Blackstone IPO Says the Markets Have Peaked For Now

Submitted by CrossProfit

Actually it is a trifle more complicated than that.

Private equity at first was a way for the wealthy to invest differently than the common man. The ideas was to find undervalued companies and by taking them private, either split them up or fix them; either way a quick buck was to be made. At a later stage when the companies taken private were doing well, they would be sold. As market conditions improved in 2005, some of the companies taken private only years ago we offered back to the public.

Blackstone is no different. As a private company it could sell off 10% to another private company or hedge fund which for all practical purposes is one and the same today. By choosing to go down the public road, what Blackstone is saying is that equities are fully valued today, perhaps even slightly overvalued. If the market wouldn’t assign a high enough premium, Blackstone would not be thinking less doing an IPO.

What strikes as a paradox today is the apparent ease with which private equity and your average Joe hedge fund raises cash! Surely investors must know that the market is fully valued. Oddly enough, investors are willing to give their money to private equity firms that in turn feed the M&A mania. Investors’ rationale is actually simple yet simultaneously overlooks a major flaw in the logic.

Investors’ Rationale

Investors fear that a market correction which will suppress stock prices will occur again. No one knows when this will happen. Having just gone through a similar period where it took over 3 years to recoup, investors are hesitant to heed the advice of their previous advisors, primarily brokers and investment bankers. The new boys on the block, private equity, have a clean track record – at least this is the perception. The callings and promises of private equity are simplistic and readily accepted. Why hold paper (stock) when you can have the underlying asset? Simply put, the hedge funds are resonating; "buy the company not the stock". Upon a market crash, investors are left with a company that continues to do business as before. Profits are the same, dividends the same, no paper losses to look at and all is fine and dandy.

This is the major thrust today behind the majority of non corporate M&A activity. M&A activity initiated by the likes of IBM and GE is completely different in nature, style, cost and outlook.

Blackstone Shows the Flaw 

The flaw in the logic is just as simple. Just like no one can really promise an investor that a stock market crash will or will not happen, no one can guarantee that the underlying asset, the purchased company, will continue to perform as expected. In other words, if the market crashes, chances are it is due to a worsening economy. If the economy goes bad, then the privatized companies will not be generating the same profits as before. What Blackstone is pointing out to us all is that it makes no difference whether you are public or private. Upon a downturn all are effected.

I suspect that the mere notion of the Blackstone IPO has many long-time investors asking many questions before going ahead with new private placements. The second most touted tune is that "you should diversify and not put everything into the market". Again, Blackstone is pointing out that buying the company or buying the shares is really the same thing and there is no diversification here.

Also noticeable is the unprecedented scope of share buy-back programs. In Q4 2006, $105B was spent on buy-backs, exceeding M&A. This only occurs when companies can not find other viable alternatives. One logically concludes that the current M&A by private equity is found to be unattractive by corporate America. If given a choice to grow earnings per share by contraction or expansion, the latter is preferred yet the majority of the S&P 500 companies have chosen the former.

On the one hand one might erroneously conclude that this is a sign that a stock is undervalued. In reality, by reducing the outstanding shares when the PE is less than the going interest rate, all the buy-backs are saying is that the bond market is correct and that interests rates are not going to go much higher.

On the other hand one might erroneously conclude that all IPOs and all buy-backs are sending the same message. Each case still has to be scrutinized carefully as there are many exceptions to the rule.

Disclosure: This is the opinion of Saul Sterman, CEO CrossProfit and is not the consensus at CrossProfit.com.