Blackstone’s (BX) earnings report this week was met with disdain. It didn’t help that the report came out on Monday in which the Dow dropped below 13,000 and concerns over credit issues and write downs were running rampant. It is probably not completely surprising that the stock sold off as the headline number showed weaker earnings than expected and very weak Real Estate revenue. However, when drilling down further into the numbers I became more confident that Blackstone will give investors a great opportunity to make money at some point over the next several months.

Although the headline earnings number was light, one should develop a deeper understanding of just how Blackstone calculates these earnings numbers. Much of the figures are based on the company’s assessment of current holdings for which there is no public market to compare prices. This is primarily true in the company’s private equity division as well as the real estate division. Management typically marks the value of these holdings each quarter based on their expectation of the current fair market value of the assets. It appears that Blackstone was very conservative in their valuation which is prudent and a move that I would applaud. While it may be disappointing to see the private equity portfolio value only rise by a small amount, investors should be able to place more confidence in these values because they are obviously not being inflated in order to prop up the company’s headline earnings numbers.

At some point when liquidity becomes a bit looser (and it will happen eventually – not necessarily soon – but eventually), private equity positions will likely be sold in the form of Initial Public Offerings and Blackstone will be able to write up the value to the market price of the newly issued stock. This could trigger massive book value increases as well as massive incentive fee revenue from the offering. In the mean time the company is able to sit on the assets without the same fear that is plaguing investment bankers who continue to post write downs to their book. Blackstone has adequate capital to ride out the storm and even maintains dry powder from which they can make additional purchases at firesale prices when the opportunity is right.

According to Citigroup, all of the company’s proprietary hedge funds and fund-of-funds are positive year to date which is no small feat. Additional capital keeps flowing to these funds offering opportunity for management fees as well as annual incentive fees. With its strong brand name and increasingly clean track record, Blackstone is quickly becoming the manager of choice for large institutions and government entities who wish to gain exposure in the alternative investment area.

Earnings will continue to be volatile for the company. It is very difficult for management to know where to price non-liquid assets on its books. Access to capital is scarce for Blackstone as well as its competitors. However, the company appears to be well situated to profit from the turmoil and rise head and shoulders above the competition once the smoke clears and the picture becomes clearer.

BX Notes

FD: Author does not have a position in BX