In recent weeks, it looked like private equity giant the Blackstone Group (BX) was going to make its name with the general public as one of the worst-performing initial public offerings of the year. The firm's stock first traded in late June at $31 a share and soared to $35.06 during its first session. But it has been downhill ever since, as troubles in the credit markets have spooked investors into thinking that the glory days of private equity may be over (see BusinessWeek.com, 7/27/07, "Corporate Debt: Dressed Up, Nowhere to Go"). Shares in Blackstone have tumbled about 25% from their peak.
But on Aug. 13, Blackstone reported its first quarterly results as a publicly traded company and made a strong case for optimism. The company's financial results for the second quarter were strong, with stellar growth in revenues and profits. But more than that, the company explained why it is positioned to do better than the overall private equity field in the rough days ahead. While newcomers and smaller firms will struggle to get the money they need to do deals, Blackstone will be able to buy companies with less competition and stronger potential returns. "This is our market now," said Blackstone President Hamilton "Tony" James.
Strength in Numbers
The optimistic outlook is based on strength in a variety of markets. In Asia and the Middle East, investing and fund-raising remain strong, James said. Blackstone is expanding in Tokyo and Hong Kong, and business in India is booming. In the U.S., James said the markets for smaller buyouts, corporate lending, restructuring, and mergers-and-acquisitions advisory work also are solid. And the company's real estate business is strong because commercial rents are rising, despite troubles with subprime mortgages. "We realize you are focused on the future, not the past," James told investors and analysts in a conference call. "The market for mega-public to private buyouts will be tough, although when that market [revives] the returns will be attractive. In the meantime there are a lot of other ways to invest," James said.
Blackstone's profits for the second quarter tripled to $774.4 million, from $224.1 million in the second quarter of 2006. Its revenues also tripled to $975 million, from $325 million in the second quarter of 2006. Investors reacted positively to the news: Blackstone shares were up 8% first thing Monday morning, to more than $27, before closing the day up 2%, at $25.71, as the market slid.
Blackstone doesn't give guidance to Wall Street, the way many companies do, so analysts were left to make their best estimates of the company's results. Some had hoped that revenue growth would be even stronger and top $1 billion. "I was a little surprised real estate gains weren't higher," says Douglas Sipkin, an analyst with Wachovia (WB).
Blackstone said the growth was broad based. Sales in the real estate business tripled from $92 million to $320 million. Private equity revenue rose from $126 million to $426 million, and asset management revenue rose from $32 million to $169 million.
Discipline Pays Off
Blackstone argues that it's insulated from the worst of the market meltdown because it avoided the excesses that became prevalent during the peak. "We stayed very disciplined during the first half of the year. We found it extremely frustrating because we were outbid 10% to 15%," James said. Blackstone also avoided heavy use of so-called covenant-lite debt, which allows borrowers to repay their interest by borrowing more money (see BusinessWeek.com, 7/30/07, "The Deep Risks of 'Asset-Light' Debt"). James said Blackstone took on less debt than lenders offered during the first half of year. "I think the discipline we showed during the first half of the year is paying off now. We kept our powder dry. We have little in the way of hung-up deals," he said.
Now Blackstone can use the money that it held onto to buy assets at cheaper prices (see BusinessWeek.com, 7/27/07, "Bye-bye, Private Equity Premiums"). Equity prices in the public and private markets are falling for leveraged buyouts. And there are fewer private equity players in the market, because latecomers who aggressively waded into private equity toward the peak have been pushed out. In the near future, private equity returns could be the best they have been in two years, because assets can be acquired at lower prices. Asset values, James said, already have started to correct, which means target companies are falling in price.
Slower Turnaround Ahead
That doesn't mean that the next phase of the cycle will be a breeze. Blackstone expects to hold onto the companies that it buys for longer periods, before it takes a profit. During the peak, it was able to cash out of its investments in two years, a quick turnaround that drives up the internal rate of return. Blackstone expects the turnaround time to revert to its historic average, which is about four years. In addition, setting up deals, especially large ones, will be more difficult. "There will clearly be fewer mega deals until the market comes back," James said.
How long will investors have to wait for the turnaround at the upper end of the market? James said the people who expect a turnaround after Labor Day are being too optimistic. But he wouldn't be more specific. "It's as clear as mud. No one really knows," James said.
Blackstone has shown an uncanny ability to navigate the private equity market. It entered the field years ago, when assets were cheap. The timing of its IPO may have been perfect, at least for the company's principles, coming within a month of the market's peak. Public shareholders have certainly suffered, losing out where they hoped to cash in. But the money that Blackstone raised may help it weather the downturn, allowing it to thrive even as smaller and weaker players struggle.
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