Now, we turn to the news for more details on the fabulous offer by the Blackstone Group. We say ‘fabulous’ because it is the stuff of fable…a morality tale telling itself.
The facts: The Blackstone Group is the largest private equity firm in the world. According to the report in the Financial Times, Blackstone’s assets have grown from $14 billion to $78 billion in less than six years. That is, it has multiplied its assets under management more than five times in six years.
Even more remarkable has been the incredible profitability of the firm.
Its annual rate of return is better than Warren Buffett’s. Since 1987 it has averaged 23% a year, while Buffett’s rate of return has been 22% – though over a much longer time. Blackstone’s real estate holdings have done even better – up 29% per year since 1991.
How does it make so much money? We turned to our colleague Eric Fry, who was sitting next to us, for an explanation:
“Private equity can mean a number of things. But what a company like Blackstone does, typically, is to buy a company from the public, reorganize it and sell it back to the public. Or, sometimes it will buy a private company and sell it to the public. The paper almost always ends up with the public.”
We have commented on private equity before. It is the hottest thing on Wall Street. Here’s why:
Profits in 2006 reached $2.27 billion, more than double that of the previous year.
“That means,” says the FT, “each of its 770 workers produced an average of $2.95 million in net income. By comparison, employees at Goldman Sachs Group Inc. – the largest U.S. investment bank – each averaged about $360,000 for the company in 2006.”
And now cometh these über money shufflers with an offer to shuffle some money to the public.
Or from it?
Blackstone, this fabulously successful firm of private equity investors, will now offer 10% of its shares to the public for $4 billion. Earlier in the week, we asked, “Why?!”
Today, we just stop to marvel at the chutzpah of it.
The Associated Press describes the deal:
“Consider this: Blackstone is a great firm. Going public will bring even greater riches to those at the top. That said, great riches have already been captured by those up and down the management hierarchy. This is not the case of a go-go high-technology firm that generates little free cash flow and requires an IPO or a sale to [crystallize] value for its shareholders. Blackstone has been, and will continue to be, a cash machine that can distribute substantial sums to its minions every year.
Therefore, either an IPO or a leveraging of the balance sheet is simply a means of extracting even more cash from the business. Given the friendly nature of today’s equity markets, going public offers the best risk/reward decision for Blackstone’s existing shareholders. This is an opportunistic step driven by the state of today’s equity markets and other considerations such as the state of the private equity market.”
Yes, but what does it mean?
The Financial Times comments:
“These self-motivated, intelligent individuals are trying to tell us something important. The question is: Do we have the ability to look beyond their words and actions and intuit motivation? Greed, uncertainty and fear. What are the implications? That the equity markets are in trouble? That the credit markets are on the verge of a sharp sell-off?
That we are at the dangerous stage of a private equity bubble?”
There is no magic to the Blackstone Group or other private equity firms. The genius of private equity prime capital is no different from the genius of subprime credit. When liquidity rises…both ride high.
But money and credit are no different from bananas or lovers: The more you have, the more will go bad on you. This is what economists call the Law of Marginal Utility. Each additional increment, of whatever it is, is less valuable than the one that came before.
We find in the Fed statistics that the total credit market debt has been increasing five times as fast as GDP for the entire 21st century, or what we have seen of it so far. Subprime lenders had so much money to lend that they gave it away to people who couldn’t possibly pay it back. There are only so many good borrowers. And there are only so many good private equity deals. And a credit bubble lasts only so long.
“What will happen when the debt markets grow less friendly and additional equity is required to get deals done? Returns will fall. What will happen to those who have invested in private equity funds? They will not be happy. And those who have invested in common shares of the private equity management company? Unhappier still.”
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