?Q1. What are the built-in tensions with a public private equity firm? How does Blackstone’s structure attempt to reconcile them? 1. Transparency (disclosures of financial statements) The reason why investors are willing to let the required rate of return decrease is the lower concerns about asymmetric information due to the disclosures of financial statements. In the past, in order not to be subjected to Investment Company Act of 1940, Blackstone once analyzed its operations and concluded that it was not an investment company.
The SEC subsequently reviewed the conclusions and did not object. However, if it goes public, it will face problems such as its financial reporting, which should compliant with the GAAP. Therefore, Blackstone hired Jasvinder Khaira and tried to consider the business scope and to create the best business model. Nevertheless, we think that as an IPO company, Blackstone must fully disclose its financial statements and it is also the must-pay and tradeoff to lower the costs of capital.
This is also the problem that Blackstone couldn’t wholly resolve from purely adjusting the financial structure. 2. Risk of employees resigning triggered from the change of compensation package Before going IPO, underwriters raised the concerns from unitholders: ‘though it will bring benefits to the existing LPs as the managing of closed deals from employees, it may also let them neglect the growth of company from developing new deals. ’ Part of carried interests, as proposing closed deals, should be converted into units and withdraw in the coming eight years.
As a result, the benefits of both unitholders and employees can be adjusted into the same direction. However, the lock-up eight years of the units will face the volatility risk of stock price, which will also trigger the possibility of resigning trend. Therefore, the management team came up with the idea that the other part of closed deals should be converted into unpaid carried interests, which can be converted into shares immediately without withdrawing in the coming eight years.
Then, employees can both care about the benefits of unitholders and LPs. [Note] Additionally, in order to compensate the shares dilution of the existing partners when going public, Blackstone established a pool of unissued shares and kept the shares in the pool at the 15% level of shares outstanding. Whenever employees get promotion in the future, shares will be taken from this pool as rewards and motivation for employees to work hard with the company and lowering the resigning risk. [Note]
The risks of professionals resigning mainly come from the following two parts: (i) Locking up for eight years of all carried interests will let them face the volatility risk of stock price and consider of quitting jobs; (ii) If converting all carried interests into units and vested immediately, employees will cash all of them out from the market and quit jobs as well. In order to get the balance, the hybrid way as mentioned above was adopted. 3. Volatility of stock price After going public, stock price will be influenced by not only the disclosure of quarter financial reports but also the macroeconomic environment.
It may cause the panic to investors as well. Investors may overweight the short-term performance and ignore the long-term value of the company. Blackstone still targeted on the benefits of Limited Partners, which meant it still cared more about the long-term rather than short-term performance. This investment strategy made its short-term profitability more volatile, which could be explained by the essence of private equity. That is, if there is a significant business/case done in one specific season, the earnings of the season will be much higher that the others. As a consequence, the stock price might volatile significantly.
To reassure unitholders who might be disconcerted by the unevenness of private equity returns, and the resulting volatility in the stock price, Blackstone offered a guaranteed annual dividend of $1. 20 per unit through 2009. The firm would pay more if possible, and the dividend would occur before any distributions were made to other equity owners. As our point of view, though IPO will lead to short-term ups and downs of stock price, it will eventually reflect the real values of the company in the long run, consisting the stock price with its long-term performance.
4. Short-term losses from the change of compensation package after going public With the shares vesting in the future, Blackstone expected to face deferred cost approximated $13 billion. It may record significant net losses for a number of years following without paying any interests or dividends hereafter. As a result, Blackstone developed a metric called “economic net income,” which excluded the impact of income taxes, noncash charges related to the vesting of equity-based compensation, and amortization of intangible assets.
By using the economic net income metric, the Blackstone‘s executive team argued that this metric was justified, as the future noncash charges reflected an extraordinary situation, incurred only because of the one-time event of the firm’s listing. Moreover, the stream of income against which these expenses would be offset was uncertain but highly likely to be more than enough to cover these costs. Furthermore, the management team also thought that this $13 billion expenses was based on the extreme assumption that all the employees would not leave their jobs in the coming eight years.
If they left the firm before their vesting period was up, they would forfeit unvested shares. Therefore, the current assets were very likely to produce more than enough futures revenues to cover the costs. 5. Two-tiered taxation problem Take limited company as an example, profits taxed at the corporate level and then again at the level of the recipient when paid out as dividends. As a consequence, Blackstone decided to adopt the Master Limited Partnership (MLP) structure.
In this way, the taxation at the corporate level can be wiped out and profits will only be taxed at the recipient level based on the units he/she gets. 6. Interference of management If Blackstone had adopted the limited company structure, investors (i. e. , shareholders) would get voting rights and have the chance to influence the company’s strategies. The MLP structure retained the limited partnership form of governance, allowing the existing management tame to continue to run the firm. Unitholders had only limited voting rights and could not elect the general partner or directors.
That is, the MLP structure would permit Blackstone a governance structure that resulted in minimal change from that currently in place and minimized its ability to continue to focus on the best interests of the LPs in its investment funds. Therefore, Blackstone can ease the tensions about interference of management and governance after going public. Q2. If you were an LP in Blackstone, how would you view the structure Blackstone has put in place to go public? We think that there are some advantages and disadvantages after the changes in corporate structure worth
our concerning: Advantages: 1. The Reputation Of The Company A public offering company can easily raise their reputation and earn the investor’s awareness, and regular disclosure of financial statement will make the outsider have more comprehensive understanding about how the company operates. Therefore, we can likely receive more cases and stand a leading position in the market. 2. Acquisition Of Cheaper Capital Companies expect the P/E ratio to be around 20 after the public offering, this also implies that you can use 5% interest rate for financing.
Comparing with those companies in history with ROI hovering around 30% to 35%, we can earn the significant spreads and increase our capital scale, which also help us win more cases. Disadvantages: 1. Losing Talented People Under the current operation structure, the company can successfully combine employee’s effort and pay in the Fee and Carry Interest framework. However, in the open market, professional managers can choose when to sell their own stock shares and it will decrease the incentive that they will do their best for the stockholder’s interest.
It might also bring to the result with the decline in investment performance and negative influences on the limit partner’s interest. 2. Transparency There are quite a few matters required by the government after the company was public offered. While the companies must act in line with a number of related laws and regulations , they may have to comply with these requirements and make adjustments to the company’s operations. In addition, the financial statements should also be published to both the public and the competitors. 3. Whether The Management Echelon Is Still Under Control
After the public offering of the company, we have to take active shareholder issue into consideration when the investors are selling their shares or executing their right to vote. The company must take the cost of solving problems between the shareholders and the management echelons as well. 4. Still Focus On The Long-term Investment Or Not Since the company has set its orientation as a long-term investment target, will the company adjust their operation strategy to meet those investors who prefer the stock’s short-term performance?
Q3. Would you rather be a unitholder in Blackstone or a limited partner? As a financial supporter, Limited Partner mainly profit from the performance of the fund handled by the company. Also, Limited Partner would distribute related fee and carry interest, according to the performance of the fund, to the company. On the other hand, Unitholder plays a role similar to that of a stockholder, except that Unitholder has neither the right to participate in direct decision-making, nor the right to vote.
Unitholder, however, has the claim to the fee and carry interest, granted by the Limited Partner, of the company. Given the difference between this two roles and the reasons listed below, we’d rather be a limited partner of Blackstone in the short term: 1. Outstanding achievements of Blackstone: Considering that the limited partner’s profit is highly dependent on the performance of the fund, compared to the profit of the unitholder, we believe that if we are to directly take part in the excellent returns of Blackstone, our best choice is to become a limited partner instead of a unitholder.
Inevitably, the IPO of Blackstone would, in some degree, alter the structure of the company, however, we believe Blackstone, can still retain its operating-flexibilities through modification of policy. Simply put, we think Blackstone possesses the competence to maintain, or even surpass, its current performance, and by becoming its limited partner, we can gain a share of the profit, maximizing the value of our mutuality with Blackstone. 2. Option of transforming into another form
In terms of the by-laws of Blackstone, a limited partner would be endowed with the right to switch him/herself to a unitholder, even in several years. That is, we can choose to turn ourselves into a unitholder if we’d like to carry our claims with less liquidity risk. This system would grant us the option of transforming ourselves, so is our asset and the risk we’d be bearing in another form. In other words, it would be like holding an option, which offers us the right, but not the obligation to exercise our contract.
As a result, we’d be able to manage our asset in a more flexible way than we could otherwise have. Q4. As a potential employee, how do you evaluate the Blackstone compensation package against a commensurate offer from a similar large-scale private equity firm that was not public? With IPO, the stock price will reflect value of Blackstone more efficiently and objectively. The MLP employees of Blackstone can get not only salaries but also carried interests depending on their performance and promotion, which could transfer to units after a lock-up period.
This compensation package will encourage their employees to work harder because the value of the units they hold on hand are bounded with the performance of company. Furthermore, the number of employees in Blackstone is fewer than that of similar large-scale equity firm which was not public, the unit’s gain of per employee is larger. Last but not the least, when Blackstone went IPO, not only does it mean that Blackstone would face more regulations than before, it also pointed out that Blackstone, heading to become a well-known public listed company, would face more potential pressure from outside investors.
To abide by the regulations of the state, and keep investors’ confidence toward Blackstone, the company itself would be less likely to exploit the right of its employees. If it does any harm to workers under their roof, the negative impressions toward the company would soon be spread around the financial market, causing damages to itself. Hence, by working under the public listed company such as Blackstone, employees could be more confident that their rights and benefits would be partly, if not all, guaranteed. These factors make Blackstone an attractive choice to workers.
