Fitch Affirms Blackstone at 'A+'; Outlook Stable
OREANDA-NEWS. Fitch Ratings has affirmed the long-term Issuer Default Ratings (IDRs) of The Blackstone Group L.P. and its related entities (collectively Blackstone) at 'A+'. The Rating Outlook is Stable. Approximately $2.8 billion of unsecured debt is affected by these actions. A complete list of ratings is detailed at the end of this release.
Today's rating actions have been taken as part of a periodic peer review of the alternative Investment Manager (IM) industry, which comprises seven publicly rated global firms. Fitch's outlook for the sector is stable, reflecting the relative stability of core operating fundamentals, given the locked-in nature of a large portion of fee revenue, modest but increased leverage levels, manageable near-term obligations relative to available liquidity resources, increasing asset under management (AUM) diversity, and investors' increasing allocation to alternative investments, particularly those managed by alternative IMs with strong franchises such as those included in Fitch's peer review. While fund realization activity has increased significantly over the last three years, leading to the amortization of existing AUM, managers have continued to replace capital, and therefore fees, with follow-on funds and expansion into other product categories through step-out strategies, seed investments, and/or acquisitions.
The variable cost structure of the alternative IMs has contributed to relatively steady cash flows through cycles. Fee-related earnings before interest, taxes, depreciation, and amortization (FEBITDA) margins had been trending down in recent years, given lower fee rates on new product categories, higher fundraising costs, and because the cost of doing business has risen with increased regulation and administrative costs associated with operating as public companies. However, FEBITDA margins have turned a corner more recently as many alternative IMs have begun to raise follow-on funds for newer strategies, which adds scale to the platform. The FEBITDA margin for 'A' category alternative IMs averaged 35.5% for the trailing 12 months (TTM) ended Sept. 30, 2015, which compared to a 34.9% average for 2012.
Leverage levels have increased across the industry, as issuers have taken advantage of the low interest rate environment to issue long-duration funding and have also used debt financing for acquisition purposes. Average leverage, defined as debt divided by FEBITDA, was 3.54x for 'A' category firms for the TTM ending Sept. 30, 2015, which compared to an average of 2.55x at year-end 2012. Fitch believes the issuances have been largely opportunistic and views the reduction in refinancing risk favorably. Over time, Fitch expects leverage levels to migrate toward historical averages, as cash proceeds are deployed into FEBITDA-generating opportunities and recent acquisitions begin to contribute to consolidated results.
While core issuer fundamentals remain solid, alternative IMs continue to have record levels of capital to invest at a time when conditions are increasingly challenging. Therefore, there is more capital chasing fewer deals, which could lead to significant fund underperformance if competition bids prices up further. Outsized vintage concentration could potentially exacerbate this issue. While most of the large managers have operated through a variety of market cycles, and have demonstrated investment restraint, pressure for returns from limited partners remains high, given the length of time that interest rates have been at low absolute levels. That said, a meaningful portion of the industry's uncalled capital is not yet earning fees, often referred to as shadow AUM, which could provide some material upside to alternative IM FEBITDA as the capital is deployed.
KEY RATING DRIVERS
IDRs AND SENIOR DEBT
The rating affirmation for Blackstone reflects its strong competitive position as a global alternative IM, experienced management team, solid investment track record, significant fee-earning assets under management (FAUM), strong operating margins, incentive income-generating capability, ample liquidity, relatively low leverage, and subordination of general partner interests to outstanding indebtedness.
Risks to the ratings include 'key man' risk, which is institutionalized throughout many limited partnership agreements; reputational risk, which can impact the company's ability to raise future funds; reduced earnings generation and diversity following the announced sale of the firm's advisory and restructuring businesses; and legal and regulatory risk, which could alter the alternative asset space.
FAUM amounted to $240.9 billion at Sept. 30, 2015, up 12.2% year-over-year, driven by strong fundraising across the firm, particularly in real estate and credit, which more than offset nearly $20 billion in realizations and $17.8 billion in outflows, representing the end of closed-end fund investment periods and redemptions in more liquid vehicles. Additionally, FAUM does not yet include Blackstone's seventh global private equity fund, which had $16.8 billion of committed capital at Sept. 30, 2015. In aggregate, Blackstone had $48 billion of AUM not yet earning base management fees at third quarter 2015 (3Q15).
Fundraising is expected to remain strong, given the diversity of Blackstone's product offerings, and the potential scalability of new product launches, including core plus real estate. However, Fitch believes FAUM growth may moderate over the near term given Blackstone's absolute overall size, continued realization activity, and the recent raising of flagship funds in private equity (PE) and real estate (RE).
At Sept. 30, 2015, Blackstone had approximately $85 billion in uncalled capital, a record for the firm. Investing this amount of capital may be challenging in the current environment, with high equity valuations and loosening credit terms. However, Blackstone has a track record of investing through a variety of market cycles, and has a global reach and extensive network of relationships which provide an ample pipeline of deals to review. Fund investment periods also generally allow anywhere from three-to-five years to deploy the capital, which allows the firm additional deployment flexibility.
Blackstone's core operating performance remains strong due to the relative stability of management fees on a growing FAUM base and the variable cost structure. The firm's FEBITDA margin was a peer superior 43.6% for the TTM ended Sept. 30, 2015 - evidence of the scalability of the business model. Fitch expects management-fee growth near term given continued fundraising and the start of the investment period for the flagship RE and PE funds in 3Q15 and 2016, respectively. Still, the pace of growth will be somewhat dependent on the magnitude and pace of investment and realization activity.
FEBITDA will decline with the spin-off of the firm's advisory, restructuring, and fund placement businesses on Oct. 1, 2015, which have been relatively stable, albeit small, contributors to earnings. However, Fitch expects Blackstone to cover the FEBITDA decline in a relatively short time, given the growth trajectory of the remaining businesses and the scalability of the asset management platform. Additionally, firm margins may benefit as the advisory/restructuring segment is lower margin than the asset management business, given the higher number of employees and the associated compensation ratio.
Performance fees and investment income are down year-to-date 2015, year over year, due to stronger returns in 2014 and, more recently, marks on public holdings in the funds. These revenue categories will be lumpy over time due to deal activity and market volatility. Accrued performance fees were a strong $3.6 billion at Sept. 30, 2015, net of associated compensation expense, and relate largely to the RE and PE segments. Fitch does not view the accrual as a liquid asset, but the accrual does point to potential future income generation and cash flow.
Blackstone's funding diversity improved in 2015, as it accessed the European markets for the first time, issuing EUR300 million of 10-year notes with a 2% coupon in May. Blackstone also extended its funding duration, issuing $350 million of 30-year notes at 4.45% in April, which compared to a coupon of 5% on its prior 30-year issuance, in April 2014.
Blackstone's leverage, as measured by corporate debt divided by FEBITDA, was 2.49x at Sept. 30, 2015 on a TTM basis, compared to Fitch's general tolerance level of 2.5x for 'A' category firms. Debt service coverage, defined as FEBITDA divided by interest expense, remained adequate at 6.93x on a TTM basis, but will decline as the run-rate impact of recent debt issuance has yet to be fully incorporated in interest expense.
Fitch expects Blackstone to manage leverage at or below 2.5x over the long term, but leverage will increase in 4Q15 given the spin-off of the majority of the advisory segment. Assuming Blackstone loses the full fee-related earnings contribution of the segment, which is overly conservative given the retention of the capital markets business, leverage would be 2.86x on a TTM basis through Sept. 30, 2015.
Fitch believes Blackstone has a solid liquidity profile. Performance fees can be highly volatile and could be virtually zero when market conditions are stressed, so Fitch looks to FEBITDA, cash, and liquid assets as the primary sources of liquidity. At Sept. 30, 2015, balance sheet cash amounted to $1.4 billion, total investments in cash management strategies were $2.6 billion, investments in liquid funds were $172 million, and the company had $1.1 billion of unused capacity on its management company revolver. At June 30, 2015, unfunded commitments to the funds amounted to approximately $2.3 billion and the clawback obligation, assuming all positions were liquidated at their current fair values, amounted to a very modest $3.5 million, including employee obligations.
Distributions for year-to-date 2015 were $2.12 per common unit, while distributable earnings were $2.51 per unit, yielding a payout ratio of about 84.5%. Blackstone's distribution policy is above the peer group average, but Fitch believes the company has the flexibility to reduce distributions, if necessary, to bolster liquidity.
The Stable Rating Outlook reflects Fitch's expectations that management will continue to generate stable management fees, maintain strong operating margins, grow/retain FAUM through the raising of new and expansion of existing funds (albeit at a more moderate pace), operate with relatively low leverage, and retain a solid liquidity profile in order to fund operations and meet co-investment commitments to the funds.
IDRs AND SENIOR DEBT
Positive rating momentum is considered relatively limited, given the nature of the business and the company's existing risk profile. However, it could develop over time with a meaningful reduction in key man risk, enhanced stability of incentive income through a variety of market cycles, stronger funding diversity, and declines in leverage.
Negative rating actions could be driven by material changes in operating strategy or leverage tolerance resulting from changes in senior management or declines in investment performance which adversely impact the business franchise, meaningful FAUM and margin contraction which impairs FEBITDA, reduced product line diversity, and/or impairment of the liquidity profile as it relates to operating needs, debt maturities, and co-investment commitments.
Legislative risk and/or prolonged market disruptions that impact the ability to fundraise or arrange attractive exit opportunities could yield negative rating momentum for the industry overall.
Blackstone, a Delaware incorporated limited partnership, is a leading global alternative investment manager specializing in private equity, real estate, credit funds, and hedge fund solutions. As of Sept. 30, 2015, FAUM amounted to $240.9 billion and total AUM was $333.9 billion. The company's stock is listed on the NYSE under the ticker 'BX'.
Fitch has affirmed the following ratings:
The Blackstone Group L.P.
-- Long-term IDR at 'A+;
-- Short-term IDR at 'F1'.
Blackstone Holdings Finance Co. L.L.C.
-- Long-term IDR at 'A+;
-- Senior unsecured debt at 'A+';
-- Short-term IDR at 'F1'.
Blackstone Holdings I, II, III, and IV L.P.
-- Long-term IDR at 'A+;
-- Short-term IDR at 'F1'.
The Rating Outlooks are Stable.