Blackstone's year of discontent

Private equity not gone yet

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Blackstone CEO Stephen Schwarzman has seen his firm's stock value get cut in half since its IPO last year.

NEW YORK (CNNMoney.com) -- Blackstone Group isn't celebrating a happy first anniversary as a public company.

It was exactly one year ago on June 22 that the private equity giant staged the biggest U.S. public offering that the markets had seen in years, raising more than $4 billion by selling a 12.3% stake in the firm and opening up the red-hot private equity industry to everyday investors.

That day shares finished up 13% from the offering price of $31. For an encore, it announced a day before the Fourth of July that it planned to buy hotel chain Hilton for $26 billion, the biggest deal in the lodging industry ever.

But the buzz about Blackstone (BX) proved short-lived. Shares of the private equity giant plunged in the months that followed as the credit markets blew up.

The stock bottomed out at $13.40 a share on March 17 - the first trading day after JPMorgan Chase (JPM, Fortune 500) announced its dramatic last-minute rescue of Bear Stearns.

Blackstone's share price has improved since then. But at $18 a share, it is still trading more than 50% below the all-time high of $38 it hit during its first day of trading.

"For Blackstone's purposes it was absolutely the right time [to go public]," said Jackson Turner, an equity research analyst with Argus Research in New York. "For those investors that bought in at the IPO, it is understandable for them to be a little embittered."

Blackstone has failed to live up to the market's lofty expectations.

Profits in the third and fourth quarter of last year, excluding compensation charges, fell short of estimates. Blackstone reported an actual net loss in both quarters when including the compensation expenses.

And in the fourth quarter, even after backing out the compensation expenses, Blackstone reported a loss of 6 cents per share as tough conditions in the credit markets hurt results. Analysts were expecting a profit of 14 cents per share, according to Thomson Reuters.

For the second quarter, analysts are forecasting a profit of 12 cents per share, down from 46 cents a share a year ago.

By nature, Blackstone's business is notoriously volatile, which has been difficult to digest for investors accustomed to viewing steady earnings growth year in year out.

And yet the firm has taken some steps to smooth out its earnings by beefing up other areas of its business. In January, Blackstone bought GSO Capital Partners, a hedge fund that specializes in credit.

But Blackstone's bread and butter remains buying companies with the aim of overhauling their businesses and selling them at a profit or taking them public -- usually within three to five years.

Without access to cheap and easy credit, Blackstone and its peers like the Carlyle Group and KKR, which filed to go public last July, may no longer be able to deliver the outsized returns they captured in recent years from doing mega-deals.

But buyouts are happening nonetheless, albeit at a much smaller scale.

This week, Blackstone announced it was taking health care service provider Apria Healthcare Group (AHG) private for $1.6 billion, including debt.

And what may be more encouraging to investors is that the industry continues to raise an impressive amount of cash from pension funds and foreign wealth funds.

To date, buyout funds worldwide have raised nearly $301.6 billion, and could top the record $321 billion in capital raised during the first half of 2007, according to the London-based research house Private Equity Intelligence.

With all that cash and the number of undervalued companies on the rise as a result of the ongoing market turmoil, Blackstone and its peers may have plenty of takeover targets to choose from in the coming months.

"They have a little bit of wind at their backs and have hundreds of billions in dry powder," said Benjamin Phillips, managing director at New York-based Jefferies Putnam Lovell. "Guys that can find opportunities that don't need to lever up dramatically to find returns will succeed."

Blackstone's success will hinge to some extent on how management navigates the credit crunch. Stephen Schwarzman, the firm's chairman and CEO, is widely respected for his deal-making savvy.

Michael Holland, a former Blackstone executive that left the firm in 1995 who currently runs his own investment management firm Holland & Company, noted that it would be tough to bet against Schwarzman and his team even in a market climate such as this.

"The smartest and most successful have used times of turmoil to position themselves to leap forward," said Holland. "I would expect Schwarzman to take Blackstone in that direction."

But Blackstone faces more challenges as well. New accounting rules hit the company's results last quarter as it was forced to write down the value of some of its portfolio companies.

And lately, there has been renewed interest on Capitol Hill in raising taxes on carried interest - the 20 percent cut managers take when their funds make a profit.

Such a measure might only have a negligible impact on Blackstone's stock price, but it is certain to elicit a collective groan from the private-equity industry at large.

Still, some fund managers believe that Blackstone's stock could recapture the heights it once saw when it first went public.

And it may not necessarily require an impressive quarterly showing or even a major deal announcement, notes Jerry Jordan, president and portfolio manger at Hellman, Jordan Management Company, which oversees close to $800 million and runs the Jordan Opportunity Fund. All that may need to happen is for the broader market to turn around.

"I think you could easily see stock in the mid-20s based on the perception that the environment is improving," said Jordan, whose fund acquired Blackstone stock in November for around $18 a share. "This is a bet on the stock market and the financial system."