Blackstone blames Deutsche Telekom, FAS 157 for first quarter loss

On a conference call, president Tony James touted his firm’s deal flexibility but said prices are ‘still way too high’ in the middle market.

The Blackstone Group has reported a loss of $58 million (€37 million) for its private equity division, citing the tumbling stock of German telecom company Deutsche Telekom and fair-value accounting regulations as the primary reasons behind its poor first quarter performance.

The Stephen Schwarzman-led buyout group posted an overall loss of $93.6 million. The firm’s leaders acknowledged in a shareholder conference call earlier today that the lingering effects of credit market turbulence have slowed the firm’s deal activity considerably.

The $93.6 million figure does not include compensation costs associated with Blackstone’s initial public offering.

“All of us are living through one of the worst financial crises since the Great Depression,” Schwarzman told shareholders during the call. “Blackstone has navigated through several cycles before. . . and in the periods after our down cycles, we made our very best investments. This cycle, we anticipate, will be no different.”

This is the second consecutive quarter in which Blackstone has reported negative results from its private equity division, as last year the firm recorded a $37 million loss. In the first quarter of 2008, Blackstone gained more than $166 million from its buyout group, still considered the core franchise of the increasingly diversified alternatives giant.

Blackstone’s executive staff, which has watched the company’s stock tumble 46 percent since its public float last June, attributed much of the private equity losses to the declining stock price of portfolio company Deutsche Telekom.

Blackstone acquired a minority stake in the German mobile phone and internet giant for €2.68 billion two years ago. Over the past year, the Deutsche Telekom’s stock has dropped as much as 30 percent over the last year.

“We are pleased with the management team the new leadership at the supervisory board level and continue to believe this investment will deliver attractive returns to our LPs,” Blackstone president Hamilton “Tony” James told investors.
James and Schwarzman also echoed the sentiments voiced by many private equity leaders that recently imposed fair value accounting procedures, specifically federal accounting standard FAS 157, have made its balance sheets misleadingly volatile and unfairly prices portfolio companies according to current market conditions when firms have no intention of selling them in the near future.

“While we hold our investments long term, we’re required by accounting rule FAS 157 to carry them at fair value, and report the impact of the change in value on our carried interest and performance fees and investment income, this is what you see this quarter,” said Schwarzman.

Discussing tightness in the leveraged loan markets, James said that “less than a third” of Blackstone’s private equity deals over the years have been megadeals. However, he added, he is not enthusiastic about current conditions in the middle market.

 “Generally speaking I think the prices are still way too high there,” James said. “There’s too much capital chasing relatively few opportunities  there. You’re also buying companies that are inherently smaller and therefore are going to be more vulnerable when economic conditions get choppy. It’s like a battleship in a storm, you want to be on a big boat.”

Although revenue from Blackstone's management and transaction fees increased modestly from a year before, its performance fee related revenue declined markedly, from a gain of $123 million the first quarter of 2007 to a loss of $163 million this year.

Despite the firm’s recent struggles, Blackstone continues to rack up huge amounts of capital from investors. Its assets under management increased 37 percent from $83.14 billion a year ago to $113.53 billion.

Blackstone’s real estate revenues declined 94 percent from the same time last year, from $766.8 million to $47.9 million. Blackstone cited the sale of Equity Office Properties office portfolio last year for distorting the severity of the drop-off.