Thursday, November 6, 2008

Woe is Private Equity

Blackstone Group, the world's largest public private-equity firm, posted a sizable quarterly loss today, shocking even the most pessimistic analysts' estimates.  The company posted a net loss of $340.3 million, compared with a profit of $234 million a year earlier.  I must admit that the only thing shocking about Blackstone's loss is that it isn't significantly higher.  According to Bloomberg's report on the earnings announcement, the company wrote down its corporate holdings by about 7.5% and its real estate investments by 9%.  Since the beginning of the year, the firm has reduced the value of about a third of the 40 companies it owns.  Seriously?  It has written down the value of ONLY one third of its portfolio?  I admit I haven't a clue as to what assets Blackstone owns, but I can throw out a few thoughts that might put it in perspective: 
  • S&P and Dow down over 35% YTD
  • Commercial real estate prices down at least 15-20%, although nobody even knows because NOTHING IS TRADING
  • All LBO debt getting marked at around 70 cents on the dollar, although even this is highly suspect as very little is trading
  • Zero financing available for any new deals
So really, are we sure that we only want to mark down that commercial real estate by 9% and the corporate portfolio by a mere 7.5%, or are we going to put the crack pipe down and start talking some real numbers?  If that weren't enough, as I mentioned in my last mockery of Blackstone back in May, the company expects to post net losses during the next five years due to vesting expenses.  Why anyone is willing to subsidize insane compensation costs just for a "piece of the private equity pie" is beyond me and yet people buy this stock.  Who are these people?  Even at $7.55 a share, who on earth thinks this is a good business model anymore and that the company's biggest losses are behind them?
The Wall Street Journal had a great story about Blackstone Group's LBO of Hilton Hotels completed roughly a year ago.  It is certainly worth a read for anyone who has forgotten how preposterous the private equity boom period became.  Blackstone put in $6 billion of equity, its largest investment to date, and financed the balance of the $26 billion takeover with debt.  Blackstone paid 13 times estimated 2008 pre-tax cash flow for the company (translation: steep.)  Mind you, this was five years into an economic boom that was already looking tired when the deal was done.  Currently, the hotel chain's closest rival, Starwood, trades at about seven times before-tax cash flow.  The best part, the part you're really going to love as a US taxpayer, is that $4 billion of Hilton's LBO debt now sits on the Fed's balance sheet and we own it.  Apparently the Hilton LBO debt is part of the $30 billion in illiquid assets that the Fed guaranteed for JP Morgan when JP bought Bear.  The funny thing is that Lehman also held some of the Hilton LBO debt when it went bankrupt.  No doubt the bankruptcy court is working on finding a bid for the garbage so that Lehman creditors can be repaid.  Maybe the Fed can buy it and add it to the kitty.
At least the backlash against the private equity community is in full swing.  President-elect Obama will more than likely try to increase taxes on private equity investors from the long term capital gains tax rate to the ordinary income rate.  But not to worry, these guys won't see capital gains again for a really long time.    

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