Blackstone Going Public—Its Own Way

The private equity firm plans to raise $4 billion in its initial public offering, but vows not to change its management approach

The Blackstone Group made it official late on Mar. 21, filing with the Securities & Exchange Commission to raise $4 billion in the most highly anticipated initial public offering since Google (GOOG) went public in August, 2004. But just because Blackstone is looking to tap the public markets, that doesn't mean this once highly secretive private equity behemoth is completely changing its stripes.

The opening lines of the 330-page IPO prospectus make clear that Blackstone, led by Chief Executive Stephen Schwarzman, is not going to play by Wall Street's traditional rules for public companies. The company, whose shares will trade on the New York Stock Exchange (NYX), says in its prospectus: "We intend to continue to follow the management approach that has served us well as a private firm of focusing on making the right decisions about purchasing and selling the right assets at the right time and at the right prices, without regard to how those decisions affect our financial results in any given quarter." Blackstone also warns if you can't stand lumpy returns, then stay away.

In other words, Blackstone may be going public, but it plans to go public in its own way.

Revealing Document

For now, Blackstone isn't saying how many shares it intends to sell in the offering, nor does it suggest a price for those shares. It doesn't even propose a ticker symbol for its stock. The firm does say that some of the proceeds from the offering will be used to buy out the "equity interests" from some of its current owners, which include insurance giant American International Group (AIG). The filing doesn't indicate whether any current owners will be selling shares in the offering.

But the IPO filing does reveal a great deal about how Blackstone became the behemoth that is. Blackstone is really four firms: a giant private equity buyout firm, a real estate management firm, a hedge fund conglomerate, and a financial adviser. But more than anything, the New York-based investment firm is a phenomenal asset-gobbling machine, with its private equity and real estate operations managing about $49 billion in assets.

In less than six years, total assets under management at Blackstone have risen more than fivefold, from $14 billion to $78 billion. To put that in perspective, Blackstone manages more assets than all of these well-known hedge funds combined: D.E. Shaw Group, Atticus Capital, SAC Capital, and Citadel Investments.

Lucrative Fees

The draw has been Blackstone's returns. The offering documents show that the firm's limited partners—the pension funds, endowments, and others who invested in its private equity funds—have earned 23% a year after fees since 1987. Real estate fund limited partners have done even better, earning 29% annually since 1991.

Blackstone knows how to generate fees for itself too, mostly from its management activities. In 2006, the firm took in $852 million in fund management fees, more than twice the amount it generated in 2005. Overall, Blackstone's revenues, which also include advisory fees, totaled $1.12 billion in 2006.

Revenues from management activities and corporate advisory work are only a small part of the story at Blackstone. Last year, the firm raked in $7.59 billion from its investment activities, representing a 48% gain over 2005. Less taxes and expenses, Blackstone posted a profit of $2.27 billion in 2006, compared to a profit of $1.33 billion in 2005.

On a Roll

While the firm's fees are heady, there are some pro-investor features. The firm earns 1% to 2% of each fund's assets as a management fee, while the assets are being invested (see, "Blackstone Mints Money—Well, Duh"). But after that period, the fee drops to 0.75%.

And the firm gets 20% of the gains of its funds, but only as long as the limited partners in each fund are getting a minimum return of 7% to 9%. In other words, if a fund has problems, Blackstone's 20% disappears before its limited partners suffer any losses. The funds also have a clawback provision requiring Blackstone to pay back prior fees if losses down the road breach the minimum return rates. And while Blackstone also gets monitoring fees from companies that its funds buy, the firm has to reduce the management fees it takes directly from its funds by 50% to 100% of those fees received from portfolio companies.

Blackstone's leveraged buyout group has been on a roll of late, completing one big mega-deal after another. The most recent transaction was its $39 billion debt-laden acquisition of Equity Office Properties Trust (EOP). The deal, which includes $16 billion in assumed debt, is the largest completed buyout to date (see, 11/20/06, "Sam Zell: A Question of Timing"). Private equity firms like Blackstone have been expanding at a torrid pace, making liberal use of the easy credit market to fund bigger and bigger leveraged buyouts.

In filing for an IPO, Blackstone is one of the first U.S. private equity firms to propose selling shares to the public. Earlier this year, Fortress Investment Group (FIG), a combination private equity firm and hedge fund, raised $643 million in an IPO. Shares of Fortress soared 68% in their first day of trading, although they've given back some of that gain in subsequent trading (see, 2/9/07, "Investors Storm Fortress IPO").

More Information to Come

Blackstone's IPO filing doesn't reveal much about how its top executives are paid. The filing says Schwarzman"will receive no compensation other than a $350,000 salary." But don't feel too sorry for Schwarzman because he's getting paid in many other ways. The filing notes that he owns a "significant portion of the carried interest earned from our carry funds," as well as a "significant amount of equity" in the firm.

If you want to know just how much Schwarzman can expect to earn from those "carry funds," however, the filing doesn't say. The section describing the "carried interest" earned from those funds and how they are allocated to Blackstone officials is blank. Of course, Blackstone probably will provide more information about its compensation practices in subsequent filings. But for now, investors can only wonder.

One thing is sure, a lot of Wall Street banks were angling for a piece of the Blackstone IPO. The underwriting team is led by Morgan Stanley (MS) and Citigroup (C). But also on the deal are Merrill Lynch (MER), Credit Suisse Group (CS), Lehman Brothers (LEH), and Deutsche Bank (DB). Notably, Goldman Sachs (GS), arguably Wall Street's preeminent investment bank, is not part of the offering.

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