Blackstone Group LP (BX)
I spent some time last week and over the weekend finding stocks that would benefit most from the rate cut and found myself looking at alternative investment managers. I have already written an article about Fortress Investment Group (FIG) so I decided to profile Blackstone Group (BX).
Blackstone is an alternative investment manager that participates in private equity, real estate investment, hedge funds and related alternatives, and also acts as an investment advisory as a fourth business division. The diversification of revenue helps smooth the total income stream for the company and offers BX multiple channels to employ their expertise. Lehman Brothers lists the company’s competitive advantages:
- Diversification of investment products
- Positive brand recognition
- Attractive long-term track record
- Access to investment banks for deal participation
- International presence
- Permanent capital base
The company raised some of the permanent capital mentioned above through its initial public offering this summer. The offering was met by unprecedented political scrutiny as company founders reaped windfall gains for their portion of company ownership, most of which would be taxed at very attractive rates. The company’s structure allows most of earnings to be taxed at a low 15% rate due to the long-term investment nature of its revenue stream. This has Washington up in arms and one of the largest overhangs in the stock right now is the concern over how earnings will be taxed going forward. It seems most likely that a bill will be passed that requires the company to pay taxes at a rate similar to traditional asset managers but it is likely there will be a grandfather clause that will allow the company to have 5-7 years before the new rates kick in.
A second issue overhanging the company is the deterioration in the financial markets and the lack of liquidity and availability of funding for transactions. Since Blackstone often enters transactions from a LBO perspective, borrowing money to buy other companies and putting up only a small portion of the capital needed for the transaction, this funding is necessary and an important part of the overall business. A bright side of this constraint is that most competitors are facing similar struggles and BX has more flexibility in securing funding because of their financial strength and track record of successful investments. Furthermore, the price necessary to take many of their target companies private will likely be lower as fewer investment firms are competing to engage in such transactions.
It appears at this time that the market is concentrating on the negative issues of taxation and financial liquidity right now, while the opportunities presenting the company, and the positive operating metrics may be overlooked. Last month, Blackstone reported Q2 distributable earnings per share of $0.63 which blew away analyst expectations. During the conference call, management acknowledged the difficult financing environment for private equity, but stated that its hedge fund business and real estate business were in good shape so far for the year. Blackstone is expected to open 7 new hedge funds between now and the end of next year, raising $15 to 20 billion in assets under management which will significantly increase fee based revenue, not to mention the potential for large incentive fees if the funds produce attractive returns.
Another exciting opportunity for BX is its relationship with the Chinese government. Before the IPO, the Chinese government bought approximately 9% of the company in a move that signified the expansion of investment from US treasuries to a broader assortment of US equity investments. The relationship with the Chinese should allow BX to participate in deals that would previously been unavailable to US based investment firms. Since the Chinese economy is expanding so rapidly, and the government restricts foreign investment in national companies, this could open very attractive doors for Blackstone and investors in funds managed by Blackstone. Already the investment advisory arm of BX has been retained by the China Development Bank to advise them on a stake they are taking in the Barclays / ABN Amro merger.
While earnings are almost certain to be difficult to analyze and volatile, the opportunity in BX is immense. Even if the funds are taxed at a higher rate, the growth in this portion of asset management should still make it an attractive investment. Any positive news from Washington should benefit the stock very quickly and if BX is able to find funding for one or two important deals, investors will begin to look past the current liquidity crisis towards the value BX is able to create in its investment strategies. The stock has begun to trade better the past week and I believe that is a direct response to the interest rate cut and the improving outlook for the company as well as the industry.
FD: Author has long position in BX
I have a few questions and hope that you could givge me some help:
(1) From every espect, BX looks like a good company and worth investing in it. But the stock has been under pressure for such a long time after it went public. Is it the only the problem to raise money? Or something has problems in the business way, management or in the fundamentals?
(2) I believed the analysis on BX, then I bought some shares @$26.4 few days ago, because I thought the most difficult time should be gone already for BX based on my reading about BX. Unfortunately it came down to $24.xx again. Could you predict what could be the highest volatility before it starts to grow substantially?
(3) What hedge funds do you run? How about the performance in the past? How much position do you have in BX?
(4) What hedge funds will BX open? what could you expect on their funds? Any info about them?
Thank you very much.
Q.C.
September 24th, 2007 at 11:23 amHello Gordon, Thanks for the comment…
1) I believe the majority of the problem was the taxation issue as this could take a significant chunk out of earnings. Its likely an issue that will affect earnings in 5 years but is still applicable to pricing today. Another key problem was the credit crunch which made leveraged buyouts nearly impossible for a couple of weeks. There appears to be more liquidity in the market now and the rate cut should have a significant effect.
2) Volatility is very difficult to determine. One way you might want to play it would be to buy the stock and sell November 25 calls for $1.55. This would cap your gains but would also add some degree of stability. Many would suggest buying a put option which is also a possibility but keep in mind you are paying for insurance and that premium can eat you up over time.
3) I will send you an email personally about the funds. I want to be careful about avoiding any appearance of soliciting investors on this site. This is a personal venture for me and I enjoy the blogging experience but it is not meant to attract investors for the fund in any way.
4) I haven’t seen the specifics on the new funds launched. I would assume they would each cover a different strategy within the broad hedge fund universe (macro, long/short, riskarb, convertable arb, etc). The key is that they will be pulling in a huge amount of assets and charging management fees (and incentive fees) on these new funds.
Hope this helps,
September 24th, 2007 at 11:47 amZDS
Hi Zach,
I like your analysis about Blackstone, it is well written. However, you forgot to mention about the team management, which is the core of Blackstone. It is composed of very smart people who just came out Billionaires after the IPO(for instance President Hamilton “Tony” James). The investment is very risky. Rumors says that Blackstone might take itself private again in a future as the stock continues to fluctuate. What do you say?
September 24th, 2007 at 12:59 pmI have a long term position on BX, because they are diversified and the team is well managed. They make smart decisions. For example, they were betting against the subprime mortgage business. I am sure that BX will report record earnings again. But, will it make the stock price go higher? I do not think so! D.C has to clear out the air of the private equity market first.
Hey F.T.
DC definitely holds the short term key to vastly improving the outlook for BX if they step away from changing the tax code… We were all joking around in the office saying BX could take itself private and pocket the difference between their offering price (31) and its current price (25). However there is no way the company would do this as it would reek of foul play. Washington would be all over that trade and the last thing BX needs right now is more scrutiny. I think this is more of a joke than a rumor.
All the best,
September 24th, 2007 at 3:49 pmI think Blackstone is a well-run company that will probably do well in the long run. My question is, why BX over a stock like Goldman Sachs right now? Goldman is clearly showing its dominance in the investment banking industry over the past couple of quarters and looks very cheap on a valuation basis.
September 25th, 2007 at 6:29 pm[…] Blackstone Group LP (BX). An article on Blackstone Group and how they will benefit from a rate cut. Stocks: […]
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