Equity Research Financial Services and Technology | Asset Management January 15, 2016 Christopher Shutler, CFA +1 312 364 8197 [email protected] Andrew Nicholas, CPA +1 312 364 8689 The Blackstone Group L.P. [email protected] Near-Term Market-Related Headwinds, but Significant Long-Term Opportunities; Reiterate Outperform Stock Rating: Outperform Company Profile: Core Growth Since launching coverage on December 14, several of Blackstone’s key public holdings have struggled, with high-profile positions such as Hilton (HLT $18.40), NXP Semiconductors Symbol: BX (NYSE) (NXPI $74.51), and Michaels (MIK $21.12) down considerably. Consequently, we expect the Price: $25.64 (52-Wk.: $23-$44) company to face ENI headwinds in the near term (particularly in the first quarter), and Market Value (mil.): $30,534 weaker secondary activity could also depress distributable earnings. Still, the beauty of the Long-Term EPS Growth Rate: 13% Blackstone model lies in its diversification and ability to be patient when others are not; Dividend/Yield: $2.90/11.3% volatility can often present compelling investment opportunities, and we expect the credit Fiscal Year End: December segment in particular to be a beneficiary. Our Blackstone thesis is a long-term call. We expect the stock to remain a high-beta name 2014A 2015E 2016E (as evidenced by the chart on page 13 of our initiation report) that trades on near-term Estimates EPS FY $3.76 $2.16 $2.53 equity market sentiment, despite Blackstone’s track record as a premiere value-creator in CY $2.16 $2.53 a variety of market environments. We believe near-term dips offer a good entry point for patient investors willing to live with mark-to-market accounting-driven volatility. We see Valuation significant upside based on our sum-of-the-parts analysis, which includes a product-by- FY P/E 6.8x 11.9x 10.1x product DCF model for future performance fees, and we maintain our Outperform rating. CY P/E 11.9x 10.1x For a copy of our initiation report or working copy of our detailed SOTP framework, please Trading Data (FactSet) Shares Outstanding (mil.) 618 contact your William Blair representative. Float (mil.) 237 Average Daily Volume 5,151,591 Estimate Changes Financial Data (FactSet) • Fourth quarter Book Value Per Share (MRQ) 10.5 Return on Equity (TTM) 23.7 - We are reducing our fourth-quarter ENI per unit estimate by $0.08, to $0.70, but are still above the current consensus of $0.57. Two-Year Price Performance Chart $45 We are increasing our estimate for fourth-quarter distributable earnings per unit - $40 by $0.02, to $0.77; this implies a cash distribution of $0.66 per unit. Current consensus calls for a cash distribution of $0.61. $35 $30 • 2016 and 2017 $25 Flow-through impact from fourth-quarter adjustments and, more importantly, Jan-15 Jan-16 - downward revisions to our first-quarter market estimates lead us to reduce our Sources: FactSet, William Blair & Company estimates 2016 ENI per unit estimate to $2.53 from $3.32 previously. We are well below consensus of $3.21 but note that ENI per unit is a volatile metric and is even more volatile right now since BCP V is in catch-up. For 2017, we slightly raised our ENI per unit estimate to $3.34, from $3.27. - We expect heightened market volatility to damper distributable earnings in the first half of 2016. We are lowering our 2016 cash DE per unit estimate to $2.37, from $2.66 previously; consensus is $2.41. We are maintaining our 2017 cash DE per unit estimate at $2.60. The Blackstone Group L.P. is the largest alternative asset manager in the world, with four industry-leading businesses: private equity, real estate, credit, and hedge fund solutions. Please refer to important disclosures on pages 7-8. Analyst certification is on page 7. William Blair or an affiliate does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as a single factor in making an investment decision. William Blair Market Performance • By our calculations, the weighted average performance of publicly traded private equity and real estate investments in fourth quarter 2015 was -0.8% and -2.3%, respectively. Since publicly traded investments represented only 27% of unrealized investment value in private equity drawdown funds at the end of the third quarter and 23% in real estate, we prefer to look at public company returns relative to prior quarters to inform our estimates. For reference, our calculated fourth-quarter return on public company investments in the private equity portfolio of -0.8% compares to a calculated return of -2.4% in second quarter 2015, and in the latter case the segment actually experienced 2.3% of investment appreciation. In real estate, our calculated fourth-quarter return on public company investments of -2.3% compares to a calculated return of -7.3% in second quarter 2015, and in the latter case the segment actually experienced 1.6% of investment appreciation. - Key private equity performance contributors were Kosmos Energy (KOS $4.24; -8.3%), Hilton Worldwide (-8.9%), Seaworld (SEAS $17.70; +10.0%), Zimmer Biomet Holdings (ZBH $102.70; Outperform; +9.2%), Vivint Solar (VSLR $9.47; -9.9%), and Intertrust (INTER €18.20; +31.1%). - Key real estate performance contributors were La Quinta (LQ $11.27; -14.1%), Hilton Worldwide (-8.9%), Extended Stay (STAY $13.41; -5.9%), and Brixmor Property Group (BRX $25.08; +11.1%). • By our calculations, the weighted average performance of publicly traded private equity and real estate investments in first quarter 2016 (through January 14) was -8.7% and -10.3%, respectively. Given the brutal start to the new year, we have lowered are market assumptions materially. We model blended market performance of -2.0% and +1.0% for private equity and real estate AUM, respectively. - Key private equity performance contributors were Kosmos Energy (-15.8%), Hilton Worldwide (-10.5%), and Michaels (-5.5%). - Key real estate performance contributors were La Quinta (-13.2%), Hilton Worldwide (-10.5%), Extended Stay (-8.8%), and Hudson Pacific Properties (HPP $24.68; -8.6%). • The HFRI Fund Weighted Composite Index appreciated 0.9% in the fourth quarter, relatively in line with our +1.4% estimate. Given the S&P 500’s year-to-date 2016 decline, we lowered our first-quarter estimate to -2.5% for the BAAM segment. Fundraising • Despite being in between fundraises for its flagship private equity (BCP) and real estate (BREP) funds, we expect other strategies to continue to generate solid inflows over the next several years. We model gross inflows of $12.8 billion during fourth quarter 2015, which would bring the full year 2015 total to $90.6 billion. • Current fundraising areas include BREDS III, Strategic Partners (secondaries), Tactical Opportunities III, BREP Europe IV, and core-plus real estate. We expect these products to remain the focus through 2016 and beyond. Other longer-term focuses include a third mezzanine fund and a third rescue lending fund in the firm’s credit segment and a newly designed core-plus private equity platform, which we expect to hear more about in the near future. • In the hedge fund segment, direct investing (Senfina and Special Situations) and hedge fund ownership (Strategic Alliance and Strategic Capital) should drive growth outside of the fund-of-funds business. After generating returns of 23% in 2015 (through the end of November), Blackstone is looking to expand its Senfina platform to the United Kingdom, per a recent Reuters article. Capital Deployment • Blackstone’s real estate group was very active in the fourth quarter, closing five deals with total transaction values of at least $1.9 billion: a portion of GE’s (GE $29.06; Outperform) U.K. home lending portfolio ($5.8 billion), Strategic Hotels & Resorts ($5.7 billion), Manhattan’s largest apartment complex—Stuveysant Town ($5.3 billion), over 10,000 apartment units from Greystar ($2.0 billion), and U.S. shopping centers from RioCan ($1.9 billion). The business also agreed to 2 | Christopher Shutler, CFA +1 312 364 8197 William Blair acquire BioMed Realty Trust for $4.8 billion, although the deal is not expected to close until first quarter 2016. In the final days of the quarter it appears Blackstone also completed the purchase of a portfolio of 4,500 rental homes from a Spanish bank for close to $600 million. • On the private equity side, momentum in the secondaries business continued, highlighted by Strategic Partners’ acquisition of approximately $3.0 billion of global real estate fund interests from The California Public Employees’ Retirement System (“CalPERS”) on November 12. Other noteworthy investments included the closing of an investment in First Eagle Investment Management ($2 billion-plus deal value shared with Corsair Capital), a water infrastructure project with Pemex ($800 million, in a joint partnership with Pemex), an $820 million equity investment in NCR Corporation (NCR $20.43), and the acquisitions of both MB Aerospace and Diamonds Direct (details not disclosed). • While we expect a near-term slowdown in the private equity space, real estate deployment should continue to hum along. One of the benefits to Blackstone’s diversification is that when market uncertainty pressures certain segments, it can create opportunity in others. In this particularly instance, we believe the credit business is poised to capitalize on a low liquidity environment and the uncertainty surrounding interest rate policy. We also expect energy investments to pick up, but likely not until later in the year or 2017.