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  Private equity going public?

BENJ GALLANDER and BEN STADELMANN

Thursday, April 12, 2007

What is the purpose of a corporation? In most cases, the bottom line is to make money, a goal that can be achieved in many ways. McDonald's makes hamburgers that people are willing to eat; Goodyear manufactures decent tires; DaimlerChrysler has to deliver quality cars.

But what about a private equity fund? Its mandate is not to produce goods or services in order to make profits; rather, it must produce money to make profits.

Blackstone Group, a highly successful private equity firm, has decided to cash in some chips by selling 10 percent of itself through an initial public offering worth $4 billion (U.S.) and then listing on the NYSE.

This outfit specializes in managing money, including equity, real estate and hedge funds, and its documentation boasts returns of better than 30 percent per year over the long term. But will this same bottom line, or even a somewhat similar one, flatter that of investors who pony up for this IPO?

In our estimation: highly doubtful. Blackstone's goal, it seems, is to raise money at the maximum price, primarily for its own benefit. It is looking to proffer its wares in a hot market, perhaps one that might be topping out. It becomes a stretch to think that the key players would do an offering where the goal is to benefit those who are doing the buying.

How rich is this arrangement? It values the business at more than General Electric, and about twice the worth of a struggling General Motors, almost seven times the capitalization of Dollar General and 20 times that of Cathay General Bancorp, which is growing like an adolescent on steroids and has way more potential than Blackstone.

There is an irony in this deal: Blackstone is an enterprise that specializes in taking corporations private, yet now it is going public. It seems as if there is too much yin and yang to make this believable, yet odds are the markets will suck up this deal. Given that the offer is being underwritten by bigwigs Citigroup and Morgan Stanley, with supporting roles to Credit Suisse, Deutsche Bank, Lehman Brothers and Merrill Lynch, Blackstone has a Who's Who of motivated salespeople on their side.

This team can be heartened in some ways by what they have to pitch. Without question, management is extremely intelligent. Last year, net income was a whopping $2.27 billion, a bottom line that will shine a dazzling light for many potential investors.

However, looking a tad deeper, investors should note that the profit was better than double that of a year previous, so definitely not the norm. Even if profits stay at the current level, 10 percent would be $227 million, not much of a return on a $4 billion investment. And these results are being achieved when times are positively scorching, and without all of the costs associated with being a public entity.

Blackstone writes: "We have built a leading global alternative asset management and financial advisory firm that has achieved success and substantial growth. While we believe that becoming a publicly traded company will provide us with many benefits, it is our intention to preserve the elements of our culture that have contributed to our success as a privately-owned firm."

That sounds lovely. However, it seems somewhat contradictory to what head honcho Steven Schwarzman has said over the years. He stated, "Being public sucks because of costs, complexity, scrutiny, etc." Well maybe it doesn't always suck, Steve.

We'll assume, because of our kindly nature, that the vendors truly believe that this is a fair transaction for investors. However, even with the best of intentions, the fact is that the vast majority of IPOs are down in value one year later. So, simply given the odds, it is unlikely that Blackstone's IPO will prove worthwhile unless one is a short-term investor who is fortunate to achieve a fast pop and exit. The prudent investment decision would be to wait at least a year before revisiting what will likely be a master limited partnership.

This structure also warrants a further look before dollars are thrown, as this arrangement limits some partners' control. No, we're not talking the current principals here. With a master limited partnership, an annual meeting is not even necessary. And compensation is not determined by a committee but by the top brass themselves. How convenient!

Evidently, it is possible to have your cake and eat it, too! However, given the sickly sweet icing, we'll stay as far away from this one as possible.


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