Blackstone: LPs flock to alternatives in down cycle

The M&A environment is shaky, growth in the emerging markets has slowed and LPs are putting more money into alternatives, according to the firm’s president, Tony James.

The lending environment for deals is “robust” in the US, which is causing private equity buyers to pay more for investments, according to Tony James, president of The Blackstone Group, during the firm’s first quarter earnings call Thursday.

“In the US, it’s robust, there a lot of credit available. It’s pretty good, it ebbs and flows a bit week to week, but it’s pretty good,” James said.

Europe is a different story, however, where the bond market and banks are both impaired and “it’s hard to get loans there”, he said. “The fundamental problems of Europe have not improved.”

Even worse news for private equity, growth in the emerging markets is slowing, James said, as rising commodity prices are “squeezing profit margins”.

Overlaying the market dynamics are geo-political risks of governments not addressing fundamental economic problems head on, or what James termed “policy mistake risk”, as well as lurking inflation.

The fundamental problems of Europe have not improved.

Tony James

In this environment, institutional investors will not be able to hit their return targets to meet their obligations without the presence of alternative investments in their portfolios, James said.

“Only top alternative asset managers have the ability to consistently outperform the public markets, provide uncorrelated returns and do so in large enough scale to make a difference” to the world’s largest pools of capital, James said.

Limited partners have great appetite for alternatives, James said, though “the strength of fundraising varies by asset class; it’s pretty tough in private equity in general today, most of the big funds coming back to market will be much smaller than they were before. In real estate, we’re finding very good success – there’s a lot of appetite [among] investors for hard assets and [inflation hedges]”. The firm has raised about $10 billion so far for its next flagship real estate vehicle.

Blackstone invested $643.4 million in the first quarter, compared to $652.9 million during the first quarter of 2011. The firm invested primarily in energy investments during the quarter, James said, including its announced $2 billion investment in Cheniere Energy Partners, which will help the Houston-based developer finance construction of a gas-liquefaction plant for export markets.

The firm’s debut energy fund, Blackstone Energy Partners, held an interim close during the quarter on $1.5 billion, James said. The firm had $16.9 billion of dry powder as of 31 March.

Blackstone reported economic net income – a way that private equity firms show earnings that includes unrealised gains and losses – of $432.3 million in the first quarter of 2012, a decrease of $138.7 million

Tony James

from the $571 million in the same time period a year ago.

The firm’s private equity business revenues slipped in the quarter to $170 million from $273.7 million in the first quarter of 2011. The decrease in private equity revenues was driven by a $76.9 million drop in performance fees, a $17.2 million decrease in transaction and other fees and a $16.7 million drop in investment income, according to the earnings statement.

However, the carrying value of the firm’s private equity holdings increased 4 percent in the quarter, driving by investments in the retail/consumer and industrial sectors, the statement said.

“The private equity portfolio continued to perform well with a majority of the portfolio companies exhibiting year over year revenue and earnings before interest, taxation, depreciation and amortisation growth in 2011 and for the first quarter of 2012,” the firms said in the statement.