JL: Man, what a week. I m starting to sound like a broken record here maybe insane is just the new normal. A massive Fed bailout plan, a market moonshot, and a few days later the fifth biggest house on Wall Street goes kaput. How are things looking from the Cash McDash turret?
CASH: Turbulent, my friend, turbulent. But the good news is, this is the stuff that lows are made of. In my opinion, we re very close to a tradable push higher. That means the opportunity to make a ton of money.
JL: Whoa. Are you calling for a major bottom here?
CASH: Hey now, don t pin that on me! Remember, I m just a lowly trader. I get hints and glimmers of the macro picture, but mostly I just trade my book on a day to day basis. And today, it looks like we re setting up for a decent rebound.
JL: Gotcha. So are you going off your gut feeling here, or do you have something more tangible to back it up?
CASH: Well, you re a bit of a market history buff. Take any historical bear market and tell me how things looked at the bottom.
JL: Ugly. Despondent. A sense of all hope lost.
CASH: Right. And not only that, but large institutional names failed too. There s almost an unwritten rule that someone or something major has to fail before the bears are done. We re seeing that with Bear Sterns right now, and it s putting a huge strain on our financial system. In panic mode, investors aren t just selling risky positions. They re selling whatever they can find a market for.
CASH: The way I see it, the chance to make the biggest fortunes occur not during bull markets but during panic sell offs when everything s on sale! I can hardly keep my hands off the buy it now button!
JL: But aren t you concerned that weakness could continue to send prices lower? There are so many phrases that come to mind, like catching a falling knife or stepping in front of a train. I m not convinced the big capitulation has happened yet.
CASH: Of course that s a concern and I m definitely not talking about buying blindly. Being cavalier in a catastrophe is nothing short of gambling. But selectively picking up quality stocks at fire sale prices yields the potential for huge gains.
JL: So I assume you ve got the picks in mind?
CASH: Actually, I ve figured out a way to outsource the process.
JL: Say what?
CASH: I know it sounds funky, but hear me out. This is an idea that could make sense for readers too. I m talking about picking up a stock (a relatively new issue, surprise surprise) that will benefit from the upcoming surge in IPO pricings that we ve been anticipating for the past couple weeks. This company actually holds positions in many of the firms that will sell shares to the market in 2008 not to mention some of the more recent issues that could spike higher when the market turns.
JL: Sounds like an IPO incubator or something. I d guess it was a private investment, except you talked about picking up a stock.
CASH: The company is actually the king of private investments or private equity, as it s referred to on Wall Street. I m talking about Blackstone (symbol BX on the NYSE).
JL: Blackstone! You just made me spit out my coffee! Well, almost.
CASH: Heh. I know you re not crazy about those guys
JL: Darn right I m not. Those jokers milked the liquidity bubble like nobody s business. Steve Schwarzman, Blackstone s CEO, went public and walked away with billions right at the top. They made headlines with a multi billion dollar investment from China, and then their stock tanked 50 or 60% over the next six months. How could you possibly think Blackstone is a good idea?
CASH: Just between you and me, I know I ve been wrong before. (Keep that under your hat.) But I sincerely believe the stars are lining up for this company. Despite the poor stock performance, Blackstone s management has really been building a solid franchise the last few months. The company has increased its assets under management (AUM) by steadily bringing in more investors, which increases fee based earnings for the company.
JL: Okay, but why is the stock so depressed? It s below fifteen bucks and the chart looks awful. Is there a lot more risk in the name, or do you think the market is getting it wrong?
CASH: There s still some risk in BX, but it s more sentiment risk than balance sheet risk. The perception in the market right now is that anything with financial exposure is crap. Since Blackstone clearly falls under the financial category, the stock has sold off relentlessly. Investors are worried about a catastrophic loss popping up out of nowhere, like we ve seen in so many other places week after week.
JL: I think I get it. You re seeing this as a case of mistaken identity. Investors are afraid that Blackstone s balance sheet could be loaded up with toxic waste, like a Citigroup or a Bear Sterns, but that s a misconception because Blackstone doesn t run those kinds of plays.
CASH: Exactly. The common perception simply doesn t reflect reality. As it stands, the company does not have a leveraged position and is not at all subject to the overnight redemptions that killed Bear Stearns. Even better, Blackstone s investment vehicles have plenty of cash to buy positions today, in what can only be described as a panic stricken market.
JL: So Blackstone is financially strong, they re free from dangerous leverage, and they re getting lumped in with the wrong crowd. I can see that. But what about earnings? If the company has a strong balance sheet and plenty of opportunity, why aren t the numbers telling the story?
CASH: To fully grasp the earnings picture for Blackstone, you have to understand the different types of earnings the company produces and how those are calculated.
JL: That sounds complicated.
CASH: Stick with me here. First, the company charges management fees for the assets that it invests. Similar to a traditional mutual fund, investors are willing to pay Blackstone a fixed fee for the privilege of parking their money under the company s control. This earnings stream is very stable, but at the same time very boring. It s not really what owners of Blackstone stock look for.
JL: Gotcha. So what do they look for.
CASH: The exciting part of the earnings stream comes in the form of incentive fees. Incentives usually kick in when Blackstone actually sells one of its private investments (think venture capital) and books a significant gain. So investors in the company s private equity fund realize a gain on their investment, but 20% of that gain goes to Blackstone. Many of these cash outs are from selling companies that were incubated by Blackstone or bought at a very low price in their infancy. So it is easy to see why when these positions are sold it represents a huge profit source for the company.
JL: So it s a pretty lumpy business in terms of earnings then. If there are no private investments actually converted or sold during a quarter, I assume it winds up being a pretty quiet earnings report.
CASH: That s pretty much the way it works. Management does their best to give investors a picture of what the pipeline looks like in terms of future earnings, but keep in mind that many of these assets have no market, which they trade on for the time being. So it s very hard to accurately gauge what they are worth.
JL: So why should you have a handle on what these hard to value assets are worth?
CASH: I don t, really no one does. But right now, the market is pricing Blackstone s stock as if their entire private investment portfolio is worthless. All it takes is for one or two of these deals to come to market in a successful IPO, and the stock could quickly rise as incentive earnings stack up.
JL: But what about nervous attitudes in the IPO market? What happens when Blackstone prices one of its crown jewels at a low multiple because of the market s aversion to risk?
CASH: Blackstone has a way of selling smartly. They may issue 20% of one of their holdings in an IPO transaction, and watch it quickly trade up from, say, $12 to $18. It may sound like they left money on the table, but the reality is that they intentionally priced the stock well below what the market would value the company at.
JL: Why sell so cheaply on purpose?
CASH: Simple. The post IPO price rise instills confidence in the market. After all, this stock is now up 50% from its offering! Journalists write reports, analysts raise expectations, brokers tell their clients to buy the stock, and so on. Next thing you know everybody wants a piece of this company.
JL: Ah, very slick. So now Blackstone is sitting on 80% of a company that has a strong market, and they can casually liquidate the rest at a higher price.
CASH: That s right. They are willing to take less profit initially to realize greater gains on the full position. These guys are no dummies! Just because they ve gone a few quarters without great earnings doesn t mean they re all out of moves.
JL: So what about that big China investment? They put several billion into Blackstone before last year s offering and now the stock is worth less than half the IPO price. I hear there is some real political heat in Beijing as a result of that investment.
CASH: Heh. Beijing certainly isn t happy about the stock price decline. Nobody enjoys looking foolish. But at the same time, those guys aren t country bumpkins. They know what they got themselves into, and will likely be patient so long as the company itself is operating profitably. Since assets are growing, the balance sheet is healthy, and Blackstone has an attractive slate of potential investments, China has to be fairly confident its investment will pay off in the long run. The nice thing is, you and I can make the exact same investment today at half price and realize the benefit.
JL: So Blackstone is a buy, eh? I gotta admit, your argument is convincing. But still, it feels risky.
CASH: Yup. You know I m no stranger to risk. But I like to be well paid for the risk I take. The stock is definitely an aggressive play on private equity and the IPO market in general. If it works, I expect Blackstone to double and approach the old IPO price before running into resistance. Anyone who wants to get involved should have quick reflexes, because once BX gets going it could move extremely quickly.
JL: Always shucking and jiving.
CASH: That s the only way to stay on top of this market.
JL: Is there an entry point that looks particularly attractive?
CASH: I think the $17 area is a place to watch closely. Once BX gets above that level, its momentum will pick up and people will take notice. But I have to repeat that once this stock gets moving, it could go fast! A trade through $17 could means hitting $19 in the the same week, if not the same day. In the high $20 range, I start to get worried that it will run into sellers from the IPO, which would hold the stock back for a few weeks. After that, it depends on the market and the number of deals the company can bring but there s no telling where this thing could end up 18 months from now.
JL: You like it that much, eh?
CASH: In the right context, it could be a super holding.
JL: And you think that context is coming up?
CASH: You tell me, macro man what s the stuff market bottoms are made of? Don t you usually see major institutions failing? Don t you see government intervention? Isn t there fear in the streets and blood on the headlines (or is it the other way around)? Anyways, yes. I think we re going to see some buying opportunities soon. I m not talking the bottom, of course, but we should have a chance to trade an intermediate bottom over the next month or two.
JL: I have to admit, you could be right. There are a lot of moving parts
CASH: And I m one of them got to wrap up my Visa calls! Back at you next week.