The old saw about the sucker and the card game is only partly true. You know the one: If you walk into a card game and you can't spot the sucker, guess what? You're the sucker.
With the $33 blillion IPO of Blackstone (NYSE:BX) last week, I think there's no doubt that unit (not "share"-) holders were playing the sucker to Wall Street's card sharps. I just think that, to most of them, it should have been completely obvious. Let's put it this way. You sit across the table from founder Stephen Schwarzman, who cashed out a few hundred million dollars in the IPO. He's one of the best dealmakers of all time, a guy who's entire philosophy is buying cheap and selling high. Do you really think you're the one getting the bargain?
Tell that to the poor shmoes who paid more than $40 a share the morning of the opening. Tell it to the suckers who saw their shares dip below the IPO price of $31 a stub yesterday. Someone's already sitting on a 25% haircut thanks to Blackstone. This is an ugly chart, but the question for potential investors now is: Will it get uglier?
Rock stars
There's no doubt that Blackstone the business has been a phenomenal success. A brief perusal of the registration statement gives you the glitzy song and dance. Assets under management (AUM) have grown at a compound annual growth rate (CAGR) of more than 40% since 2001. It's got some $88 billion under management, and earned $2.27 billion for fiscal year 2006.
The company has done all this with disciplined investing and a long-term frame of mind. And it intends to keep that philosophy, according to the registration statement: "We intend to continue to follow the management approach that has served us well as a private firm of focusing on making the right decisions about purchasing and selling the right assets at the right time and at the right prices, without regard to how those decisions affect our financial results in any given quarter."
I think that's good. Very good. Blackstone is saying, up front, that it doesn't intend to play the Wall Street game. Forget guidance and quarterly nonsense. They manage for the long term benefit of the ... whom? Well, there's the rub.
Base minerals
Blackstone the stock has looked like a losing proposition to me ever since I read the first filings. Investors buying "units" of Blackstone aren't getting access to the firm's great returns, its management of leverage, or its legendary dealmaking. They're not investing their money in Blackstone's holdings pool. They're buying limited-rights units of the management entity. That managing entity skims only a fraction of those legendary returns, and as the filings make clear, there are other individuals -- such as Blackstone founder Schwarzman -- who suckle first. Unfortunately, unitholders aren't just at the back of the line financially. They'll also have little (effectively, zero) voice in governance, strategy, or capital allocation.
Screaming fans
Clearly, Blackstone was one hot rock. The IPO garnered round-the-clock coverage from CNBC, and the mainstream media was abuzz. (Where's a Paris Hilton jailbreak when we needed it?) If it weren't for Apple's iPhone, I bet we'd still be hearing about it every 15 minutes. I'm not really convinced that Main Street is really all that fascinated with private equity, but last week, Blackstone was inescapable. Why couldn't the press just let this one go?
Because that's the nature of the beast. I've worked in deadline newsrooms, and they're nearly all characterized by a couple of unflattering tendencies: timidity and laziness. They're afraid of being left behind on "a scoop," so they talk about what the other guy is talking about, even if they know nothing about it and have nothing to add. Then the next guy says "Wow, they're both talking about it! We'd better get on it!" And so forth.
Then the laziness kicks in. It's pretty tough to understand a company like this, so most press rooms don't even try. Instead, they hit the Rolodex and call the easily-booked-men-in-suits-who-smile-on-camera-and-say-nice-things. The men in suits who say nice things like to be on TV, and in the press, so they say nice things. That's how they keep getting calls. But on the consumer side of this ludicrous news cycle, the result is a slanted, overhyped story.
Only the rare news organization -- The Wall Street Journal, for instance -- stands out in these situations. But Main Street doesn't read the WSJ -- not, at least, until Rupert Murdoch's News Corp. (NYSE:NWS) buys Dow Jones (NYSE:DJ) and begins hyping it during the local 10 o'clock news, right after breaking headlines from Hell's Kitchen.
The complicity of money
While I claimed up there that Blackstone wouldn't be playing the Wall Street game going forward, it certainly played for keeps before. Nearly every investment bank in the biz was involved in the IPO. What's more, they reportedly did this on the cheap, for half the usual price.
The reason is simple: Wall Street wanted this to be the biggest news of the year. Wall Street wants to see more private-equity IPOs, because it gets a slice of that cake, as well as all those fat banking fees that come along when these firms go about the business of deploying that capital.
Quid pro quo, Clarice.
The only surprise for me is that Wall Street didn't have enough juice to keep these shares floating for too long after the initial pop. For those who are familiar with the belly of the beast, that's part of the unwritten compact when shares are allotted to the anointed moneybags out there. The fact that The Street's sales machine couldn't keep Blackstone's inflated share price afloat bodes ill, I think, for the private-public wannabes who are now lining up to try and fleece retail investors. At least, I hope it does.
Wall Street will throw out more rocks
As many people (who went largely unquoted by the mainstream media machine) have pointed out, Blackstone's shares were horribly overpriced to begin with, selling at a premium multiple to any roughly comparable asset manager -- Goldman Sachs (NYSE:GS), Lehman Brothers (NYSE:LEH), Fortress Investment Group (NYSE:FIG), whoever. Depending on which earnings proxy you pick from the registration statement, the $31-per-share Blackstone sells for an earnings multiple of around 14, 19, or 23. It trades for roughly 33% of assets under management, a huge figure compared to peers. I figure the units to be worth $23 each, granting Blackstone some growth assumptions that I consider to be on the very smiley side of conservative. And that's before taking into account the fact that our grandstanding legislators in Washington are, at this very moment, lining up a variety of plans to extract a pound of flesh from private equity through changes in tax code.
Finally, Blackstone carries this prime price just as the credit cycle is tightening, valuations on potential takeover candidates remain high, inflation is biting, and there is more competition than ever for those good deals that made Blackstone's returns possible.
I have no doubt that Wall Street will do its best to manufacture a media frenzy and money-throwing party for as many private-equity firms as possible. My suggestion is that Fools learn from Blackstone. Pay close attention to the hype and the valuation, and leave the speculation to the little-f fools out there. Let someone else hold private equity's units.
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At the time of publication, Seth Jayson had no positions in any company mentioned here. See his latest blog commentary here. View his stock holdings and Fool profile here. Fool rules are here.
