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A First Look at Blackstone
By Matt Koppenheffer
March 23, 2007
Well, it's happening after all.
After talk of an IPO from the Blackstone Group made its rounds through the rumor mill, the firm and its underwriters made the plans official by filing an initial S-1 with the SEC. I took a look through Blackstone's 300-plus-page filing to give you Fools the skinny on what exactly the IPO is bringing to the market.
This is the initial filing, and Blackstone and its underwriting team still have the revision process with the SEC to look forward to, so a few segments are still just skeletons. Though the filing currently has Blackstone looking to raise $4 billion, the offering's price range is one obvious blank right now. The other areas left blank for now mostly relate to how the offering will be priced and what ownership stake the new shareholders will have in the company. Unfortunately, the compensation for CEO Stephen Schwarzman is another area that's still "to come."
And speaking of Schwarzman, I'm going to ignore for now the irony inherent in Blackstone's IPO. That a company responsible for taking multibillion-dollar companies out of the public markets would want to have the scrutiny and burden of being a publicly held company is a topic for another day. For now, let's take a look at some of the highlights.
The bizWho says there's no business like show business? I'd say there's no business like alternative asset management, but it doesn't sound nearly as snappy.
Blackstone's alternative asset management business is comprised of an assortment of funds that manage billions of dollars for pension funds, insurance companies, high-net-worth individuals, and endowments. In total, Blackstone manages $78.7 billion in capital as of March 1, and the funds break down as follows:
Corporate private equity. Blackstone is probably best known for its corporate private equity investing, not just because it has an obscene amount of capital at its disposal, but also because it's also been one of the key players in the recent private-equity assault on the public markets. Corporate private equity makes up roughly 40% of the money Blackstone manages, and these funds have put up a fee-adjusted internal rate of return (or IRR, a measure of aggregate annual returns) of 22.8% since 1987. Some of the notable investments these funds have made over the past few years include Freescale Semiconductor, The Nielson Company (formerly VNU), Michael's Stores, Deutsche Telekom, and SunGard Data Systems.
Real estate opportunity. While corporate private equity is definitely the headliner at Blackstone, it could easily be argued that the real estate fund has stolen the show lately. This has been thanks to the recent win over Vornado Realty (NYSE: VNO) to buy out Sam Zell's Equity Office Properties for $39 billion. At least for now, it is the largest take-private transaction ever. Since Blackstone started its real estate investing back in 1991, the funds have managed to return a 29.2% fee-adjusted IRR. Other recent real estate investments include LaQuinta Inns, Wyndham International, and Extended Stay America.
Funds of hedge funds. They're just like they sound -- a fund of hedge funds puts an extra layer between hedge fund investors by distributing investor money (and risk) over a number of different hedge funds. This adds another layer of fees on top of already high hedge fund fees, but Blackstone's fund-of-fund fees are about half that of the typical stand-alone hedge fund. These funds manage $17.1 billion of Blackstone's total assets under management, and have returned just shy of 12% per year since they started in 1990.
And the rest. The remaining $12.8 billion of Blackstone's AUM is distributed among a few other vehicles, including debt funds, hedge funds, and closed-end mutual funds. The hedge funds and mutual funds are new to the Blackstone family. Though it's had the fund of funds for 17 years now, the firm just started a distressed securities hedge fund in 2005 and an equity-focused hedge fund in 2006. Both closed-end mutual funds, India Fund (NYSE: IFN) and Asia Tigers Fund (NYSE: GRR), were started in 2005.
Blackstone brings in fee revenue through these funds via management fees, which range from 0.5% to 2% of AUM. The firm also takes overrides of 20% of the profits from the funds (past a certain threshold), and it benefits from investments it makes in its own funds.
In addition to its well-known asset management business, Blackstone also has a financial advisory arm that does M&A advisory, restructurings, and fund placement though Park Hill Group, which it formed in 2005. While it may not be as familiar a name in advisory as Goldman Sachs (NYSE: GS) or Morgan Stanley (NYSE: MS), Blackstone has a pretty impressive client list that includes the likes of Microsoft (Nasdaq: MSFT), Kinder Morgan, Procter & Gamble, W.R. Grace, and Winn-Dixie.
The maze of holdingsInvesting in Blackstone is not quite as straightforward as investing in, say, Apple, where you own shares that represent an equity position in the Apple operating company. Similar to fellow alternative investment IPO Fortress Investment Group (NYSE: FIG), Blackstone has been set up in a holding-company structure, so it's useful to know exactly what common shareholders will actually own.
The Blackstone Group L.P. (TBG for short) has been set up as a holding partnership that, in turn, holds 100% ownership of five separate holding companies (we'll call them Holdings I). Holdings I is the general partner to five other holding companies that are the actual Blackstone operations (we'll call these Holdings II). A general partner is the partner that actually manages the partnership, as opposed to the limited partner, which does not.
Holdings I will have a percentage ownership in Holdings II that will be determined later in the IPO process, while the rest of Holdings II will be owned directly by Blackstone's senior managers and other current owners. Economically speaking, TBG's primary assets will be its interests in Holdings I, which will be entitled to its pro rata share of the fees and investment income from Holdings II. Ipso facto, each TBG shareholder is basically a claimant to a portion of a portion of the income of Blackstone's operations.
Still with me? A separate entity called Blackstone Group Management (BGM) will be 100% owned by Blackstone's senior managing directors and will be the general partner of TBG. Though BGM will not have an economic interest in TBG, it will have exclusive say over just about all important governance issues.
The priceGiven Blackstone's past success, the size and firepower of the firm, and the current mania around alternative investments, I can't imagine that the offering won't be really well received. The question is what kind of valuation it will garner. The U.K.'s Man Group is probably a decent comparable firm, since it's an alternative asset manager with a captive brokerage arm. Man's stock trades at around 18 times trailing earnings, and has a total market cap equal to about one-third of its AUM.
Using Blackstone's FY2006 as a proxy for trailing earnings, these metrics would give Blackstone a total value of somewhere in the $30 billion to $40 billion range. Of course, that's assuming that you're comfortable using FY2006, which was a particularly good year for the firm and may not be indicative of the future.
More detail is sure to emerge soon enough, as the banking team feels out the market for Blackstone's shares. If the offering ends up being anything like the Fortress IPO, though, pricing thoughts might be a mostly academic question. Though Fortress went public at an arguably reasonable 24 times trailing earnings and 25% of AUM, it nearly doubled before it hit the market. Today it trades at $28, which is around 36 times trailing earnings and 37% of AUM.
Despite this price, a few freshly released Wall Street analyst reports are still calling Fortress a buy. Go figure.
I think one thing is for sure though: Viva la Blackstone!
Fool on:
Private Equity, Unveiled at Last?
The Fortress IPO: Opening the Drawbridge to Hedge Funds
Marching on the Fortress
Microsoft is an Inside Value recommendation. You can check out any of the Fool's newsletters with a 30-day free trial.
Fool contributor Matt Koppenheffer would love to party it up with Steve Schwarzman -- he can feel free to give a call anytime. Matt owns shares of Goldman Sachs but does not own shares of any of the other companies mentioned. The Fool's disclosure policy sees a red door and wants to paint it black.

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