NEW YORK, July 26 (Reuters) - Pity the poor analyst covering newly public hedge funds and private equity firms.
Blackstone Group (BX.N) and a gaggle of other “alternative investment” firms are descending on public markets with equity offerings, putting billions of dollars in the hands of retail and institutional investors.
That should make them good candidates to be followed by equity analysts advising investors on whether they are worth buying or not, based on earnings and other measures.
But more than most listed companies, these formerly private firms are keeping operations veiled — to the frustration of shareholders and analysts.
“To make private equity — and arguably hedge funds — work, you’ve got to keep it confidential,” said Sanford Bernstein analyst Brad Hintz. “And if you keep it confidential, the analyst has a very difficult time valuing it.”
Insight into Blackstone, which floated common units last month, is limited by a variety of factors. The company will not be required to hold annual meetings, according to filings, and does not plan to provide analysts with earnings forecasts.
Rival private equity firm Kohlberg Kravis Roberts & Co. [KKR.UL] plans similar moves after its own initial public offering, for which it filed earlier this month.
“Traditional analysis for these companies is an oxymoron,” said Mike Holland, founder of private investment firm Holland & Co. and a former Blackstone partner. “There is an enormous element of ‘trust me’ involved in these situations.”
Blackstone, which closed up nearly 15 percent on June 22 after its first day trading publicly, is now about 15 percent below its initial share price of $31.
Shareholders of private equity firm and hedge fund Fortress Investment Group FIG.N, which led the charge to public markets with its February IPO, have also had a bumpy ride. Fortress shares are off nearly 40 percent from their initial $35 price, after gaining almost 70 percent on their first day.
Difficulty covering the cryptic firms will be exacerbated by a thinning analyst core, strained by the settlement with regulators in 2003 that erected strict walls between investment banking and research arms of the same firm after allegations of conflicts of interest.
“There is a fundamental problem with equity research,” said Bernstein’s Hintz. “The economics of the institutional equity business have changed and there has been a lot of shrinkage of the equity research franchises on Wall Street.”
Frustrated by increased scrutiny and cutbacks, many “sell-side” analysts have fled to “buy-side” hedge funds and private equity firms — or quit research altogether.
“We’re getting to a situation where the demand for analysts is exceeding the supply,” said Holland. “It’s going to be problematic.”
Covering hedge funds and private equity firms may also renew conflict-of-interest concerns. Private equity-related fees, including those from advising and underwriting, accounted for $15.6 billion, or 20 percent of total global investment banking revenue last year, according to data provider Dealogic.
“The greatest challenge one faces as an equity analyst looking at Blackstone is the fact that they are one of the largest investment banking clients,” said Hintz. “It isn’t going to make you very popular if you put an ‘underperform’ on them.”
For now, analysts who will cover alternative asset managers are anticipating a tough time.
Jeffrey Ptak, a Morningstar analyst who covers financial companies, said the stocks are likely to be volatile until trends and comparables are established.
“Could they be a bit more helpful? I suppose so,” Ptak said. “It is pretty messy stuff. It’s our job to pore through that stuff — but that’s an involved process and it will continue to be.”
Bernstein’s Hintz says the limited visibility will be a challenge for analysts.
“Unfortunately, that often leads to one of two extremes: massive overvaluation with the assumption you own the goose that lays the golden egg,” he said. “Or massive undervaluation because it’s a big black box and you have no faith in your ability to forecast anything.”
Perhaps anticipating difficulty communicating with analysts, last month Blackstone hired Joan Solotar, who previously headed equity research at Banc of America Securities (BAC.N), to oversee its public investor relations.
Solotar — who will manage industry analyst relationships — was herself a top-ranked analyst covering the financial services sector.
Solotar and Blackstone declined to comment.