Blackstone Group COO Tony James and CEO Steven Schwarzman delivered the buyout behemoth’s results. Below, a summary of comments from the media call and official analyst call. Below that, a transcript of Steven Schwarzman’s comments.
Despite a massive loss, James and crew displayed unflappable positivity on Blackstone’s position while dropping bombs of bearishness on the economy. The loss “reflects declines in values across almost all asset classes,” James said. However, he insisted, “despite a pretty awful market environment, we are still in a strong position.”
On Buyout Funds: Returns and Deployment
One third of portfolio companies took write-downs this quarter, while two thirds had write-ups or remained flat. There are 40 companies in Blackstone’s current portfolio.
“The high levels of leverage prevailing in ’06 and ’07 were not healthy and not necessary,” James said. Lower deal values will generate returns this time around, not leverage.
Of the firm’s portfolio companies, 68% are at or above projections Blackstone made at the time of investment. The average debt maturity on portfolio companies is 2013.
On the Advisory Business
It “continues to fly.” The group is hiring in Europe and Asia. M&A is down, but the group has mandates in the pipeline, especially on the restructuring side.
On Buyout Funds: Fundraising and LPs
Blackstone is not worried about LPs missing capital calls: “They’re legally required to fund them,” James said.
The firm has nine different funds in the market right now and is “making progress on almost all of them.” The environment has clearly changed, James admitted. “There used to be a time when we took orders and sat back and now we have to pound the pavement,” he said.
Leveraged Loan Buying
The firm still feels good about debt investments made at the beginning of the year, even though leveraged loans are trading much lower than they were three or six months ago. The firm plans to continue to invest in this area. “The loans we bought were on very strong credits, all the underlying companies are performing in line with our underwriting We’re very pleased with the borrowers,” he said.
On the Leveraged Loan Market
“The credit market hit a nadir on October 10, if I had to pick a day,” James said. I think he was mildly amused with that answer. He continued, “The risk of systemic meltdown is behind us. We’re seeing LIBOR coming down and more cash flow going into leverage loans. Leveraged loan pricing is coming up.” However, the economy is a different story. With the economic downturn in its earlier stages, James said “Companies will keep a lid on where credit markets will go.”
Good morning and welcome to our third quarter call.
What the world capital markets experienced in the third quarter and in the month since the third quarter ended, is remarkable in both scope and depth. The face of financial services has changed, with many storied financial institutions either gone, under new ownership, or re-chartered as commercial banks. Like all of you, we are living in this unsettled environment and the questions we ask are: How and when is this going to settle out, how does it affect the industries we operate in and how is that going to affect us at Blackstone.
What has taken place to date, as you know, is a whole series of rolling credit crises, starting with the sub-prime crisis which then, because the mono-line guarantors had problems, moved into the municipal area and through the banking system, causing a whole variety of problems regarding extension of credit. And as this rolling credit crunch hit each of the areas, it locked it up to the point where we ended up with a system that was more or less frozen in terms of extension of credit in almost every asset class regardless of the health of the borrower. Unfortunately, Lehman was a casualty, that then materially worsened the situation.
As bleak as the reality was, I believe that the actions taken to date, by the U.S. Treasury, the Fed and governments around the world, will define the bottom of the credit crisis. World governments have deployed their financial weapons so that the global financial system now is secure, with liquidity slowly returning as borrowing spreads have narrowed materially. And all of these financial institutions are getting enormous pressure from the government to lend the money that the governments are putting into these institutions, which ultimately will stop the contraction of credit. These efforts will take time but governments working together to bring back stability and confidence, I believe, will be effective. Libor has declined from 5.1% to 2.5% over the past few months. While its spread to the Fed Funds rate remains wider than is typical, it has been trending lower from mid-October highs when the inter-bank lending model virtually shut down. The same can be said of credit spreads for many large financial services corporations.
I think it is relatively clear at this point that we are headed towards a good-sized recession. Nobody can accurately predict how deep or how long the recession will be, but we can see indicators from our portfolio companies that this is happening, particularly in the U.S. and Europe. In Asia, on the other hand, economic conditions are not nearly as bad and should remain in a growth position, with China for example, at 6-7% in 2009 and India at 4-6% in 2009.
In many ways the capital markets crisis accelerated and deepened the global economic slowdown by leading to a shut-down of lending, even to healthy companies. A few weeks ago we met with all of our portfolio company CEOs from around the world. Our CEOs have been implementing plans for recession typically for greater than a year. We have now determined that it is imperative for them to plan for a recession that will be deeper than originally contemplated. Consumers have capitulated on spending, resulting in revenue decreases materializing in September and October from July and August. Our portfolio management team, which works with the portfolio company CEOs, is extremely busy.
With global equity markets down sharply this year, you should expect that some of our assets will temporarily decline in value on a mark basis. We have made good investments and created strong financial structures. This last point on financial structures is key. In real estate, for example, it can be everything. We have only 4% of our real estate debt, for example, due prior to 2011. In the meantime we are still generating excess cash flow on those assets and not being forced to sell into a down market. In private equity, we have taken a similar approach to building solid capital structures.
And we have taken the same approach to our own financial structure. Laurence Tosi will take you through our liquidity position in a moment.
Fundamentally we feel good and you should feel assured about the state of our portfolios in both private equity and real estate. Our capital structures are strong; our portfolio fundamentals are favorable overall. And we will not be forced to sell at inopportune times because the capital in the funds is locked up for the life of the funds. Given depressed values in equity markets, you should not expect much in the way of realizations. While these conditions could change, one should not plan on large realizations occurring.
There is also a positive side of asset pricing declines when you have capital to invest. We are convinced that we are going into a really remarkable period to buy assets at low prices. I believe that Blackstone itself will make some of its best investments these next few years.
In the hedge fund business, industry-wide redemptions are reaching record levels, and those funds’ need to raise cash to meet redemptions has further exacerbated the pressure on stocks. Most of our hedge funds are experiencing redemptions well below the industry averages and both GSO and BAAM, our largest pockets of hedge fund assets, will have net inflows for the year.
Institutional investors generally have seen their assets under management decline and in the near term, this may limit positive asset flows overall in the investment industry. However in each of our major investment businesses, we continue to outperform most peers and we believe that track record will preserve our favorable competitive standing.
Outside of the investment business, in our advisory businesses, our expertise is also being leveraged. Companies are increasingly seeking our advice in the midst of distress. Our Restructuring and reorganization as well as our corporate advisory and M&A businesses are extraordinarily busy and are likely to have a record year this year.