Funds News

DealTalk: Looking for Blackstone's bottom line? Good luck

NEW YORK (Reuters) - Potential investors in the Blackstone Group are likely to be left scratching their heads when they try to put their fingers on the company’s bottom line.

In a filing issued on Monday for its upcoming public offering, Blackstone makes it clear that net earnings won’t be one of its key metrics. Instead, bearing in mind the company’s warning that it expects significant net losses for years, investors should get familiar with less common measurements of performance, such as “pro forma economic net income.”

With many other private-equity firms and hedge funds expected to pursue a path similar to Blackstone’s, Monday’s filing shows that investors are likely to be flummoxed when it comes to understanding the earnings of these private partnerships that go public.

Management at Blackstone looks to “economic net income” -- or net income excluding the impact of income taxes, noncash charges related to vesting of equity-based compensation and amortization of intangible assets -- as a “key performance measure,” according to the filing.

Blackstone said economic net income should not be considered in isolation or as an alternative to income before taxes in accordance with GAAP -- Generally Accepted Accounting Principles.

While net income is considered a company’s bottom-line profit, a quick search through databases finds the term “economic net income” used by only one other major publicly traded company in the past year, Southwest Airlines Co


It isn’t the only term used by Blackstone that will have investors reaching for financial dictionaries. They should also get used to terms like “finite-lived intangible assets.”

It’s a far cry from calls by U.S. Securities and Exchange Commission Chairman Christopher Cox for “greater clarity” in financial disclosure.

This doesn’t mean Blackstone shares won’t perform strongly when they list, probably in the next couple of weeks, but it does mean that the normal metrics of performance may not apply.

“If someone is going to invest in Blackstone they have to close their eyes a bit, trust management and look at the track record,” said Lee Norton, an analyst who covers financial stocks at JS Asset Management in West Conshohocken, Pennsylvania.

Blackstone declined to comment beyond Monday’s filing, which clearly labels the risks associated with investing in its $4.75 billion IPO.

The filing warns that the stock is not for those focused on the short term.

It warns that its earnings will be “highly variable.”

What appears to be the starkest warning in the filing, however, is a line that reads: “We expect to record significant net losses for a number of years following this offering as a result of the amortization of finite-lived intangible assets and noncash equity-based compensation.”

“I think it is significant,” said private-equity attorney Steve Howard, referring to the net loss warning.

“It’s not a deal breaker or a blemish, but they have ... found that there are significant tax implications,” added Howard, chairman of the investment funds group at law firm Thacher Proffitt & Wood.

But Robert Willens, accounting and tax analyst at Lehman Brothers, played the net loss warning down, saying that income as reported in its accounts does not give a clear picture of Blackstone’s ability to generate cash.

“It’s the kind of expense that most analysts and most investors would ignore,” Willens said. “It’s not an expense that requires them to spend any cash, and so therefore most investors would not be so concerned with the accounting loss.”

However, comparing Blackstone with other publicly traded companies will be difficult because of its unique accounting structure.

For example, potentially comparable companies -- like newly public hedge fund Fortress Investment Group LLC FIG.N or financial services giant Goldman Sachs Group GS.N -- don't mention "economic net income" in their filings.

“It strikes me that there are not any true comparables on this stock,” said Sanford Bernstein analyst Brad Hintz. Blackstone could possibly be analyzed on the basis of private-equity portfolio returns, he said.

“This probably will understate the value that the market will give a unique IPO stock like this,” Hintz said, adding that “retail overenthusiasm for a name-brand, private-equity play is always a little tough to justify.”

Monday’s filing is not the first indication that Blackstone will be a different kind of stock, one that doesn’t follow some of the mainstream market’s rules.

Blackstone had previously disclosed that senior managing directors will operate and manage the new company and, unlike in a conventional corporation, common unitholders will have only limited voting rights and almost no ability to influence the company or even obtain information.

It also says it will be exempt from major corporate governance rules of the New York Stock Exchange, including those requiring a majority of independent directors on the board and fully independent committees for compensation, corporate governance and director nominations.

“It definitely makes me nervous,” said JS Asset Management’s Norton of Blackstone’s filing. “But no matter what any of us may think it’s going to do well as long as this private-equity run continues.”