Blackstone: Biding Its Time

The private-equity player has taken its lumps, but says it has lots of cash on hand to start investing in distressed assets

by David Bogoslaw

The credit crisis has taken a toll on Blackstone Group's (BX) profitability, and the company doesn't expect market conditions to improve any time soon. But that hasn't stopped it from making nine new private equity commitments totaling $2.8 billion since the credit crunch began -- and it's only a matter of time before the M&A kingpin pounces on the distressed equity and debt opportunities it sees.

Investors appeared to like the company's readiness to snap up cheap assets, and bid the shares 2.9% higher on Mar. 10.

The New York-based private equity company's ability to realize profits on sales of assets and its incentive fees has been hurt by the seizing up of credit markets, deterioration in the financial markets and weaker economic conditions in the U.S., Western Europe and Asia.

Those factors hurt Blackstone's profits in the second half of 2007 and will continue to weigh on earnings this year. Over the longer run, however, the current economic environment "creates enormous future opportunities for firms like ours to buy assets cheaply," Stephen Schwarzman, the company's chairman and chief executive, said during a Mar. 10 conference call to discuss the latest results.

"It's during these disruptive periods when we typically make our best performing investments," he said.

Last week, the company completed its $910 million acquisition of GSO Capital Partners, an alternative asset manager that specializes in leveraged finance. The acquisition adds $10 billion to Blackstone's assets under managements, while the purchase price can be paid off over the next five years based on performance.

In a Mar. 3 research note, Lehman Brothers cited the transaction as proof of the company's ability to take advantage of attractive conditions in the leveraged finance market, "an area with plenty of investing opportunities." (Lehman Brothers, which has an overweight rating on the stock, does and seeks to do business with companies covered in its research reports.)

Given how far the credit contagion has spread from subprime mortgages to investment-grade securities, Schwarzman said he expects it to continue to migrate to different asset classes until all the leverage has been squeezed out of the market. Blackstone plans to remain cautious in its investments until it sees evidence not only of a bottom but of the beginnings of an uptrend in asset values.

One of nine new funds the company has in reserve is a $1.4 billion fund created specifically to take advantage of the turmoil in the credit markets. Blackstone is biding its time because it expects the value of debt securities to continue to fall. "We think sometime in the next 90 days might be a time to do something significant with it," Schwarzman said.

Reduced ability to borrow due to tightness in the credit markets led to a substantial drop in new private equity acquisitions, while recently announced private equity-led deals have been smaller, with less leverage and less favorable terms for the debt provided, the company said in its earnings release.

For the fourth quarter, Blackstone reported adjusted economic net income of $128.2 million, or eight cents per share, after taxes, vs.$894.9 million, or 72 cents per share, in the year-ago period. The results fell far short of an estimate of 19 cents per share among Wall Street analysts.

Under generally accepted accounting principles, the company swung to a net loss of $170 million from net income of $1.18 billion in the fourth quarter of 2006. It didn't provide any per-share figures.

For the full year 2007, Blackstone reported adjusted earnings of $2.12 billion, or $1.62 per share, vs. $1.68 billion, or $1.27 per share, in 2006. On a GAAP basis, net income was $1.62 billion – including $1.88 billion in non-cash charges – vs. $2.27 billion for 2006, which included $553.1 million in expenses.

Revenue in the corporate private equity business plummeted to -$15.4 million from $533.4 million in the fourth quarter of 2006 on lower performance fees and investment income.