there is more money in this sector if you can do larger things like we can. We haven't really detected when we actually put out the money that we're doing it on a disadvantageous or higher risk basis. You just have to be a little pickier as to what you do in terms of volumes.

But there's still a really good flow of stuff, we do it here and we do it in Europe. And credit wise, we don't have any particular concerns. Remember, the economy is still relatively good. In fact, the economy is quite good. And so you have ratios improving after you make the loan, but I'm giving you statistics not for the future, but as it is today. So we don't -- we see the money, we lose some deals. The stuff we do is just as conservative. And we have that in the corporate sector, in real estate. We have huge equity underneath any of these loans, and we basically don't lose money on the real estate side. In the leverage equity, why would you have to lose it with loan, and we don't.

Unidentified Analyst

Are there any areas of excessive risk buildup you've seen in the system that you guys are trying to actively avoid?

Steve Schwarzman

We don't do as much sort of outright tech investing as some other people. So the multiples in that area that can get really hurt. We've avoided energies now pretty much rerated. And down around whatever it is $53 a barrel, that's had -- when energy goes down and it doesn't waste a lot of time, it just seems to go. And I think part of that is a potential opportunity for us, but it happened because there was a miscalculation of what would happen when Iran went off line. And so you had the Saudis and the Russians doing a lot of supply. And the supply from Iran kept going with special deals, so there's too much supply in the system. And that leads to -- it's a real supply demand market. And so when they tighten up a bit, I think you’ll see the price, probably go up a little bit, and we each have our own guess on energy. But it’s probably closer to some stability around $50 than it was at $80. So this stuff moves around $10, $15 a barrel. But for us, I think with these kinds of levels, it’s a much better play.

Unidentified Analyst

Got it. Maybe shifting gears a little bit and we’ll talk about the fundraising for the industry and really for you guys. So as I mentioned earlier doubled your AUM base over the last several years and have a solid target over the next couple of years. And at the Investor Day we outlined multiple reasons of how you’re going to get there, we'll unpack some of those a little bit more. But a bigger picture, if we are in a little bit more of a range bound market or little bit more challenges in macro backdrop, do you see any risk to the fundraising cycle of that the alternative industry has seen really over the last five, six, seven years?

Steve Schwarzman

Well, if you have massive declines in public markets, you'll change whatever it is, its numerator or the dominator when you raise money. To the extent that we’re really close to flat for the year even though it's been sort of a pretty violent adventure, flows to the alternative side are very substantial. And the reason for that is that we can take a debt product, for example, such as you were talking about whether it’s corporate or real estate, turn it into roughly 10% rate of return. For people who are in liquid securities, earning 10% seems somewhat heroic today. For us it's just like every day. That's what we do in that business. And if you are an investor, and you could allocate money, and you can play in the world of volatility or you could sort of give us some money to do this stuff, what would you do? And you make a presentation and somebody says geez, 10? That sounds pretty good to me. Our private equity business sort of typically in our industry, in the bad part of the cycle, you only out-earn the S&P by about 500 basis points after fees, as you do this cycling through. And in better part of the cycle, you could earn 1,500 basis points. So everywhere we go the rates have returned regardless of cycles, and the capital protection is really terrific. So we have a product overall that's institutional and increasingly individual investors love and the only reason they love it is that it’s mathematically compelling. So if you can compound at our rates over long periods of time, you would put more money there. And we were talking in the car coming down from midtown about how we went public 11 years ago. The allocations to alternatives have about doubled for pension funds. And we have some brave people like Dave Swenson at Yale, who like 40% alternatives. So what happened to him? Well, surprise, surprise. He became the best performing endowment manager in the world. And so the class is a good class, and it's not a mystery. I mean, we buy things with full due diligence, we have control of that asset, and we set up an improvement plan before we buy it. And then our objective is to grow significantly faster than the S&P. Our average company grows about 50% faster. So if you grew 50% faster and then you put leverage on top of it, what would the model be for an outcome? The outcome would be really good. And if we make a mistake, which every once in a while happens, you change the management, and you get on track and you fight it out. You don't just say, well, I made a mistake, I’m selling that security at a loss. And so, in our current levels of funds, there's -- I'd have to have my General Counsel tell me not to say this. But we fundamentally don't have realized losses of any magnitude. Can I say that Wesley? Don’t? And that's sort of a nice place to be because if you earn a lot and you don't lose on the downside, that's our theory of investing. And when we started, I told my partner, just passed away that that's what we should do, and he said but that's there is no free lunching, except I guess, apparently at a Goldman conference. And you'll pay them somehow.

And that we can cut off the bottoms, the left hand side and just have the right hand tail, because we have the ability to get information that's different than a public market investor, take control, improve it, put leverage on it. You're just going to get a higher return. And that's what we do.

So it's a fun business. I wish you all were in it. Apparently you've chosen careers that don't do that. But you can, sort of join in, by owning us. That's the way you solve that problem. And we'll work for you. We have normal 14, 16 hour days at the firm, and you can get it for free. It's just like buy a ticket. I mean, yes, just take the lunch.

Unidentified Analyst

So maybe unpacking some of the fundraising opportunities, one of the bigger themes really for you guys over the last couple years has been this expansion into retail, retail plus kind of work, but really the individual investor as you highlighted. I think you're about $60 billion in assets there today. You talked about that business eventually going $250 billion over time. Can you spend a minute on what products you expect to lead the growth there? And really, how do you make sure that the returns that you've been able to generate don't get cannibalized by just the size getting bigger?

Steve Schwarzman

Yes, people always worry about that, and I've been talking about that since I guess our second fund raising, in 1991. How are you ever going to continue this performance? Aren't you going to be too big? Well, the enemy of performance is being too big in one strategy. And there are enough opportunities and you force it by overpaying. And so you have to know what size to limit an individual strategy and keep inventing new strategies. So we're really in the invention of business -- innovation business. And when we see something, some place, some place in the world or different part in the capital structure, we go into that area and sort of fill out a product suite. So I don't worry about that. We also have an interesting phenomena, we have limited partners who give us money and they don’t like us to be too much bigger in the next fund, even though we've been successful, so we can improve them size wise, 20% something like that, sometimes 25%. But that's usually the thing. When I was younger, I looked at Magellan Fund, which I guess is likely the classic case, you make it bigger, bigger, bigger and then it reaches a point where it can't perform. And we've not had that problem, and we’re on guard. We’re nothing other than sort of delivering performance with exceptionally low risk to investors. If you have a different point of view, you're wrong, right? I mean that's how you build a great investing business and you’re just zealous about not losing money.

Unidentified Analyst

Obviously, within retail and individual, a large untapped market has been DC 401k channel for you guys and your peers. I know over the years there's been conversations around potentially that opening up. Where are we in that process? Is that an opportunity on the horizon?

Steve Schwarzman

Yes, I think -- this was totally off the table until the current administration politically. I think they have a point of view which will be borne out that in principal. There are more interested in giving regular people opportunities that today are reserved for wealthy people or institutions. And I think they’re going to take a look at this area. I have no idea how that’s going to turn out. But they have a much more open-mind to that than previous administrations. And when they put them in those target date funds or whatever the descendents up rolling into the system, there are people studying that. I can’t tell you how it will turn out. I can tell you that the individual retirement systems for most individuals in America are in a terrible trouble. And you look at the statistics of who can afford to retire, and there aren’t many people. And so increasing the return over time is one of the ways you solve that problem and keeping people away from our products just seems would like histories of decades to not make sense or to learn and finances sometimes things don’t make sense or certainly in politics. But I think that's going to have to get changed at some point.

Unidentified Analyst

Another bigger growth for you guys has been the insurance space. And you made a number of senior insurance hires this year, and again that's really very much part of your growth mosaic, as you outlined a few months ago, of course. How do you expect to grow this business? What differentiates Blackstone versus some of your peers that also already have pretty significant existing footprint in the insurance base?

Steve Schwarzman

Yes, it's interesting. This is like a $30 trillion pool of capital that has very little in the way of alternative exposure, and has a devil of a time earning money. And so it's tough because they keep selling insurance, but they have trouble growing their equity account, which is tough, if you're responsible for that company. And so the only thing that stops them from putting more money is some of the regulatory restraints, but there are some interesting ways to do things to help those types of companies. What makes us somewhat unusual is there's sort of nobody in the alternative space that has the breadth of activities and the scale. And so we can manufacture products and in fact place them directly with some of these type of insurance companies that we do with the largest financiers in the world. We pay the largest number of fees in case anybody has got their hand out. And we manufacture very large amounts of debt products off of companies who buy real estate. We buy other areas where we're involved that are unique to us. So as we take products of this type and give them in effect to people we manage money for with enough sharings of it, there's a fairness type of the thing, nobody thinks they're getting products without sort of arms-length test, geez, that's like a great thing that we can do that other people can't do. Our size now is, I guess we're about double anybody else triple most people, normal year will raise capital that's about the size of our next three competitors combined. And so what you do with this stuff is you use it as a differentiator to help growing other business. And in the insurance area there are a lot of different ways you can grow from buying certain types of companies or buying operating effective operating control or much smaller amount of ownership taking money management contracts back. Sometimes it's just somebody can give you $0.5 billion just to manage money and if you can increase their returns and we're doing that now for real. And we're just getting started. And so this is actually quite an interesting area. When you solve problems for people who have them in finance, life gets really good for you if you're a problem-solver. And if you got $30 trillion, which is having trouble making money, and all you have to do is enhance the return of their asset side, but stay within the limits of the regulatory structure, then this is exciting for them. It's hard to imagine people get excited about 50 basis points or 100 basis points. I mean who gets excited about that, apparently people in the insurance business. And that's not so hard to do. And so you can do it in scale. And we think it's a very interesting opportunity.

Unidentified Analyst

Before we turn over to the audience, I wanted to ask another question slightly from a different angle with respect to transaction activity from kind of realization perspective. Given your scale diversification, you guys don't tend to have the boom bust realization cycle as you've illustrated a couple of times now. But in this environment, what is your outlook for exits? And what is the appetite maybe from either corporate or other financial sponsors to put capital at work, which would also enable you guys to exit at the public markets?

Steve Schwarzman

Yes, exits. We’ve always the ability to exit. The only question is what’s the price? And if you own a quality asset, somebody will usually take you out. And we’re trying to be profit-maximizers. So when markets are uncertain or really volatile or I wake up just sitting on the stage, looking at this [bart burger] of a market I mean, geez, stuff down 3%, 4%, would you be a seller today? I guess half of the market is, but we’re not. And so we’d rather be selling more when people are more optimistic. So we will cycle down a bit by choice, not by circumstance, by choice and let the companies grow at the kind of rates and then we pop out. And when we sell something historically compared to our mark-to-markets, which we have to report on our financial statements, we usually get about 25% to 35% more than what is on our books, which no one gives us credit for by the way, but we’ve been only been doing it for several decades. Thank you SEC for mark-to-market. And so that’s how we look at the realization. I think it’s our choice, and some of its market-driven, some of its economy-driven. But the economy is still quite good.

Question-and-Answer Session

Unidentified Analyst

With a couple of minutes left, I want to make sure we have some time for questions from the audience. So just raise your hand and we'll have some mics come around.

Unidentified Analyst

Steve, I want to talk about Blackstone stock. I believe you went public, and my numbers are probably wrong, that was 11 years ago, at a price not too different from where you are right now. Now you do pay dividend, so I don’t know what the average yield has been. But assuming it’s been 7% or 8%, I am not sure, okay, I don’t know what percentage of that yield is taxable because obviously your accounting is complicated. But having said all that, is it worth the candle? And conversely can you help us, because obviously your accounting is different, and looking at the corporation, how would you value your business today? Thank you.

Steve Schwarzman

Well, that's a great question. We’ve grown our business, I guess around five times since we went public. That’s pretty big growth. I think it’s about as good as anybody in the financial community could do through the global financial crisis, and the stock is more or less in the same level. So what that says is that we either went public at a price that was too high at that time or sort of people are incorrectly valuing us now, one of the two. Just in terms of overall performance our dividend, I think has it been in 7% to 8% level. And so since we went public, the world did sort of collapse soon thereafter, we’ve been pretty close to the S&P during that period. So it looks like we've underperformed, but we put out enormous amount of current income money. The way people tend to look at us is they say "we wish you were just sort of a fee generating business and never had profit from anything you ever invested". I happen to own a lot of the firm. I like getting those other profits. They're quite substantial. And you would want to get them too as opposed to not getting them. So the way people look at us valuation wise, is they say, if you were just a long-only manager, how should we look at you? And there are one or two comps out. There's a small European company called Partners Group. I think it trades somewhere around 23 times, 24 times, 25 times that current income.

So what we said at our Investor Day is -- in two or three years, as we grow our current income from roughly $5 a share to someplace close to $2 dollars a share that if you look at that and if you were valued the way these other people are that you have $45, $47 a share just from that. Our stock today is $33. Our carried interest average, somewhere, so that you guys correct me, I've got my front row coaches here somewhere around $50, $75 on average. Is that right, John? Something like that. So that gets valued by the market incorrectly at 7x, 8x. So what is that? That's another $10 or something. So that's 56, 57, and then you have stuff on our balance sheet, that's another $2. So basically, so it's sort of got to be around $60. And that's without the current income, right? So assuming we don't convert just to make that easier for this discussion for a second, that if you're getting a dividend of like 7% a year, and you get up to $60 in three years from $33, is there anybody here who can figure that out what your compound rate of return would be? So it's sort of 7% a year for three years, plus taking close to sort of -- close to $30 a share over three years. Geez, that’s like 17% over 33%. Come on, this is like pretty amazing. And all we have to do is raise money and invest it the way we've only been doing for 33 years. So I don't know. You decide. I like what we do. I love what we do. I love the people we do it with. We have an amazing culture and a great model. And I think that logic and numbers show that this is a very good place to be. So I don't know whether I was allowed to say any of that. Do I get arrested or something? No. I think we sort of did this on Investor Day. So I can like say that. But, geez this is pretty good. It's really pretty good. I'm frustrated myself, but I've learned to not be emotionally engaged with that frustration. And all we got to do is go out, do we know how to do. And these things are logical to happen. Could that be delayed by a year, by down cycle of some type or whatever, but we’re definitely -- I can’t say definitely. John Finley would shut me up, my counsel. But we’re going to get there to that kind of thing, because it’s logical. It’s just like what we do. So join us for the ride, if you like, if you don’t, that’s okay.

Unidentified Analyst

On that note, I think we’re out of time. Thank you for your perspective. Appreciate your answers.