Blackstone, Fortress: Time to bargain hunt?

LONDON (CNNMoney.com) -- What a difference a few months can make.

Turmoil in the credit markets has turned off everyday investors from risk in general and taken a toll on stocks in the financial sector.

Analysts are upbeat on the long-term prospects of Fortress Investment Group (yellow) and Blackstone Group (blue), but the stocks could have further to fall.

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Shares of private equity titan Blackstone Group have been in a free fall since they started trading in June, and over the same period stock in hedge fund manager Fortress Investment Group has plunged.

"The concern is they're not going to be able to finance deals at the attractive rates they have before," said Ryan Lentell, an equity analyst at Morningstar.

When Blackstone made its splashy debut, investors were betting the firm would be able keep doing deals at favorable rates, Lentell said. But the credit markets have seized up since then.

Blackstone (Charts) shares have plunged about 34 percent from the high of $38 a share touched on their first day of trading. Six months since Fortress's (Charts) debut, the stock is barely trading above its offering price of $18.50 a share. The stock had topped $30 on its first day.

Investors will get a better idea of just how exposed the two firms are to the credit crunch next week. Blackstone on Monday is due to report its first set of quarterly results since going public. Fortress posts results on Tuesday.

Despite the beating both stocks have taken, Wall Street analysts are overwhelmingly optimistic - not surprising since many had a hand in underwriting their IPOs.

Despite the recent shudders in the credit markets, institutional investors are likely to maintain a healthy appetite for alternative investments, according to Lehman Brothers analyst Roger Freeman.

"We believe that the alternative asset management industry, including private equity, should continue to grow. Like Fortress, we view Blackstone as a play on the growth in the alternative investments space," he wrote in a note this week.

Blackstone on Wednesday showed investors are still flocking to alternative investments when it said it raised a whopping $21.7 billion for its latest private equity fund, making it the biggest fund ever raised.

Plus, the optimists say, both firms are well positioned to withstand economic downturns - Blackstone because it's diversified and Fortress since it has a reputation for finding opportunities during times of distress.

When it began coverage of Fortress, Citigroup said, "The investment team has a reputation for being opportunistic during times of distress and we believe that management will continue to take advantage of mis-priced assets as they become available."

Still, these are risky times for both stocks. That's because it's unclear how the knock-on effects from the credit market volatility will impact their businesses.

"It takes time to let credit problems play themselves out, and for any cracks in the foundation to become known. Bargain hunting in the financial sector would be a high-risk venture at this time," said James Stack, president of InvesTech Research.

The private equity industry has already been feeling the sting of cooling debt markets, which have become more inhospitable to the aggressive financing that leveraged buyout deals rely on.

In addition, because trading for some debt securities are highly illiquid, there are concerns that the asset values at some hedge funds aren't accurate - and that they will eventually have to be marked down.

The credit markets are so misaligned that investors are in for a long period of readjustment, according to Chris Whalen, managing director of Institutional Risk Analytics. "We're still in the first inning," he said.

Companies with deep pockets may be able to wait out the turmoil, but investor appetite for risky debt is diminishing and the environment for leveraged buyouts is "clearly deteriorating," Whalen said.

Many analysts are expecting the debt financing markets to stabilize sometime after Labor Day, but there's no guarantee that will happen. And if it doesn't, Blackstone and Fortress shares could take additional hits.

Even if their businesses can withstand these problems, it's still tough to assign a value to such stocks, said Russ Lundeberg, chief investment officer of Barrett Capital Management.

"These aren't predictable and reliable revenue streams and don't lend themselves to traditional methods of valuation," he said.

That's one of the reasons analysts at boutique investment bank Keefe, Bruyette & Woods warn stocks like Fortress are "ill-suited" for investors focused on shorter-term financial results.

But like most of Wall Street, they're upbeat on the long-term prospects for Fortress, rating it an "outperform."

Whether Blackstone and Fortress end up meeting Wall Street's lofty expectations, only time will tell. What is clear is that investors had better buckle up for a rough ride.