Blackstone Inc. annual report, Q4 FY2007

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Business Context and Reporting Period

Company: The Blackstone Group L.P.
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2007
Overview: Blackstone is a leading global alternative asset manager and financial advisory firm. As of December 31, 2007, the firm managed $102.43 billion in assets across four segments: Corporate Private Equity, Real Estate, Marketable Alternative Asset Management, and Financial Advisory. The reporting period was significantly impacted by the firm's reorganization into a holding partnership structure and its Initial Public Offering (IPO) completed on June 27, 2007.

Key Financial Metrics

Metric 2007 2006
Total Revenues $3.05 billion $2.62 billion
Net Income $1.62 billion $2.27 billion
Net Loss Per Common Unit (Post-IPO) $(1.29) N/A
Total Assets $13.17 billion $33.89 billion
Total Liabilities $2.87 billion $2.37 billion
Assets Under Management (AUM) $102.43 billion $69.51 billion
Adjusted Cash Flow from Operations $3.31 billion $1.68 billion

Note: The significant decrease in Total Assets and Net Income compared to 2006 is primarily due to the deconsolidation of investment funds following the IPO, which shifted the accounting treatment from gross consolidation to the equity method for most funds.

Material Changes vs. Prior Period

  • Reorganization and Deconsolidation: Following the June 2007 IPO, Blackstone deconsolidated most of its investment funds. This resulted in a shift from reporting gross fund assets and liabilities to reporting only the firm's equity interest, causing a sharp decline in reported Total Assets (from $33.9B to $13.2B) and Net Gains from Fund Investment Activities.
  • Revenue Growth: Total revenues increased 17% to $3.05 billion, driven by a 45% increase in Management and Advisory Fees ($1.57B) and a 32% increase in Investment Income. This was partially offset by an 11% decrease in Performance Fees and Allocations.
  • Expense Surge: Total expenses rose 400% to $2.76 billion. This increase is largely attributable to the new accounting treatment post-IPO, which reclassified senior managing director compensation from partnership distributions to employee compensation expense, adding approximately $2.0 billion in reported costs.
  • Segment Performance:
    • Corporate Private Equity: Revenues declined 23% due to a $215 million drop in performance fees, largely driven by a write-down of the investment in Financial Guaranty Insurance Company ($110.2 million) and tighter credit markets.
    • Real Estate: Revenues increased 33% to $1.33 billion, fueled by transaction fees from the acquisitions of Hilton Hotels and Equity Office Properties Trust.
    • Marketable Alternative Asset Management: Revenues nearly doubled (96% increase) to $628 million due to significant net inflows and strong performance in funds of hedge funds.

Guidance, Outlook, and Risks

Guidance: Blackstone explicitly states it does not provide guidance regarding expected quarterly or annual operating results due to the high variability of its revenue streams, particularly carried interest and transaction fees.

Management Commentary & Outlook:

  • Market Conditions: Management noted that the second half of 2007 was characterized by severe credit market dislocations and a lack of liquidity, which hindered the initiation of new large-sized private equity and real estate transactions.
  • Acquisition: On March 3, 2008, Blackstone announced the acquisition of GSO Capital Partners LP for approximately $635 million in cash and units, plus up to $310 million in contingent consideration, to strengthen its credit platform.
  • Distributions: The firm intends to distribute substantially all of its net after-tax share of annual adjusted cash flow from operations to common unitholders on a quarterly basis. A distribution of $0.30 per unit was declared for the first quarter of 2008.

Risks and Contingencies:

  • Tax Legislation: Significant risk exists regarding proposed U.S. legislation (e.g., the Baucus-Grassley Bill) that could preclude Blackstone from qualifying as a partnership for tax purposes or tax carried interest as ordinary income, potentially increasing tax liability materially.
  • Market Volatility: Continued credit market turmoil could reduce the value of portfolio investments, limit exit opportunities, and decrease performance fees.
  • Key Personnel: The firm relies heavily on its founders and senior managing directors. Founder Peter G. Peterson indicated an intention to retire by December 31, 2008.
  • Legal Proceedings: The firm is defending against antitrust class-action lawsuits alleging conspiracy to rig bids and restrict financing in the private equity market.

Investor Verification Checklist

  • Deconsolidation Impact: Verify the impact of deconsolidating funds on the comparability of 2007 financial statements versus prior years; GAAP Net Income is not a direct measure of the firm's economic performance due to non-controlling interest eliminations.
  • Compensation Accounting: Confirm the treatment of senior managing director compensation, which shifted from distributions to expense, significantly inflating reported operating expenses.
  • Tax Status: Monitor legislative developments regarding the taxation of publicly traded partnerships and carried interest, as changes could materially affect unitholder returns.
  • Carried Interest Volatility: Assess the timing and magnitude of carried interest realizations, which are lumpy and dependent on successful exits in a challenging credit environment.
  • GSO Integration: Evaluate the synergies and integration risks associated with the March 2008 acquisition of GSO Capital Partners.