vaeenmaDear readers, Blackstone (NYSE:BX) is arguably the most well-known alternative asset manager and the first one to be included in the S&P 500 (SPX) index. The firm has over a trillion dollars in assets under management (“AUM”) and has delivered outstanding returns for investors over the past 20 years, matching the over 250% return of the S&P 500. Over a shorter period of time (e.g. 10 years), the stock has outperformed, mainly due to a massive 2021 rally, which has led to a lot of optimism among investors. I have, however, come to a conclusion that it is unlikely that such outperformance will repeat over the next 10 years. Today, I present the reasons why BX is unlikely to outperform the broader market. Data by YChartsI have covered Blackstone before, most recently in February, in an article called There Are Better Alternatives. In particular, I issued a SELL rating at $127 per share because the stock’s valuation had become stretched at nearly 35x fee-related earnings and 30x distributable earnings. And while there were arguments in favor of some valuation premium (strong balance sheet, great reputation, long track-record etc.), ultimately I saw the price tag as too high. Among the main reasons for my conclusion that the valuation premium is too high were the facts that (1) the company had just posted unexciting full year 2023 results which showed a meaningful slowdown in AUM growth (especially due to very poor performance of real estate), (2) Blackstone’s large size would make it very difficult for the company to grow its AUM by 15-20%+ which is required to justify the valuation multiple, and (3) the business model tied to performance fees makes a large part of earnings unpredictable and lumpy and these earnings in turn take to be valued at a lower multiple. David KsirDon’t get me wrong. I think that Blackstone is here to stay and I don’t expect any sort of a doomsday crash in the stock price. Quite the opposite, in stable market conditions, the stock could easily deliver a market level return of 8-10%. It’s just that I see other much better opportunities in the asset management space. In particular, two firms that focus much more on private credit and insurance, which are the two most promising segments (you will see below that Blackstone’s Q1 results confirm this), and which run more predictable business models with no performance fees. These two firms, which have been some of my best performing investments last year, are Blue Owl Capital (OWL) – latest thesis here – and Apollo Global Management (APO) – latest thesis here. Why Blackstone in unlikely to outperform Blackstone’s is invested in four segments – real estate (32%), private equity (29%), credit and insurance (31%), and multi-asset investing (8%). BX IRThe company makes money through fixed management fees of about 0.85% charged on all fee-earning AUM and performance fees tied (you guessed it) to the performance of the underlying funds. As a result, Blackstone’s bottom line is driven by its ability to grow AUM through net inflows and the performance of its individual funds. First, let’s consider AUM growth. Over the first quarter of 2024, inflows and outflows came in at $34 Billion and $11 Billion, respectively, for $23 Billion in net flows, representing a 2% quarter-over-quarter increase in total AUM. That is quite low, but importantly, net inflows were disproportionally weighted towards credit and insurance, which accounted for 56% of net flows, despite only accounting for 31% of total AUM. This confirms that private credit and insurance is the place to be. BX IRLooking at the recent performance of BX’s funds, it is evident that not all segments are performing well. In particular, real estate performance fees continue to cause a drag on earnings with a negative return over the past 12 months. The rest of the segments have performed well, but once again private credit is at the top. BX IRWe have seen this theme in BX’s past earnings reports as well. Credit and insurance, and to some extent also private equity, have been performing well, but real estate exposure has been hurting the core business. I do expect the real estate market to improve when interest rates decline, which continues to be my base case, summarized in my recent article on REITs (VNQ). But in the meantime, I expect both the AUM growth and performance fees to be negatively impacted by the firm’s large exposure to real estate and therefore result in lower than expected EPS growth. My view is that significant annual EPS growth of 15-20%, which the high multiple would imply, is unlikely for the simple fact that the company has become too big for its own good. Growing from a baseline of trillion dollars requires large acquisitions to move the needle. The company can no longer look for the best deal out there, instead it needs to look for a deal that is big enough. And those rarely come at the best price. A good example of this is the recent purchase of Apartment Income REIT (AIRC) which Blackstone acquired in an all-cash transaction for about $10 Billion at $39 per share. That represents a 25% premium to the stock price prior to announcement. Although I am not deeply familiar with AIRC, I doubt that the market got the price wrong by such a wide margin. Instead, I think that Blackstone was desperate to put some of the nearly $200 Billion of dry powder to work so that it would accruing management fees and did not mind overpaying. This will, of course, catch with the company in the future as performance fees from such expensive acquisition are unlikely to be high. Analysts are very optimistic in their forecast average 20% annual EPS growth for the next three years. But given what we have discussed, I am very cautious to use this forecast in my valuation. I think that private credit and insurance has the potential to deliver this sort of returns over the next few years, but do not expect BX’s whole business to deliver on the forecast. Rather, I expect 10-15% EPS growth, driven by a continually strong performance of the credit and insurance segment and a gradual recovery of the real estate segment driven by a decline in interest rates. SAAssuming 12.5% EPS growth, I forecast 2026e EPS of $5.70. Then using a 25x multiple which is at the top-end of the 20-25x fee-related earnings which I like to use for alternative asset managers, I get a price target of $145 per share, up 16% from today. 16% in price appreciation + 3% dividend yield for 3 years = 8.5% expected total return Bottom Line Blackstone is a quality company, and 10-15% EPS growth is nothing to laugh at. At 33x trailing EPS and 31x trailing distributable earnings, the valuation is not cheap to reasonably expect any sort of outperformance, but it is enough to deliver 8-10% market level returns. Therefore, I upgrade BX to a HOLD here at $122 per share.
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