Blackstone IPO Signals Private Equity Market is “As Good as it Gets”

Throughout history, what has been one of the worst types of investments to buy? If you answered IPOs, you’re correct. Before commenting on the $4 billion IPO of private equity behemoth Blackstone Group, let’s review why exactly IPOs are such bad investments.

Companies sell stock when demand for shares is high, and they buy stock when interest is lacking. If things are going great, demand will be high and an IPO is the preferred way to cash in. The “smart money” as it’s called, sells to the dumb money.

Well, guess what? Steve Schwarzman and the rest of the Blackstone Group gang is very “smart” money. If they want to sell a piece of their management company to you, it’s probably for a good reason. If they thought the bull market in private equity had a few more years left in the tank, they certainly wouldn’t choose to sell now.

This event, unlike the Fortress Investment Group (FIG) IPO (which I don’t think marks a top in hedge funds), signals that the bull market in private equity, and perhaps in the stock market in general, is running thin. Think back to the Goldman Sachs (GS) IPO. Like Blackstone, Goldman refused to go public for years, but when things got so good, they couldn’t resist anymore. In case you don’t remember, Goldman’s IPO was in 1999 and the market peaked less than a year later.

Much like the bull still ran a bit after GS went public, I don’t think the market will necessarily peak coincidentally with the Blackstone IPO. However, it’s important to understand that IPOs are traditionally bad investments for a reason, and it’s that reason and that reason alone that explains why Blackstone has chosen to go public. Also, be aware that Blackstone is selling a piece of its management company, so investors in the IPO are buying ownership of their 2-and-20 fee income. The IPO proceeds is not going to be used to fund more private equity deals.

Of course, the irony is that private equity’s whole game is convincing companies that the public market isn’t worth the trouble and they would be better suited going private. You know if Blackstone wants to go public there is a pretty good reason why. In this case, that reason is dollar bills. Four billion of them, in fact.

Full Disclosure: No positions in the companies mentioned at time of writing

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One Thought on “Blackstone IPO Signals Private Equity Market is “As Good as it Gets”

  1. CrossProfit on March 24, 2007 at 6:35 AM said:

    Actually it is a bit more complicated than that. Private equity at first was a way for the wealthy to invest differently than the common man. The ideas was to find undervalued companies and by taking them private, either split them up or fix them; either way a quick buck was to be made. At a later stage when the companies taken private were doing well, they would be sold. As market conditions improved in 2005, some of the companies taken private only years ago we offered back to the public.

    Blackstone is no different. As a private company it could sell 10% to another private company or hedge fund (which for all practical purposes is one and the same today). Buy choosing to go down the public road, what Blackstone is saying is that equities are fully valued today, perhaps even slightly overvalued. If the market wouldn’t assign a high enough premium, Blackstone would not be thinking less doing an IPO.

    What strikes as a paradox today is the apparent ease with which private equity is raised! Surely investors must know that the market is fully valued. Oddly enough, investors are willing to give their money to private equity firms that in turn feed the M&A mania. The reasoning is actually simple and overlooks a major flaw in the logic.

    Investors fear that a market correction which will suppress stock prices will occur again. No one knows when this will happen. Having just gone through a similar period where it took over 3 years to recoup, investors are tentative to the advice of their previous advisors (brokers and investment bankers). The new boys on the block, private equity, have a clean track record – at least this is the perception. The callings and promises of private equity are simplistic and readily accepted. Why hold paper (stock) when you can have the underlying asset? Simply put, the hedge funds are resonating; “buy the company not the stock”. Upon a market crash, investors are left with a company that continues to do business as before. Profits are the same, dividends the same, no paper losses to look at and all is fine and dandy.

    This is the major thrust behind the majority of non corporate M&A activity. M&A activity associated with the likes of IBM and GE is completely different in nature, style, cost and outlook.

    Blackstone Says It All

    The flaw in the logic is just as simple. Just like no one can really promise an investor that a stock market crash will or will not happen, no one can guarantee that the underlying asset, the purchased company, will continue to perform as expected. In other words, if the market crashes, chances are it is due to a worsening economy. If the economy goes bad, then the privatized companies will not be generating the same profits as before. What Blackstone is pointing out to us all is that it makes no difference whether you are public or private. Upon a downturn all are effected.

    Disclosure: This is the opinion of Saul Sterman, CEO CrossProfit and may not be the opinion of CrossProfit.com.

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