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WIKI ANALYSIS
The Blackstone Group (NYSE: BX) is an alternative asset manager and provider of financial advisory services. Originally an M&A boutique, Blackstone's current activities involve a broad range of both advisory and investment expertise. Its investing activities are spread among private equity funds, real estate opportunity funds, and a variety of hedge funds. In addition to advising on mergers and acquisitions, the firm also advises institutional clients on matters such restructuring and reorganization and fund placement. As of March, 2007, Blackstone had $78.7 billion in assets under management. While the company's operational performance has benefited from a boom in the private equity industry, the debt market, which is key to private equity's operations, has been showing signs of contracting due in large part to the subprime lending crisis. This growing credit crunch could make it difficult for Blackstone to continue realizing the same high level of returns.
Interest rates are a key metric for any Blackstone investor to watch - private equity companies borrow billions of dollars from banks to fund their purchases of companies. Then they use the companies' own revenues to pay off this debt, or else re-sell the company at a profit. Low interest rates make it cheap for companies like Blackstone to do business. When interest rates rise, it becomes more difficult for them to buy and resell companies at a profit.
Corporate Overview
The Blackstone Group operates in four distinct business segments: Corporate Private Equity, Real Estate, Marketable Alternative Asset Management, and Financial Advisory.
Blackstone's performance has been on an upward trend over the past five years, with revenue, net income, and gains from investments all rising significantly since 2002 (the company went public in mid-2007). These substantial increases have been the result of a boom in the private equity industry, relatively low interest rates, and an expanding U.S. economy.
For the past four years, Blackstone's net income has exceeded its total revenue. This is possible because the company's earnings from investments are not classified as revenue and actually account for the most significant portion of Blackstone's income. Revenue, which includes fees collected for asset management and advisory services, was only one-seventh the size of investment earnings in 2006. It is important to note that investments are subject to market conditions and can fluctuate significantly.
Key Trends and Forces
- Private equity boom may have peaked: The private equity industry, which has been booming since the early 2000s, is showing signs of slowing down. A principal feature of private equity industry is its extensive use of debt to finance transactions, usually in the form of high-yield bonds. While these highly leveraged buyouts can yield very high returns, they're also significantly riskier than other types of investments. The fallout in the subprime lending industry has diminished investors' appetite for risk; as a result, it has become more difficult for private equity firms and the investment banks that structure their deals to find buyers for these high-yield bonds (also known as "junk" bonds"). These bonds are critical to Blackstone's continued ability to finance its operations, which could mean a significant decrease in the number of deals it makes in the years to come.
- Fed rate cuts should ease pressure on debt market: In response to the growing contraction in the debt market, the U.S. Federal Reserve decided to cut interest rates, with the intention of stimulating economic activity. As interest rates fall, the cost of borrowing money falls as well, which is particularly beneficial for a large borrower like Blackstone. In addition, lower interest rates make traditional savings accounts less attractive to consumers, driving them to invest their money elsewhere. The rate cuts should relieve some pressure in the debt market, which has been the biggest source of concern for Blackstone and other private equity firms.
- Regulatory changes would impact Blackstone's operations: Since its IPO, Blackstone has had to reconcile its private equity roots with the regulatory requirements of a publicly traded company. Currently, the firm is classified as a limited partnership rather than a corporation, a distinction that provides it with substantial tax savings. Additionally, Blackstone relies on a number of very complex exemptions to avoid being classified as an "investment company" (as defined by the U.S. Investment Company Act of 1940). Any changes to these rules or Blackstone's legal classification would have a significant, material impact on the firm's performance. The Antitrust Division of the U.S. Department of Justice has reportedly requested information from several of Blackstone's competitors regarding private equity transactions; the meaning of these requests is unclear, but it does signal a potential increase in legislative hurdles for the lightly regulated private equity industry.
- Opportunities in China: China took a $3 billion stake before Blackstone's IPO, which amounted to approximately 10% of the company's pre-public value. This investment by the Chinese government may be a boon to Blackstone's current and future investments in China's burgeoning economy.
- Betting that subprime lending has hit bottom: In November 2007, Blackstone announced that it believed the subprime mortgage market, after a steep collapse that dragged down other large financial institutions, was inexpensive enough to warrant investment. The company announced it would begin taking long equity positions in the subprime market.
Competition
Most of Blackstone's competition comes from other private equity firms, which are almost all privately held. Large investment banks, such as Goldman Sachs Group (GS), Merrill Lynch (MER), and Bank of America (BAC), often have internal private equity divisions, though the majority of their income is generated from other business activities.
- Goldman Sachs' Private Investment Advisory division, which had $145 billion in alternative assets under management at the end of 2006, generates a substantial portion of the firm's net income.
- Kohlberg Kravis Roberts & Co. filed in July 2007 to go public.
- Texas Pacific Group
- The Carlyle Group
- Bain Capital LLC
- Clayton, Dubilier, & Rice
- Apollo Capital Partners
References
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