Blackstone Shows Strength Despite Crisis

Here's a clue as to the future of the shadow banking system. Publicly-traded Blackstone Group gave credible indication that it's likely to come out of the crisis not only intact but capable of taking advantage of the new financial environment -- notwithstanding a loss of $1.33 billion in 2008, reflecting investment markdowns.

All of Blackstone's business lines -- private equity and hedge fund management, real estate investing, advising on mergers and acquisitions -- are under severe pressure. Yet the firm provided evidence of financial strength with significant growth in fee-paying assets and a substantial cache of ready money to take advantage of market opportunities such as cheap corporate debt.

This upbeat picture goes against the trend. Shadow banks, that is, non-bank financial entities, have in significant measure collapsed. "Banks may be lending but the larger shadow banking system is not," wrote PIMCO's Bill Gross in his latest commentary. But not all shadow banks are in the same predicament. Some are open for business.

Consider the numbers from Blackstone:

• It has $13 billion in private equity capital waiting to be invested, mostly from a newly raised fund. "We have substantial dry powder in all of our funds," said Chief Executive Stephen Schwarzman at a conference call. And he says there is several billion dollars of additional capital coming from clients who want Blackstone to invest for them in hedge funds.
• Fee-paying assets grew by 10 percent to $91 billion, even as total assets under management shrank somewhat from $102 billion in 2007 to $94.5 billion at the end of 2008. Fee revenue for last year was $1.6 billion, of which $1 billion is covered by long-term contracts, "a locked-up recurring revenue source" as chief financial officer Laurence Tosi put it at the conference call.
• The firm operates with no net debt. It paid off a revolving loan and had $768 million in cash as of January.

That description, apt for structured investment vehicles, does not do justice to a diversified investment management business. While not subject to reserve requirements, Blackstone if anything has a more stable capital base than traditional banks because it has long-term commitments from its clients. Private equity funds don't have to distribute any money for many years to come-that's the agreement with institutions like pensions that make such investments.

Perhaps two words best capture the built-in advantage of the firm's business model: sticky assets. Schwarzman described the expected growth in the hedge fund investing advisory business and added, "We believe this translates into even stickier assets." The stickiness of its capital -- that is, investors' willingness to keep their money in the funds for lengthy periods -- allows Blackstone to wait for the right conditions to buy or sell.
Mind you, given its loss the firm did reduce payroll, albeit modestly. There were layoffs and some employees were relocated to the growing business of advising companies on restructuring and bankruptcy -- no surprise, as there's plenty of demand for advice in those areas. Schwarzman himself took a much-publicized 99 percent pay cut -- albeit from the lordly sum of $180 million in 2007.

Last fall, Nouriel Roubini predicted the demise of shadow banking via the unraveling of hedge funds, private equity groups, broker-dealers, structured investment conduits and mortgage lenders.

Judging from Blackstone, reports of demise are premature for certain parts of the system. "We have a rock solid balance sheet," says Schwarzman, apparently in full fighting form. "When the environment turns we think we will have the opportunity to harvest very substantial gains." Apparently the market agreed -- since Friday, Blackstone shares have almost doubled.

And while the firm Schwarzman founded and leads is certainly a "shadow bank" by Mr. Roubini's description, it is a public company subject to Sarbanes-Oxley and a slew of other regulation. No more shadowy than any corporation, it may actually be one of a new generation of investment banks, a potential competitor to Goldman Sachs.