In May, Blackstone (BX) executives returned from the Middle East with the spoils of negotiation: a $20 billion equity commitment from the Public Investment Fund (PIF) of Saudi Arabia, which will anchor Blackstone's new $40 billion U.S. Infrastructure Fund. With leverage, the company expects to build assets worth $100 billion, which would be the largest infrastructure fund ever raised.
Blackstone, as I've written, is somewhat of a battleground stock, trading at only 10 times this year's expected net income. On the other hand, CEO Steve Schwartzman thinks the company is worth double or even triple its current price.
The infrastructure fund gave Blackstone's stock a boost, climbing roughly 9% since the announcement. I'd argue the boost was too modest, as the massive raise proved two big things that helps the bull case.
Image source: Getty Images.
Size dilutes returns?
Skeptics on Blackstone believe it is a "melting ice cube." In other words, investors don't like the fact that Blackstone must both continue to generate high returns on its investments and raise ever larger sums of money in order to grow.
As Warren Buffett once said, "prospective returns fall as assets increase," and Blackstone is the largest alternative asset manager, with more assets under management than the second (Caryle Group and third-largest (Kohlberg-Kravis & Roberts) alternative asset managers combined.
This $40 billion raise would single-handedly boost Blackstone's AUM about 9%, and would be the largest infrastructure fund ever. This year, infrastructure funds had been raised by Brookfield Asset Management ($14 billion) and Global Infrastructure Partners ($15.8 billion). In 2015, KKR raised a $3.1 billion infrastructure fund. Other private equity funds EQT Partners and Stonepeak Infrastructure Funds are seeking $4.2 billion and $5 billion, respectively.
In this light, Blackstone's fund is roughly as big as all of these infrastructure funds combined. The ability of Blackstone to raise such a massive amount of money proves it is not too big to grow.
In fact, CEO Schwartzman has proclaimed Blackstone's size could actually enhance returns. Massive projects such as infrastructure, or any sort of macroeconomic bet, requires large amounts of capital. But many other funds don't have the ability to raise the requisite amount of cash, and therefore can't do certain high-return projects.
An example of this was when General Electric (GE 6.64%) wanted to quickly divest some $23 billion in real estate after the financial crisis. There aren't that many funds with access to that amount of money, nor many that could analyze that many assets that quickly. Blackstone had the resources and expertise, and quickly bought $14 billion in real estate.
Schwartzman also points out that Blackstone's large staff across asset classes can provide different perspectives and expertise that may uncover unique opportunities or create new ones. In fact, as of 2015, over half of Blackstone's AUM was in funds it didn't have prior to the financial crisis.
Blackstone has recently hinted at a new venture capital-like fund, so the fact that it has executed on the infrastructure fund bodes well for future products.
Investors are desperate for returns
The equity raise from the PIF also shows that large investors, many of which are highly indebted governments or pensions, are desperate for higher returns, and Blackstone's funds have outperformed stock market indices by 1000 basis points on average since the firm's founding 30 years ago.
According to Preqin, infrastructure funds historically have had a median invested rate of return of 9%, but these funds typically have much lower standard deviation (a measure of risk) than other asset classes such as private equity or venture capital. JMP analyst Devin Ryan is even more optimistic. He believes a 15% IRR is possible, and that Blackstone will charge a 1.25% management fee (on $40 billion equals $500 million in revenue per year, or 8.3% of Blackstone's last 12 months revenue) .
The fact that the PIF was willing to make such a big commitment is a good indication other pension and endowment funds will follow. Saudi Arabia is suffering huge deficits from the oil crash,and needs high and safe returns on large amounts of capital going forward. Their investment is a signal to others regarding Blackstone's ability to execute.
According to Barron's, wealthy investors are under-invested in alternative asset managers such as Blackstone. . Given the low returns of bonds and equity markets near highs, it's a decent bet that private equity will be a secular growth area going forward.
What it means to Blackstone
Of course, performance is not automatic. Bridges, tunnels, pipelines, airports, hospitals and other infrastructure projects are subject to lengthy permitting processes and construction complications. .
That said, the new fund and PIF investment is a great sign that Blackstone can still create new products at massive scale, which means even the largest alternative asset manager still has room to grow.
