Sector

Asset Management

Background

Marc Rubinstein is the author of Net Interest and a former hedge fund manager. We cover the different ways Blackstone earns money, how that’s changing, and what else management has done to make the business more shareholder-friendly.

Cover

Date

August 4, 2021

Episode Number

20

Blackstone Business Breakdown

Background / Overview

Blackstone, founded in 1985 by Steve Schwarzman and Pete Peterson, began as a boutique M&A advisory firm with $400,000 in seed capital. Both founders were former Lehman Brothers executives, with Schwarzman heading global M&A and Peterson serving as Chairman and CEO. The firm initially focused on leveraged buyouts (LBOs), capitalizing on the booming LBO market of the mid-1980s. Over 35 years, Blackstone evolved into the world’s largest alternative asset manager, managing over $650 billion in assets under management (AUM) across private equity, real estate, credit, and hedge fund strategies. With just over 3,000 employees, the firm oversees 250 portfolio companies employing over 500,000 people. Its scale, integration across asset classes, and ability to adapt to market dynamics have made it a leader in the alternative asset management industry.

Ownership / Fundraising / Recent Valuation

Blackstone went public in 2007, a strategic move to gain a currency for acquisitions and retention while aligning interests among limited partners (LPs), employees, and shareholders. The IPO was nuanced, as it did not primarily aim to raise capital for core operations but to enhance strategic flexibility. In 2007, the Chinese sovereign wealth fund and AIG, a long-term partner since 1998, invested in the firm. While exact enterprise values (EVs) and multiples from the IPO are not specified, the market re-rated Blackstone in 2019, reflecting confidence in its growing fee-related earnings. The firm raises capital from institutional investors (pension funds, endowments), insurance companies, and high-net-worth individuals through its private wealth channel, which generates $20 billion annually. Valuation metrics focus on fee-related earnings (valued at higher multiples due to recurrence) versus performance fees, with no net asset value (NAV) akin to a Berkshire Hathaway, as Blackstone invests only ~5% of its balance sheet in its funds.

Key Products / Services / Value Proposition

Blackstone operates in four key segments, each with distinct value propositions:

The value proposition lies in delivering high returns (historically targeting 15% net returns, now 4-8% for lower-yield products) by sacrificing liquidity, leveraging scale to access large deals, and integrating insights across segments for superior investment decisions.

Segments and Revenue Model

Blackstone’s revenue model comprises two streams:

1. Management Fees: 0.9% on fee-earning AUM ($600B of $650B), generating ~$5B annually. These are recurring, providing stability.
2. Performance/Incentive Fees: 20% carried interest on private equity/real estate exits, 10-20% on hedge fund/credit performance, contributing ~$2.5B annually. These are back-end loaded, tied to exits (e.g., 2003 exit of Transtar, acquired in 1987).

Segments:

• Corporate Private Equity (30%): Focuses on LBOs, e.g., $30B Medline deal, the largest LBO since the financial crisis.
• Real Estate (30%): Capitalizes on market cycles, e.g., post-2008 rental housing platforms, life sciences real estate.
• Credit (25%): Grew post-financial crisis via GSO acquisition, lending to businesses and partnering with insurers.
• Hedge Funds (15%): Allocates to third-party funds, leveraging Blackstone’s scale and relationships.

Splits and Mix

• Channel Mix: Institutional investors dominate, but private wealth contributes $20B annually. Insurance companies provide permanent capital, reducing redemption risk.
• Geo Mix: U.S.-centric, with early fundraising from Japanese insurers. Global exposure via portfolio companies.
• Customer Mix: Pension funds, endowments, insurers, and high-net-worth individuals. LPs receive ~$100B in returns over five years, employees $10B, shareholders $15B.
• Product/Segment Mix: Balanced across private equity (30%), real estate (30%), credit (25%), and hedge funds (15%).
• End-Market Mix: Diverse, including life sciences, e-commerce (via real estate), hospitality (e.g., Hilton), and industrial (e.g., Medline).
• Revenue Mix Shift: Historically, performance fees were two-thirds of earnings, management fees one-third. Now, management fees are two-thirds ($5B), performance fees one-third ($2.5B), reflecting growth in perpetual capital (e.g., insurance, retail).

EBITDA Mix: Mirrors revenue mix, with ~55% margin on fee-related earnings and ~45% overall EBIT margin, driven by scale (3,000 employees managing $650B).

KPIs

• AUM Growth: $650B, up from $400B eight years ago, driven by yield-seeking investors and low interest rates.
• Fee-Related Earnings: $5B annually, with 55% margin, growing 1% per year.
• Performance Fees: $2.5B, variable due to exit timing.
• Returns: Private equity (2.1x realized), real estate (2.2x), tactical opportunities (1.8x) over 35 years.
• Fundraising: $20B annually from private wealth, multi-billion-dollar institutional funds.

No clear deceleration; AUM and fee-related earnings show steady growth, though performance fees fluctuate with exits.

Headline Financials

• Revenue Trajectory: $7.5B, with management fees ($5B) growing steadily due to AUM expansion and perpetual capital. Performance fees ($2.5B) are lumpy, tied to exits.
• EBITDA: ~$3.375B at 45% margin, driven by scale (3,000 employees). Fee-related earnings margin (55%) reflects operating leverage.
• FCF: Not detailed, but low capital intensity (minimal capex, balance sheet-light model) suggests strong cash conversion. NWC cycles are minimal, as AUM is pre-funded.

Long-Term Trends:

• Revenue growth tracks AUM (from $400B to $650B in ~8 years).
• EBITDA margin expansion (1% annually) reflects fixed-cost leverage.
• Performance fees’ share declining, enhancing earnings durability.

Value Chain Position

Blackstone operates midstream in the alternative asset management value chain, between capital providers (LPs, insurers, retail) and investment targets (portfolio companies, real estate, credit opportunities). It adds value via:

• Deal Sourcing: Scale and relationships enable access to large deals (e.g., Medline, Hilton).
• Operational Expertise: Drives value in portfolio companies through management interventions.
• Integration: Cross-segment insights (e.g., real estate and private equity in Hilton) enhance returns.

GTM Strategy: Direct fundraising from institutions, insurers, and retail, leveraging brand and performance track record. Investments are thematic, targeting macro trends (e.g., life sciences, e-commerce logistics).

Competitive Advantage: Scale, integration, and information-sharing culture allow Blackstone to outmaneuver smaller players and execute complex, high-value deals.

Customers and Suppliers

• Customers: LPs (pension funds, endowments), insurers, and high-net-worth individuals. LPs receive ~$100B in returns over five years, reflecting strong alignment.
• Suppliers: Capital providers (same as customers) and portfolio companies’ operational inputs. No concentrated supplier power due to diversified investments.

Pricing

• Management Fees: ~0.9% on fee-earning AUM, fixed and predictable.
• Performance Fees: 20% carried interest (private equity, real estate), 10-20% incentive fees (credit, hedge funds), tied to exits/performance.
• Contract Structure: Long-term (10+ years for fixed-term funds), with exits driving performance fees. Perpetual capital (e.g., insurance) enhances visibility.
• Pricing Drivers: Brand, scale, and performance track record justify fees. Investors accept lower returns (4-8%) for liquidity trade-off, driven by low bond yields.

Bottoms-Up Drivers

Revenue Model & Drivers

Blackstone earns $1 of revenue via:

• Management Fees (67%): 0.9% on ~$600B fee-earning AUM, yielding $5B. Driven by AUM growth (institutional, insurance, retail channels).
• Performance Fees (33%): 20% carried interest on exits (e.g., Transtar’s 26x return over 16 years) or 10-20% on credit/hedge fund gains, yielding $2.5B. Driven by deal performance and exit timing.

Price:

• Fixed management fees (0.9%) are stable, driven by brand and scale.
• Performance fees vary by asset class, reflecting mission-criticality and investor willingness to pay for high returns.

Volume:

• AUM growth (from $8T to $14T industry-wide in 5-8 years) drives management fees.
• Deal flow (e.g., 250 portfolio companies) and exits drive performance fees.
• Growth factors: new geos, new products (e.g., life sciences), and reputation.

Mix:

• Product Mix: Private equity and real estate dominate (60% of AUM), with credit and hedge funds growing.
• Customer Mix: Shift toward perpetual capital (insurance, retail) reduces redemption risk.
• Geo Mix: U.S.-focused, with global portfolio exposure.
• Channel Mix: Private wealth ($20B/year) supplements institutional capital.

Organic vs. Inorganic: Organic AUM growth via fundraising; inorganic via acquisitions (e.g., GSO for credit).

Cost Structure & Drivers

Variable Costs:

• Compensation: ~46% of fee-related earnings ($2.3B of $5B), plus a share of performance fees.
• Direct deal costs: Minimal, as portfolio companies bear operational costs.

Fixed Costs:

• Overhead (facilities, admin): Low, given 3,000 employees manage $650B.
• R&D/Marketing: Limited, as brand and track record drive fundraising.

Cost Analysis:

• % of Revenue: Compensation (31% of $7.5B), overhead (10%), leaving ~45% EBIT margin.
• % of Total Costs: Compensation dominates (~70%), with overhead and other costs minimal.
• Operating Leverage: High fixed-cost leverage, as AUM scales without proportional employee growth (e.g., $1T AUM possible with ~3,100 employees).

EBITDA Margin: 45% overall, 55% on fee-related earnings, driven by scale and low variable costs.

FCF Drivers

• Net Income: Not specified, but EBITDA ($3.375B) less taxes and interest suggests strong profitability.
• Capex: Minimal (balance sheet-light, no significant maintenance/growth capex).
• NWC: Low, as AUM is pre-funded, and exits drive cash inflows.
• Cash Conversion: High, with FCF likely close to EBITDA due to low capex/NWC needs.

Capital Deployment

• M&A: Strategic acquisitions (e.g., GSO for credit) expand AUM and capabilities.
• Organic Growth: Fundraising ($20B/year from retail, multi-billion institutional funds).
• Shareholder Returns: $15B to shareholders over five years, via dividends/buybacks.
• Synergies: Acquisitions enhance scale and integration (e.g., credit business leveraging insurance capital).

Market, Competitive Landscape, Strategy

Market Size and Growth

• Size: Alternatives are $14T (vs. $250T in public markets), growing from $8T in 5-8 years.
• Growth: Driven by yield-seeking investors (low bond yields), with 4-8% returns now acceptable vs. historical 15% net.
• Industry Growth Stack: Low interest rates, deregulation (post-1970s), and investor demand for yield.
• 3 KDs: Yield demand, liquidity trade-off, and scale advantages.

Market Structure

• Competitors: Fragmented, with Blackstone, Apollo, KKR, and BlackRock as leaders. Oligopolistic in large-scale deals due to high MES.
• MES: High, as scale enables large deals (e.g., $30B Medline). Smaller players compete in niche markets.
• Cycle: Secular growth, with tailwinds from low rates and bank lending constraints post-2008.
• Traits: Low regulation, high margins, and capital intensity for entrants.

Competitive Positioning

• Matrix: High-price, high-return focus, targeting institutional and perpetual capital.
• Disintermediation Risk: Low, as scale and relationships deter new entrants.
• Market Share: Leader in alternatives, with $650B of $14T (4.6%). Growing faster than market due to retail/insurance channels.

Competitive Forces (Hamilton’s 7 Powers)

1. Economies of Scale: High MES enables large deals, with fixed-cost leverage (3,000 employees for $650B). Competitors need significant AUM to compete.
2. Network Effects: Limited, but integration across segments creates internal synergies (e.g., Hilton’s real estate and operational improvements).
3. Branding: Strong, with 35-year track record (2.1x private equity, 2.2x real estate returns). Attracts LPs and justifies fees.
4. Counter-Positioning: Balance sheet-light model and perpetual capital (insurance) differentiate from traditional asset managers.
5. Cornered Resource: Proprietary deal access (e.g., Medline) and relationships (e.g., AIG since 1998).
6. Process Power: Thematic investing (e.g., life sciences, e-commerce logistics) and information-sharing culture enhance returns.
7. Switching Costs: High for LPs due to long-term funds (10+ years) and performance track record.

Porter’s Five Forces:

• New Entrants: High barriers (scale, brand, relationships).
• Substitutes: Moderate, as public markets offer liquidity but lower returns.
• Supplier Power: Low, as capital providers are diversified.
• Buyer Power: Moderate, as LPs negotiate fees but are locked into long-term funds.
• Rivalry: High among top players (Apollo, KKR), but Blackstone’s scale provides an edge.

Strategic Logic

• Capex Bets: Minimal, as capital is LP-funded. Investments are offensive (e.g., life sciences) to capture growth.
• Economies of Scale: Achieved MES, enabling large deals. No diseconomies, as lean structure (3,000 employees) avoids bureaucracy.
• Vertical Integration: Limited, but integration across segments mimics vertical synergies.
• Horizontal Expansion: Credit (post-GSO), retail ($20B/year), and insurance capital expand scope.
• M&A: Strategic (e.g., GSO) to enter high-growth areas, with synergies via scale and integration.

Unique Business Model Dynamics

Blackstone’s business model is unique due to:

• Scale as a Niche: Unlike traditional asset managers facing diminishing returns, Blackstone leverages scale to access mega-deals (e.g., $30B Medline), unattainable by smaller peers. This creates a virtuous cycle: performance drives investor confidence, enabling larger funds and deals.
• Integration Across Asset Classes: The ability to share insights across private equity, real estate, credit, and hedge funds (e.g., Hilton’s dual real estate and operational focus) enhances returns. With only 3,000 employees, Blackstone’s lean structure fosters collaboration, amplifying its $650B AUM’s impact.
• Perpetual Capital Shift: The pivot to insurance and retail capital ($150B of AUM) reduces redemption risk, boosting fee-related earnings ($5B, 67% of revenue). This durability led to a 2019 market re-rating, as investors valued recurring fees over lumpy performance fees.
• Thematic Investing: Blackstone’s top-down, macro-driven approach (e.g., life sciences, e-commerce logistics) contrasts with bottom-up cost-cutting, aligning with growth trends and leveraging scale for high-value deals.
• Information as a Moat: Schwarzman’s emphasis on information (rooted in his public market frustrations) drives a culture of cross-referencing data, enabling better decisions (e.g., turning around Hilton post-2007 crisis).
• Regulatory Tailwinds: Post-2008 bank constraints fueled Blackstone’s credit business, with no significant regulatory headwinds, unlike banks or neobanks.

Standout Points:

• Marc Rubinstein highlights the “virtuous circle” of performance, investor confidence, and innovation, but notes the long time lags (10+ years for fixed-term funds) that make asset management unique. This patience is critical, as seen in Transtar’s 26x return over 16 years.
• The shift from performance fees (two-thirds) to management fees (two-thirds) reflects strategic adaptation to yield-seeking markets, making earnings more predictable.
• Schwarzman’s “don’t lose money” philosophy, combined with a lean, integrated structure, creates a resilient culture that sustains performance across cycles.

Critical Analysis

While Blackstone’s scale and integration are strengths, risks include:

• Performance Dependency: Lumpy performance fees ($2.5B) rely on exits, which can falter in downturns (e.g., Hilton’s near-loss in 2008).
• Regulatory Risk: Though currently a tailwind, future oversight could target private equity’s credit operations or tax treatment of carried interest.
• Succession: Schwarzman’s integral role raises questions about post-transition performance, despite John Gray’s appointment as COO.
• Market Saturation: As alternatives grow ($14T), competition for yield may compress returns, especially in the 4-8% range.

However, Blackstone’s diversified AUM, perpetual capital, and thematic investing mitigate these risks, positioning it to sustain leadership.