On Thursday, January 31, 2019, private equity giant The Blackstone Group L.P. (BX) announced its fourth quarter 2018 earnings results. While the company beat the expectations of analysts on its top line, the market was somewhat disappointed by these results as it drove the units down in the pre-market session accompanying the earnings announcement. Admittedly, the decline in distributable earnings that we saw during the quarter was rather disappointing, although there were some other factors here that were nice to see and do support the firm's overall growth narrative.
As my long-time readers are no doubt well aware, it is my usual practice to share the highlights from a company's earnings report before delving into an analysis of its results. This is because these highlights provide a background for the remainder of the article as well as serve as a framework for the resultant analysis. Therefore, here are the highlights from The Blackstone Group's fourth quarter 2018 earnings results:
- The Blackstone Group reported total revenues of $504.978 million in the fourth quarter of 2018. This compares very unfavorably to the $1.959213 billion that the company had in the fourth quarter of 2017.
- The company reported distributable earnings of $722.081 million in the most recent quarter. This represents a 41.73% decline over the $1.239146 billion that the company reported in the year-ago quarter.
- Blackstone had total assets under management of $472.2 billion at the end of the quarter. This represents a 9% increase year over year.
- The company declared a distribution of $0.58 per unit for the quarter. This consists of a $0.48 per unit regular distribution and a $0.10 per unit special distribution.
- The Blackstone Group reported a net loss of $78.718 million in the fourth quarter of 2018. This compares very unfavorably to the $803.540 million profit that the company had in the fourth quarter of 2017.
One of the more notable and disappointing developments here was the fairly steep decline in distributable earnings on a year-over-year basis. This is a metric that is generally considered to be a better underlying measure of performance for partnerships than net income. This is because net income is affected by numerous non-cash transactions that do a good job of reducing taxes but do not accurately measure the cash generated by the company. In the fourth quarter of last year, Blackstone recognized the sale of its European logistics platform, which resulted in a fairly large cash gain for the company and boosted its distributable earnings. There was no similar transaction this year, so the company's distributable earnings fell somewhat. Even so, this was the third straight quarter of distributable earnings in the $700 million range and is higher than the numbers that the company typically posted during those quarters in previous years in which it had no extraordinary transactions, so this is solid performance overall.
We can see here that in the 2017 fiscal year, Blackstone Group had distributable earnings that varied significantly from quarter. Unlike this year, it was not at all steady:
In the third quarter of 2017, the company had distributable earnings of $639 million. As it had distributable earnings of $1.234 billion in the fourth quarter of 2017, we can clearly see the impact of the European logistics business sale. In this year, however, it was consistently over $700 million per quarter. Thus, we do see that there is some organic growth here absent one-off events such as this.
One other thing that some readers may notice is that Blackstone Group had higher distributable earnings than it did revenues. This may not make sense at first since the company clearly generated more money that it can pay out than it actually brought in. In fact, this is due to an accounting fluke. As is the case with other alternative asset managers, Blackstone Group receives a percentage of all the returns that its funds generate over a set benchmark. It also invests these performance allocations into its own funds. If the company has unrealized losses from this, then the firm actually deducts these unrealized losses from its revenues. In the fourth quarter of 2018, Blackstone Group had unrealized losses of $1.024 billion. The company actually deducted this value from its revenue to arrive at the reported $504 million value:
However, the company's distributable earnings are more of a measure of cash flow. Since unrealized losses do not actually result in any money leaving the firm, it does not deduct that from its distributable earnings. It does still, however, include net realized gains (or losses) in the distributable earnings number since that does actually result in money leaving the firm. For this reason, it is possible for distributable earnings to be larger than revenues, as we saw in this quarter.
As is the case with most asset management firms, Blackstone generates a not insignificant portion of its income by imposing a fee upon the funds that it manages. This is generally levied as a percentage of the assets under management in the given fund. Therefore, an increase in the firm's total assets under management should result in a boost to the management fees that it earns. As mentioned in the highlights, Blackstone had $472.2 billion under management at the end of 2018, a 9% increase over the $434.1 billion that the company had at the end of 2017.
Source: The Blackstone Group
This was one of the factors that caused Blackstone's fee related earnings to climb over the past year. Blackstone reported fee-related earnings of $1.21 per unit in 2018. This is a 9% increase year over year and is the highest level that the company has ever had.
Source: The Blackstone Group
In addition to the increase in assets under management, the company's fee-related earnings were boosted by an improvement in its margin, which climbed from 45.2% to 46.1% over the course of the year.
In previous articles on the Blackstone Group, I discussed how the company's ability to attract assets will prove to be beneficial in the years to come. We continued to see this play out during the fourth quarter of 2018 as Blackstone saw net inflows of $38.6 billion into its funds. The two most notable raises that were driving these inflows were the $15.4 billion ninth global real estate opportunistic fund and the $3.4 billion eighth Strategic Partners secondary funds. It is important to note that Blackstone managed to achieve these capital raises despite the market weakness and overall aura of fear that permeated the investor community during the quarter. This speaks well of the strength of Blackstone's reputation due to the historical performance of its funds. This may be perhaps the most important asset that Blackstone possesses.
Blackstone was originally founded as a private equity firm that operated in a similar manner to other buyout shops like Kohlberg, Kravis, and Roberts (KKR). Today, however, Blackstone is known mostly for its array of real estate funds. This does make some sense as the company's earnings from its real estate operations accounted for nearly half of its fiscal year 2018 total.
This unit does not, however, account for most of Blackstone's dry powder (cash or highly liquid securities that can be invested in short order if the proper opportunity comes along). As we can see here, Blackstone had $44.4 billion in dry powder in its private equity funds compared to $40.6 billion in its real estate funds:
It makes some sense that real estate would prove to be a popular asset class with the company's investors. Real estate tends to deliver steady returns. Private equity can be a bit more hit and miss as it can certainly deliver outsized returns, but this is done with a relatively high amount of risk. Thus, the real estate funds could be much more attractive to a certain group of investors. The company's core+ real estate funds were up 2.3% in the quarter, which is very impressive, considering that almost everything else went down. This solid performance may help the company raise even more money for these funds in the coming quarters.
In conclusion, this was a reasonable quarter for Blackstone and does show that the company continues to deliver on its AUM growth narrative. The decline in distributable earnings year over year was certainly disappointing, but it was caused by Blackstone having the benefit of a one-off event last year that it didn't have this year. On a continuing basis, earnings were solid, and the improvement in fee-related earnings was nice because that is recurring revenue. Overall, the results were acceptable, and our thesis continues to hold.
Disclosure: I am/we are long BX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.