Samuel Johannes 11/20/2012 FINC 410 Paper #1: Blackstone Group LP (BX)

Mission Statement & Business Overview

While Blackstone Group LP does not have a mission statement, they state the following guiding principles: Everything we do is guided by a set of principles that define our character and culture; they have been at the core of Blackstone since its inception. These enduring qualities are the shared convictions that we bring to our professional and personal conduct they are a fundamental strength of our business. Accountability Our capital and reputation are always on the line Excellence Anything less is never acceptable Integrity Leadership demands responsibility Teamwork Always makes us better Entrepreneurship Using creativity to find opportunities overlooked by others1 Blackstone makes three claims concerning its five guiding principles. First, they claim that their guiding principles define their corporate culture. Second, Blackstone claims that their five guiding principles are reflected in their professional and personal conduct. Finally, Blackstone claims that their guiding principles are a fundamental strength of their business. According to BusinessUG.com, People who encounter Blackstone

employees are often impressed with their depth of knowledge in their transactions...

1www.blackstone.com/the-firm/guiding-principles

Analysts are given quite a bit of responsibility, sometimes working directly with just a partner - some say that they are tasked with associate-level work after a year. 2 Blackstone analysts are given associate-level responsibilities within several years of being hired, and often work directly with partners. This indicates a culture of

accountability and teamwork, with value being added at multiple levels of management. Additionally, a strong emphasis on quantitative modeling requires Blackstone analysts to have an increased attention to detail. Blackstone recruits almost exclusively from the top business schools in the country. Such practices indicate high expectations for excellence in their staff. According to the Crimson, Blackstones Senior Managing Director John Studzinski said at a recruitment event that, Harvard and Wharton are the two major programs of schools that fill our analyst program.3 Blackstone projects a culture of accountability and excellence in both their professional and personal interactions. In this capacity, Blackstone adheres to its guiding principles. Blackstone is a leading global manager of private capital and provider of financial advisory services. Blackstone had $166.2 billion of assets under management as of December 31, 2011. Its alternative asset management businesses include the management of private equity funds, real estate funds, funds of hedge funds, credit-oriented funds, collateralized loan obligation (CLO) vehicles and separately managed accounts. Blackstone also provides a wide range of financial advisory services, including financial advisory, restructuring and reorganization and fund placement services.

http://businessug.com/services/bx.htm http://www.thecrimson.com/article/2009/9/14/crimson-careers-theblackstone-groupnowhere-to-hide/
2 3

As of December 31, 2011, Blackstone had 112 senior managing directors and employed approximately 620 other investment and advisory professionals at their headquarters in New York and offices in Atlanta, Beijing, Boston, Chicago, Dallas, Dubai, Dsseldorf, Hong Kong, Houston, Istanbul, London, Los Angeles, Menlo Park, Mumbai, Paris, San Francisco, Santa Monica, Seoul, Shanghai, Singapore, Sydney and Tokyo. Blackstone credits the depth and breadth of the intellectual capital and experience of their employees as the key reasons they have generated excellent returns while managing downside risk for their investors. Blackstones five business segments are: Private Equity, Real Estate, Hedge Fund Solutions, Credit Businesses, and Financial Advisory.4 Blackstone LLP., FY 11 Form 10K for the Period Ending December 31, 2011 (filed Feb. 2012). The Private Equity Segment manages seven hedge funds, including funds specializing in communicationsrelated investments, energy-focused investments, and investments in China. Blackstones Private Equity segments investment approach is guided by several core investment principles: corporate partnerships, sector expertise, a contrarian bias (e.g., investing in out-of-favor / under-appreciated industries), global scope, distressed securities investing, significant number of exclusive opportunities, superior financing expertise, operations oversight and a strong focus on value creation. Their existing private equity funds, collectively referred to as the Blackstone Capital Partners (BCP) funds, invest primarily in control-oriented, privately negotiated investments and generally leverage the

Blackstone LP., FY 11 Form 10-K for the Period Ending December 31, 2011 (filed Feb. 2012).
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investments they make. As of December 31, 2011, the Private Equity segment had $45.9 billion of assets under management.5 Blackstone manages several types of real estate funds that are diversified geographically and across a variety of sectors. They have managed six opportunistic real estate funds; three European focused opportunistic real estate funds and several real estate debt-investment funds. Blackstones real estate opportunity funds, collectively referred to as the Blackstone Real Estate Partners (BREP) funds, have invested in lodging, major urban office buildings, shopping centers and a variety of real estate operating companies. The BREP funds invest primarily in control-oriented, privately negotiated real estate investments and generally leverage the investments they make. In addition, Blackstones real estate debt-investment funds, referred to as the Blackstone Real Estate Debt Strategies (BREDS) funds, target non-controlling real estate debtrelated investment opportunities in the public and private markets, primarily in the United States and Europe. In addition, Blackstone manages Bank of America Merrill Lynchs Asian real estate assets. The Real Estate segments investing approach is guided by several core investment principles including global scope, a significant number of exclusive opportunities, superior financing expertise, operations oversight and a strong focus on value creation. As of December 31, 2011, the Real Estate segment had $42.9 billion of assets under management. Blackstones Hedge Fund Solutions segment is comprised of funds of hedge funds. Referred to as Blackstone Alternative Asset Management (BAAM), the Hedge Fund Solutions segment manages a broad range of commingled funds of hedge funds and

Ibid.

customized vehicles. BAAMs overall investment philosophy is to protect and grow investors assets through both commingled and custom-tailored investment strategies designed to deliver compelling risk-adjusted returns and mitigate risk. Diversification, risk management, due diligence and a focus on downside protection are key tenets of their approach. Although certain underlying managers that BAAM invests with may utilize leverage in connection with the investments those managers make in their respective underlying hedge funds, BAAM does not utilize long-term leverage for the investments it makes in the underlying hedge funds. As of December 31, 2011, the Hedge Fund Solutions operation had $40.5 billion of assets under management.6 Blackstones credit-oriented funds, CLOs, credit-focused separately managed accounts and publicly registered debt-focused investment companies are managed by their subsidiary, GSO. GSO is a major participant in the leveraged finance markets with $37.0 billion of assets under management as of December 31, 2011. GSO manages or advises a variety of credit-oriented funds including senior credit-oriented funds, distressed debt funds, mezzanine funds and general credit-oriented funds focused on the leveraged finance marketplace. In addition, GSO manages a number of credit-oriented separately managed accounts and publicly registered investment companies. These vehicles have investment portfolios comprised of loans and securities spread across the capital structure, including senior debt, subordinated debt, preferred stock and common equity. GSO may utilize leverage in connection with the investments the credit-oriented

Ibid.

funds, separately managed accounts or investment companies make. As of December 31, 2011, GSO had $16.1 billion of total assets under management.7 Blackstones Financial Advisory segment (Blackstone Advisory Partners L.P.) provides financial and strategic advisory services, restructuring and reorganization advisory services and fund placement services for alternative investment funds. Our financial and strategic advisory business focuses on a wide range of transaction execution capabilities with respect to acquisitions, mergers, joint ventures, minority investments, asset swaps, divestitures, takeover defenses, corporate finance advisory, private placements and distressed sales. Recent clients include Aluminum Corporation of China, American International Group, Inc. (AIG), Bank of America Corporation, Nestle S.A, The Procter & Gamble Company, and Xerox Corporation. Blackstone Advisory Partners L.P.s core principles are protecting client confidentiality, prioritizing clients interests, avoidance of conflicts and senior-level attention. Blackstones restructuring and reorganization group advises companies, creditors, corporate parents, hedge funds, financial sponsors and acquirers of troubled companies. The group is particularly active in large, complex and high-profile bankruptcies and restructurings. Recent clients include Alliance Medical, Lee Enterprises, and the Los Angeles Dodgers. The restructuring and reorganization groups key principles are senior-level attention, out-of-court focus, global emphasis and the ability to facilitate prompt, and creative resolutions. Park Hill Group provides Blackstones fund placement services. Park Hill Group provides fund placement services for private equity funds, real estate funds, venture capital funds and hedge funds.

Ibid.

Park Hill Group primarily provides placement services to unrelated third-party sponsored funds. It also assists Blackstone in raising capital for their investment funds.

SWOT Analysis & Porters Five Forces

EXTERNAL

General Economy
As a private equity and financial services firm, Blackstones business is materially affected by the conditions of the general economy, particularly financial markets. Changes in interest rates, availability of credit or debt financing, inflation rates, commodity prices, and currency exchange rates may affect the level and volatility of securities prices and the liquidity and value of investments.8 For example, turmoil in global financial markets during 2008 and 2009 caused significant volatility of securities prices, contraction in the availability of credit and the failure of a number of companies, including leading financial institutions, which had a significant material adverse effect on Blackstones investment businesses. During that period, many economies around the world, experienced significant declines in employment, household wealth, and lending. In addition, the recent speculation regarding the inability of Greece and other European countries to pay their national debt, the response by Eurozone policy makers, and the concerns regarding the stability of the Euro have created uncertainty in the credit markets. As a result, there was been a strain on banks and other financial services participants, which adversely affected Blackstones ability to obtain credit. Those events led to a significantly diminished availability of

Private Equity Growth Capital Council, Issues, Tax policy, the Dodd-Frank Act, and the Foreign Accounting Tax Compliance Act. 2012.
8

credit and an increase in the cost of financing. The lack of credit in 2008 and 2009 prevented the initiation of new, large-sized transactions for Blackstones private equity and real estate segments and adversely impacting revenue. Additionally, the deterioration of the credit markets may hinder Blackstones opportunities to realize value on investments made before 2008, as their expected return has decreased.9 In addition to credit markets, Blackstone is vulnerable to changes in debt financing markets. Any recurrence of the significant contraction in the market for debt financing that occurred in 2008 and 2009 or other adverse change such as, higher rates, higher equity requirements, and/or more restrictive covenants, would create difficulty for Blackstone in completing otherwise profitable acquisitions, or may generate profits that are lower than would otherwise be the case.10 Contracting credit and debt markets pose financing challenges to Blackstone that could be amplified by reduced liquidity. If the global economy fails to improve, Blackstones fund investment performance could suffer, resulting in little or no carried interest earned. The decrease in carried interest would cause cash flow from operations to significantly decrease, adversely affecting the amount of cash available to conduct operations. Less cash on hand could require Blackstone to rely on financing from credit and debt markets, which may not be available on acceptable terms.11 In addition to directly affecting the performance of Blackstones fund investment performance, the general economy affects firms in which Blackstone holds an equity position. During periods of difficult market conditions or slowdowns Blackstones

Ibid. Ibid. 11 Ibid.

9 10

portfolio companies may experience adverse operating performance, decreased revenues, financial losses, difficulty in obtaining access to financing and increased funding costs. Negative financial results in portfolio companies could adversely affect Blackstones ability to raise new funds as well as operating results and cash flow. To the extent those portfolio companies experience adverse operating performance, Blackstone may sell those assets at values resulting in a loss, thereby significantly affecting those investment portfolios performance and consequently Blackstones operating results and cash flow.12 Historically, during the Great Recession of 2008-2009, private equity backed firms (i.e. companies acquired in a leveraged buyout or similar transaction) defaulted at less than one-half the rate of comparable noninvestment grade companies: 2.84% versus 6.17%. According to a study by the Private Equity Council, during the Great Recession, companies backed by private equity sponsors with strong track records tended to borrow on more favorable terms than comparable companies. This trend indicates that private equity firms with strong reputations, like Blackstone, may be less sensitive to financing challenges precipitated by a poorly performing economy.13

Legislation and Regulation

Several pieces of legislation, including the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) and the Foreign Account Tax Compliance Act (FATCA), materially affect Blackstones operations. The Dodd-Frank Act, passed in 2010, was intended as a response to the 2008 financial crisis, in particular to reform banks (i.e. deposit takers) and non-bank financial institutions. A fundamental intention of the Dodd-Frank Act, tasked to the Financial Stability Oversight Council (FSOC), as
12 13

Ibid. Ibid.

articulated by the Obama administration, is to mitigate the risk that firms deemed too big or interconnected to fail pose to the aggregate financial system. With a market capitalization of $18.5 billion and $150 billion in assets under management, Blackstone could potentially qualify as too big or interconnected to fail and a systemic risk.14 However, it is uncertain as to whether Blackstone does, in fact, pose a systemic risk, for the following reasons. First, private equity firms are not leveraged in the same manner as the too big to fail banks of the 2008 financial crisis, such as Lehman Brothers. Blackstone maintains limited or no leverage at the fund level, an important distinction from leverage maintained at the portfolio company level. As a result, Blackstone is not subject to unsustainable debt or creditor margin calls. Furthermore, the average gross leverage ratio of private equity portfolio companies is historically about 2.85:1, while Lehman Brothers was leveraged at approximately 32:1.15 Second, Blackstone invests in companies across the country and is not intertwined with other financial market participants through derivatives positions, counterparty exposures or prime brokerage relationships, limiting their degree of interconnectedness. Additionally, private equity investments are not cross collateralized; neither an investor nor debt holder can force a fund to sell unrelated assets to repay a debt. Investments are isolated so that a non-performing investment does not affect another investment.16 Third, Blackstone does not engage in the short-term speculative positions that fueled real estate asset-price bubbles during 2008. Private equity investors commit their capital for approximately 10-

Ibid. Ibid. 16 Ibid.

14 15

12 years, with few redemption rights. Thus, Blackstone invests in companies in order to create long-term value.17 Another main element of the Dodd-Frank Act is the Volcker Rule. The rule serves two primary purposes: to ban proprietary trading by banks (i.e. trading on their own account) and to cap bank ownership in hedge funds and private equity funds at three percent. The Volcker Rule poses a threat to Blackstones operations in the United States. Gains from proprietary trading allow Blackstone to meet short-term liquidity needs. Any limit on or ban of proprietary trading in the United States will force firms to seek new markets to meet their cash needs. Accordingly, Blackstone may relocate their proprietary positions to markets with less stringent rules, such as London or Hong Kong.18 Though the Dodd-Frank Act was passed in 2010, ambiguities in the legislation have delayed implementation. Six agencies, including the Securities and Exchange Commission, the Federal Reserve, and the Commodities and Futures Trading Commission, are in the process of implementing the Volcker Rule. Once regulations are completed, and the Volcker Rule becomes effective, banking institutions will have at least two years to meet compliance standards. The Federal Reserve Board is also given authority to grant an additional extension of up to five years for illiquid funds, such as Blackstone. The uncertainty regarding both the specific regulations and the implementation timeline of Dodd-Frank disallows financial market participants from enacting anticipatory changes in their operations, limiting firms abilities to accommodate increased regulatory costs.19

Ibid. Ibid. 19 Ibid.

17 18

Increased regulatory costs have centered on ensuring compliance with the new regulation. Blackstone, like most private equity firms, has created a hierarchy of compliance officers, in every segment of their business, ultimately reporting to the Chief Compliance Officer (CCO). The CCO sets policies that are enforced by compliance officers to ensure the firms compliance with the law. This hierarchy costs a significant amount, as it requires the creation of new full-time positions, and the requirement to generate an increased number of data reports. Depending on the nature of the business in which it engages, a single firm may have to file data reports with multiple regulatory agencies.20 Additionally, Dodd-Frank requires most private equity firms to register with the SEC. Registration entails SEC oversight as to professional qualifications of the principals of the firms legal fitness for office, as well as basic corporate governance standards (e.g. board structure, independent accounting etc.) Dodd-Frank also requires registered private equity investors with at least $1 billion in assets under management to file a new Form PF. Form PF would require firms to supply data on monthly valuations of assets (including hard-to-value illiquid assets) and quarterly filings on managed assets, details on credit providers, risk profiles, investor concentration and firm performance among others. Registration and increased data reporting are guaranteed to increase the administrative costs of private equity firms, like Blackstone.21 Another main focus of Dodd-Frank was aimed at addressing perceived abuses and conflicts of interest in the area of executive compensation, including the perception that some financial firms operated under compensation practices that encouraged overzealous
20 21

Ibid. Ibid.

risk-taking. Section 952 of Dodd-Frank requires the independence of compensation committees, so that compensation is appropriately linked to performance. Several exchanges have proposed that once regulations regarding the independence of compensation committees are finalized, to exempt an employee of a private equity firm or other non-management significant shareholder that holds a significant equity stake in a covered issuer, even if that stake is considerably less than 50%, from the compensation committee independence requirements.22 The Foreign Account Tax Compliance Act (FATCA) requires that Foreign Financial Institutions (FFIs) enter into reporting agreements with the Internal Revenue Service (IRS) and provide the IRS with relevant information. Blackstone has a sizable number of entities in its funds families that are expected to become participating FFIs, which will be required to comply with FATCA reporting or certification procedures. The additional costs associated with administering FATCA will materially increase Blackstones general and administrative costs, as well as adversely affect their ability to raise funds from certain foreign investors. Under FATCA, all entities in a broadly defined class FFIs are required to comply with a complicated and expansive reporting regime or, beginning in 2014, be subject to a 30% United States withholding tax on certain U.S. payments (and beginning in 2015, a 30% withholding tax on gross proceeds from the sale of U.S. stocks and securities). The reporting obligations imposed under FATCA require FFIs to enter into agreements with the IRS to obtain and disclose information about certain investors to the IRS. Regulations implementing FATCA have not yet been finalized. Recently issued proposed regulations, if finalized, would delay the

22

Ibid.

implementation of certain reporting requirements under FATCA but no assurance can be given that the proposed regulations will be finalized or that any final regulations will include any delay. Accordingly, some foreign investors may hesitate to invest in U.S. funds until there is more certainty around FATCA implementation. In addition, the administrative and economic costs of compliance with FATCA may discourage some foreign investors from investing in U.S. funds, like Blackstone.23 In addition to the compliance cost of regulations concerning business operations, tax laws pose a legislative risk to Blackstone. The U.S. Congress has considered legislation that, if enacted, would have (a) precluded Blackstone from qualifying as a partnership or required them to hold carried interest through taxable subsidiary corporations and (b) taxed individual holders of common units at increased rates. If any similar legislation were to be enacted Blackstone could incur a material increase in tax liability and a substantial portion of their income could be taxed at a higher rate to the individual holders of common units.24 On May 28, 2010, the U.S. House of Representatives passed legislation that would have, in general, treated income and gains, including gain on sale, attributable to an investment services partnership interest, or ISPI, as income subject to a new blended tax rate that is higher than the capital gains rate applicable to such income under current law, except to the extent such ISPI would have been considered under the legislation to be a qualified capital interest. Blackstones common units and the interests Blackstone holds in entities that are entitled to receive carried interest would likely have been classified as ISPIs for purposes of this legislation. In June 2010, the U.S. Senate
23 24

Ibid. Ibid.

considered but did not pass legislation that was generally similar to the legislation passed by the U.S. House of Representatives. On February 14, 2012, Representative Levin introduced similar legislation, or 2012 Levin bill, that would tax carried interest at ordinary income tax rates (which would be higher than the proposed blended rate under the May 2010 House bill). It is unclear whether or when the U.S. Congress will pass such legislation or what provisions will be included in any final legislation if enacted.25 Both the May 2010 House bill and the 2012 Levin bill provide that, for taxable years beginning ten years after the date of enactment, income derived with respect to an ISPI that is not a qualified capital interest and that is subject to the rules discussed above would not meet the qualifying income requirements under the publicly traded partnership rules. Therefore, if similar legislation were to be enacted, following such ten-year period, Blackstone would be precluded from qualifying as a partnership for U.S. federal income tax purposes or be required to hold all such ISPIs through corporations. If Blackstone were taxed as a U.S. corporation or held all ISPIs through U.S. corporations, their effective tax rate could increase significantly.26 On September 12, 2011, the Obama administration submitted similar legislation to Congress in the American Jobs Act that would tax income and gain, including gain on sale, attributable to an ISPI at ordinary rates, with an exception for certain qualified capital interests. The proposed legislation would also characterize certain income and gain in respect of ISPIs as non-qualifying income under the tax rules applicable to publicly traded partnerships after a ten-year transition period from the effective date, with an exception for certain qualified capital interests. This proposed legislation follows
25 26

Ibid. Ibid.

several prior statements by the Obama administration in support of changing the taxation of carried interest. In its published revenue proposal for 2013, the Obama administration proposed that the current law regarding the treatment of carried interest be changed to subject such income to ordinary income tax. The Obama administration proposed similar changes in its published revenue proposals for 2010, 2011 and 2012.27 States and other jurisdictions have also considered legislation to increase taxes with respect to carried interest. For example, in 2010, the New York State Assembly passed a bill, which could have caused a non-resident of New York who hold Blackstone common units to be subject to New York state income tax on carried interest earned by entities in which Blackstone holds indirect interest, thereby requiring the non-resident to file a New York state income tax return reporting such carried interest income. It is unclear whether or when similar legislation will be enacted. Finally, because of widespread state budget deficits, several states are evaluating ways to subject partnerships to entity level taxation through the imposition of state income, franchise or other forms of taxation. If any state were to impose a tax upon Blackstone as an entity, dividend payouts would reduce.28 Additional proposed changes in the U.S. taxation of businesses could adversely affect Blackstones business. On February 22, 2012, the Obama administration announced its framework of key elements to change the U.S. federal income tax rules for businesses. Few specifics were included, and it is unclear what any actual legislation would provide, when it would be proposed or what its prospects for enactment would be. Several parts of the framework could adversely affect Blackstone. First, the framework
27 28

Ibid. Ibid.

would reduce the deductibility of interest for corporations in some manner not specified.29 A reduction in interest deductions could increase tax rates thereby reducing cash available for distribution to investors or for other uses. Such a reduction could also increase the effective cost of financing by portfolio companies, which could reduce the value of Blackstones carried interest in respect of such companies. The framework would also reduce the top marginal tax rate on corporations from 35% to 28%. Such a change could increase the effective cost of financing such investments, which could again reduce the value of carried interest. The framework suggests that some entities currently treated as partnerships for tax purposes should be subject to an entity-level income tax similar to the corporate income tax. Finally, the framework reiterates the Presidents support for treatment of carried interest as ordinary income, as provided in the Presidents revenue proposal for 2013 described above. Because the framework did not include specifics, its effect on Blackstone, and private equity firms in general, is uncertain.30 Finally, another potential legislative compliance cost would be the SECs requirement that public entities report financial results under International Financial Reporting Standards (IFRS) instead of under accounting principles generally accepted in the United States of America (U.S. GAAP). IFRS is a set of accounting principles that has been gaining acceptance on a worldwide basis. There remain significant and material differences in several key areas between U.S. GAAP and IFRS, which would affect Blackstone. Additionally, U.S. GAAP provides specific guidance in classes of accounting transactions for which equivalent guidance in IFRS does not exist. The adoption of IFRS is highly complex and would have an impact on many aspects and
29 30

Ibid. Ibid.

operations of Blackstone, including but not limited to financial accounting and reporting systems, internal controls, taxes, borrowing covenants and cash management. It is expected that a significant amount of time, internal and external resources and expenses over a multi-year period would be required for this conversion.31

Societal Values
As a result of the Great Recession, negative sentiments towards the investment and financial services gained moment with the general public. In particular, the Occupy Wall Street movement represented a populist reaction to income inequality, corporate greed and corruption, and undue corporate influence in government, particularly from the financial services sector. According to a November 2011 poll by Public Policy Polling, 33% of voters supported the Occupy Wall Street Movement, with 45% opposing, and 22% undecided. Despite its minority support amongst voters, the Occupy Wall Street Movements goals did parallel, to a degree, the policy objectives of the Obama administration and congressional Democrats. In an October news conference Barack Obama stated, I think it expresses the frustrations the American people feel, that we had the biggest financial crisis since the Great Depression, huge collateral damage all throughout the country ... and yet you're still seeing some of the same folks who acted irresponsibly trying to fight efforts to crack down on the abusive practices that got us into this in the first place. In addition to policy makers, several labor unions, such as the Transport Workers Union of America, the Industrial Workers of the World, and the National Nurses Union, voiced support for the Occupy Wall Street movement.

31

Ibid.

In opposition, several Republican lawmakers voiced their opinions, including Presidential Candidate Mitt Romney, who said that while there were "bad actors [that needed to be] found and plucked out, [he] believes that to aim at one industry or region of America is a mistake, and views the Occupy Wall Street protests as "dangerous" and inciting "class warfare". Additionally, several notable business people expressed opposition to the Occupy Wall Street movement. John Paulson, founder of Paulson & Co. Hedge Fund, in an interview with the Wall Street Journal, claimed that Occupy Wall Street vilified successful business people, also citing The top 1% of New Yorkers pay over 40% of all income taxes, providing huge benefits to everyone in our city and state. Peter Schiff, CEO of the hedge fund Euro Pacific Capital Inc. stated in his article In Defense of the 1%, I own a brokerage firm, but I didnt receive any bailout money. In fact, I have to work twice as hard to compete with bigger financial firms that are propped up by the US government. The least I deserve is the ability to keep what I earn. The extent to which distrust of the financial services industry, embodied by Occupy Wall Street, can influence legislation is limited. Disgruntled voters can elect candidates with similar ideologies; exercising this mechanism of influence is constricted by the timing of election cycles. Alternatively, various sections of society can, through the influence of lobby groups, attempt to shape legislation regarding the financial services industry. One could argue that the Dodd-Frank Act is a product of such influence. The influence of lobbying interests input into legislation is diluted in the implementation process. The actual writing of regulations is delegated to regulatory agencies, which often require the input of market participants. Thus, market participants,

who stand to be regulated, have a more direct influence on the regulations governing them than anti-Wall Street elements of society.

Technology
Technology plays a vital role in the infrastructure of the financial services industry. As the financial services industry operates on the exchange of information amongst millions of parties, efficient and effective systems of communication are essential. The importance of the exchange of information at the firm level is reflected in the role information technology departments play in financial services firms. The digitization of transactions and account record keeping requires a high degree of security, only attainable through substantial investment in IT. An effective IT department can lower costs by increasing the accuracy and turn-around speed of a firms operations. At an industry level, technology and the efficient, accurate exchange of information, is essential to the pricing of many asset classes. Price levels on exchanges such as the NYSE, NASDAQ, and CME are calculated from the up-to-the-minute flow of information from locations across the globe. The reliability of such infrastructure facilitates the integration of emerging markets into the global financial system. The expansion of global capital resources contributes to more efficient markets, and stimulated growth. In these capacities, a failure of technological systems would have immediate material effect on the operation of financial services firms. In addition to the infrastructural role of technology in the financial services industry, the capacity of modern computers has given rise to high frequency algorithmic trading. Many hedge and pension funds utilize high-powered computers to execute orders according to market data processed at fractions of a second. Firms rely on

computers ability to process massive amounts of data, such that they can implement highly precise trading strategies that require executing multiple orders per second. If a firm that engages in high frequency trading suffers a malfunction in their computer system, a tremendous amount of trading volume, and thus potential profit, can be lost.

Population Demographics
A key demographic trend that will affect private equity firms is the aging population in the United States. A growing segment of people aged 65 and over will create a severe strain on programs such as Medicare and Social Security. Given current projections regarding the sustainability of those programs, most people age 65 and over, as well as those becoming so within the decade, will require substantial income from retirement investments. As the aforementioned tax burden will increase labor costs, many firms will reduce the size of their pension contributions. This trend will put an even greater strain on pension funds to garner substantial returns, in a market of low interest rates. Pension funds have steadily been increasing their allocations in private equity. Private equity firms have outperformed many pension fund internal benchmarks, over a ten-year period. Both the California State Teachers Retirement System (Calstrs) and the Teachers Retirement System of Texas have committed several billion dollars to firms such as Blackstone, TPG Capital, and Apollo Global Management. The heightened expectations for returns on pensions, and the subsequent migration to private equity investment will provide more business for Blackstone in the future. However, sizable pension funds, like Calstrs, have pushed for lower management fees. In response, many large firms, including Blackstone, have started providing

strategic partnerships with some pension funds. In these strategic partnerships, the private equity firm will provide a wide range of advisory and investment services at a lower fee, in return for a large investment from the pension fund. On the opposite end of the age spectrum, people aged 18-25 exhibit trends that could materially affect Blackstone. According to the Associated Press, roughly 50% of college graduates aged 25 or younger are unemployed or in jobs that do not require a degree. The U.S. Department of Labor estimates that only three of the thirty jobs expected to have the greatest growth by 2020 will require a degree. These trends suggest an overconsumption of higher education. If higher education continues to be over consumed, and the federal government continues to increase aid-per-student, tuitions will rise. Rising tuitions will cause a greater strain on young people entering the work force with large amounts of student loan debt. In four-year institutions, more than 40% of firsttime, full-time students do not complete their programs within six years. The result of these trends will be students incurring debt, and being unqualified for jobs that would allow them to comfortably repay it. A heavily indebted, inappropriately qualified labor force will translate to slower growth in the U.S. GDP. Business will become less productive, making them less attractive candidates for investment. Disposable incomes will decrease as interest rates rise on lingering debt, stifling consumption. Such conditions cause slow growth in the general economy. As private equity firms reflect the performance of the general economy, the future indebtedness of undergraduates, and the current qualification issues of workers 25 and younger will affect Blackstone.

INTERNAL

Strengths
A primary driver of Blackstones success is its easy access to credit financing, relative to other non-private equity financial institutions and the availability of favorable terms under which it can receive credit. Blackstone uses credit financing to leverage its investments in marketable securities, real estate, and other firms. The extent to which Blackstone levers a company or an individual investment deal is measured by the ratio of debt-to-equity; it is a measure of the risk they are taking and, commensurately, the financial return they can expect. Thus, both the upside and downside effects of leveraging can be accurately measured and tailored to investors with an explicit required rate of return, such as a pension fund.32 A simple numerical example is as follows: Blackstone is going to buy a Spanish bank (or any other investment e.g. U.S. real estate developer) for $1 billion. It only wishes to use $200 million of its own money as equity. The balance of financing ($800 million) it borrows from a bank (e.g. JP Morgan). The leverage ratio on the deal is 4 to 1. If one year from now the value of the investment--the foreign bank--has gone up to $1.2 billion, then Blackstone has made 100% profit. If it sold at $1.2 billion, Blackstone would still owe $800 million of debt, leaving net proceeds of $400 million. The higher the leverage ratio, the higher the potential profit.33 However, if one year from now, the investment fell in value to $0.8 billion, then Blackstone's investment would have a negative 100% return. The value would be just

Blackstone LP., FY 11 Form 10-K for the Period Ending December 31, 2011 (filed Feb. 2012). 33 Ibid.
32

enough to pay off the debt. The higher the leverage ratio, the greater the potential downside risk. If the probability of each outcome ($1 billion or $0.8 billion) is equal, then Blackstone's expected return is 50%. If it had to put all it's own money in, i.e. $1 billion at the start, expected return would be zero. In essence, Blackstone is taking a greater risk through leverage, and thus can expect a higher return. Clearly, the availability of bank financing (i.e. the J P Morgan loan) is important to Blackstone's profits.34 There are four principal reasons why Blackstone has better access to and better terms for credit, relative to an average corporation or average financial institution. First, debt is secured on specific project revenues, typically in the form of secured loans. Loan obligations are secured against cash receivables or assets. Thus, Blackstone invests in a collection of business projects, the loans for which are tied to a specific project and secured by it. Even when the loans are not formally secured, they are typically well protected by covenants in the loan documents that give the lender a lot of influence over the borrower in case of an unexpected loss.35 The second principal reason Blackstone has better access to and better terms for credit is banks tend to favor private equity firms in the hope of attracting other business from them. The market for private equity leverage is a buyers market, as there are fewer private equity firms than potential lenders. Banks compete to loan to private equity firms by providing flexible loaning terms. If the bank established a strong relationship with a private equity firm, it can expect additional business from additional private equity

34 35

Ibid. Ibid.

takeovers in the form of underwriting fees when the portfolio company makes its initial public offering.36 The third principle reason is Blackstone is traditionally a large, well-capitalized institution. Banks are more likely to lend to well-capitalized firms, as they present less default risk. In addition to well-capitalized sponsors balance sheets, private equity firms tend to own well-capitalized companies. Greg Mondre, managing director of Silver Lake (a large tech-oriented private equity firm), noted private equity sponsors also own better companies than they did in past downturns. During the most recent period of private equity expansion in the early 2000s, sponsors were able to acquire an increased number of large, stable companies with leading market positions than in the past. Mondre said, "In any downturn, it is the leaders that come out with the highest market share and better margins. The weaker competitors fall by the wayside."37 The second primary driver of Blackstones success is the value added through its partners management expertise. Contrary to public perception, private equity firms do not simply flip companies. Rather, they invest with the intent to create long-term value, by focusing on core competencies and cost cutting. Private equity firms are in a unique position to create such value for several reasons.38 First, to attract continued investment from limited partners, private equity firms have to maintain a focus on substantive operational improvements that result from the application of deep industry and functional expertise. Private equity firms focus on core value begins with due diligence. General partners choose each target company and

Ibid. Ibid. 38 Ibid.

36 37

explicitly define how they will create value and on what timeline. This is an ongoing assessment as the firm periodically evaluates the value creation potential of their portfolio companies. Private equity firms will quickly draw capital from projects that create value in favor of those that do. The perpetual monitoring of value creation often means private equity firm exiting entire lines of business that are not drawing on the companys core strengths and differentiating capabilities.39 Second, private equity firms usage of high-leverage models, as previously discussed, instills a focus and sense of urgency to liberate and generate cash as expeditiously as possible. To improve cash flow, private equity firms tightly manage portfolio companies receivables and payables, reduce their inventories, and scrutinize discretionary expenses. To preserve cash, they delay or altogether cancel lower-value discretionary projects or expenses, investing only in resources that contribute significant value.40 Third, consistent with the imperative to generate cash quickly to pay down debt is private equitys focus on quickly enacting plans for improvement. Private equity firms invariably impose a 100-day program on portfolio companies during the first few months of ownership. Private equity firms and their management teams feel a sense of urgency and rapidly make decisions to change. Their structure frees them from some of the obligation for consensus building inherent in corporation management structures. They do not need to navigate layers of oversight or appease external stakeholders.41

Ibid. Ibid. 41 Ibid.

39 40

Fourth, private equity firms have a long-term focus. They typically have three to five years to invest the funds, providing time to carefully assess potential targets and develop an investment thesis. Private equity firms then have a window of about 10 years to exit these deals and return the proceeds to investors. After realizing the short-term cost benefit of eliminating low-value activities, the general partners can afford to invest in the long-term value creation potential of the companies they acquire. In fact, that is the only way they will secure their targeted returns upon exit by convincing a buyer that they have positioned the company for future growth and profitability.42 Fifth, private equity general partners understand that effective leadership is critical to the success of their investment. The assessment of talent begins as soon as due diligence commences and intensifies after the loan or acquisition is made. Decisions about management are executed swiftly. One-third of portfolio company CEOs exit in the first 100 days, and two-thirds are replaced during the first four years. A private equity firm will act assertively to put the right CEO and management in place, and may well draw on its own in-house experts or external network to fill talent gaps.43 Sixth, the CEO and senior managers at a private equity portfolio company are deeply invested in the performance of their business. Private equity firms pay modest base salaries to their portfolio company managers, but add in highly variable and annual bonuses based on company and individual performance, plus a long-term incentive compensation package tied to the returns realized upon exit. This package typically takes the form of stock and options. A 2009 study in the Journal of Economic Perspectives of

42 43

Ibid.

Ibid.

43 leveraged buyouts pegged the median CEOs stake in the equity upside at 5.4%, whereas the management team collectively received 16% of company stock. Top managers receive their annual performance bonus only if they achieve a several performance targets, unlike bonuses at public companies, which have become an expected part of overall compensation irrespective of performance. Private equity firms will reduce or even eliminate bonus payments if an operating company fails to achieve its targets. Not only does management participate in the upside in a private equity operating company, but it also shares in the potential downside. General partners have skin in the game in the form of a meaningful equity investment in the acquired company. Because this equity is essentially illiquid until the private equity firm sells the company, it reinforces the alignment between top managements agenda and that of the private equity shareholders, reducing any temptation to manipulate short-term performance.44

Weaknesses
The main weakness in Blackstones business model is its downside leverage exposure to the performance of its portfolio companies. For example, in August 2009, Blackstone issued $600 million of ten-year senior notes at a rate of 6.625% per annum, and in September 2010, they issued $400 million of ten-year senior notes at a rate of 5.875% per annum.45 Blackstones funds use of leverage, and their ability to achieve attractive rates of return on investments will depend on their ability to access sufficient sources of indebtedness at attractive rates. For example, in many private equity investments, indebtedness may constitute approximately 70% or more of a portfolio companys or real
44 45

Ibid. Ibid.

estate assets total debt and equity capitalization, including debt that may be incurred in connection with the investment. The absence of available sources of debt financing for extended periods of time could therefore materially and adversely affect Blackstones private equity and real estate businesses. Investments in highly leveraged entities are inherently more sensitive to declines in revenues, increases in expenses and interest rates and adverse economic, market and industry developments. The incurrence of a significant amount of indebtedness by an entity could:46 give rise to an obligation to make mandatory prepayments of debt using excess cash flow, which might limit the entitys ability to respond to changing industry conditions to the extent additional cash is needed for the response, limit the entitys ability to adjust to changing market conditions, thereby placing it at a competitive disadvantage compared to its competitors who have relatively less debt, allow even moderate reductions in operating cash flow to render it unable to service its indebtedness, leading to a bankruptcy and a loss of part or all of the equity investment in it, limit the entitys ability to engage in strategic acquisitions that might be necessary to generate attractive returns or further growth, and limit the entitys ability to obtain additional financing or increase the cost of obtaining such financing. As a result, the risk of loss associated with a leveraged entity is generally greater than for companies with comparatively less debt. For example, many investments

46

Ibid.

consummated by private equity sponsors during 2005, 2006 and 2007 that were significantly leveraged subsequently experienced severe economic stress and, in certain cases, defaulted on their debt obligations due to a decrease in revenues and cash flow precipitated by the subsequent economic downturn.47 When Blackstones existing portfolio investments reach the point when debt incurred to finance those investments mature in significant amounts and must be either repaid or refinanced, those investments may materially suffer if they have generated insufficient cash flow to repay maturing debt and there is insufficient capacity and availability in the financing markets to permit them to refinance maturing debt on satisfactory terms. If a limited availability of financing for such purposes were to persist for an extended period of time, when significant amounts of the debt incurred to finance their private equity and real estate funds existing portfolio investments came due, these funds could be materially and adversely affected.48 Many of the hedge funds in which Blackstones funds of hedge funds invest, creditoriented funds and CLOs may choose to use leverage as part of their respective investment programs and regularly borrow a substantial amount of their capital. The use of leverage poses a significant degree of risk and enhances the possibility of a significant loss in the value of the investment portfolio. A fund may borrow money from time to time to purchase securities or may enter into derivative transactions with counterparties that have embedded leverage. The interest expense and other costs incurred in connection with such borrowing may not be recovered by appreciation in the securities purchased and will be lost. The timing and magnitude of such losses may be accelerated or
47 48

Ibid. Ibid.

exacerbated in the event of a decline in the market value of such securities. Gains realized with borrowed funds may cause the funds net asset value to increase at a faster rate than would be the case without borrowings. However, if investment results fail to cover the cost of borrowings, the funds net asset value could also decrease faster than if there had been no borrowings.49

Economic Conditions & Forecasts

U.S. Economy
The following table contains data from the Congressional Budget Office and Federal Reserve on several metrics of the general economy. As previously discussed, Blackstone is exposed to the risks associated with the performance of the general economy. To the extent that portfolio firms results reflect the condition of the general economy, Blackstone is materially affected by changes in interest rates.

49

Ibid.

Year GDP (% change from previous period) Unemployment Rate Interest Rates (3 month T-Bill/10 year Treasury)

2007 1.9%

2008 -0.3%

2009 -3.1%

2010 2.4%

2011 1.6%

2012 2.0%

2013 1.1%

2014-2017 4.1%

4.6% 4.5%/4.6%

5.8% 1.4%/3.7%

9.2% 0.15%/3.3%

9.6% 0.14%/3.2%

8.7% 0.1%/2.8%

8.9% 0.1%/2.3%

9.2% 0.1%/2.5%

5.6% 2.0%/3.8%

Inflation (Consumer Price Index)

2.9%

3.9%

-0.3%

1.6%

3.2%

1.4%

1.5%

1.9%

Evaluation of Management and Operating Results

Business Environment World equity and debt markets were mixed in 2011, characterized by high levels of volatility due to macroeconomic, political and regulatory uncertainty. In equities, the MSCI World Index declined 8%, with developed markets generally outperforming developing markets in Asia and elsewhere. Credit indices rose in 2011, due to strong corporate earnings and higher demand.50 The development of monetary policy throughout the world was mixed, but in the U.S., the Federal Reserve has remained committed to keeping inflation at low levels. Corporate earnings were generally better than expected for most of 2011, and cash flows and balance sheets remained very healthy, although companies have remained cautious in hiring. The U.S. unemployment rate remains elevated, but declined to its lowest level in three years at the end of 2011.51 In commercial real estate, despite volatility in the global economy and equity markets, operating fundamentals remain healthy across all of Blackstones real estate investment types. The office sector is benefiting from historically low levels of new supply, combined with slow, steady growth in GDP and employment, which has resulted in increasing occupancy and rents. There are similar trends in Blackstones industrial, Blackstone LP., FY 11 Form 10-K for the Period Ending December 31, 2011 (filed Feb. 2012). 51 Ibid.
50

retail and senior living sectors. In the hospitality sector, trends remain positive, with U.S. industry RevPAR (Revenue per Available Room) up 8% for 2011.52 There remains some uncertainty regarding Blackstones future taxation levels. Over the past several years, a number of legislative and administrative proposals to change the taxation of Carried Interest, a material source of revenue for Blackstone, have been introduced and, in certain cases, have been passed by the U.S. House of Representatives.53 Proposed legislation stipulated that Carried Interest due to publicly traded partnerships be held in taxable subsidiary corporations, rather than being treated as capital gains. If publicly traded partnerships were to be taxed as a corporation or were forced to hold interests in entities earning income from Carried Interest through taxable subsidiary corporations, Blackstones effective tax rate could increase significantly. The federal tax rate for corporations is currently 35%, and the state and local tax rates aggregate approximately 10%. If future legislation precludes Blackstone from qualifying for treatment as a publicly traded partnership for U.S. federal income tax purposes, this could materially increase their tax liability, and could well result in a reduction in their share price.54 Results of Operations Revenues Total Revenues were $3.3 billion for the year ended December 31, 2011, an increase of $133.2 million compared to $3.1 billion for the year ended December 31,

Ibid. Ibid. 54 Ibid.

52 53

2010. The increase in revenues were driven by an increase of $227.0 million in Management and Advisory Fees and an increase in Performance Fees of $244.8 million, partially offset by a decrease of $347.8 million in Investment Income. The increase in Management and Advisory Fees was due to (a) increases in management fees in Blackstones Private Equity segment, driven by fees generated from Blackstone Capital Partners (BCP) Tier VI and Blackstone Energy Partners (BEP) funds, which commenced their investment periods during the first and third quarters of 2011, respectively, (b) increases in transaction fees in Blackstones Real Estate segment, due to the continued increase in investment activity in Blackstone Real Estate Partners (BREP) funds, primarily as a result of BREP Tier VIs acquisition of the U.S. assets of Centro in the second quarter of 2011, and management fees earned from the management of the Bank of America Merrill Lynch Asia real estate platform, and (c) increases in management fees in Blackstones Credit Businesses and Hedge Fund Solutions segments due to higher Fee-Earning Assets Under Management.55 The increase in Performance Fees was due to improved operating performance and projected cash flows resulting in the appreciation of the fair value of the investments across the Real Estate carry funds and the impact of the catch-up provisions of the Real Estate funds profit allocations. The catch-up provisions of the Real Estate funds profit allocations specify that once a funds preferred return hurdle has been reached, Blackstone is entitled to a

Blackstone LLP., FY 11 Q1 Form 10-Q for the Period Ending June 30, 2011 (filed Aug. 2012).
55

disproportionately greater share (80% of the profits) until it effectively reaches its full share of performance fees (20% of the total profits).56 Expenses Expenses were $3.4 billion for the year ended December 31, 2011, a decrease of $755.9 million, or 18%, compared to $4.1 billion for the year ended December 31, 2010. The decrease in expenses was due to a decrease of $871.8 million in Compensation and Benefits. Compensation decreased $831.5 million from the prior year period to $2.4 billion as a result of the absence of expenses related to equity-based compensation awards.57 General, Administrative and Other expenses were $566.3 million for the current year period, an increase of $100.0 million due to an increase in the levels of business activity, revenue growth and headcount. Interest Expense was $57.8 million for the current year, an increase of $16.6 million from the same period of 2010 due to Blackstones issuance of senior notes in 2010.58 Other Income Other Income was $212.8 million for the year ended December 31, 2011, a decrease of $289.2 million compared to $502.0 million for the year ended December 31, 2010. The decrease of $487.1 million of Net Gains from Fund Investment Activities was due to declines in income from Blackstones Private Equity and Real Estate consolidated side-by-side entities and consolidated collateralized loan obligation (CLO) vehicles. This decrease was partially offset by $197.8 million of Other Income, resulting from the reversal of the tax receivable agreement liability. The reversal occurred from corporate Blackstone LLP., FY 11 Form 10-K for the Period Ending December 31, 2011 (filed Feb. 2012). 57 Ibid. 58 Ibid.
56

subsidiaries adopting a New York City law for sourcing of revenue that reduces their effective tax rate and therefore reduces the expected future tax savings that would result in payments under the tax receivable agreements.59 Assets Under Management Assets Under Management were $166.2 billion at December 31, 2011, an increase of $38.1 billion, or 30%, compared to $128.1 billion at December 31, 2010. Inflows of $49.5 billion consisted of (a) inflows of $18.6 billion in the Private Equity segment as BCP Tier VI began its investment period, (b) inflows of $11.3 billion in the Hedge Fund Solutions segment due to growth in the hedge fund manager seeding platform, (c) inflows of $11.3 billion in the Credit Businesses segment primarily from the acquisition of $2.3 billion of CLO vehicles and capital raised across its long only platform, and (d) inflows of $8.3 billion in the Real Estate segment primarily from the deployment of coinvestment capital and the beginning of BREP Tier VIIs investment period.60 Outflows of $16.5 billion, principally from the Credit Businesses, Private Equity and Hedge Fund Solutions segments, were attributable to (a) outflows of $4.8 billion in the Credit Businesses segment from the deleveraging of CLO vehicles post their reinvestment periods, (b) outflows of $3.4 billion in the Real Estate segment from realizations from the Bank of America Merrill Lynch Asia real estate platform and the end of BREP Tier VIs investment period, and (c) reductions of $3.2 billion in the Private Equity segments FeeEarning Assets Under Management due for the most part to the end of BCP Tier Vs investment period during the first quarter of 2011.61 Net market appreciation of $5.1

Ibid. Ibid. 61 Ibid.

59 60

billion consisted of appreciation in the Real Estate and Private Equity segments of $4.4 billion and $2.2 billion, respectively, and depreciation in the Hedge Fund Solutions segment of $1.7 billion. Real Estate and Private Equity benefited from improvements in the carrying values of their investments while Hedge Fund Solutions was affected by equity market declines.62 Performance by Segment Private Equity Revenues Revenues were $578.8 million for the year ended December 31, 2011; a decrease of $249.6 million compared to $828.4 million for the year ended December 31, 2010. The decrease in revenues consisted of decreases in Performance Fees and Investment Income of $237.5 million and $114.2 million, respectively, and an increase in Total Management Fees of $102.6 million.63 Performance Fees were $70.9 million for the year ended December 31, 2011, a decrease of $237.5 million, compared to $308.4 million for the year ended December 31, 2010. The decrease was due to lower Performance Fees in BCP Tier IV which had net returns of 8% in 2011 versus 30% during the 2010 year.64 The returns in 2011 derived from investments in the energy sector and Blackstones publicly traded portfolio, particularly the investments which had initial public offerings in 2011, including Nielsen Holdings N.V., Kosmos Energy Ltd., BankUnited, Inc., and Vanguard Health Systems, Inc. Investment Income was $54.5 million, a decrease of $114.2 million, compared to

Ibid. Ibid. 64 Ibid.

62 63

$168.6 million for the year ended December 31, 2010, principally determined by the performance of BCP Tier IV and V funds, which had lower fund returns than for the prior year.65 Total Management Fees were $437.9 million for the year ended December 31, 2011, an increase of $102.6 million compared to $335.4 million for the year ended December 31, 2010, comprised of increased Base Management Fees and Transaction and Other Fees, partially offset by an increase in Management Fee Offsets. Base Management Fees were $332.0 million for the year ended December 31, 2011, an increase of $68.7 million compared to $263.3 million for the year ended December 31, 2010, principally as a result of an increase in Fee-Earning Assets Under Management due to the beginning of the BCP Tier VI and BEP funds investment periods.66 Transaction and Other Fees were $133.0 million for the year ended December 31, 2011, an increase of $60.8 million compared to $72.2 million for the year ended December 31, 2010, resultant of one time fees earned from the termination of management advisory service agreements with portfolio companies that completed initial public offerings, as well as fees generated from the subsequent increase in new investment.67 Management Fee Offsets were determined by the reduction of management fees payable by Blackstones limited partners in BCP Tier VI, based on the amount they reimbursed Blackstone for placement fees.68 Expenses Expenses were $337.7 million for the year ended December 31, 2011; a decrease of $5.2 million, compared to $342.9 million for the year ended December 31, 2010. The Ibid. Ibid. 67 Ibid. 68 Ibid.
65 66

$5.2 million decrease was comprised of a $54.7 million decrease in Performance Fee Compensation, mostly offset by a $38.2 million increase in Compensation and an $11.3 million increase in Other Operating Expenses.69 Performance Fee Compensation decreased as a result of the decreases in Performance Fees revenue. Compensation rose due to increased headcount and an improvement in the performance measures to which a portion of compensation is linked.70 Other Operating Expenses increased from $11.3 million to $120.9 million, principally due to interest expense allocated to the segment and occupancy costs.71 Real Estate Revenues Revenues were $1.6 billion for the year ended December 31, 2011, an increase of $545.8 million compared to $1.0 billion for the year ended December 31, 2010. The increase in revenues were due to an increase of $652.3 million in Total Performance Fees and an increase of $102.1 million in Total Management Fees, offset by a decrease of $209.6 million in Total Investment Income.72 Performance Fees were $949.5 million for the year ended December 31, 2011, an increase of $652.3 million compared to $297.3 million for the year ended December 31, 2010. Investment Income was $120.6 million for the year ended December 31, 2011, decreasing $209.6 million from $330.2 million for the year ended December 31, 2010. The net appreciation in fair value of the investments in BREP Tier V and VI carry funds primarily contributed to the increase in Performance Fees for the year ended December Ibid. Ibid. 71 Ibid. 72 Ibid.
69 70

31, 2011.73 Performance Fees benefited from the strong performance of carry funds, augmented by the catch-up provisions of the Real Estate funds profit allocations. The decrease in Investment Income resulted from the year over year decrease in the appreciation of investments related to the BREP Tier VI fund. 74 The carrying fair value of assets for Blackstones contributed Real Estate funds increased 16.7% for the year ended December 31, 2011. Positive performance in year ended December 31, 2011 resulted from improved operating performance and projected cash flows across the Real Estate carry funds investments, which resulted in the appreciation of Blackstones holdings, principally within their office, hotel and retail portfolios.75 As of December 31, 2011, the unrealized value and cumulative realized proceeds of Blackstones Real Estate funds represented 1.4 times investors original investment.76 Total Management Fees were $499.3 million for the year ended December 31, 2011, increasing $102.1 million from $397.3 million for the year ended December 31, 2010. Base Management Fees were $394.8 million for the year ended December 31, 2011, increasing $56.4 million from $338.4 million for the year ended December 31, 2010, primarily derived from the management of the Bank of America Merrill Lynch Asia real estate platform and management fees earned from co-investments. Transaction and Other Fees were $109.5 million for the year ended December 31, 2011, increasing $49.6 million from $59.9 million for the year ended December 31, 2010, reflecting the

Ibid. Ibid. 75 Ibid. 76 Ibid.

73 74

continued increase in investment activity in BREP funds, primarily as a result of BREP Tier VIs acquisition of the U.S. assets of Centro.77 Expenses Expenses were $579.5 million for the year ended December 31, 2011, an increase of $183.5 million, compared to $396.1 million for the year ended December 31, 2010. The increase was primarily attributed to a $100.2 million increase in Performance Fee Compensation, resulting from improved Performance Fees revenue and an increase in Compensation of $53.6 million to $236.8 million. Compensation rose primarily due to headcount increases related to the management of the Bank of America Merrill Lynch Asia real estate platform and the profitability of the segment.78 Other Operating Expenses increased $29.7 million to $103.9 million for the year ended December 31, 2011, principally due to placement fees related to debt investment funds, interest expense allocated to the segment, and expenses related to the management of the Bank of America Merrill Lynch Asia real estate platform.79 Hedge Fund Solutions Revenues Revenues were $338.5 million for the year ended December 31, 2011, decreasing $28.2 million from year ended December 31, 2010. The decrease in revenues was primarily attributed to decreases of $47.4 million in Performance Fees to $12.2 million

Ibid. Ibid. 79 Ibid.

77 78

and $30.5 million in Investment Income to $(1.3) million, partially offset by an increase of $41.7 million in Total Management Fees to $317.7 million.80 Total Management Fees were $317.7 million for the year ended December 31, 2011, increasing $41.7 million from $276.0 million for the year ended December 31, 2010.81 Base Management Fees were $315.9 million for the year ended December 31, 2011, increasing $43.1 million from the prior year period, driven by an increase in FeeEarning Assets Under Management of 14%.82 Performance Fees were $12.2 million for the year ended December 31, 2011, decreasing $47.4 million from $59.6 million for the year ended December 31, 2010. Investment Income was $(1.3) million for the year ended December 31, 2011, decreasing $30.5 million from the prior year period.83 Both decreases reflect the lower returns in the segment in 2011 compared to 2010. The returns of the underlying assets for Blackstones Hedge Fund Solutions funds were (1.8)% during the year ended December 31, 2011. Fee-Earning Assets Under Management related to funds of funds above their respective hurdle rate, thus eligible for Performance Fees, also decreased during the year ended December 31, 2011 compared to the year ended December 31, 2010.84 Expenses Expenses were $197.8 million for the year ended December 31, 2011, increasing $29.3 million compared to the year ended December 31, 2010. The $29.3 million increase was primarily attributed to a $15.6 million increase in Total Compensation and

Ibid. Ibid. 82 Ibid. 83 Ibid. 84 Ibid.

80 81

Benefits and a $13.7 million increase in Other Operating Expenses.85 Compensation was $129.0 million for the year ended December 31, 2011, increasing $33.6 million, from $95.4 million for the prior year period, due to an increase in headcount to support the growth of the business.86 Other Operating Expenses increased $13.7 million to $65.1 million for the year ended December 31, 2011, from $51.4 million for the year ended December 31, 2010, due to increased professional fees from to the growth of the business and other expenses.87 Credit Business Revenues Revenues were $395.0 million for the year ended December 31, 2011, decreasing $83.7 million from the year ended December 31, 2010. The decrease in revenues was resulted from lower Performance Fees of $141.8 million compared to $261.1 million for the year ended December 31, 2010. This was partially offset by an increase of $44.1 million, or 23%, in Total Management Fees. Performance Fees were $141.8 million for the year ended December 31, 2011, which is $119.2 million lower than the prior year period. The lower Performance Fees were primarily attributable to a slowing in the increase of the carrying value of the underlying assets. The returns of the underlying assets for Blackstones credit-oriented business were 8.9% for the flagship hedge funds, 28.1% for the mezzanine funds and 4.4% for the rescue lending funds for the year ended December 31, 2011.88

Ibid. Ibid. 87 Ibid. 88 Ibid.

85 86

The Realized Performance Fees for the year ended December 31, 2011 of $146.6 million were primarily determined by realizations in the Credit Businesses mezzanine and flagship hedge funds.89 Total Management Fees were $240.0 million for the year ended December 31, 2011, increasing $44.1 million from the prior year period. Base Management Fees were $238.5 million for the year ended December 31, 2011, increasing $43.6 million compared to the prior year period, primarily due to higher Fee-Earning Assets Under Management.90 Expenses Expenses were $253.4 million for the year ended December 31, 2011, a decrease of $51.6 million, or 17%, compared to the year ended December 31, 2010, resulting from a decrease of $67.8 million in Performance Fee Compensation, partially offset by increases of $5.3 million in Compensation and $10.8 million in Other Operating Expenses. Performance Fee Compensation was $74.8 million for the year ended December 31, 2011, compared to $142.6 million for the prior year period.91 The decrease was due to lower Performance Fee accruals in the current year compared to the prior year period. Compensation increased $5.3 million to $128.6 million for the year ended December 31, 2011, from $123.3 million for the prior year period. Other Operating Expenses increased $10.8 million to $50.0 million for the year ended December 31, 2011, from $39.1 million for the prior year period primarily due to increases in professional fees related to business development and fund-raising activities.92 Financial Advisory Ibid. Ibid. 91 Ibid. 92 Ibid.
89 90

Revenues Revenues were $389.9 million for the year ended December 31, 2011, decreasing $42.0 million, or 10%, from $431.9 million for the year ended December 31, 2010, driven by decreases in Blackstones restructuring and reorganization business and in Blackstone Advisory Partners business, partially offset by an increase in Blackstones fund placement business.93 Cyclical declines across the industry, from a peak in 2009 as the global economy continued to stabilize during 2011, caused decreases in Blackstones restructuring and reorganization business.94 The decrease in Blackstone Advisory Partners business was due reduced transaction activity compared to the prior year period. The increase in fees earned by Blackstones fund placement business was driven by improvements in the fund-raising of capital from institutional investors for alternative investment products compared to the prior year period.95 Expenses Expenses were $330.2 million for the year ended December 31, 2011, decreasing $18.0 million, or 5%, from $348.2 million for the year ended December 31, 2010. Compensation and Benefits decreased $29.3 million compared to the year ended December 31, 2010, due to decreased compensation expenses in Blackstones restructuring and reorganization business and Blackstone Advisory Partners business.96 Compensation expense for these businesses is related to their financial performance. Other Operating Expenses increased $11.3 million over the year ended December 31,

Ibid. Ibid. 95 Ibid. 96 Ibid.

93 94

2010, principally due to increases in all other expenses, partially offset by a decrease in bad debt expenses.97 Sources of Cash and Liquidity Needs Blackstone expects their primary liquidity needs will be cash to (a) provide capital to facilitate the growth of existing businesses, principally funding general partner and coinvestment commitments to funds, (b) provide capital to facilitate expansion into new businesses that are complementary, (c) pay operating expenses, including cash compensation to employees and other obligations as they arise, (d) fund modest capital expenditures, (e) repay borrowings and related interest costs, (f) pay income taxes and (g) make distributions to shareholders.98 Taking into account prevailing market conditions and both liquidity and cash balances, Blackstone believes that the following sources of liquidity will be more than sufficient to fund their working capital requirements: On March 23, 2010, indirect subsidiaries of Blackstone entered into an unsecured revolving credit facility (the Credit Facility) with Citibank, N.A., as Administrative Agent. On November 23, 2010, the Credit Facility was amended to set the facility aggregate borrowing limit at $1.02 billion. On April 8, 2011, the Credit Facility was further amended to extend the maturity date from March 23, 2013 to April 8, 2016. Borrowings may also be made in U.K. Sterling or Euros, in each case subject to certain sub-limits.99 In August 2009, Blackstone Holdings Finance Co. L.L.C. issued $600 million in aggregate principal amount of 6.625% Senior Notes which will mature on

Ibid. Ibid. 99 Ibid.

97 98

August 15, 2019, unless earlier redeemed or repurchased. In September 2010, Blackstone Holdings Finance Co. L.L.C. issued $400 million in aggregate principal amount of 5.875% Senior Notes which will mature on March 15, 2021, unless earlier redeemed or repurchased.100 In addition to the cash we received in connection with our IPO, debt offering and our borrowing facilities, we expect to receive (a) cash generated from operating activities, (b) Carried Interest and incentive income realizations, and (c) realizations on the carry and hedge fund investments that we make.101 With respect to fiscal year 2011, Blackstone paid distributions of $0.30 per common share and has declared an additional distribution of $0.22 per common share in the fourth quarter of 2011 payable on March 30, 2012.102

Ibid. Ibid. 102 Ibid.

100 101

Balanced Score Card Perspective

Financial

Goals
Continuously improve financial performance Continue to add value to portfolio firms Continue to improve operational efficiency Continue to develop and refine due diligence processes

Objectives
Decrease costs, maintain adequate liquidity Find creative opportunities to generate value Increase quality, Increase productivity Increase accuracy on forecasted returns

Measurements
EVA, Debt-toequity, Quick ratio ROI, ROCE, ROA

Customer

Internal Business

Learning and Growth

Employee retention, performance based compensation Estimated-to-actual return spreads