Why Equity Partnerships Need Consider Changing its Structure to C Corps
Why Equity Partnerships Need Consider Changing its Structure to C Corps
Today, Blackstone is the world’s largest private equity company, or, as they describe themselves, “alternative asset managers.” And it’s big. It manages $512 billion in assets. It is way ahead. There two closest rivals, Apollo and Carlyle, together are almost as big.
The recipe used to be simple: take a company over, load it with debts, strip away the assets, fire the labor force, and make billions for your investors.
As the markets matured Blackstone diversified. They now take on commercial property and corporate assets – anything that is not traded on public exchanges. Moreover, they toned the aggression down a bit. Rather than destroy companies in their capitalist fury, they now come on to their targets with a softer approach. Collaboration, rather than destruction is currently the only viable approach.
Over the past 30 years, Blackstone’s internal rates of returns average out at 15%, and after listing, the company created shareholder’s value of more than $41 billion. Moreover, in the age of collaboration, Blackstone companies now employ 400,000 workers.
Despite the success, Blackstone is not done. Just like in the movie Wall Street, Money Never Sleeps, when Jacob asked Bretton Woods what his number is, Blackstone answers: “More.”
“The old model is dead,” says Stephen Schwarzman. Buying low, adding leverage and selling off the assets, is over. What Blackstone wants now, is to dominate alternative investments much like BlackRock with their $6 trillion in assets under management is doing with publically traded investments.
One question though, is whether Blackstone can continue making these abnormal profits if they are morphing into a regular company?
We will only know the answer after July 1st, 2019, when one of the founders, Schwarzman, will oversee the massive changes in the structure of the company.
Up to this point, like most buy-out groups, Blackstone has had a complex partnership structure, which allows the firm to pay almost no tax at all. Tax payments are left to the shareholders who end up paying as much as 23.8% to the IRS.
Now things have changed. Corporations no longer pay 35% tax. After the Trump tax reform, the corporate rate is now down to 21%. Moreover, it is not only the benefits derived from partnerships that have declined for Blackstone; the costs continue to grow.
One of the highest costs inherent to the partnership structure is its exclusion from equity indices. Equity indices are confined to funds invested into corporations alone; no partnerships.
The consequence of this exclusion is that firms like Blackstone (PE companies) are out of bounds as an investment target for most of the significant mutual funds.
Put differently: American mutual funds control $12 trillion in investments, and of this, only $4.5 trillion can be invested with partnership structured firms. Many mutual funds would like nothing better than to invest a lot more into partnerships.
This becomes obvious if you look at Blackstone’ share price. Since its announcement that it is changing its structure and becoming a corporation, in the background of a market like the S&P 500 which grew with 0.5% in the period, Blackstone’s share price increased with a heart-stopping 24%, adding $11 billion to its market cap.
Since the advent of Blackstone’s involvement in property in the 1990s, almost a third of their assets today are property. Notable new investments include GSO, the private-credit business, a fund-of-funds operation that selects hedge funds to invest and funds that invest in biotechnology firms and funds for insurers that are explicitly tailored to their required return profile.
Of course, the bigger Blackstone becomes, the bigger the projects they can finance. Two Blackstone funds combined recently to buy 179 million square feet of warehouse space for e-commerce. More means more variety, which means Blackstone can now offer investors a more extensive choice of time horizons.
Blackstone already offers property investment funds that invest over 20 or 30 years, highlighted by its purchase of a $5.3 billion apartment complex in New York on the condition that it does not resell it for several decades. There are even Blackstone funds that hold on to capital in perpetuity; put differently, Blackstone will never have to return the initial money invested – only the annual returns.
As a market leader (early mover) Blackstone is poised to reap the benefits of the upcoming growth period the industry faces. Oliver Wyman Consultancy believes that alternative investments will grow from 7% of all assets to 9% by 2023. If the overall stock of assets continues to grow by 5% per annum, the total in investments in private markets will grow with almost $3.9 trillion!
According to Schwarzman, Blackstone funds historically double the return of a typical index fund, which is excellent news for the world of low yields where both passive funds and actively managed funds often do not do very well.
According to Morgan Stanley and Oliver Wyman Consultancy, PE returned 6.2% more per annum than global public-equity indices from 1997 to 2016. Just so, private credit outperformed high yield credit indices by the same margin.
It is unlikely that this can go on forever. Academic studies find smaller differences recently. However, one thing is clear. The super-rich who now holds between 1-5% of their assets in non-traditional assets, could very well be persuaded to funnel in more. Moreover, the same goes for pension funds which, under pressure to make returns of 8% to keep their promises to future pensioners, hold up to 10% of their assets in non-traditional assets.
For sovereign-wealth funds, the figure goes up to 15%, and for endowments, it goes up to 25%. However, the competition for this money is becoming more intense. New rivals are coming to the fore in Blackstone’s world. In April BlackRock entered the market with a raise of more than $2.8 billion and a view to up this to $12 billion. Reports say that Vanguard (2nd biggest asset manager in the world) and Goldman Sachs are considering to enter the market too.
Schwarzman says he welcome competition since capital will be drawn to the sources of the highest performance. Traditional asset managers struggle in the PE realm. It takes time to build up this type of expertise. Moreover, the same goes for capital. In contrast with BlackRock’s $12 billion, Blackstone raised $238 billion over the last two years, and it has $133 billion to spend. When markets tumble, as they always do, this kind of spending power can acquire a lot of cheap assets.
Schwarzman has a date with history. If the transition into a corporation succeeds with Schwarzman relaxing his hold on the controls and maintaining the discipline not to spend all its money at the top end of the cycle goes well, half is won. If Schwarzman also succeeds in transitioning power to his successor, Mr. Gray, sooner rather than later, it will be proven that his firm’s success can outlive him. If these two transitions work well, the likes of Pierpoint Morgan and Marcus Goldman will be joined by one Schwarzman from Blackstone.
Readers should note that this article is only intended to convey general information on these issues and that FAS CPA & Consultants (FAS) in no way intends for the contents of this article to be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services. This article cannot serve as a substitute for such professional services or advice. Any decision or action that may affect the reader’s business should not rely solely on the contents of this article, but should rather be consulted on with a qualified professional adviser. FAS shall not be responsible for any loss sustained by any person who relies on this presentation. This article is subject to change at any time and for any reason.
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