Is Blackstone Actually Tempting Here?
Everyone -- myself included -- has had their fun ridiculing hedge funds and private equity lately. The implosions of a few relatively high profile funds, the growing awareness of the fact that most hedge funds make their money not on successful investments but on fees (and the investor backlash from that), and the very strong feeling that Steve Schwarzman has played everyone for a fool by taking a small slice of Blackstone public at the top of the market.
But maybe there's a contrarian buy in there, especially now that we see, from the Goldman Sachs earnings, that not everyone loses money when turmoil hits the markets. Goldman and Blackstone are in similar positions reputation-wise, as the top tier of their respective (and related) businesses, and it might be worthwhile to speculate that even in a difficult environment for private equity, which many people foresee, Blackstone could potentially significantly outperform our expectations. And as was announced today, Blackstone's President is claiming (though they haven't reported yet) that they, like Goldman, enjoyed a nice return on short positions in subprime mortgages (and as an aside, that they believe the debt logjam for private equity will be sorted out within six months). It'd be interesting to see just how significant those short positions were, and how much it impacts their bottom line.
I am not yet really convinced, but I'm taking a few things into account as I consider whether a position in Blackstone or in Fortress or one of the similarly exposed firms is worthwhile. Most of my speculation would be based around the "best of breed" argument that even in a relatively poor market the top performers might well continue their performance, so I'm probably not interested in the Listed Private Equity Portfolio ETF (PSP), even though that fund holds some companies I really like, including Leucadia and Affiliated Managers Group.
So what makes me think about possibly throwing some of my cash in with Blackstone?
1. Blackstone has incredibly huge piles of money. Not only do they get to reap nice fees from that money as they invest it, but they also have significant potential to make big investments in firms, even taking them private, without nearly as much leverage as has been used in the past. This might be significant, given the difficulty in getting some debt deals done.
2. It's entirely possible that interest rates will remain low if the Fed decides to further prop up the economy -- in that case, I think we'll see the covenants on private equity financing probably remain a bit stricter than they were in past years, but in all likelihood there will be money chasing these deals again. Nothing lasts forever, but, as many people have speculated, they may have refilled the punch bowl just one more time.
3. There are still plenty of opportunities to buy cheap companies around the world, and Blackstone's massive size, which enables them to have fingers in pies in every section of the globe, should benefit them. Not the least of the appeal here is the Chinese interest in Blackstone, which should give them a bit of an entree to that market.
4. High yielding stocks should be incredibly appealing if interest rates fall. Blackstone, as a partnership, has every potential for spitting out significant dividends. The risk, as I see it, is that shareholders might be taxed on distributed income that's not necessarily actually distributed in cash.
5. A severe shakeup in private equity and hedge funds, perhaps resulting in more attention paid to fees and to a closer eye taken by institutional investors, might actually be GOOD for Blackstone. The massive proliferation of hedge funds and private equity funds has brought competition to their marketplace, the implosion of the weaker funds among those might make for a more orderly environment and for fewer bidding wars for choice assets.
and 6. If the analysts are anywhere near correct, the shares trade at around a market multiple going forward ... and I would imagine that Blackstone, being financially savvy folks, are focused on finding ways to outperform analyst targets. They trade at a substantial premium to the big brokers and diversified financials, of course, but quite in line with the large asset managers like Legg Mason and at a significant discount to T. Rowe Price or Franklin Resources ... to say nothing of the really rich comparative valuation for Blackrock, which must chap the folks at Blackstone quite a bit given their history with the similarly named firm.
So that's what I'm thinking so far ... maybe we're giving Blackstone too much credit when we say they sold shares at the top of the market. Even in a weaker private equity environment the strongest players should still have plenty of business -- there will always be demand for private investments and for excellent asset managers who can cater to the pension funds that are truly desperate for outsize returns as the baby boomers begin their retirement years.
The risks?
1. Taxes. I would argue that part of the weakness in BX shares is the fear of increased taxes on partnership income/carried interest/etc., so perhaps some of that is baked into the shares. I certainly have no idea, even though the White House is a mere five miles from my house, what will happen there.
2. Fee erosion. It's possible that the attention paid to fees will lead to private equity and hedge funds competing on fees, smashing the 2/20 golden egg. I'm inclined to believe that institutional investors have no problem paying these fees FOR PERFORMANCE, but I do think that lower performing funds will see significant rebellion.
3. Exit strategy. For private equity investors who are depending on exiting their positions by re-IPOing their leveraged buyout targets, the market sentiment at the time they're ready for the IPO will of course be of paramount performance. I have no way of predicting that, and I won't try ... suffice to say, if they can't sell the companies they own, they may have to serve peanut butter and jelly sandwiches in the executive cafeteria for a few weeks.
If Blackstone can remain among the top performers, I see no reason why they won't be able to continue to charge ridiculous fees -- the investors who migrate to them want the outsize returns and some market neutral return, and they believe in the power of excellent management ... they are not likely to become index investors overnight, especially with the increasing demands on pension funds to fund ever larger groups of retirees in the years ahead.
Other than that, the standard risks of competition, a general collapse in the economy, or personal or corporate scandal are always there, for nearly any investment, but I don't think they're outsize risks for this particular company.
As I said, I'm undecided ... I'm interested enough that I'm looking right now at a small position in Blackstone options, but I need to research further if I'm to consider really opening a stock position here and committing more capital. The shares seem to be in a bit of a recovery here over the last week or so, after bottoming out in the low 20s during the worst of the August swoon.
But maybe there's a contrarian buy in there, especially now that we see, from the Goldman Sachs earnings, that not everyone loses money when turmoil hits the markets. Goldman and Blackstone are in similar positions reputation-wise, as the top tier of their respective (and related) businesses, and it might be worthwhile to speculate that even in a difficult environment for private equity, which many people foresee, Blackstone could potentially significantly outperform our expectations. And as was announced today, Blackstone's President is claiming (though they haven't reported yet) that they, like Goldman, enjoyed a nice return on short positions in subprime mortgages (and as an aside, that they believe the debt logjam for private equity will be sorted out within six months). It'd be interesting to see just how significant those short positions were, and how much it impacts their bottom line.
I am not yet really convinced, but I'm taking a few things into account as I consider whether a position in Blackstone or in Fortress or one of the similarly exposed firms is worthwhile. Most of my speculation would be based around the "best of breed" argument that even in a relatively poor market the top performers might well continue their performance, so I'm probably not interested in the Listed Private Equity Portfolio ETF (PSP), even though that fund holds some companies I really like, including Leucadia and Affiliated Managers Group.
So what makes me think about possibly throwing some of my cash in with Blackstone?
1. Blackstone has incredibly huge piles of money. Not only do they get to reap nice fees from that money as they invest it, but they also have significant potential to make big investments in firms, even taking them private, without nearly as much leverage as has been used in the past. This might be significant, given the difficulty in getting some debt deals done.
2. It's entirely possible that interest rates will remain low if the Fed decides to further prop up the economy -- in that case, I think we'll see the covenants on private equity financing probably remain a bit stricter than they were in past years, but in all likelihood there will be money chasing these deals again. Nothing lasts forever, but, as many people have speculated, they may have refilled the punch bowl just one more time.
3. There are still plenty of opportunities to buy cheap companies around the world, and Blackstone's massive size, which enables them to have fingers in pies in every section of the globe, should benefit them. Not the least of the appeal here is the Chinese interest in Blackstone, which should give them a bit of an entree to that market.
4. High yielding stocks should be incredibly appealing if interest rates fall. Blackstone, as a partnership, has every potential for spitting out significant dividends. The risk, as I see it, is that shareholders might be taxed on distributed income that's not necessarily actually distributed in cash.
5. A severe shakeup in private equity and hedge funds, perhaps resulting in more attention paid to fees and to a closer eye taken by institutional investors, might actually be GOOD for Blackstone. The massive proliferation of hedge funds and private equity funds has brought competition to their marketplace, the implosion of the weaker funds among those might make for a more orderly environment and for fewer bidding wars for choice assets.
and 6. If the analysts are anywhere near correct, the shares trade at around a market multiple going forward ... and I would imagine that Blackstone, being financially savvy folks, are focused on finding ways to outperform analyst targets. They trade at a substantial premium to the big brokers and diversified financials, of course, but quite in line with the large asset managers like Legg Mason and at a significant discount to T. Rowe Price or Franklin Resources ... to say nothing of the really rich comparative valuation for Blackrock, which must chap the folks at Blackstone quite a bit given their history with the similarly named firm.
So that's what I'm thinking so far ... maybe we're giving Blackstone too much credit when we say they sold shares at the top of the market. Even in a weaker private equity environment the strongest players should still have plenty of business -- there will always be demand for private investments and for excellent asset managers who can cater to the pension funds that are truly desperate for outsize returns as the baby boomers begin their retirement years.
The risks?
1. Taxes. I would argue that part of the weakness in BX shares is the fear of increased taxes on partnership income/carried interest/etc., so perhaps some of that is baked into the shares. I certainly have no idea, even though the White House is a mere five miles from my house, what will happen there.
2. Fee erosion. It's possible that the attention paid to fees will lead to private equity and hedge funds competing on fees, smashing the 2/20 golden egg. I'm inclined to believe that institutional investors have no problem paying these fees FOR PERFORMANCE, but I do think that lower performing funds will see significant rebellion.
3. Exit strategy. For private equity investors who are depending on exiting their positions by re-IPOing their leveraged buyout targets, the market sentiment at the time they're ready for the IPO will of course be of paramount performance. I have no way of predicting that, and I won't try ... suffice to say, if they can't sell the companies they own, they may have to serve peanut butter and jelly sandwiches in the executive cafeteria for a few weeks.
If Blackstone can remain among the top performers, I see no reason why they won't be able to continue to charge ridiculous fees -- the investors who migrate to them want the outsize returns and some market neutral return, and they believe in the power of excellent management ... they are not likely to become index investors overnight, especially with the increasing demands on pension funds to fund ever larger groups of retirees in the years ahead.
Other than that, the standard risks of competition, a general collapse in the economy, or personal or corporate scandal are always there, for nearly any investment, but I don't think they're outsize risks for this particular company.
As I said, I'm undecided ... I'm interested enough that I'm looking right now at a small position in Blackstone options, but I need to research further if I'm to consider really opening a stock position here and committing more capital. The shares seem to be in a bit of a recovery here over the last week or so, after bottoming out in the low 20s during the worst of the August swoon.
Labels: Blackstone, BX
This article posted by One Guy @ 9/20/2007 10:23:00 AM 0 comments
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