Blackstone blames EOP for drop in RE revenues

Founder Stephen Schwarzman today told shareholders the market is seeing “one of the worst financial crises since the Great Depression”, but he says the “very best” investments awaited the firm.

The Blackstone Group blamed last year’s huge Equity Office Property deal for its falling private equity real estate earnings.

Reporting their first quarter earnings, Blackstone said real estate revenues were down 94 percent in the three months to March 31 this year. The New York-based private equity firm reported earnings of just $48 million compared to $766.8 million a year previously.

navigating the cycle

Significantly impacting the decreased revenue was the drop-off in transaction fees following the firm’s January 2007, $39 billion purchase of Equity International’s office portfolio. The deal was, at the time, the largest private equity deal ever. Within a matter of months, Blackstone had earned back 70 percent of its purchase price with the sale of key EOP assets.

According to the earnings report, Blackstone’s management fees for real estate fell by $168.8 million in the first quarter of this year, compared to the same period in 2007 when the firm closed the EOP deal. The deal, the firm said, “generated a substantial transaction fee in connection with that acquisition.”

Assets under management however increased for the first quarter of 2008 owing to the recent close of Blackstone’s latest real estate vehicle, the $10.9 billion Blackstone Real Estate Partners VI fund. AUM, the firm said, now totaled $28.28 billion, an increase of $6.8 billion compared with the first quarter of 2007.

Blackstone – which posted an overall loss of $93.6 million for the first quarter – also blamed the tumbling stock of German telecom company Deutsche Telekom and fair-value accounting regulations as the primary reasons behind a $58 million loss for its private equity division.

in a storm

Blackstone acquired a minority stake in the German mobile phone and internet giant for €2.68 billion two years ago. Over the past year, Deutsche Telekom’s stock has dropped as much as 30 percent.

In a conference call today, founder Stephen Schwarzman, said the firm was navigating its way through the market dislocation. “All of us are living through one of the worst financial crises since the Great Depression,” he said. “Blackstone has navigated through several cycles before. . . and in the periods after our down cycles, we made our very best investments. This cycle, we anticipate, will be no different.”

This is the second consecutive quarter in which Blackstone has reported negative results from its private equity division, with the firm last year recording a $37 million loss. Blackstone has watched the firm’s stock tumble 46 percent since its public float last June.

Blackstone president Tony James also echoed concern among private equity leaders that recently imposed fair value accounting procedures, specifically federal accounting standard FAS 157, have made its balance sheets misleadingly volatile and unfairly prices portfolio companies according to current market conditions when firms have no intention of selling them in the near future.

“While we hold our investments long term, we’re required by accounting rule FAS 157 to carry them at fair value, and report the impact of the change in value on our carried interest and performance fees and investment income, this is what you see this quarter,” added Schwarzman.

Discussing tightness in the leveraged loan markets, James said that “less than a third” of Blackstone’s private equity deals over the years had been megadeals. However, he added, he was not enthusiastic about current conditions in the middle market. “Generally speaking I think the prices are still way too high there,” James said. “There’s too much capital chasing relatively few opportunities there. You’re also buying companies that are inherently smaller and therefore are going to be more vulnerable when economic conditions get choppy. It’s like a battleship in a storm, you want to be on a big boat.”

Blackstone’s total assets under management increased 37 percent to $113.53 billion from $83.14 billion a year ago.