Over the past decade, alternative assets (private equity, real estate, hedge funds, and complex debt instruments) have become increasingly popular, with assets under management nearly quadrupling.
The future is bright as well. PricewaterhouseCoopers expects total alternative assets to reach close to $14 trillion by 2020, growing by about 9% annually.
Given the complex nature of these investments, and the fact that most are only accessible to high income and high net worth individuals, many dividend investors might be drawn to publicly-traded alternative asset managers such as The Blackstone Group (BX), The Carlyle Group (CG), and Icahn Enterprises (IEP).
However, while the financial media may make these legendary asset managers seem like masters of the universe, that doesn’t necessarily mean that income investors can do well owning these complex financial stocks. In fact, many of these complicated businesses violate Warren Buffett’s top piece of investment advice to remain within one’s circle of competence.
Let’s take a look at The Blackstone Group, the largest of the private equity/alternative asset managers, to see if most dividend investors are better off staying away from this industry or if Blackstone Group’s 5.7% dividend yield could be worth pursuing for our Conservative Retirees dividend portfolio.
The Blackstone Group is the world’s largest alternative asset manager with over 2,200 employees in over 20 countries, managing $361 billion of investor capital.
The firm specializes in private equity (owning private companies), real estate, hedge funds, and investing in private debt. Blackstone earns its money by charging investors a base management fee (about 0.8%) plus performance fees (% of profits above a certain hurdle rate), which in this industry can be extremely lucrative.
In 2015, the vast majority of the firm’s revenue and operating profits came from its real estate and private equity divisions, which has historically been where Blackstone’s expertise lies.
|Business Segment||2015 Revenue||2015 Operating Income||% Of Revenue||% Of Operating Income|
|Real Estate||$1.791 billion||$948 million||42.2%||44.9%|
|Private Equity||$1.382 billion||$656 million||32.5%||31.0%|
|Hedge Funds||$590 million||$296 million||13.9%||14.0%|
|Credit||$485 million||$213 million||11.4%||10.1%|
|Total||$4.248 billion||$2.113 billion||100%||100%|
Source: Blackstone Group Supplemental Presentation
Blackstone is the biggest, most diversified name in alternative asset management, having been founded in 1985 by Stephen Schwarzman, who continues to serve as Chairman and CEO.
The company prides itself on taking a long-term approach to investing partner capital, including long lock-up periods on its funds that prevent Blackstone from having to sell at the bottom of market panics.
This has allowed the company’s funds over a five, 10, and 15 year period to generate returns of about 15% net of fees, which is among the best of any asset manager.
The long-term success of Blackstone has resulted in truly astounding growth, with over $200 billion in new capital being raised in just the last five years alone. To put that in context, this amount of new capital inflow is more than its next four largest rivals combined.
The massive size of Blackstone not just means a lot of fee income, but also serves as a major competitive advantage. Specifically, the company is a wide moat business thanks to its excellent reputation and access to some of the world’s best fund managers.
In addition, its vast capital resources mean that Blackstone can put together private equity deals of mammoth size that few if any rivals could even attempt, reducing the amount of competition it faces and improving the rate of return available.
Some examples include the 2007 acquisitions of Hilton and Equity Office Properties, which at $27 billion and $39 billion, respectively, were two of the largest private equity buyouts in history.
Better yet, Blackstone never just does deals to make headlines. For example, the Hilton acquisition was a leveraged buyout that Blackstone poured $5.6 billion of equity into.
After a seven-year period in which Blackstone turned the troubled hotel chain around, it IPO’d Hilton in 2013, netting Blackstone a $12 billion profit.
Meanwhile, it continues to sell off Equity Properties Assets and eventually expects to triple its money on that deal.
Beyond its unique ability to make massive deals, the company also gains competitive advantages from its strong brand and innovation. Roughly half of Blackstone’s total assets under management come from products and business that were not part of its mix just a few years ago.
Launching new offerings is easier for Blackstone because of its established reputation, distribution relationships with major investors, and economies of scale.
While Blackstone truly is one of the best long-term capital allocators in this fast-growing industry, there are several reasons why dividend investors should consider avoiding the stock.
The reasons are because of several important facts regarding both the industry in general and Blackstone Group in particular.
First, understand that alternative asset management is a highly cyclical and volatile industry, with fee revenues and profits rising and falling by staggering amounts based on fast-changing, unpredictable market conditions.
The same is true for the company’s margins, free cash flow, and return on capital, which are very important objective measures of whether or not management is being a good steward of investor capital.
In other words, because of the highly complex nature of its business, Blackstone investors have few ways to know whether or not the investment thesis remains intact.
They must simply take it on faith that management continues to execute well and that, over time, the growth in assets under management and fee revenues that go with it will result in higher distributions (more on this in a moment) and a greater share price.
With Blackstone Group, there are two categories of risks to consider: risks to the company and risks to investors.
In terms of risks to the partnership itself (Blackstone is structured as a limited partnership, similar to an MLP and comes with the same tax complexities, including a K-1 tax form), the world of alternate asset management is becoming increasingly competitive.
Record low interest rates and easy credit conditions mean more and more capital chasing the same number of potentially good deals, which can cause long-term returns to underperform.
This is especially true as there is a growing trend around the world to increase financial regulations on private equity and hedge funds, especially in Europe and Asia. This could lead to lower returns on Blackstone’s funds, making attracting new capital (and thus growing the asset base on which the fees are based on) more difficult.
And then there is the risk to actual Blackstone Group limited partners (i.e. regular investors). The biggest of these is that massive unit holder dilution, courtesy of the fact that Blackstone sells new units to raise investment capital (as well as raising capital from other sources).
In particular, since 1996 the unit count has grown over 24% annually, which explains why investors in Blackstone Group have badly underperformed the market despite its impressive fund performance.
And lest you think that this kind of investor dilution has slowed, be aware that in the last year alone the unit count has increased another 35%. That means that fee income and distributable earnings per share (which pays the dividend) need to grow that much just to offset dilution.
Or to put it another way, heavy investor dilution makes long-term distribution growth very difficult for Blackstone, even if the company is growing well over time.
Dividend Safety Analysis: The Blackstone Group
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend.
Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.
Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.
We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their real-time track record has been, and how to use them for your portfolio here.
The Blackstone Group has a Dividend Safety Score of 22, meaning that investors seeking a secure, stable, and consistently growing payout should look elsewhere.
This is because the partnership’s results are so volatile, resulting in payout ratios that swing wildly and requiring management to pay a variable distribution each quarter.
In addition, be aware that EPS and free cash flow don’t necessarily give a good impression of the safety of the payout. That’s because what pays the distribution for Blackstone Group investors is the distributable earnings per share, which can be very different than regular EPS.
Distributable EPS is what’s generated when Blackstone actually sells an asset and locks in the gains. Since management is focused on maximizing long-term returns, the timing of such sales is highly unpredictable, resulting in highly irregular distributions.
Of course there’s also that nasty investor dilution. Each new share of Blackstone Group sold to raise capital for management to invest means that future distributable EPS will be divided up among a larger number of units, which will make future payout growth (and market-beating total returns) that much harder to come by.
The company’s dividend also scores low for safety because of Blackstone Group’s poor performance during the last recession.
Blackstone Group’s net income swung from a profit of $1.6 billion in 2007 to a loss of $1.2 billion in 2008, and dividend payments fell from a high of $1.20 per share in 2008 to a low of 52 cents in 2012. BX’s stock also plunged nearly 70% in 2008, significantly underperforming the S&P 500.
While no one knows when the current bull market will end, Blackstone Group’s investors (and the company’s dividend) will likely not fare well during the next inevitable recession.
Dividend Growth Analysis
Our Dividend Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
The Blackstone Group has a Dividend Growth Score of 53, meaning that the dividend, over the long-term, should in theory, be able to grow around 6%, the median dividend growth rate of S&P 500 companies.
Of course, that’s only over the long-term. As you can see below, Blackstone Group’s actual quarterly distribution is immensely volatile, which means that this is not a dividend stock that can be relied upon for safe, consistent, or predictable income.
For more predictability, you’d have to invest in a lower yielding, but less risky asset manager, such as T.Rowe Price Group (TROW), which has a much lower yield but a highly secure and fast-growing dividend.
Valuing a highly complex financial partnership with extremely volatile returns is not easy. However, two sensible methods include looking at the price/operating cash flow (P/CFO), as well as the yield, and comparing them to Blackstone Group’s historic norms.
From that perspective, we can see that Blackstone Group is trading at a relatively nice discount to its historical valuations.
|P / CFO||Historical P / CFO||Yield||Historical Median Yield|
Source: Gurufocus, Fastgraphs
Of course, that only makes the stock an interesting investment candidate if you are aware of the high risks involved with the industry and don’t mind large unit price volatility that comes with a completely unpredictable payout.
Or to put it another way, for most conservative dividend growth investors who look for consistency and a steady increase in the dividend, Blackstone, even at today’s seemingly attractive valuation, doesn’t represent a buy.
Closing Thoughts on The Blackstone Group
Don’t get me wrong, Blackstone is among the best in what they do. However, the alternative asset management industry is incredibly volatile and risky, and simply put, not something that most dividend investors should or even need to consider.
Given Blackstone’s highly erratic distributions, courtesy of its cyclical and volatile distributable EPS, I can’t get interested in Blackstone as a long-term dividend growth stock. Especially when far more stable and less risky alternatives such as T. Rowe Price Group and Franklin Resources (BEN) are available.
Not only are these two companies well respected and proven asset managers, but they are also both dividend aristocrats to boot, meaning they have proven themselves excellent long-term, core income growth holdings.