Description

Blackstone (ticker BX) – long                

Upside: +35-40% from $33.84

Quick Pitch

-          BX is the leading alternative asset-manager

-          It’s cheap (especially versus traditional asset managers), despite having long term secular tailwinds and top tier management & operations

Business Overview

-          Consistent top performance across business lines (real estate, fund of HFs, private equity, and credit)

-          Segments

• Private Equity ($66bn AUM, 24% of total)
  • Even their worst fund vintages – i.e. 2000 and 2006 – achieved 6% and 7% net IRRs respectively
  • $1.5bn 2013 revenues, $741mm 2013 Economic Net Income
• Real Estate ($83bn AUM, 30% of total)
  • 17% net IRRs across their real estate funds, which invest around the world
  • $3.2bn in 2013 revenues, $2bn  ENI < they had a great year of realizations / distributions
• Blackstone Alternative Asset Management - a.k.a. fund of hedge funds ($61bn of AUM, 22% of total)
  • $650mm revenues, $376mm ENI
  • Commingled products, customer accounts, HF GP interests,  long only, mutual fund)
• Credit ($69bn AUM, 25% of total)
  • $880mm revenues, $358mm ENI
  • GSO, CLOs, mezz funds, rescue lending, customized strategies
• Advisory (basically investment banking)
  • $420mm revenues, $76mm ENI

Bull Case / Positives

-          Long-term growth:

• 23% AUM CAGR from 2005 to 2013 (25-30% growth in each of the last 4 years)
  • Now $272bn as of Q1 2014
• 13% ENI (and ENI/share) CAGR since 2005

-          Leading franchise and reputation

• Difficult to replicate their scale, breadth, expertise, track record, and depth; which they’ve utilized to expand into areas such as secondary fund investing, hedge funds, seeding, special situations, residential housing, BDCs, mortgage REITs, mutual funds, ETFs, energy (e.g. Cheniere – LNG), CLO consolidation / equity, shipping, spectrum, etc.
• On the leading edge of new opportunities (e.g. penetrating private wealth management & ‘tactical opportunities’ funds), while other PE firms constantly play catch up

-          Secular tailwinds:

• Investors are shifting more allocations towards alternatives, and the big keep getting bigger
• Blackstone is also filling the void after capital for illiquid investments has shrunk – as investment banks and HFs pull back post 2008  
• LPs increasingly want to deal with fewer managers, and can let BX allocate their investment dollars as they see fit
• LPs realize that liquidity is a ‘resource’ that they can ‘spend’ in pursuit of higher return

-          Operational expertise

• BX’s private equity and commercial real estate groups have experienced operators and industry experts, which allow them to add value through their projects, companies, etc.
• Executive advisors, functional experts, alignment of interests, and the Blackstone umbrella help improve operations

-          Management: Stephen Schwarzman (co-founder and CEO)

• Steve continues to lead the firm and drive best in class growth and performance (usually without resorting to acquisitions)
• He owns $7.8bn of BX stock (out of his total $10.8bn net worth) so clearly he is highly incentivized to drive BX’s numbers and stock higher (which he tries to do at every opportunity).  Here’s a perennial cheerleader

-          High dividend yield

• Currently yielding 6.8% based on 2014 expected distributions (with the stock at $33.84)
• BX is structured as a partnership and is treated as such for tax purposes

-          Current valuation:

• Trading at 9.4x 2014 ENI, Blackstone is relatively cheap vs. other traditional asset managers trading at 18x 2014 EPS
• At 10.4x 2014 EV/EBITDA, again BX is cheap vs. traditional asset managers at ~11-13x EV/2014 EBITDA
• SOTP
  • Management-fee-related earnings in 2015 of $0.77 at 18x multiple = $13.88
  • Net investments / cash on the balance sheet = $5.43
  • Performance Fee related  earnings of $2.37 at 6x = $14.22
  • Total = $33.54, around where it is now
• Dividend yield 6.8%

-          Price target:

• Even at 13x 2015 ENI, the stock is worth $45.50,  +35% upside
• Using a Dividend Discount Model, assuming
  • They can compound ENI at 11.5%
  • 55% of ENI is distributed
  • 10.5% discount rate
  • 3% terminal growth
  • BX is worth $47.50,  or 40% upside
• Long-term growth
  • If BX can keep compounding ENI & DE at around 11-12% and pay a ~5-6% dividend yield, over time, that is a ~17% annual return (assuming a stable multiple)
• SOTP
  • 22x 2015 management-fee-related earnings of $0.77 = $18.50
    • Since much of Blackstone’s management fee income is locked-up / guaranteed, BX’s management fee related earnings should trade at a premium to traditional asset managers. 
  • 9x performance fees = $21.33
  • Plus $5.76 net cash/investments (cash and principal investments across their funds)
  • Total = $43.25,  +35% upside 

Bear Case / Negatives

-          Cyclicality / high beta:

• Given that much of Blackstone’s earnings emanate from carry funds, they need to be able to sell or IPO their holdings to realize performance fees, and hence need healthy markets in order to generate sizeable distributions
• That being said, their funds have performed well across the cycle
  • In periods of stress, they simply won’t sell; meanwhile, they can invest in attractive opportunities

-          Are they too big?

• They’ve continued to execute and operate very well, so not yet 
• They consistently expand into other assets, strategies, geographies, etc.  
  • It’s certainly not just a PE firm anymore
• The pullback in capital to fund illiquid investments benefits BX

-          Economic Net Income

• ENI includes unrealized earnings / gains, which isn’t as tangible as distributable earnings (DE), but is still reflective of some economic return
  • DE historically has been roughly 40-60% of ENI
• Hence why some investors use a “SOTP” valuation and assign different multiples to management & performance fees
  • And why BX already trades at a low ENI multiple

-          Downside:

• Just focusing on the management fee-related earnings (and putting an 18x multiple on 2015 EPS of $0.77 – inline with where traditional asset managers trade) gets to $14 in value/unit
• Add the $5.76 in net investments & cash / unit
• Totals ~$20 in value – vs. the stock at $33.84
• That doesn’t include any incremental value from performance fees
  • Historically, performance fee related earnings are almost always 100-200%+ of fee related earnings (except in 2008 when it was negative)
  • Of course, there is some significant incremental value from here, at least $5 if you want to be very conservative in your discounting
  • So maybe downside of 26% to $25

History

-          Founded in 1985.  They started as a boutique advisory firm, then progressed into merchant banking

-          They’ve consistently grown and expanded into new areas ever since

-          BX IPOed on June 21, 2007 (rather impeccable timing) and was the first private equity firm to do so

• At that time, it managed $88.4bn in total AUM (now has $272bn)
• They generated $1.63 in ENI  in 2007 (which has grown at 11% CAGR since)
  • IPO price of $31 = 18x 2007 ENI

-          Position history

• We first invested in BX in January 2013 when the stock was around $18 (currently at $33.84)

Financial Model

-          In 2013, BX’s PE funds and especially their real estate funds had large performance fees gains, so 2014 and beyond have tough comparisons

-          Overall, my model assumes that recent trends in performance continues, and that they grow AUM at low-teens % rates

-          BX’s payout ratio is near 100%

Comp Table - i couldn't paste all the tables, so i'll just describe  them

-          Blackstone screens cheap on an absolute basis and relative basis vs. other alternative asset managers and especially so when compared to traditional asset managers

• Despite their having leading growth, returns, management, innovation, diversification, and operations
• The cloud hanging over the alternative asset managers is (understandably) the volatility of their performance fees 
  • But if they can continue to grow and outperform peers, that valuation gap should narrow

-          Alternative Asset Manager comp sheet

BX has a smoother 2014/2015 EPS profile than other alternative managers because BX is more diversified, while other comparables have recently gone through realization periods in their main funds

 The space is trading around 10.4x 2014 ENI, 9.4x 2015 ENI,  8.7% EV/AUM,  

7.1% 2014 dividend yield, and 7.% 2015 dividend yield  

< all in all, pretty cheap especially if  the market keeps humming 

-          Alternative Asset Manager – value decomposition between  management fee earnings, net value/share, and performance fee earnings

Roughly speaking, the space is trading at around 18.4x mgmt fee related earnings + net cash/accrued carry  + 4.2x performance fee earnings. 

Given that performance fee earnings are historically around 50-300%+ of management fee earnings (in practically any year), I think that having some level of performance fees is more dependable than people think

-          Traditional Asset Manager & Alternative Asset Manager Comp Sheets

I think the alternative are way cheaper than traditional asset managers despite being better businesses.  

You've got large traditional asset managers trading at 17x 2014 PE , and small ones trading at 22x.  < Despite having secular decline concerns

Illustrative Charts (again I couldn't paste all the pictures and charts)

-          Steve Schwarzman loves to pitch this slide in his presentations (and he likes to mention how cheap his stocks are versus traditional asset managers)

 Basically, he highlights that if BX can continue its historic growth (of 12% AUM ( 60% below their historic rate),  make 2x multiple on invested capital,   and  get 7-10% return on liquid funds:  then he can get up to $4.15 in distributable earnings,  $610bn in assets, and the total return could be $27 in dividends + a $70-104 stock if you use a 4-6% dividend yield

For a total of $96-$131 in value in 10 years

• LTM distributable earnings = $1.39;  their projections imply 11.6% compound annual dividend growth over the next 10 years
• That would imply that the NPV is ~$47.5 (40% upside) using a dividend discount model and 10.5% cost of equity, and 3% terminal growth rate

-          Stock Chart 

 The stock is back to where it IPOed.  Had a very long basing period  

- Carry Fund Details

MOIC = Multiple on Invested Capital

Catalyst