UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
| x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2008 |
OR
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO |
Commission File Number: 001-33551
The Blackstone Group L.P.
(Exact name of Registrant as specified in its charter)
| Delaware | 20-8875684 | |
| (State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) |
345 Park Avenue
New York, New York 10154
(Address of principal executive offices)(Zip Code)
(212) 583-5000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class |
Name of each exchange on which registered | |
| Common units representing limited partner interests | New York Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein and will not be contained, to the best of the Registrant’s knowledge, in the definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer x |
Accelerated filer ¨ | |
| Non-accelerated filer ¨ (do not check if a smaller reporting company) |
Smaller reporting company ¨ |
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
The aggregate market value of the common units of the Registrant as of June 30, 2008 was approximately $4,679.6 million, which includes non-voting common units with a value of approximately $1,845.3 million.
The number of the Registrant’s voting common units representing limited partner interests outstanding as of February 20, 2009 was 157,618,895. The number of the Registrant’s non-voting common units representing limited partner interests outstanding as of February 20, 2009 was 109,083,468.
DOCUMENTS INCORPORATED BY REFERENCE
None
| Page | ||||
| ITEM 1. |
5 | |||
| ITEM 1A. |
17 | |||
| ITEM 1B. |
50 | |||
| ITEM 2. |
50 | |||
| ITEM 3. |
50 | |||
| ITEM 4. |
51 | |||
| ITEM 5. |
52 | |||
| ITEM 6. |
55 | |||
| ITEM 7. |
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
57 | ||
| ITEM 7A. |
91 | |||
| ITEM 8. |
94 | |||
| ITEM 8A. |
UNAUDITED SUPPLEMENTAL PRESENTATION OF STATEMENTS OF FINANCIAL CONDITION |
148 | ||
| ITEM 9. |
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES |
151 | ||
| ITEM 9A. |
151 | |||
| ITEM 9B. |
152 | |||
| ITEM 10. |
153 | |||
| ITEM 11. |
158 | |||
| ITEM 12. |
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS |
176 | ||
| ITEM 13. |
CERTAIN RELATIONSHIPS, RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE |
179 | ||
| ITEM 14. |
185 | |||
| ITEM 15. |
187 | |||
| 192 | ||||
2
Forward-Looking Statements
This report may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 which reflect our current views with respect to, among other things, our operations and financial performance. You can identify these forward-looking statements by the use of words such as “outlook,” “believes,” “expects,” “potential,” “continues,” “may,” “will,” “should,” “seeks,” “approximately,” “predicts,” “intends,” “plans,” “estimates,” “anticipates” or the negative version of these words or other comparable words. Such forward-looking statements are subject to various risks and uncertainties. Accordingly, there are or will be important factors that could cause actual outcomes or results to differ materially from those indicated in these statements. We believe these factors include but are not limited to those described under section entitled “Risk Factors” in this report, as such factors may be updated from time to time in our periodic filings with the SEC, which are accessible on the SEC’s website at www.sec.gov. These factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included in this report and in our other periodic filings. We undertake no obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise.
In this report, references to “Blackstone,” “we,” “us” or “our” refer (1) prior to the consummation of our reorganization into a holding partnership structure in June 2007 as described under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Significant Transactions—Reorganization”, to Blackstone Group, which comprised certain consolidated and combined entities historically under the common ownership of (a) our two founders, Mr. Stephen A. Schwarzman and Mr. Peter G. Peterson, and our other senior managing directors, (b) selected other individuals engaged in some of our businesses and (c) a subsidiary of American International Group, Inc., to whom we refer collectively as our “predecessor owners” or “pre-IPO owners,” and (2) after our reorganization, to The Blackstone Group L.P. and its consolidated subsidiaries. Unless the context otherwise requires, references in this report to the ownership of our founders and other Blackstone personnel include the ownership of personal planning vehicles and family members of these individuals.
“Blackstone Funds,” “our funds” and “our investment funds” refer to the corporate private equity funds, real estate funds, funds of hedge funds, credit-oriented funds, CLOs, and closed-end mutual funds that are managed by Blackstone. “Our carry funds” refer to the corporate private equity funds, real estate funds and certain of the credit-oriented funds (with multi-year draw down, commitment-based structures that only receive carry on the realization of an investment) that are managed by Blackstone. “Our hedge funds” refer to our funds of hedge funds, our real estate special situations fund and our other credit-oriented funds that are managed by Blackstone.
“Assets under management” refers to the assets we manage. Our assets under management equals the sum of:
| (1) | the fair value of the investments held by our carry funds plus the capital that we are entitled to call from investors in those funds pursuant to the terms of their capital commitments to those funds (plus the fair value of co-investments arranged by us that were made by limited partners of our funds in portfolio companies of such funds and as to which we receive fees or a carried interest allocation); |
| (2) | the net asset value of our funds of hedge funds, certain of our credit-oriented funds (where an investor’s investment is funded upon subscription and incentive fees or allocations are generally paid or allocated, as applicable, annually) and our closed-end mutual funds; and |
| (3) | the amount of capital raised for our CLOs. |
3
“Fee-earning assets under management” refers to the assets we manage on which we derive management fees. Our fee-earning assets under management equal the sum of:
| (1) | for our carry funds where the investment period has not expired, the amount of capital commitments; |
| (2) | for our carry funds where the investment period has expired, the remaining amount of invested capital; |
| (3) | the fair value of co-investments arranged by us that were made by limited partners of our funds in portfolio companies of such funds and as to which we receive fees; |
| (4) | the net asset value of our hedge funds and our closed-end mutual funds; and |
| (5) | the gross amount of assets of our CLOs. |
Our calculations of assets under management and fee-earning assets under management may differ from the calculations of other asset managers, and as a result this measure may not be comparable to similar measures presented by other asset managers. In addition, our calculation of assets under management includes commitments to and the fair value of invested capital in our funds from Blackstone and our personnel regardless of whether such commitments or invested capital are subject to fees. Our definitions of assets under management or fee-earning assets under management are not based on any definition of assets under management or fee-earning assets under management that is set forth in the agreements governing the investment funds that we manage.
For our carry funds, total assets under management includes the fair value of the investments held whereas fee-earning assets under management includes the amount of capital commitments or the remaining amount of invested capital at cost depending on whether the investment period has or has not expired. As such, fee-earning assets under management may be greater than total assets under management when the aggregate fair value of the remaining investments is less than the cost of those investments.
4
| ITEM 1. | BUSINESS |
Overview
Blackstone is a leading global alternative asset manager and provider of financial advisory services. We are one of the largest independent alternative asset managers in the world, with assets under management of $94.56 billion as of December 31, 2008. Our alternative asset management businesses include the management of corporate private equity funds, real estate funds, funds of hedge funds, credit-oriented funds, collateralized loan obligation (“CLO”) vehicles and publicly-traded closed-end mutual funds. We also provide a wide range of financial advisory services, including corporate and mergers and acquisitions advisory, restructuring and reorganization advisory and fund placement services.
We seek to deliver superior returns to investors in our funds through a disciplined, value-oriented investment approach. Since we were founded in 1985, we have cultivated strong relationships with clients in our financial advisory business, where we endeavor to provide objective and insightful solutions and advice that our clients can trust. We believe our scaled, diversified businesses, coupled with our long track record of investment performance, proven investment approach and strong client relationships, position us to continue to perform well in a variety of market conditions, expand our assets under management and add complementary businesses. Moreover, our businesses have yielded a significant positive impact on society through, for example, increases in employment, additional capital investment and research and development expense by our portfolio companies, increased tax revenue to federal and local governments and additional retirement benefits to pensioners.
Over the past several years we have invested in augmenting our credit investment platform, expanding our Asia operations and building a top operations management group. In early 2008, we purchased GSO Capital Partners LP (“GSO”) to produce what we believe is one of the dominant credit investment platforms in the industry today and is, we believe, especially well positioned to grow in the current economic environment. In the last four years we have opened offices in India, China and Japan to extend our investment prowess in Asia as well as to service the increasingly global demands of our advisory clients. Our operations management group, which is particularly focused on driving value in our portfolio companies in our corporate private equity segment, seeks to create operational improvements to our investments in a multitude of ways. These improvements are aimed at value creation which, we believe, not only benefits the investors in our investment funds but contributes to economic growth and productivity.
As of December 31, 2008, we had 90 senior managing directors and employed approximately 535 other investment and advisory professionals at our headquarters in New York and our offices in Atlanta, Beijing, Boston, Chicago, Dallas, Hong Kong, Houston, London, Los Angeles, Menlo Park, Mumbai, Paris, San Francisco and Tokyo. We believe that the depth and breadth of the intellectual capital and experience of our professionals are key reasons why we have generated excellent returns while managing downside risk over many years for the investors in our funds. This track record in turn has allowed us to successfully and repeatedly raise additional assets from an increasingly wide variety of sophisticated investors.
Business Segments
Our four business segments are: (1) Corporate Private Equity, (2) Real Estate, (3) Marketable Alternative Asset Management, which comprises our management of funds of hedge funds, credit-oriented funds, CLOs and publicly-traded closed-end mutual funds, and (4) Financial Advisory, which comprises our corporate and mergers and acquisitions advisory services, restructuring and reorganization advisory services and Park Hill Group, which provides fund placement services for alternative investment funds.
Information about our business segments should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the historical financial statements and related notes included elsewhere in this Form 10-K.
5
Corporate Private Equity Segment
Our Corporate Private Equity segment, established in 1987, is a global business with approximately 110 investment professionals and offices in New York, London, Menlo Park, Mumbai, Hong Kong and Beijing. We are a world leader in private equity investing, having managed five general private equity funds as well as one specialized fund focusing on communications-related investments. In addition, we are in the process of raising our seventh private equity fund and are seeking to launch complementary investment funds to separately target investments in each of the infrastructure and clean technology asset classes. From an operation focused in our early years on consummating leveraged buyout acquisitions of U.S.-based companies, we have grown into a business pursuing transactions throughout the world and executing not only typical leveraged buyout acquisitions of seasoned companies but also transactions involving growth equity or start-up businesses in established industries, minority investments, corporate partnerships, distressed debt, structured securities and industry consolidations, in all cases in strictly friendly transactions. Our Corporate Private Equity segment’s multi-dimensional investment approach is guided by several core investment principles: corporate partnerships, sector expertise, a contrarian bias (e.g., investing in out-of-favor / under-appreciated industries), global scope, distressed securities investing, significant number of exclusive opportunities, superior financing expertise, operations oversight and a strong focus on value creation. As of December 31, 2008, our Corporate Private Equity segment had $23.93 billion of assets under management, or 25% of our total assets under management. For more information concerning the revenues and fees we derive from our Corporate Private Equity segment, see “—Incentive Arrangements / Fee Structure” in this Item 1.
Real Estate Segment
We are a world leader in real estate investing, having managed as of December 31, 2008, a total of six general real estate funds, two internationally focused real estate funds, a European focused real estate fund and a special situations real estate fund that is focused primarily on debt and non-controlling equity investments in the real estate sector. Our real estate funds have made significant investments in lodging, major urban office buildings and a variety of real estate operating companies. The Real Estate segment is comprised of approximately 75 investment professionals with offices in New York, Chicago, London, Paris, Mumbai, Tokyo, and Hong Kong. Our Real Estate segment’s investing approach is guided by several core investment principles, many of which are similar to our Corporate Private Equity segment, including global scope, significant number of exclusive opportunities, superior financing expertise, operations oversight and a strong focus on value creation. As of December 31, 2008, our Real Estate segment had $24.15 billion of assets under management, or 26% of our total assets under management. For more information concerning the revenues and fees we derive from our Real Estate segment, see “—Incentive Arrangements / Fee Structure” in this Item 1.
Marketable Alternative Asset Management Segment
Our Marketable Alternative Asset Management segment comprises our funds of hedge funds, credit-oriented funds, CLO vehicles and publicly-traded closed-end mutual funds. As of December 31, 2008, our Marketable Alternative Asset Management segment had $46.47 billion of assets under management, or 49% of our total assets under management. For more information concerning the revenues and fees we derive from our Marketable Alternative Asset Management segment, see “—Incentive Arrangements / Fee Structure” in this Item 1.
Funds of hedge funds. Our funds of hedge funds group was organized in 1990 and manages a variety of funds of hedge funds. Working with our clients over the past eighteen years, our funds of hedge funds group has developed into a leading manager of institutional funds of hedge funds with approximately 85 investment professionals and offices in New York, London and Hong Kong. Our funds of hedge funds group’s overall investment philosophy is to utilize leading non-traditional investment managers to achieve attractive risk-adjusted returns with relatively low volatility and low correlation to traditional asset classes. Diversification, risk management, due diligence and a focus on downside protection are key tenets of our approach. Our funds of hedge funds operation had $23.09 billion of assets under management as of December 31, 2008.
6
Credit-oriented funds / CLOs. Our credit-oriented funds are managed under the brand of GSO Capital Partners, which we acquired in March 2008. Our CLO vehicles are managed by GSO under the GSO Capital Partners and Blackstone brands. As a result of the GSO acquisition, we have grown to become a major participant in the leveraged finance markets with $22.64 billion of assets under management as of December 31, 2008. The credit-oriented businesses have approximately 105 investment professionals and offices in New York, London and Houston. The credit-oriented funds we manage include senior credit-oriented funds, distressed debt funds, mezzanine funds and general credit-oriented funds focused on the leveraged finance marketplace. Those funds have investment portfolios comprised of securities spread across the capital structure, including senior debt, subordinated debt, preferred stock and common equity. GSO is responsible for managing 25 separate CLO vehicles with total assets under management of approximately $14.07 billion focused primarily in senior secured bank debt issued by a diverse universe of non-investment grade companies.
Effective December 31, 2008, we executed a restructuring of two single manager proprietary hedge funds. We consolidated our Blackstone distressed debt hedge fund onto a single operating platform with our funds managed by GSO to eliminate duplication, benefit from shared intellectual capital and better serve the investors in that fund. The Blackstone distressed debt hedge fund had $754.2 million of assets under management as of December 31, 2008, at which time we commenced the process of liquidating the prior fund in an orderly fashion. We also decided to spin out our equity hedge fund business to its management team. As of December 31, 2008, the equity hedge fund had $825.9 million in assets, at which time we also commenced the process of liquidating the prior fund in an orderly fashion. The investors of both funds have the option of reinvesting their proceeds in GSO vehicles (in the case of the distressed hedge fund) and a new equity hedge fund unaffiliated with Blackstone (in the case of the equity hedge fund).
Closed-End Mutual Funds. In 2005, we were appointed the investment manager and adviser of two publicly-traded closed-end mutual funds called The India Fund and The Asia Tigers Fund. The India Fund, with $671.1 million in assets under management as of December 31, 2008, trades on the New York Stock Exchange under the symbol “IFN.” The India Fund’s investment objective is long-term capital appreciation through investing primarily in the equity securities of Indian companies. The Asia Tigers Fund, with $49.1 million in assets under management as of December 31, 2008, trades on the New York Stock Exchange under the symbol “GRR.” The Asia Tigers Fund’s investment objective is long-term capital appreciation through investing primarily in the equity securities of Asian companies.
Financial Advisory Segment
Our Financial Advisory segment comprises our corporate and mergers and acquisitions advisory services, restructuring and reorganization advisory services and Park Hill Group, which provides fund placement services for alternative investment funds. Our financial advisory businesses are global businesses with approximately 190 professionals and offices in New York, Atlanta, Chicago, Dallas, Boston, Los Angeles, San Francisco, Menlo Park, London, Hong Kong, Beijing and Tokyo.
Corporate and Mergers and Acquisitions Advisory Services. Our corporate and mergers and acquisitions advisory operation has been an independent provider of financial and corporate and mergers and acquisitions advisory services for over 23 years. We provide financial and corporate and mergers and acquisitions advisory services with a wide range of transaction execution capability with respect to acquisitions, mergers, joint ventures, minority investments, asset swaps, divestitures, takeover defenses and distressed sales as well as other forms of reorganization with offices in New York, London, Hong Kong, Atlanta, Boston, Menlo Park and Beijing. Some recent clients include American International Group, Inc., Aquila, Inc., Genworth Financial, Inc., Kraft Foods, Microsoft Corporation, Nisource, Inc., Pennsylvania Insurance Commission, The Procter & Gamble Company, Reuters Group PLC, Sony Corporation, and Suez S.A. The success of our corporate and mergers and acquisitions advisory services has resulted from a highly experienced team focused on our core principles, including protecting client confidentiality, prioritizing our client’s interests, avoidance of conflicts and senior-level attention. The 17 senior managing directors in our corporate and mergers and acquisitions services group have an average of 20 years of experience in providing financial and mergers and acquisitions advice.
7
Restructuring and Reorganization Advisory Services. Our restructuring and reorganization advisory operation is one of the leading advisers to companies and creditors in restructurings and bankruptcies with offices in New York and London. Our restructuring and reorganization advisory services clients include companies, creditors, corporate parents, hedge funds, financial sponsors and acquirers of troubled companies. This operation is particularly active in large, complex and high-profile bankruptcies and restructurings. Some of the debtor clients that we have advised include Delta Air Lines, Enron, Global Crossing, W.R. Grace, Mirant, and Winn-Dixie Stores in their Chapter 11 reorganizations. In addition to restructuring advice, the group has provided general advice to General Motors, Goodyear, the Government of Ukraine, Northern Rock plc and Xerox. Senior-level attention and the ability to facilitate prompt resolutions are critical ingredients in our restructuring and reorganization advisory approach. We believe we have one of the most seasoned and experienced restructuring and reorganization advisory operations in the financial services industry, working on a significant share of all major restructuring assignments. Our nine senior managing directors in this area have an average of 20 years of experience in restructuring assignments and employ the skills we feel are crucial to successful restructuring assignments.
Park Hill Group. Park Hill Group provides fund placement services for corporate private equity funds, real estate funds, venture capital funds and hedge funds. Park Hill Group primarily provides placement services to unrelated third-party sponsored funds. It also assists us in raising capital for our own investment funds from time to time and providing insights into new alternative asset products and trends. Park Hill Group has approximately 90 employees and offices in New York, Chicago, Dallas, London, Los Angeles, San Francisco, and Tokyo. Park Hill Group and our investment funds each benefit from the others’ relationships with both limited partners and other fund sponsors.
Financial and Other Information by Segment
The following table illustrates Fee-Earning Assets Under Management and the percentage of total Fee-Earning Assets Under Management on a segment basis at December 31, 2008, 2007 and 2006:
| Fee-Earning Assets Under Management | ||||||||||||||||||
| At December 31, | % of Total | |||||||||||||||||
| 2008 | 2007 | 2006 | 2008 | 2007 | 2006 | |||||||||||||
| (Dollars in Thousands) | ||||||||||||||||||
| Corporate Private Equity |
$ | 25,509,163 | $ | 25,040,513 | $ | 21,122,326 | 28 | % | 30 | % | 38 | % | ||||||
| Real Estate |
22,970,438 | 18,637,673 | 9,084,168 | 25 | % | 22 | % | 17 | % | |||||||||
| Marketable Alternative Asset Management |
42,561,456 | 39,474,067 | 24,588,966 | 47 | % | 48 | % | 45 | % | |||||||||
| $ | 91,041,057 | $ | 83,152,253 | $ | 54,795,460 | 100 | % | 100 | % | 100 | % | |||||||
Financial and other information by segment for the years ended December 31, 2008, 2007 and 2006 is set forth in Note 14 to our consolidated and combined financial statements.
Investment Process and Risk Management
We maintain a rigorous investment process across all of our funds. Each fund has investment policies and procedures that generally contain requirements and limitations for investments, such as limitations relating to the amount that will be invested in any one investment and the types of industries or geographic regions in which the fund will invest.
Corporate Private Equity Funds
Our Corporate Private Equity investment professionals are responsible for selecting, evaluating, structuring, diligencing, negotiating, executing, managing and exiting investments, as well as pursuing operational improvements and value creation. After an initial selection, evaluation and diligence process, the relevant team of investment professionals will present a proposed transaction at a weekly review committee meeting comprised of
8
the senior managing directors of our Corporate Private Equity segment, a number of whom participate in each weekly meeting. Review committee meetings are co-chaired by our President and Chief Operating Officer, Hamilton E. James, and senior managing director, Garrett M. Moran. After discussing the contemplated transaction with the deal team, the review committee decides whether to give its preliminary approval to the deal team to continue the selection, evaluation, diligence and negotiation process and provides guidance on strategy, process and other pertinent considerations.
Once a proposed transaction has reached a more advanced stage, it undergoes a detailed interim review by the review committee of our corporate private equity funds. Members of the review committee provide guidance to the deal team on strategy, process and other pertinent considerations. Following assimilation of the review committee’s input and its decision to proceed with a proposed transaction, the proposed investment is vetted by the investment committee. The investment committee of our corporate private equity funds is comprised of certain members of our senior management, including Stephen A. Schwarzman and Hamilton E. James, and the senior managing directors of our Corporate Private Equity segment. The investment committee is responsible for approving all investment decisions made on behalf of our corporate private equity funds. Both the review committee and the investment committee processes involve a consensus approach to decision making among committee members.
The investment professionals of our corporate private equity funds are responsible for monitoring an investment once it is made and for making recommendations with respect to exiting an investment. In addition to members of a deal team and our portfolio operations group, which is responsible for monitoring and assisting in enhancing portfolio companies’ operations and value, all professionals in the Corporate Private Equity segment meet several times each year to review the performance of the funds’ portfolio companies.
Real Estate Funds
Our real estate operation has an investment committee similar to that described under “—Corporate Private Equity Funds.” The real estate investment committee, which includes Stephen A. Schwarzman, Hamilton E. James, Kenneth C. Whitney and the senior managing directors in the Real Estate segment, scrutinizes potential transactions, provides guidance and instructions at the appropriate stage of each transaction and approves the making of each investment as well as each disposition.
The investment professionals of our real estate funds are responsible for monitoring an investment once it is made and for making recommendations with respect to exiting an investment. In addition to members of a deal team and our asset management group responsible for monitoring and assisting in enhancing portfolio companies’ operations and value, senior professionals in the Real Estate segment meet several times each year to review the performance of the funds’ portfolio companies.
Marketable Alternative Asset Management
Funds of Hedge Funds
Before deciding to invest in a new hedge fund, our funds of hedge funds team conducts extensive due diligence, including an on-site “front office” review of the hedge fund’s performance, investment terms, investment strategy and investment personnel, a “back office” review of the hedge fund’s operations, processes, risk management and internal controls, industry reference checks and a legal review of the fund investment structures and legal documents. Once initial due diligence procedures are completed and the investment professionals are satisfied with the results of the review, the team will present the potential hedge fund investment to the investment committee of our funds of hedge funds operation. The investment committee is comprised of the senior managing directors on the investment team and other senior investment personnel. This committee meets formally at least once a month to review, and potentially approve, investment and divestment suggestions. If the investment committee approves a potential hedge fund investment, the executive committee of
9
our funds of hedge funds operation, chaired by J. Tomilson Hill, will make the ultimate decision to approve an investment decision. Members of our funds of hedge funds team monitor and review existing hedge fund investments at least weekly.
Credit-Oriented Funds and CLOs
Each of our credit-oriented funds has an investment committee similar to that described under “—Corporate Private Equity Funds.” The investment committees for the credit-oriented funds, each of which includes Bennett J. Goodman, J. Albert Smith III and Douglas I. Ostrover and senior members of the respective investment teams associated with each fund, review potential transactions, provide input regarding the scope of due diligence and approve recommended investments and dispositions. These investment committees have delegated certain abilities to approve investments and dispositions to credit committees within each operation which consist of the senior members of the respective investment teams associated with each fund. In addition, senior members of GSO, including Bennett J. Goodman, J. Albert Smith III and Douglas I. Ostrover, meet weekly with Stephen A. Schwarzman, Hamilton E. James and Garrett M. Moran to discuss investment and risk management activities and market conditions.
An investment in any new CLO security is subject to approval by the CLO Investment Committee, which is composed of the group’s Senior Managing Directors and Managing Directors. The CLO investment team is staffed by 36 professionals, organized across areas of research, portfolio management, trading, and capital formation to ensure active management of the portfolios and to afford focus on all aspects of our CLOs. Investment decisions follow a consensus based approach and require unanimous approval of the Investment Committee. Industry focused research analysts provide the committee with a formal and comprehensive review of any new investment recommendation, while our portfolio managers and trading professionals provide opinions on other technical aspects of the recommendation. Once approved, investments are subject to predetermined periodic reviews to assess their continued fit within the funds. Our research team constantly monitors the operating performance of the underlying issuers, while portfolio managers, in concert with our traders, focus on optimizing asset composition to maximize value for CLO investors.
Structure and Operation of Our Investment Funds
We conduct the sponsorship and management of our carry funds and other similar vehicles primarily through a partnership structure in which limited partnerships organized by us accept commitments and/or funds for investment from institutional investors and (to a limited extent) high net worth individuals. Such commitments are generally drawn down from investors on an as needed basis to fund investments over a specified term. All of our corporate private equity and real estate funds are commitment structured funds, except for our special situations real estate fund that has a permanent capital feature that initially draws upon commitments from investors but then can dispose of investments and reuse the related capital like a hedge fund subject to certain investor withdrawal rights. Our credit-oriented funds may be commitment structured funds or hedge funds where the investor’s capital is fully funded into the fund upon the subscription for interests in the fund. Most of our funds of hedge funds are structured as funds where the investor’s capital is fully funded into the fund upon the subscription for interests in the fund. Our investment funds are generally organized as limited partnerships with respect to U.S. domiciled vehicles and limited liability (and other similar) companies with respect to non-U.S. domiciled vehicles.
Our investment funds generally have an investment adviser, which is registered under the Investment Advisers Act of 1940, or “Advisers Act.” Substantially all of the responsibility for the day-to-day operations of the investment funds is typically delegated to the investment funds’ respective investment advisers pursuant to an investment advisory (or similar) agreement. Generally, the material terms of our investment advisory agreements relate to the scope of services to be rendered by the investment adviser to the applicable investment funds, the calculation of management fees to be borne by investors in our investment funds, the calculation of and the manner and extent to which other fees received by the investment adviser from fund portfolio companies serve to
10
offset or reduce the management fees payable by investors in our investment funds and certain rights of termination with respect to our investment advisory agreements. For a discussion of the management fees to which our investment advisers are entitled across our various types of investment funds, please see “—Incentive Arrangements / Fee Structure” below. The investment funds themselves do not generally register as investment companies under the U.S. Investment Company Act of 1940, or “1940 Act,” in reliance on Section 3(c)(7) or Section 7(d) thereof or, typically in the case of funds formed prior to 1997, Section 3(c)(1) thereof. Section 3(c)(7) of the 1940 Act excepts from its registration requirements investment funds privately placed in the United States whose securities are owned exclusively by persons who, at the time of acquisition of such securities, are “qualified purchasers.” Section 3(c)(1) of the 1940 Act excepts from its registration requirements privately placed investment funds whose securities are beneficially owned by not more than 100 persons. In addition, under current interpretations of the SEC, Section 7(d) of the 1940 Act exempts from registration any non-U.S. investment fund all of whose outstanding securities are beneficially owned either by non-U.S. residents or by U.S. residents that are qualified purchasers.
In addition to having an investment adviser, each investment fund that is a limited partnership, or “partnership” fund, also has a general partner that makes all policy and investment decisions relating to the conduct of the investment fund’s business. Furthermore, all decisions concerning the making, monitoring and disposing of investments are made by the general partner. The limited partners of the partnership funds take no part in the conduct or control of the business of the investment funds, have no right or authority to act for or bind the investment funds and have no influence over the voting or disposition of the securities or other assets held by the investment funds. These decisions are made by the investment fund’s general partner in its sole discretion. With the exception of certain of our funds of hedge funds and certain credit-oriented funds, third-party investors in our funds have the right to remove the general partner of the fund or to accelerate the liquidation date of the investment fund without cause by a simple majority vote. In addition, the governing agreements of our investment funds enable investors in those funds to vote to terminate the investment period by a simple majority vote in accordance with specified procedures or accelerate the withdrawal of their capital on an investor-by-investor basis in the event certain “key persons” in our investment funds do not meet specified time commitments with regard to managing the fund (for example, both of Stephen A. Schwarzman and Hamilton E. James in the case of our corporate private equity funds).
Incentive Arrangements / Fee Structure
The investment adviser of each of our carry funds generally receives an annual management fee that ranges from 1.0% to 2.0% of the investment fund’s capital commitments during the investment period and at least 0.75% of invested capital after the investment period, except that the investment advisers to certain of our credit-oriented carry funds receive an annual management fee that ranges from 1.0% to 1.5% of invested capital throughout the term of the fund. The investment adviser of each of our credit-oriented funds that is structured like a hedge fund generally receives an annual management fee that ranges from 1.5% to 2.0% of the fund’s net asset value and for general partners or similar entities a performance-based allocation fee (or similar incentive fee) equal to 20% of the applicable fund’s net capital appreciation per annum, subject to certain net loss carry-forward provisions (known as a “highwater mark”). The investment adviser of each of our funds of hedge funds is generally entitled to a management fee with respect to each fund it manages ranging from 0.75% to 1.5% of assets under management per annum plus, in some cases, an incentive fee generally ranging from 5% to 10% of the applicable fund’s net appreciation per annum, subject to a highwater mark and in some cases a preferred return. The investment adviser of each of our CLOs receives annual management fees typically equal to 0.50% to 1.25% of each fund’s total assets, generally with additional management fees which are incentive based (that is, subject to meeting certain return criteria). The investment adviser of each of our closed-end mutual funds receives an annual management fee that ranges from 0.75% to 1.1% depending on the amount of assets in the applicable fund. The management fees we receive from our carry funds are payable on a regular basis (typically quarterly) in the contractually prescribed amounts noted above over the life of the fund and do not depend on the investment performance of the fund. The management fees received by our hedge funds have similar characteristics, except that such funds often afford investors increased liquidity through annual, semi-annual or
11
quarterly withdrawal or redemption rights following the expiration of a specified period of time when capital may not be withdrawn (typically between one and three years) and the amount of management fees to which the investment adviser is entitled with respect thereto will proportionately increase as the net asset value of each investor’s capital account grows and will proportionately decrease as the net asset value of each investor’s capital account decreases. Our ability to generate performance fees and allocations is an important element of our business and these items have historically accounted for a very significant portion of our income.
The general partner or an affiliate of each of our carry funds also receives carried interest from the investment fund. Carried interest entitles the general partner (or an affiliate) to a preferred allocation of income and gains from a fund. The carried interest is typically structured as a net profits interest in the applicable fund. In the case of our carry funds, carried interest is calculated on a “realized gain” basis, and each general partner is generally entitled to a carried interest equal to 20% of the net realized income and gains (generally taking into account unrealized losses) generated by such fund, except that the general partner of one of our credit-oriented carry funds is entitled to a carried interest equal to 15%. Net realized income or loss is not netted between or among funds. For most carry funds, the carried interest is subject to an annual preferred limited partner return ranging from 7.0% to 10.0%, subject to a catch-up allocation to the general partner. If, at the end of the life of a carry fund, as a result of diminished performance of later investments in a carry fund’s life, the carry fund has not achieved investment returns that (in most cases) exceed the preferred return threshold or (in all cases) the general partner receives in excess of 20% (15% in the case of one of our credit-oriented carry funds) of the fund’s net profits over the life of the fund, we will be obligated to repay an amount equal to the carried interest that was previously distributed to us that exceeds the amounts to which we are ultimately entitled. This obligation is known as a “clawback” obligation and is an obligation of any person who directly received such carried interest, including us and our employees who participate in our carried interest plans. Although a portion of any distributions by us to our unitholders may include any carried interest received by us, we do not intend to seek fulfillment of any clawback obligation by seeking to have our unitholders return any portion of such distributions attributable to carried interest associated with any clawback obligation. The clawback obligation operates with respect to a given carry fund’s own net investment performance only and performance fees of other funds are not netted for determining this contingent obligation. Moreover, although a clawback obligation is several, the governing agreements of most of our funds provide that to the extent another recipient of carried interest (such as a current or former employee) does not fund his or her respective share, then we and our employees who participate in such carried interest plans may have to fund additional amounts (generally up to an additional 50%) beyond what we actually received in carried interest, although we will retain the right to pursue any remedies that we have under such governing agreements against those carried interest recipients who fail to fund their obligations. Despite the fact that since the inception of the funds, the general partners have not been required to make a cash clawback payment, we have recorded a contingent repayment obligation equal to the amount that would be due on December 31, 2008, if the various carry funds were liquidated at their current carrying value. Our ability to generate carried interest is an important element of our business and carried interest has historically accounted for a very significant portion of our income.
For additional information concerning the clawback obligations we could face, see “—Item 1A. Risk Factors, We may not have sufficient cash to pay back ‘clawback’ obligations if and when they are triggered under the governing agreements with our investors.”
Many of our investment advisors receive customary transaction fees upon consummation of many of the funds’ acquisition transactions, receive monitoring fees from many of their portfolio companies following acquisition, and may from time to time receive disposition and other fees in connection with their activities. The transaction fees which they receive are generally calculated as a percentage (that generally can range up to 1%) of the total enterprise value of the acquired entity. Our carry funds are required to reduce the management fees charged to their limited partner investors by 50% to 100% of such transaction fees and certain other fees that they receive.
12
Capital Invested In and Alongside Our Investment Funds
To further align our interests with those of investors in our investment funds, we have invested the firm’s capital and that of our personnel in the investment funds we sponsor and manage. Minimum general partner capital commitments to our investment funds are determined separately with respect to our investment funds and, generally, are less than 5% of the assets of any particular fund. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Our Sources of Cash and Liquidity Needs” for more information regarding our minimum general partner capital commitments to our funds. We determine whether to make general partner capital commitments to our funds in excess of the minimum required commitments based on a variety of factors, including estimates regarding liquidity over the estimated time period during which commitments will be funded, estimates regarding the amounts of capital that may be appropriate for other opportunities or other funds we may be in the process of raising or are considering raising, prevailing industry standards with respect to sponsor commitments and our general working capital requirements. In some cases, we require our senior managing directors and other professionals to fund a portion of the general partner capital commitments to our funds. In other cases, we may from time to time on an annual basis offer to our senior managing directors and employees a part of the general partner commitments to our investment funds. Our general partner capital commitments are funded with cash and not with carried interest.
Investors in many of our funds also receive the opportunity to make additional “co-investments” with the investment funds. Our senior managing directors and employees, as well as Blackstone itself, also have the opportunity to make co-investments, which we refer to as “side-by-side investments,” with many of our carry funds. Co-investments and side-by-side investments are investments in portfolio companies or other assets on the same terms and conditions as those acquired by the applicable fund. Co-investments refer to investments arranged by us that are made by our limited partner investors (and other investors in some instances) in a portfolio company or other assets alongside an investment fund. In certain cases, such co-investments may involve additional manager fees or carried interest. Side-by-side investments are similar to co-investments but are made pursuant to a binding election, subject to certain limitations, submitted in January of each year for the estimated activity during the ensuing 12 months under which the senior managing directors, employees and certain affiliates of Blackstone, as well as Blackstone itself, are permitted to make investments alongside a particular carry fund in all transactions of that fund for that year. Our side-by-side investments are funded in cash and are not generally subject to management fees or carried interest.
Competition
The asset management and financial advisory industries are intensely competitive, and we expect them to remain so. We compete both globally and on a regional, industry and niche basis. We compete on the basis of a number of factors, including investment performance, transaction execution skills, access to capital, reputation, range of products and services, innovation and price.
Asset Management. We face competition both in the pursuit of outside investors for our investment funds and in acquiring investments in attractive portfolio companies and making other investments. Depending on the investment, we face competition primarily from other private equity funds, specialized investment funds, hedge fund sponsors, other financial institutions including sovereign wealth funds, corporate buyers and other parties. Many of these competitors in some of our businesses are substantially larger and have considerably greater financial, technical and marketing resources than are available to us. Several of these competitors have recently raised, or are expected to raise, significant amounts of capital and many of them have similar investment objectives to us, which may create additional competition for investment opportunities. Some of these competitors may also have a lower cost of capital and access to funding sources that are not available to us, which may create competitive disadvantages for us with respect to investment opportunities. In addition, some of these competitors may have higher risk tolerances, different risk assessments or lower return thresholds, which could allow them to consider a wider variety of investments and to bid more aggressively than us for investments that we want to make. Corporate buyers may be able to achieve synergistic cost savings with regard to an
13
investment that may provide them with a competitive advantage in bidding for an investment. Lastly, any increase in the allocation of amounts of capital to alternative investment strategies by institutional and individual investors could well lead to a reduction in the size and duration of pricing inefficiencies that many of our investment funds seek to exploit.
Financial Advisory. Our competitors are other advisory, investment banking and financial firms. Our primary competitors in our financial advisory business are large financial institutions, many of which have far greater financial and other resources and much broader client relationships than us and (unlike us) have the ability to offer a wide range of products, from loans, deposit-taking and insurance to brokerage and a wide range of investment banking services, which may enhance their competitive position. Our competitors also have the ability to support investment banking, including financial advisory services, with commercial banking, insurance and other financial services revenue in an effort to gain market share, which puts us at a competitive disadvantage and could result in pricing pressures that could materially adversely affect our revenue and profitability. In the current market environment, we are also seeing increased competition from independent boutique advisory firms focused primarily on mergers and acquisitions advisory and/or restructuring services. In addition, Park Hill Group operates in a highly competitive environment and the barriers to entry into the fund placement business are low.
Competition is also intense, particularly from independent boutique advisory firms, for the attraction and retention of qualified employees. Our ability to continue to compete effectively in our businesses will depend upon our ability to attract new employees and retain and motivate our existing employees.
For additional information concerning the competitive risks that we face, see “Item 1A. Risk Factors—Risks Related to Our Asset Management Business—The asset management business is intensely competitive” and “—Risks Related to Our Financial Advisory Business—We face strong competition from other financial advisory firms”.
Employees
As of December 31, 2008, we employed approximately 1,340 people, including our 90 senior managing directors and approximately 535 other investment and advisory professionals. We strive to maintain a work environment that fosters professionalism, excellence, integrity and cooperation among our employees.
Regulatory and Compliance Matters
Our businesses, as well as the financial services industry generally, are subject to extensive regulation in the United States and elsewhere.
All of the investment advisers of our investment funds are registered as investment advisers with the SEC. Registered investment advisers are subject to the requirements and regulations of the Advisers Act. Such requirements relate to, among other things, fiduciary duties to clients, maintaining an effective compliance program, solicitation agreements, conflicts of interest, recordkeeping and reporting requirements, disclosure requirements, limitations on agency cross and principal transactions between an advisor and advisory clients and general anti-fraud prohibitions.
Blackstone Advisory Services L.P., a subsidiary of ours through which we conduct our financial advisory business, is registered as a broker-dealer with the SEC and is a member of The Financial Industry Regulatory Authority, or “FINRA,” and is registered as a broker-dealer in 50 states, the District of Columbia, the Commonwealth of Puerto Rico and the Virgin Islands. Park Hill Group LLC is registered as a broker-dealer with the SEC and is a member of FINRA and is registered as a broker-dealer in several states. Park Hill Group Real Estate Group LLC is also registered as a broker-dealer with the SEC and is a member of FINRA and is registered as a broker-dealer in several states. Our broker-dealer entities are subject to regulation and oversight by the SEC.
14
In addition, FINRA, a self-regulatory organization that is subject to oversight by the SEC, adopts and enforces rules governing the conduct, and examines the activities, of its member firms, including our broker-dealer entities. State securities regulators also have regulatory or oversight authority over our broker-dealer entities.
Broker-dealers are subject to regulations that cover all aspects of the securities business, including sales methods, trade practices among broker-dealers, use and safekeeping of customers’ funds and securities, capital structure, record keeping, the financing of customers’ purchases and the conduct and qualifications of directors, officers and employees. In particular, as a registered broker-dealer and member of a self-regulatory organization, we are subject to the SEC’s uniform net capital rule, Rule 15c3-1. Rule 15c3-1 specifies the minimum level of net capital a broker-dealer must maintain and also requires that a significant part of a broker-dealer’s assets be kept in relatively liquid form. The SEC and various self-regulatory organizations impose rules that require notification when net capital falls below certain predefined criteria, limit the ratio of subordinated debt to equity in the regulatory capital composition of a broker-dealer and constrain the ability of a broker-dealer to expand its business under certain circumstances. Additionally, the SEC’s uniform net capital rule imposes certain requirements that may have the effect of prohibiting a broker-dealer from distributing or withdrawing capital and requiring prior notice to the SEC for certain withdrawals of capital.
The Blackstone Group International Ltd. is an authorized investment manager in the United Kingdom. The U.K. Financial Services and Markets Act 2000, or “FSMA,” and rules promulgated thereunder govern all aspects of the U.K. investment business, including sales, research and trading practices, provision of investment advice, use and safekeeping of client funds and securities, regulatory capital, record keeping, margin practices and procedures, approval standards for individuals, anti-money laundering, periodic reporting and settlement procedures. Pursuant to the FSMA, certain of our subsidiaries are subject to regulations promulgated and administered by the U.K. Financial Services Authority.
In addition, each of the closed-end mutual funds we manage is registered under the 1940 Act as a closed-end investment company. The closed-end mutual funds and the entities that serve as the funds’ investment advisers are subject to the 1940 Act and the rules thereunder, which among other things regulate the relationship between a registered investment company and its investment adviser and prohibit or severely restrict principal transactions and joint transactions.
The SEC and various self-regulatory organizations have in recent years increased their regulatory activities in respect of asset management firms.
Certain of our businesses are subject to compliance with laws and regulations of U.S. federal and state governments, non-U.S. governments (including, without limitation, India, Japan and Hong Kong), their respective agencies and/or various self-regulatory organizations or exchanges relating to, among other things, marketing of investment products, the privacy of client information, and any failure to comply with these regulations could expose us to liability and/or damage our reputation. Our businesses have operated for many years within a legal framework that requires our being able to monitor and comply with a broad range of legal and regulatory developments that affect our activities. However, additional legislation, changes in rules promulgated by self-regulatory organizations or changes in the interpretation or enforcement of existing laws and rules, either in the United States or elsewhere, may directly affect our mode of operation and profitability.
Rigorous legal and compliance analysis of our businesses and investments is important to our culture and risk management. In addition, disclosure controls and procedures and internal controls over financial reporting are documented, tested and assessed for design and operating effectiveness in compliance with the U.S. Sarbanes-Oxley Act of 2002. We strive to maintain a culture of compliance through the use of policies and procedures such as oversight compliance, codes of conduct, compliance systems, communication of compliance guidance and employee education and training. Our enterprise risk management function further analyzes our business, investment, and other key risks, reinforcing their importance in our environment. We have a compliance group that monitors our compliance with all of the regulatory requirements to which we are subject and manages our
15
compliance policies and procedures. Our Chief Legal Officer supervises our compliance group, which is responsible for addressing all regulatory and compliance matters that affect our activities. Our compliance policies and procedures address a variety of regulatory and compliance risks such as the handling of material non-public information, position reporting, personal securities trading, valuation of investments on a fund-specific basis, document retention, potential conflicts of interest and the allocation of investment opportunities.
Our compliance group also monitors the information barriers that we maintain between each of our different businesses. We believe that our various businesses’ access to the intellectual knowledge and contacts and relationships that reside throughout our firm benefits all of our businesses. However, in order to maximize that access without compromising our compliance with the legal and contractual obligations to which we are subject, our compliance group oversees and monitors the communications between or among our firm’s different businesses to facilitate regulatory compliance.
Available Information
We file annual, quarterly and current reports and other information with the Securities and Exchange Commission (the “SEC”). These filings are available to the public over the Internet at the SEC’s web site at http://www.sec.gov. You may also read and copy any document we file at the SEC’s public reference room located at 100 F Street, N.E., Washington, DC 20549. Please call the SEC at 1 800-SEC-0330 for further information on the public reference room.
Our principal Internet address is www.blackstone.com. We make available free of charge on or through www.blackstone.com our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The contents of our website are not, however, a part of this report.
16
| ITEM 1A. | RISK FACTORS |
Risks Related to Our Business
Difficult market conditions can adversely affect our business in many ways, including by reducing the value or performance of the investments made by our investment funds, reducing the ability of our investment funds to raise or deploy capital and reducing the volume of the transactions involving our financial advisory business, each of which could materially reduce our revenue and cash flow and adversely affect our financial condition.
Our business is materially affected by conditions in the global financial markets and economic conditions throughout the world that are outside our control, including but not limited to changes in interest rates, availability of credit, inflation rates, economic uncertainty, changes in laws (including laws relating to taxation), trade barriers, commodity prices, currency exchange rates and controls and national and international political circumstances (including wars, terrorist acts or security operations). These factors may affect the level and volatility of securities prices and the liquidity and the value of investments, and we may not be able to or may choose not to manage our exposure to these market conditions. In the event of a market downturn each of our businesses could be affected in different ways.
For example, the unprecedented turmoil in the global capital markets and in the financial services industry during 2008 had a significant material adverse effect on our investment businesses. The deterioration of the global debt markets, the failure of companies in the financial services industry and stalled lending markets created by credit fears during 2008 created very challenging financing conditions for private equity and real estate sponsors, including us. The lack of liquidity in the financing markets has materially hindered the initiation of new, large-sized corporate private equity transactions, significantly affecting the operating performance of our corporate private equity and real estate segments. Challenging financing conditions make it more difficult for us to obtain funding for additional investments or for our funds’ portfolio companies to obtain additional capital to support their existing operations. Moreover, lack of financing makes it more difficult for potential buyers to raise sufficient capital to purchase assets in our funds’ portfolios, thereby reducing our funds’ opportunities to exit and realize value from their investments. The lack of financing in 2008 resulted in a significant reduction in asset purchases and dispositions by our investment funds. Because we may generate revenues from transaction fees on the consummation of a fund’s purchase of an asset and carried interest on the sale and realization of profits from the sale of an investment, this lack of financing in 2008 had a negative effect on our operating results and cash flow. A market downturn may also cause us to be unable to find suitable investments for our investment funds to effectively deploy capital. Because we can generally only raise capital for a successor fund following the substantial deployment of capital from the existing fund, our inability to find suitable investments and deploy capital could adversely affect our ability to raise capital for our investment funds.
During periods of difficult market conditions or slowdowns (which may be across one or more industries, sectors or geographies), our funds’ portfolio companies may experience adverse operating performance, decreased revenues, financial losses, difficulty in obtaining access to financing and increased funding costs. Negative financial results in our investment funds’ portfolio companies may result in lower investment returns for our investment funds, which could materially and adversely affect our operating results and cash flow. For example, during 2008, the performance of our investment funds for the year was generally negative due to the significant weakness in some of the portfolio companies’ operating and financial performance stemming from the global economic downturn and a decline in valuation multiples. These portfolio companies’ weak operating and financial performance and a decline in valuation multiples resulted in lower valuations, thereby adversely affecting the performance of our investment funds. To the extent the operating performance of those portfolio companies (as well as valuation multiples) do not improve or other portfolio companies experience adverse operating performance, our investment funds may sell those assets at values that are less than we projected or even a loss, thereby significantly affecting those investment funds’ performance and consequently our operating results and cash flow. During such periods of weakness, our investment funds’ portfolio companies may also
17
have difficulty expanding their businesses and operations or meeting their debt service obligations or other expenses as they become due, including expenses payable to us. Furthermore, such negative market conditions could potentially result in a portfolio company entering bankruptcy proceedings, thereby potentially resulting in a complete loss of the fund’s investment in such portfolio company and a significant negative impact to the investment fund’s performance and consequently our operating results and cash flow, as well as to our reputation. In addition, negative market conditions would also increase the risk of default with respect to investments held by our investment funds that have significant debt investments, such as our credit-oriented funds.
Our operating performance may also be adversely affected by our fixed costs and other expenses and the possibility that we would be unable to scale back other costs within a time frame sufficient to match any decreases in revenue relating to changes in market and economic conditions. In order to reduce expenses in the face of a difficult economic environment, we may need to cut back or eliminate the use of certain services or service providers, or terminate the employment of a significant number of our personnel that, in each case, could be important to our business and without which our operating results could be adversely affected.
In addition, our financial advisory business can be materially affected by conditions in the global economy and various financial markets. For example, revenues generated by our financial advisory business is directly related to the volume and value of the transactions in which we are involved. During periods of unfavorable market or economic conditions, the volume and value of mergers and acquisitions transactions may decrease, thereby reducing the demand for our financial advisory services and increasing price competition among financial services companies seeking such engagements.
Our revenue, net income and cash flow are all highly variable, which may make it difficult for us to achieve steady earnings growth on a quarterly basis and may cause the price of our common units to decline.
Our revenue, net income and cash flow are all highly variable, primarily due to the fact that we receive carried interest from our carry funds only when investments are realized and achieve a certain preferred return. In addition, transaction fees received by our carry funds and fees received by our advisory business can vary significantly from quarter to quarter. Since the latter half of 2007, the lack of financing has resulted in a significant reduction in asset purchases and dispositions by our investment funds and because we may potentially get transaction fees on the consummation of a fund’s purchase of an asset or carried interest on the sale and realization of profits from an asset, this lack of financing has had a negative effect on our operating results and cash flow. We may also experience fluctuations in our results from quarter to quarter due to a number of other factors, including changes in the values of our funds’ investments, changes in the amount of distributions, dividends or interest paid in respect of investments, changes in our operating expenses, the degree to which we encounter competition and general economic and market conditions. Such variability may lead to volatility in the trading price of our common units and cause our results for a particular period not to be indicative of our performance in a future period. It may be difficult for us to achieve steady growth in net income and cash flow on a quarterly basis, which could in turn lead to large adverse movements in the price of our common units or increased volatility in our common unit price generally.
The timing and receipt of carried interest generated by our carry funds is uncertain and will contribute to the volatility of our results. Carried interest depends on our carry funds’ performance and opportunities for realizing gains, which may be limited. It takes a substantial period of time to identify attractive investment opportunities, to raise all the funds needed to make an investment and then to realize the cash value (or other proceeds) of an investment through a sale, public offering, recapitalization or other exit. Even if an investment proves to be profitable, it may be several years before any profits can be realized in cash (or other proceeds). We cannot predict when, or if, any realization of investments will occur. In addition, upon the realization of a profitable investment by any of our carry funds and prior to us receiving any carried interest in respect of that investment, 100% of the proceeds of that investment must generally be paid to the investors in that carry fund until they have recovered certain fees and expenses and achieved a certain return on all realized investments by that carry fund
18
as well as a recovery of any unrealized losses. If we were to have a realization event in a particular quarter, it may have a significant impact on our results for that particular quarter which may not be replicated in subsequent quarters. We recognize revenue on investments in our investment funds based on our allocable share of realized and unrealized gains (or losses) reported by such investment funds, and a decline in realized or unrealized gains, or an increase in realized or unrealized losses, would adversely affect our revenue and possibly cash flow, which could further increase the volatility of our quarterly results. Because our carry funds have preferred return thresholds to investors that need to be met prior to Blackstone receiving any carried interest, substantial declines in the carrying value of the investment portfolios of a carry fund can significantly delay or eliminate any carried interest distributions paid to us in respect of that fund since the value of the assets in the fund would need to recover to their aggregate cost basis plus the preferred return over time before we would be entitled to receive any carried interest from that fund. For this reason, due to declines in the carrying values of their underlying portfolio assets, our most recent corporate private equity fund and real estate fund are not expected to generate any carried interest in the near future.
We also earn a portion of our revenue from financial advisory engagements, and in many cases we are not paid until the successful consummation of the underlying transaction, restructuring or closing of the fund. As a result, our financial advisory revenue is highly dependent on market conditions and the decisions and actions of our clients, interested third parties and governmental authorities. If a transaction, restructuring or funding is not consummated, we often do not receive any financial advisory fees other than the reimbursement of certain out-of-pocket expenses, despite the fact that we may have devoted considerable resources to these transactions.
Because our revenue, net income and cash flow can be highly variable from quarter to quarter and year to year, we do not provide any guidance regarding our expected quarterly and annual operating results. The lack of guidance may affect the expectations of public market analysts and could cause increased volatility in our common unit price.
Adverse economic and market conditions may adversely affect our liquidity position, which could adversely affect our business operations in the future.
We use cash to (1) provide capital to facilitate the growth of our existing businesses, which principally includes funding our general partner and co-investment commitments to our funds; (2) provide capital for business expansion; (3) pay operating expenses and other obligations as they arise; (4) fund capital expenditures; (5) repay debt; (6) pay income taxes; and (7) make distributions to our unitholders and the holders of Blackstone Holdings Partnership Units. In addition to the cash we received in connection with our IPO, our principal sources of cash are: (1) Net Fee Related Earnings from Operations, (2) Performance Fees and Allocations net of related profit sharing interests that are included in Compensation and (3) Blackstone Investment Income related to its investments in liquid funds and its net realized investment income on its illiquid investments. We also maintain a $1.0 billion revolving 364 day credit facility with a final maturity date of May 11, 2009. We had $503.7 million in cash and no debt in excess of our cash balances at the end of 2008. During 2008, the global economic downturn and significant disruption in the market adversely affected realization events and net returns experienced by our investment funds, thereby significantly reducing the amount of cash generated from operations compared to prior years. During 2008, the firm had adjusted cash flow from operations of $128.8 million. We also paid distributions to common unitholders of $240 million ($0.90 per common unit) in respect of the first three quarters of 2008 (but will not be making any distribution to common unitholders in respect of the fourth quarter of 2008). To the extent the current adverse conditions in the global economy and the financing markets continue or worsen, we anticipate that the cash that we receive due to realization events by our carry funds will continue to be adversely affected, which could require us to rely on other sources of cash to fund our general partner and co-investment commitments to our carry funds, which could be substantial. Furthermore, if the current challenging credit market conditions were to continue or worsen, we might not be able to renew all or part of our existing revolving credit facility or find alternate financing on commercially reasonable terms. As a result, our uses of cash may exceed our sources of cash, thereby potentially affecting our liquidity position.
19
We depend on our co-founder and other key senior managing directors and the loss of their services would have a material adverse effect on our business, results and financial condition.
We depend on the efforts, skill, reputations and business contacts of our co-founder, Stephen A. Schwarzman, our President and Chief Operating Officer, Hamilton E. James, our Vice Chairman, J. Tomilson Hill, and other key senior managing directors, the information and deal flow they and other senior managing directors generate during the normal course of their activities and the synergies among the diverse fields of expertise and knowledge held by our professionals. Accordingly, our success will depend on the continued service of these individuals, who are not obligated to remain employed with us. Several key senior managing directors have left the firm in the past and others may do so in the future, and we cannot predict the impact that the departure of any key senior managing director will have on our ability to achieve our investment objectives. The loss of the services of any of them could have a material adverse effect on our revenues, net income and cash flows and could harm our ability to maintain or grow assets under management in existing funds or raise additional funds in the future. We have historically relied in part on the interests of these professionals in the investment funds’ carried interest and incentive fees to discourage them from leaving the firm. However, to the extent our investment funds perform poorly, thereby reducing the potential for carried interest and incentive fees, their interests in carried interest and incentive fees become less valuable to them and become less effective as incentives for them to continue to be employed at Blackstone.
Our senior managing directors and other key personnel possess substantial experience and expertise and have strong business relationships with investors in our funds, clients and other members of the business community. As a result, the loss of these personnel could jeopardize our relationships with investors in our funds, our clients and members of the business community and result in the reduction of assets under management or fewer investment opportunities.
Our publicly traded structure may adversely affect our ability to retain and motivate our senior managing directors and other key personnel and to recruit, retain and motivate new senior managing directors and other key personnel, both of which could adversely affect our business, results and financial condition.
Our most important asset is our people, and our continued success is highly dependent upon the efforts of our senior managing directors and other professionals. Our future success and growth depends to a substantial degree on our ability to retain and motivate our senior managing directors and other key personnel and to strategically recruit, retain and motivate new talented personnel. The competition for talent remains fierce. As part of the reorganization we effected prior to our initial public offering in June 2007, our current senior managing directors and other senior personnel received partnership units in Blackstone Holdings (as defined under “Item 13. Certain Relationships, Related Transactions and Director Independence—Blackstone Holdings Partnership Agreements”). Distributions in respect of these equity interests may not equal the cash distributions previously received by our senior managing directors prior to our initial public offering. Until December 31, 2009, the income (and accordingly distributions) of Blackstone Holdings will be allocated on a priority basis to The Blackstone Group L.P.’s wholly-owned subsidiaries, which may reduce the amount of distributions received by our senior managing directors. Additionally, ownership of a portion of the Blackstone Holdings Partnership Units received by our senior managing directors is not dependent upon their continued employment with us as those equity interests were fully vested upon issuance. Moreover, the minimum retained ownership requirements and transfer restrictions to which these interests are subject in certain instances lapse over time, may not be enforceable in all cases and can be waived. There is no guarantee that the non-competition and non-solicitation agreements to which our senior managing directors are subject, together with our other arrangements with them, will prevent them from leaving us, joining our competitors or otherwise competing with us or that these agreements will be enforceable in all cases. In addition, these agreements will expire after a certain period of time, at which point each of our senior managing directors would be free to compete against us and solicit investors in our funds, clients and employees.
We might not be able to provide future senior managing directors with equity interests in our business to the same extent or with the same tax consequences from which our existing senior managing directors previously
20
benefited. For example, if legislation were to be enacted by the U.S. Congress or any state or local governments to treat carried interest as ordinary income rather than as capital gain for tax purposes, such legislation would materially increase the amount of taxes that we and possibly our unitholders would be required to pay, thereby adversely affecting our ability to recruit, retain and motivate our current and future professionals. See “—Risks Related to United States Taxation—Our structure involves complex provisions of U.S. federal income tax law for which no clear precedent or authority may be available. Our structure also is subject to potential legislative, judicial or administrative change and differing interpretations, possibly on a retroactive basis.” Alternatively, the value of the units we may issue senior managing directors at any given time may subsequently fall (as reflected in the market price of our common units), which could counteract the incentives we are seeking to induce in them. Therefore, in order to recruit and retain existing and future senior managing directors, we may need to increase the level of compensation that we pay to them. Accordingly, as we promote or hire new senior managing directors over time, we may increase the level of compensation we pay to our senior managing directors, which would cause our total employee compensation and benefits expense as a percentage of our total revenue to increase and adversely affect our profitability. In addition, issuance of equity interests in our business to future senior managing directors would dilute public common unitholders.
We strive to maintain a work environment that reinforces our culture of collaboration, motivation and alignment of interests with investors. If we do not continue to develop and implement the right processes and tools to manage our changing enterprise and maintain this culture, our ability to compete successfully and achieve our business objectives could be impaired, which could negatively impact our business, financial condition and results of operations.
If we are unable to consummate or successfully integrate additional development opportunities, acquisitions or joint ventures, we may not be able to implement our growth strategy successfully.
Our growth strategy is based, in part, on the selective development or acquisition of asset management businesses, advisory businesses or other businesses complementary to our business where we think we can add substantial value or generate substantial returns. The success of this strategy (including our acquisition of GSO) will depend on, among other things: (1) the availability of suitable opportunities; (2) the level of competition from other companies that may have greater financial resources; (3) our ability to value potential development or acquisition opportunities accurately and negotiate acceptable terms for those opportunities; (4) our ability to identify and enter into mutually beneficial relationships with venture partners; (5) and our ability to successfully integrate and oversee the operations of the new businesses. If we are not successful in implementing our growth strategy, our business, financial results and the market price for our common units may be adversely affected.
Legislation has been introduced in the U.S. Congress that would, if enacted, preclude us from qualifying as a partnership for U.S. federal income tax purposes or otherwise increase our tax liability. If this or any similar legislation or regulation were to be enacted and apply to us, we would incur a material increase in our tax liability that could result in a reduction in the value of our common units.
On June 14, 2007, the Chairman and the Ranking Republican Member of the U.S. Senate Committee on Finance introduced legislation (the “Baucus-Grassley Bill”) that would tax as corporations publicly traded partnerships that directly or indirectly derive income from investment adviser or asset management services. In addition, they concurrently issued a press release stating that they do not believe that proposed public offerings of private equity and hedge fund management firms are consistent with the intent of the existing rules regarding publicly traded partnerships because the majority of their income is derived from the active provision of services to investment funds and limited partner investors in such funds.
If enacted, the Baucus-Grassley Bill would be effective as of June 14, 2007 but under a transition rule contained in the proposed legislation, it would apply to us beginning with our taxable year beginning January 1, 2013. On June 20, 2007, legislation was introduced in the House of Representatives that is substantially similar to the Baucus-Grassley Bill except that if enacted it would apply to us commencing with our taxable year
21
beginning January 1, 2008. If either proposed legislation or similar legislation were to be enacted into law, we would incur a material increase in our tax liability when such legislation begins to apply to us. If we were taxed as a corporation, our effective tax rate would increase significantly. The federal statutory rate for corporations is currently 35%, and the state and local tax rates, net of the federal benefit, aggregate approximately 10%. If a variation of this proposed legislation or any other change in the tax laws, rules, regulations or interpretations preclude us from qualifying for treatment as a partnership for U.S. federal income tax purposes under the publicly traded partnership rules, this would materially increase our tax liability and could well result in a reduction in the value of our common units.
On June 25, 2008, the U.S. House of Representatives passed a bill that would generally (1) treat carried interest as non-qualifying income under the tax rules applicable to publicly traded partnerships, which would generally require us to hold interests in entities earning such income through taxable subsidiary corporations starting in 2010, and (2) tax carried interest as ordinary income for U.S. federal income taxes, rather than in accordance with the character of income derived by the underlying fund, which is in many cases capital gain. The Obama Administration’s budget proposals released on February 26, 2009 include a proposal to tax carried interest as ordinary income. If any such legislation or similar legislation were to be enacted and apply to us, it would materially increase our tax liability, which would likely result in a reduction of the value of our common units.
The requirements of being a public entity and sustaining our growth may strain our resources.
As a public entity, we are subject to the reporting requirements of the U.S. Securities Exchange Act of 1934, as amended, or “Exchange Act,” and requirements of the U.S. Sarbanes-Oxley Act of 2002, or “Sarbanes-Oxley Act.” These requirements may place a strain on our systems and resources. The Exchange Act requires that we file annual, quarterly and current reports with respect to our business and financial condition. The Sarbanes-Oxley Act requires that we maintain effective disclosure controls and procedures and internal controls over financial reporting. In order to maintain and improve the effectiveness of our disclosure controls and procedures, significant resources and management oversight are required. We have implemented and continue to implement additional procedures and processes for the purpose of addressing the standards and requirements applicable to public companies. In addition, sustaining our growth also requires us to commit additional management, operational and financial resources to identify new professionals to join our firm and to maintain appropriate operational and financial systems to adequately support expansion. These activities may divert management’s attention from other business concerns, which could have a material adverse effect on our business, financial condition, results of operations and cash flows. We have incurred and expect to continue to incur significant additional annual expenses related to these steps, including among other things additional directors and officers liability insurance, director fees, reporting requirements of the Securities and Exchange Commission, or “SEC,” transfer agent fees, hiring additional accounting, legal and administrative personnel, increased auditing and legal fees and similar expenses.
The potential requirement to convert our financial statements from being prepared in conformity with accounting principles generally accepted in the United States of America to International Financial Reporting Standards may strain our resources and increase our annual expenses.
As a public entity, the SEC may require in the future that we report our financial results under International Financial Reporting Standards (“IFRS”) instead of under accounting principles generally accepted in the United States of America (“U.S. GAAP”). IFRS is a set of accounting principles that has been gaining acceptance on a worldwide basis. These standards are published by the London-based International Accounting Standards Board (“IASB”) and are more focused on objectives and principles and less reliant on detailed rules than U.S. GAAP. Today, there remain significant and material differences in several key areas between U.S. GAAP and IFRS which would affect Blackstone. Additionally, U.S. GAAP provides specific guidance in classes of accounting transactions for which equivalent guidance in IFRS does not exist. The adoption of IFRS is highly complex and would have an impact on many aspects and operations of Blackstone, including but not limited to financial accounting and reporting systems, internal controls, taxes, borrowing covenants and cash management. It is expected that a significant amount of time, internal and external resources and expenses over a multi-year period would be required for this conversion.
22
Operational risks may disrupt our businesses, result in losses or limit our growth.
We rely heavily on our financial, accounting and other data processing systems. If any of these systems do not operate properly or are disabled, we could suffer financial loss, a disruption of our businesses, liability to our investment funds, regulatory intervention or reputational damage. In addition, we operate in businesses that are highly dependent on information systems and technology. Our information systems and technology may not continue to be able to accommodate our growth, and the cost of maintaining such systems may increase from its current level. Such a failure to accommodate growth, or an increase in costs related to such information systems, could have a material adverse effect on us.
Furthermore, we depend on our headquarters in New York City, where most of our personnel are located, for the continued operation of our business. A disaster or a disruption in the infrastructure that supports our businesses, including a disruption involving electronic communications or other services used by us or third parties with whom we conduct business, or directly affecting our headquarters, could have a material adverse impact on our ability to continue to operate our business without interruption. Our disaster recovery programs may not be sufficient to mitigate the harm that may result from such a disaster or disruption. In addition, insurance and other safeguards might only partially reimburse us for our losses, if at all.
Finally, we rely on third-party service providers for certain aspects of our business, including for certain information systems and technology and administration of our hedge funds. Any interruption or deterioration in the performance of these third parties or failures of their information systems and technology could impair the quality of the funds’ operations and could affect our reputation and hence adversely affect our businesses.
Extensive regulation of our businesses affects our activities and creates the potential for significant liabilities and penalties. The possibility of increased regulatory focus could result in additional burdens on our business. Changes in tax law and other legislative or regulatory changes could adversely affect us.
Our asset management and financial advisory businesses are subject to extensive regulation. We are subject to regulation, including periodic examinations, by governmental and self-regulatory organizations in the jurisdictions in which we operate around the world. Many of these regulators, including U.S. and foreign government agencies and self-regulatory organizations, as well as state securities commissions in the United States, are empowered to conduct investigations and administrative proceedings that can result in fines, suspensions of personnel or other sanctions, including censure, the issuance of cease-and-desist orders or the suspension or expulsion of a broker-dealer or investment adviser from registration or memberships. Even if an investigation or proceeding did not result in a sanction or the sanction imposed against us or our personnel by a regulator were small in monetary amount, the adverse publicity relating to the investigation, proceeding or imposition of these sanctions could harm our reputation and cause us to lose existing clients or fail to gain new asset management or financial advisory clients. In addition, we regularly rely on exemptions from various requirements of the U.S. Securities Act of 1933, as amended, or “Securities Act,” the Exchange Act, the U.S. Investment Company Act of 1940, as amended, or “1940 Act,” and the U.S. Employee Retirement Income Security Act of 1974, as amended, in conducting our asset management activities. These exemptions are sometimes highly complex and may in certain circumstances depend on compliance by third parties whom we do not control. If for any reason these exemptions were to become unavailable to us, we could become subject to regulatory action or third party claims and our business could be materially and adversely affected. See “—Risks Related to Our Organizational Structure—If The Blackstone Group L.P. were deemed an “investment company” under the 1940 Act, applicable restrictions could make it impractical for us to continue our business as contemplated and could have a material adverse effect on our business”. Lastly, the requirements imposed by our regulators are designed primarily to ensure the integrity of the financial markets and to protect investors in our investment funds and are not designed to protect our common unitholders. Consequently, these regulations often serve to limit our activities.
In addition, the regulatory environment in which our asset management and financial advisory clients operate may affect our business. For example, changes in antitrust laws or the enforcement of antitrust laws
23
could affect the level of mergers and acquisitions activity and changes in state laws may limit investment activities of state pension plans. See “Business—Regulatory and Compliance Matters” for a further discussion of the regulatory environment in which we conduct our businesses.
The environment in which we operate is subject to further regulation. Moreover, as a result of the recent economic downturn, acts of serious fraud in the alternative asset management industry and perceived lapses in regulatory oversight, U.S. and non-U.S. governmental and regulatory authorities may increase regulatory oversight of our businesses. We may be adversely affected as a result of new or revised legislation or regulations imposed by the SEC, other U.S. or non-U.S. governmental regulatory authorities or self-regulatory organizations that supervise the financial markets. We also may be adversely affected by changes in the interpretation or enforcement of existing laws and rules by these governmental authorities and self-regulatory organizations. It is impossible to determine the extent of the impact of any new laws, regulations or initiatives that may be proposed, or whether any of the proposals will become law. Compliance with any new laws or regulations could make compliance more difficult and expensive and affect the manner in which we conduct business.
Legislation has been adopted in Australia, Denmark, Germany and Italy that limits the tax deductibility of interest expense incurred by companies in those countries. These measures will most likely adversely affect portfolio companies in those countries in which our private equity funds have investments and limit the benefits of additional investments in those countries. Our corporate private equity business is subject to the risk that similar measures might be introduced in other countries in which our private equity funds currently have investments or plan to invest in the future, or that other legislative or regulatory measures that negatively affect their respective portfolio investments might be promulgated in any of the countries in which they invest.
In addition, regulatory developments designed to increase oversight of hedge funds may adversely affect our business. For instance, legislation has been introduced in the U.S. Congress that would give the SEC the authority to require hedge funds and private equity funds to register with the SEC and would impose other requirements on them. While all of our entities that serve as advisers to our investment funds are already registered with the SEC under the Investment Advisers Act of 1940, or “Advisers Act,” as investment advisers, other new legislation or regulatory requirements could constrain or otherwise impose burdens on our business.
Our use of leverage to finance our business will expose us to substantial risks, which are exacerbated by our funds’ use of leverage to finance investments.
We intend to use borrowings to finance our business operations as a public company. That exposes us to the typical risks associated with the use of leverage, including those discussed below under “—Dependence on significant leverage in investments by our funds could adversely affect our ability to achieve attractive rates of return on those investments”. In order for us to utilize leverage to finance our business, we are dependent on financial institutions such as global banks extending credit to us on terms that are reasonable to us. There is no guarantee that such institutions will continue to extend credit to us or renew any existing credit agreements we may have with them. These risks are exacerbated by our funds’ use of leverage to finance investments.
We are subject to substantial litigation risks and may face significant liabilities and damage to our professional reputation as a result of litigation allegations and negative publicity.
The investment decisions we make in our asset management business and the activities of our investment professionals on behalf of portfolio companies of our carry funds may subject them and us to the risk of third-party litigation arising from investor dissatisfaction with the performance of those investment funds, the activities of our portfolio companies and a variety of other litigation claims. For example, from time to time we and our portfolio companies have been subject to class action suits by shareholders in public companies that we have agreed to acquire that challenge our acquisition transactions and attempt to enjoin them.
In addition, to the extent investors in our investment funds suffer losses resulting from fraud, gross negligence, willful misconduct or other similar misconduct, investors may have remedies against us, our
24
investment funds, our senior managing directors or our affiliates under the federal securities law and/or state law. While the general partners and investment advisers to our investment funds, including their directors, officers, other employees and affiliates, are generally indemnified to the fullest extent permitted by law with respect to their conduct in connection with the management of the business and affairs of our investment funds, such indemnity does not extend to actions determined to have involved fraud, gross negligence, willful misconduct or other similar misconduct.
Our financial advisory activities may also subject us to the risk of liabilities to our clients and third parties, including our clients’ stockholders, under securities or other laws in connection with corporate transactions on which we render advice.
If any lawsuits were brought against us and resulted in a finding of substantial legal liability, it could materially adversely affect our business, financial condition or results of operations or cause significant reputational harm to us, which could seriously harm our business. We depend to a large extent on our business relationships and our reputation for integrity and high-caliber professional services to attract and retain investors and advisory clients and to pursue investment opportunities for our carry funds. As a result, allegations of improper conduct by private litigants or regulators, whether the ultimate outcome is favorable or unfavorable to us, as well as negative publicity and press speculation about us, our investment activities or the private equity industry in general, whether or not valid, may harm our reputation, which may be more damaging to our business than to other types of businesses.
Employee misconduct could harm us by impairing our ability to attract and retain clients and subjecting us to significant legal liability and reputational harm.
There is a risk that our employees could engage in misconduct that adversely affects our business. We are subject to a number of obligations and standards arising from our asset management business and our authority over the assets managed by our asset management business. The violation of these obligations and standards by any of our employees would adversely affect our clients and us. Our business often requires that we deal with confidential matters of great significance to companies in which we may invest or our financial advisory clients. If our employees were improperly to use or disclose confidential information, we could suffer serious harm to our reputation, financial position and current and future business relationships. It is not always possible to detect or deter employee misconduct, and the extensive precautions we take to detect and prevent this activity may not be effective in all cases. If one of our employees were to engage in misconduct or were to be accused of such misconduct, our business and our reputation could be adversely affected. In January 2009, an employee in our corporate and mergers and acquisitions advisory business was charged with violations of the insider trading laws.
Risks Related to Our Asset Management Business
Poor performance of our investment funds would cause a decline in our revenue, income and cash flow, may obligate us to repay carried interest previously paid to us, and could adversely affect our ability to raise capital for future investment funds.
In the event that any of our investment funds were to perform poorly, our revenue, income and cash flow would decline because the value of our assets under management would decrease, which would result in a reduction in management fees, and our investment returns would decrease, resulting in a reduction in the carried interest and incentive fees we earn. Moreover, we could experience losses on our investments of our own principal as a result of poor investment performance by our investment funds. Furthermore, if, as a result of poor performance of later investments in a carry fund’s life, the fund does not achieve certain investment returns for the fund over its life, we will be obligated to repay the amount by which carried interest that was previously distributed to us exceeds amounts to which we are ultimately entitled. Poor performance of our investment funds could make it more difficult for us to raise new capital. Investors in carry funds might decline to invest in future investment funds we raise and investors in hedge funds or other investment funds might withdraw their
25
investments as a result of poor performance of the investment funds in which they are invested. Investors and potential investors in our funds continually assess our investment funds’ performance, and our ability to raise capital for existing and future investment funds and avoid excessive redemption levels will depend on our investment funds’ continued satisfactory performance. Alternatively, in the face of poor fund performance, investors could demand lower fees or fee concessions which would decrease our revenue. During 2008, many fund sponsors experienced pressure to lower fees and subsequently did so in respect of generally poor performance across the alternative asset management industry.
Our asset management business depends in large part on our ability to raise capital from third party investors. If we are unable to raise capital from third party investors, we would be unable to collect management fees or deploy their capital into investments and potentially collect transaction fees or carried interest, which would materially reduce our revenue and cash flow and adversely affect our financial condition.
Our ability to raise capital from third party investors depends on a number of factors, including certain factors that are outside our control. Certain factors, such as the performance of the stock market or the asset allocation rules or regulations to which such third party investors are subject, could inhibit or restrict the ability of third party investors to make investments in our investment funds or the asset classes in which our investment funds invest. For example, during 2008 a large number of third party investors that invest in alternative assets and have historically invested in our investment funds experienced negative pressure across their investment portfolios, which affected our ability to raise capital from them. As a result of the significant economic downturn during 2008, these third-party investors experienced, among other things, a significant decline in the value of their public equity and debt holdings and a lack of realizations from their existing private equity portfolios. Consequently, many of these investors were left with disproportionately outsized remaining commitments to a number of investment funds, and were restricted from making new commitments to third party managed investment funds such as those managed by us. To the extent economic conditions remain negative and these issues persist, we may be unable to raise sufficient amounts of capital to support the investment activities of future funds. For instance, we are in the process of raising our sixth general corporate private equity fund and although we have raised a significant portion of capital for that fund to invest and expect to raise significant additional capital, the final amount we do eventually raise may be less than its predecessor fund and below our desired amount for that fund. Moreover, as we seek to expand into other asset classes, such as funds that focus on the infrastructure and clean technology asset classes, we may be unable to raise a sufficient amount of capital to adequately support such businesses. If we are unable to successfully raise capital, it could materially reduce our revenue and cash flow and adversely affect our financial condition. In addition, in connection with raising new funds or making further investments in existing funds, we have confronted and expect to continue to confront investor requests to decrease fees, which could result in a reduction in the fees and carried interest and incentive fees we earn.
Valuation methodologies for certain assets in our funds can be subject to significant subjectivity and the fair value of assets established pursuant to such methodologies may never be realized, which could result in significant losses for our funds.
There are often no readily ascertainable market prices for illiquid investments in our corporate private equity, real estate and certain of our credit-oriented funds. We determine the value of the investments of each of our corporate private equity, real estate and credit-oriented funds at least quarterly based on the fair value of such investments. The fair value of investments of a corporate private equity, real estate or credit-oriented fund is generally determined using several methodologies described in the investment funds’ valuation policies.
Investments for which market prices are not observable include private investments in the equity of operating companies or real estate properties. Fair values of private investments are determined by reference to projected net earnings, earnings before interest, taxes, depreciation and amortization (“EBITDA”) and balance sheets, public market or private transactions, valuations for comparable companies and other measures which, in many cases, are unaudited at the time received. With respect to real estate investments, in determining fair values
26
we consider projected operating cash flows and balance sheets, sales of comparable assets, if any, and replacement costs among other measures. The methods used by us to estimate the fair value of private investments include the discounted cash flow method and/or capitalization rates (“cap rates”) analysis. Valuations may also be derived by reference to observable valuation measures for comparable companies or assets (e.g., multiplying a key performance metric of the investee company or asset, such as EBITDA, by a relevant valuation multiple observed in the range of comparable companies or transactions), adjusted by management for differences between the investment and the referenced comparables and in some instances by reference to option pricing models or other similar methods. Private investments may also be valued at cost for a period of time after an acquisition as the best indicator of fair value. These valuation methodologies involve a significant degree of management judgment.
In certain cases debt and equity securities are valued on the basis of prices from an orderly transaction between market participants provided by reputable dealers or pricing services. In determining the value of a particular investment, pricing services may use certain information with respect to transactions in such investments, quotations from dealers, pricing matrixes, market transactions in comparable investments and various relationships between investments.
The determination of fair value using these methodologies takes into consideration a range of factors, including but not limited to the price at which the investment was acquired, the nature of the investment, local market conditions, trading values on public exchanges for comparable securities, current and projected operating performance and financing transactions subsequent to the acquisition of the investment. These valuation methodologies involve a significant degree of management judgment.
Because there is significant uncertainty in the valuation of, or in the stability of the value of illiquid investments, the fair values of such investments as reflected in an investment fund’s net asset value do not necessarily reflect the prices that would actually be obtained by us on behalf of the investment fund when such investments are realized. Realizations at values significantly lower than the values at which investments have been reflected in prior fund net asset values would result in losses for the applicable fund, a decline in asset management fees and the loss of potential carried interest and incentive fees. Changes in values attributed to investments from quarter to quarter may result in volatility in the net asset values and results of operations and cash flow that we report from period to period. Also, a situation where asset values turn out to be materially different than values reflected in prior fund net asset values could cause investors to lose confidence in us, which would in turn result in difficulty in raising additional funds or redemptions from our hedge funds.
The historical returns attributable to our funds should not be considered as indicative of the future results of our funds or of our future results or of any returns expected on an investment in our common units.
The historical and potential future returns of the investment funds that we manage are not directly linked to returns on our common units. Therefore, any continued positive performance of the investment funds that we manage will not necessarily result in positive returns on an investment in our common units. However, poor performance of the investment funds that we manage would cause a decline in our revenue from such investment funds, and would therefore have a negative effect on our performance and in all likelihood the returns on an investment in our common units.
Moreover, with respect to the historical returns of our investment funds:
| • | the rates of returns of our carry funds reflect unrealized gains as of the applicable measurement date that may never be realized, which may adversely affect the ultimate value realized from those funds’ investments; |
| • | the rates of returns of our corporate private equity and real estate funds in recent years were positively influenced by a number of investments that experienced rapid and substantial increases in value following the dates on which those investments were made, which may not occur with respect to future investments; |
27
| • | our investment funds’ returns in recent years benefited from investment opportunities and general market conditions that may not repeat themselves (including, for example, particularly favorable borrowing conditions in the debt markets during 2005, 2006 and early 2007), and our current or future investment funds might not be able to avail themselves of comparable investment opportunities or market conditions; and |
| • | the rates of return reflect our historical cost structure, which may vary in the future due to various factors enumerated elsewhere in this report and other factors beyond our control, including changes in laws. |
In addition, future returns will be affected by the applicable risks described elsewhere in this Form 10-K, including risks of the industries and businesses in which a particular fund invests.
Dependence on significant leverage in investments by our funds could adversely affect our ability to achieve attractive rates of return on those investments.
Many of our carry funds’ investments rely heavily on the use of leverage, and our ability to achieve attractive rates of return on investments will depend on our ability to access sufficient sources of indebtedness at attractive rates. For example, in many private equity investments, indebtedness may constitute 70% or more of a portfolio company’s or real estate asset’s total debt and equity capitalization, including debt that may be incurred in connection with the investment. The absence of available sources of senior debt financing for extended periods of time could therefore materially and adversely affect our corporate private equity and real estate businesses. In addition, an increase in either the general levels of interest rates or in the risk spread demanded by sources of indebtedness would make it more expensive to finance those businesses’ investments. Increases in interest rates could also make it more difficult to locate and consummate private equity investments because other potential buyers, including operating companies acting as strategic buyers, may be able to bid for an asset at a higher price due to a lower overall cost of capital. In addition, a portion of the indebtedness used to finance private equity investments often includes high-yield debt securities issued in the capital markets. Availability of capital from the high-yield debt markets is subject to significant volatility, and there may be times when we might not be able to access those markets at attractive rates, or at all, when completing an investment. Since the middle of 2007, there has been little financing of any type available for leveraged acquisition transactions, which has significantly reduced the ability of our corporate private equity and real estate funds to make investments.
Investments in highly leveraged entities are inherently more sensitive to declines in revenues, increases in expenses and interest rates and adverse economic, market and industry developments. The incurrence of a significant amount of indebtedness by an entity could, among other things:
| • | give rise to an obligation to make mandatory prepayments of debt using excess cash flow, which might limit the entity’s ability to respond to changing industry conditions to the extent additional cash is needed for the response, to make unplanned but necessary capital expenditures or to take advantage of growth opportunities; |
| • | limit the entity’s ability to adjust to changing market conditions, thereby placing it at a competitive disadvantage compared to its competitors who have relatively less debt; |
| • | limit the entity’s ability to engage in strategic acquisitions that might be necessary to generate attractive returns or further growth; and |
| • | limit the entity’s ability to obtain additional financing or increase the cost of obtaining such financing, including for capital expenditures, working capital or general corporate purposes. |
As a result, the risk of loss associated with a leveraged entity is generally greater than for companies with comparatively less debt. For example, many investments consummated by private equity sponsors during the past three years which utilized significant amounts of leverage are experiencing severe economic stress and may default on their debt obligations due to a decrease in revenues and cash flow precipitated by the recent economic downturn.
28
When our corporate private equity and real estate funds’ existing portfolio investments reach the point when debt incurred to finance those investments mature in significant amounts and must be either repaid or refinanced, those investments may materially suffer if they have generated insufficient cash flow to repay maturing debt and there is insufficient capacity and availability in the financing markets to permit them to refinance maturing debt on satisfactory terms, or at all. If the current unusually limited availability of financing for such purposes were to persist for several years, when significant amounts of the debt incurred to finance our corporate private equity and real estate funds’ existing portfolio investments start to come due, these funds could be materially and adversely affected.
Many of the hedge funds in which our funds of hedge funds invest, our credit-oriented funds and CLOs may choose to use leverage as part of their respective investment programs and regularly borrow a substantial amount of their capital. The use of leverage poses a significant degree of risk and enhances the possibility of a significant loss in the value of the investment portfolio. A fund may borrow money from time to time to purchase or carry securities or may enter into derivative transactions (such as total return swaps) with counterparties that have embedded leverage. The interest expense and other costs incurred in connection with such borrowing may not be recovered by appreciation in the securities purchased or carried and will be lost—and the timing and magnitude of such losses may be accelerated or exacerbated—in the event of a decline in the market value of such securities. Gains realized with borrowed funds may cause the fund’s net asset value to increase at a faster rate than would be the case without borrowings. However, if investment results fail to cover the cost of borrowings, the fund’s net asset value could also decrease faster than if there had been no borrowings.
Increases in interest rates could also decrease the value of fixed-rate debt investments that our investment funds make.
Any of the foregoing circumstances could have a material adverse effect on our financial condition, results of operations and cash flow.
The asset management business is intensely competitive.
The asset management business is intensely competitive, with competition based on a variety of factors, including investment performance, the quality of service provided to clients, brand recognition and business reputation. Our asset management business competes with a number of private equity funds, specialized investment funds, hedge funds, corporate buyers, traditional asset managers, commercial banks, investment banks and other financial institutions (including sovereign wealth funds). A number of factors serve to increase our competitive risks:
| • | a number of our competitors in some of our businesses have greater financial, technical, marketing and other resources and more personnel than we do; |
| • | several of our competitors have recently raised, or are expected to raise, significant amounts of capital, and many of them have similar investment objectives to ours, which may create additional competition for investment opportunities and may reduce the size and duration of pricing inefficiencies that many alternative investment strategies seek to exploit; |
| • | some of these competitors may also have a lower cost of capital and access to funding sources that are not available to us, which may create competitive disadvantages for us with respect to investment opportunities; |
| • | some of our competitors may have higher risk tolerances, different risk assessments or lower return thresholds, which could allow them to consider a wider variety of investments and to bid more aggressively than us for investments that we want to make; |
| • | some of our competitors may have better expertise or be regarded by investors as having better expertise in a specific asset class or geographic region than we do; |
29
| • | our competitors that are corporate buyers may be able to achieve synergistic cost savings in respect of an investment, which may provide them with a competitive advantage in bidding for an investment; |
| • | some investors may prefer to invest with an investment manager that is not publicly traded; and |
| • | other industry participants will from time to time seek to recruit our investment professionals and other employees away from us. |
We may lose investment opportunities in the future if we do not match investment prices, structures and terms offered by competitors. Alternatively, we may experience decreased rates of return and increased risks of loss if we match investment prices, structures and terms offered by competitors. In addition, if the current unsettled conditions in the credit markets were to continue, the attractiveness of our investment funds relative to investments in other investment products could decrease. This competitive pressure could adversely affect our ability to make successful investments and limit our ability to raise future investment funds, either of which would adversely impact our business, revenue, results of operations and cash flow.
The due diligence process that we undertake in connection with investments by our investment funds may not reveal all facts that may be relevant in connection with an investment.
Before making investments in private equity and other investments, we conduct due diligence that we deem reasonable and appropriate based on the facts and circumstances applicable to each investment. When conducting due diligence, we may be required to evaluate important and complex business, financial, tax, accounting, environmental and legal issues. Outside consultants, legal advisors, accountants and investment banks may be involved in the due diligence process in varying degrees depending on the type of investment. Nevertheless, when conducting due diligence and making an assessment regarding an investment, we rely on the resources available to us, including information provided by the target of the investment and, in some circumstances, third-party investigations. The due diligence investigation that we will carry out with respect to any investment opportunity may not reveal or highlight all relevant facts that may be necessary or helpful in evaluating such investment opportunity. Moreover, such an investigation will not necessarily result in the investment being successful.
In connection with the due diligence that our funds of hedge funds conduct in making and monitoring investments in third party hedge funds, we rely on information supplied by third party hedge funds or by service providers to such third party hedge funds. The information we receive from them may not be accurate or complete and therefore we may not have all the relevant facts necessary to properly assess and monitor our funds’ investment in a particular hedge fund.
Our asset management activities involve investments in relatively high-risk, illiquid assets, and we may fail to realize any profits from these activities for a considerable period of time or lose some or all of our principal investments.
Many of our investment funds invest in securities that are not publicly traded. In many cases, our investment funds may be prohibited by contract or by applicable securities laws from selling such securities for a period of time. Our investment funds will generally not be able to sell these securities publicly unless their sale is registered under applicable securities laws, or unless an exemption from such registration is available. The ability of many of our investment funds, particularly our corporate private equity funds, to dispose of investments is heavily dependent on the public equity markets. For example, the ability to realize any value from an investment may depend upon the ability to complete an initial public offering of the portfolio company in which such investment is held. Even if the securities are publicly traded, large holdings of securities can often be disposed of only over a substantial length of time, exposing the investment returns to risks of downward movement in market prices during the intended disposition period. Accordingly, under certain conditions, our investment funds may be forced to either sell securities at lower prices than they had expected to realize or defer—potentially for a considerable period of time—sales that they had planned to make. We have made and expect to continue to make
30
significant principal investments in our current and future investment funds. Contributing capital to these investment funds is risky, and we may lose some or the entire principal amount of our investments.
We have engaged in large-sized investments, which involve certain complexities and risks that are not encountered in small and medium-sized investments.
Our corporate private equity and real estate funds have invested and plan to continue to invest in large transactions. The size of these investments involves certain complexities and risks that are not encountered in small- and medium-sized investments. For example, larger transactions may be more difficult to finance, and exiting larger deals may present challenges in many cases. In addition, larger transactions may entail greater scrutiny by regulators, labor unions and other third parties.
Larger transactions may be structured as “consortium transactions” due to the size of the investment and the amount of capital required to be invested. A consortium transaction involves an equity investment in which two or more private equity firms serve together or collectively as equity sponsors. We participated in a significant number of consortium transactions in recent years due to the increased size of many of the transactions in which we were involved. Consortium transactions generally entail a reduced level of control by Blackstone over the investment because governance rights must be shared with the other private equity investors. Accordingly, we may not be able to control decisions relating to the investment, including decisions relating to the management and operation of the company and the timing and nature of any exit, which could result in the risks described in “—Our investment funds make investments in companies that we do not control.”
Any of these factors could increase the risk that our larger investments could be less successful. The consequences to our investment funds of an unsuccessful larger investment could be more severe given the size of the investment.
Our investment funds make investments in companies that we do not control.
Investments by most of our investment funds will include debt instruments and equity securities of companies that we do not control. Such instruments and securities may be acquired by our investment funds through trading activities or through purchases of securities from the issuer. In addition, our corporate private equity and real estate funds may acquire minority equity interests (particularly in consortium transactions, as described in “—We have engaged in large-sized investments, which involve certain complexities and risks that are not encountered in small and medium-sized investments”) and may also dispose of a portion of their majority equity investments in portfolio companies over time in a manner that results in the investment funds retaining a minority investment. Those investments will be subject to the risk that the company in which the investment is made may make business, financial or management decisions with which we do not agree or that the majority stakeholders or the management of the company may take risks or otherwise act in a manner that does not serve our interests. If any of the foregoing were to occur, the values of investments by our investment funds could decrease and our financial condition, results of operations and cash flow could suffer as a result.
We expect to make investments in companies that are based outside of the United States, which may expose us to additional risks not typically associated with investing in companies that are based in the United States.
Many of our investment funds generally invest a significant portion of their assets in the equity, debt, loans or other securities of issuers located outside the United States, and we expect that international investments will increase as a proportion of certain of our funds’ portfolios in the future. Investments in non-U.S. securities involve certain factors not typically associated with investing in U.S. securities, including risks relating to:
| • | currency exchange matters, including fluctuations in currency exchange rates and costs associated with conversion of investment principal and income from one currency into another; |
| • | less developed or efficient financial markets than in the United States, which may lead to potential price volatility and relative illiquidity; |
31
| • | the absence of uniform accounting, auditing and financial reporting standards, practices and disclosure requirements and less government supervision and regulation; |
| • | differences in the legal and regulatory environment; |
| • | political hostility to investments by foreign or private equity investors; |
| • | less publicly available information in respect of companies in non-U.S. markets; |
| • | certain economic and political risks, including potential exchange control regulations and restrictions on our non-U.S. investments and repatriation of profits on investments or of capital invested, the risks of political, economic or social instability, the possibility of expropriation or confiscatory taxation and adverse economic and political developments; and |
| • | the possible imposition of non-U.S. taxes or withholding on income and gains recognized with respect to such securities. |
There can be no assurance that adverse developments with respect to such risks will not adversely affect our assets that are held in certain countries or the returns from these assets.
We may not have sufficient cash to pay back “clawback” obligations if and when they are triggered under the governing agreements with our investors.
If, at the end of the life of a carry fund, as a result of diminished performance of later investments in any carry fund’s life, the carry fund has not achieved investment returns that (in most cases) exceed the preferred return threshold or (in all cases) the general partner receives in excess of 20% (15% in the case of one of our credit-oriented carry funds) of the fund’s net profits over the life of the fund, we will be obligated to repay an amount equal to the extent to which carried interest that was previously distributed to us exceeds the amounts to which we are ultimately entitled. This obligation is known as a clawback obligation and is an obligation of any person who directly received such carried interest, including us and our employees who participate in our carried interest plans. Although a portion of any distributions by us to our unitholders may include any carried interest received by us, we do not intend to seek fulfillment of any clawback obligation by seeking to have our unitholders return any portion of such distributions attributable to carried interest associated with any clawback obligation. The clawback obligation operates with respect to a given carry fund’s own net investment performance only and performance fees of other funds are not netted for determining this contingent obligation. To the extent one or more clawback obligations were to occur for any one or more carry funds, we might not have available cash at the time such clawback obligation is triggered to repay the carried interest and satisfy such obligation. If we were unable to repay such carried interest, we would be in breach of the governing agreements with our investors and could be subject to liability. Moreover, although a clawback obligation is several, the governing agreements of most of our funds provide that to the extent another recipient of carried interest (such as a current or former employee) does not fund his or her respective share, then we and our employees who participate in such carried interest plans may have to fund additional amounts (generally up to an additional 50%) beyond what we actually received in carried interest, although we will retain the right to pursue any remedies that we have under such governing agreements against those carried interest recipients who fail to fund their obligations.
Investments by our investment funds will in most cases rank junior to investments made by others.
In most cases, the companies in which our investment funds invest will have indebtedness or equity securities, or may be permitted to incur indebtedness or to issue equity securities, that rank senior to our investment. By their terms, such instruments may provide that their holders are entitled to receive payments of dividends, interest or principal on or before the dates on which payments are to be made in respect of our investment. Also, in the event of insolvency, liquidation, dissolution, reorganization or bankruptcy of a company
32
in which an investment is made, holders of securities ranking senior to our investment would typically be entitled to receive payment in full before distributions could be made in respect of our investment. After repaying senior security holders, the company may not have any remaining assets to use for repaying amounts owed in respect of our investment. To the extent that any assets remain, holders of claims that rank equally with our investment would be entitled to share on an equal and ratable basis in distributions that are made out of those assets. Also, during periods of financial distress or following an insolvency, the ability of our investment funds to influence a company’s affairs and to take actions to protect their investments may be substantially less than that of the senior creditors.
Investors in our hedge funds may redeem their investments in these funds. In addition, investors in our other investment funds have the right to cause these investment funds to be dissolved. These events would lead to a decrease in our revenues, which could be substantial.
Investors in our hedge funds may generally redeem their investments on an annual, semi-annual or quarterly basis following the expiration of a specified period of time when capital may not be withdrawn (typically between one and three years), subject to the applicable fund’s specific redemption provisions. In a declining market, the pace of redemptions and consequent reduction in our assets under management could accelerate. The decrease in revenues that would result from significant redemptions in our hedge funds could have a material adverse effect on our business, revenues, net income and cash flows. There were unusually large redemptions by investors in the hedge fund industry generally in the second half of 2008 due to unsettled conditions in the capital markets.
The governing agreements of all of our investment funds (with the exception of certain of our funds of hedge funds) provide that, subject to certain conditions, third-party investors in those funds will have the right to remove the general partner of the fund or to accelerate the liquidation date of the investment fund without cause by a simple majority vote, resulting in a reduction in management fees we would earn from such investment funds and a significant reduction in the amounts of total carried interest and incentive fees from those funds. Carried interest and incentive fees could be significantly reduced as a result of our inability to maximize the value of investments by an investment fund during the liquidation process or in the event of the triggering of a “clawback” obligation. Finally, the applicable funds would cease to exist. In addition, the governing agreements of our investment funds enable investors in those funds to vote to terminate the investment period by a simple majority vote in accordance with specified procedures or accelerate the withdrawal of their capital on an investor by investor basis in the event certain “key persons” in our investment funds (for example, both of Stephen A. Schwarzman and Hamilton E. James in the case of our corporate private equity funds) do not remain active managing the fund. In addition to having a significant negative impact on our revenue, net income and cash flow, the occurrence of such an event with respect to any of our investment funds would likely result in significant reputational damage to us.
In addition, because all of our investment funds have advisers that are registered under the Advisers Act, the management agreements of all of our investment funds would be terminated upon an “assignment,” without investor consent, of these agreements, which may be deemed to occur in the event these advisers were to experience a change of control. We cannot be certain that consents required to assignments of our investment management agreements will be obtained if a change of control occurs. In addition, with respect to our publicly traded closed-end mutual funds, each investment fund’s investment management agreement must be approved annually by the independent members of such investment fund’s board of directors and, in certain cases, by its stockholders, as required by law. Termination of these agreements would cause us to lose the fees we earn from such investment funds.
33
Third party investors in our investment funds with commitment-based structures may not satisfy their contractual obligation to fund capital calls when requested by us, which could adversely affect a fund’s operations and performance.
Investors in all of our carry funds (and certain of our hedge funds) make capital commitments to those funds that we are entitled to call from those investors at any time during prescribed periods. We depend on investors fulfilling their commitments when we call capital from them in order for those funds to consummate investments and otherwise pay their obligations when due. We have not had investors fail to honor capital calls to any meaningful extent. Any investor that did not fund a capital call would be subject to several possible penalties, including having a significant amount of its existing investment forfeited in that fund. However, the impact of the penalty is directly correlated to the amount of capital previously invested by the investor in the fund and if an investor has invested little or no capital, for instance early in the life of the fund, then the forfeiture penalty may not be as meaningful. If investors were to fail to satisfy a significant amount of capital calls for any particular fund or funds, the operation and performance of those funds could be materially and adversely affected.
Certain policies and procedures implemented to mitigate potential conflicts of interest and address certain regulatory requirements may reduce the synergies across our various businesses.
Because of our various lines of asset management and advisory businesses, we will be subject to a number of actual and potential conflicts of interest and subject to greater regulatory oversight than that to which we would otherwise be subject if we had just one line of business. In addressing these conflicts and regulatory requirements across our various businesses, we have implemented certain policies and procedures (for example, information walls) that may reduce the positive synergies that we cultivate across these businesses. For example, we may come into possession of material non-public information with respect to issuers in which we may be considering making an investment or issuers that are our advisory clients. As a consequence, we may be precluded from providing such information or other ideas to our other businesses that might be of benefit to them.
Risk management activities may adversely affect the return on our funds’ investments.
When managing our exposure to market risks, we may (on our own behalf or on behalf of our funds) from time to time use forward contracts, options, swaps, caps, collars and floors or pursue other strategies or use other forms of derivative instruments to limit our exposure to changes in the relative values of investments that may result from market developments, including changes in prevailing interest rates, currency exchange rates and commodity prices. The success of any hedging or other derivative transactions generally will depend on our ability to correctly predict market changes, the degree of correlation between price movements of a derivative instrument, the position being hedged, the creditworthiness of the counterparty and other factors. As a result, while we may enter into a transaction in order to reduce our exposure to market risks, the transaction may result in poorer overall investment performance than if it had not been executed. Such transactions may also limit the opportunity for gain if the value of a hedged position increases.
Our real estate funds are subject to the risks inherent in the ownership and operation of real estate and the construction and development of real estate.
Investments in our real estate funds will be subject to the risks inherent in the ownership and operation of real estate and real estate related businesses and assets. These risks include those associated with the burdens of ownership of real property, general and local economic conditions, changes in supply of and demand for competing properties in an area (as a result for instance of overbuilding), fluctuations in the average occupancy and room rates for hotel properties, the financial resources of tenants, changes in building, environmental and other laws, energy and supply shortages, various uninsured or uninsurable risks, natural disasters, changes in government regulations (such as rent control), changes in real property tax rates, changes in interest rates, the reduced availability of mortgage funds which may render the sale or refinancing of properties difficult or
34
impracticable, negative developments in the economy that depress travel activity, environmental liabilities, contingent liabilities on disposition of assets, terrorist attacks, war and other factors that are beyond our control. During 2008, real estate markets in the U.S. and Europe generally experienced increases in capitalization rates and declines in value as a result of the overall economic decline and the limited availability of financing. As a result, the value of investments in our real estate funds declined significantly. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Business Environment” for further discussion of the real estate market environment. In addition, if our real estate funds acquire direct or indirect interests in undeveloped land or underdeveloped real property, which may often be non-income producing, they will be subject to the risks normally associated with such assets and development activities, including risks relating to the availability and timely receipt of zoning and other regulatory or environmental approvals, the cost and timely completion of construction (including risks beyond the control of our fund, such as weather or labor conditions or material shortages) and the availability of both construction and permanent financing on favorable terms.
Certain of our investment funds may invest in securities of companies that are experiencing significant financial or business difficulties, including companies involved in bankruptcy or other reorganization and liquidation proceedings. Such investments are subject to a greater risk of poor performance or loss.
Certain of our investment funds, especially our credit-oriented funds, may invest in business enterprises involved in work-outs, liquidations, spin-offs, reorganizations, bankruptcies and similar transactions and may purchase high risk receivables. An investment in such business enterprises entails the risk that the transaction in which such business enterprise is involved either will be unsuccessful, will take considerable time or will result in a distribution of cash or a new security the value of which will be less than the purchase price to the fund of the security or other financial instrument in respect of which such distribution is received. In addition, if an anticipated transaction does not in fact occur, the fund may be required to sell its investment at a loss. Investments in troubled companies may also be adversely affected by U.S. federal and state laws relating to, among other things, fraudulent conveyances, voidable preferences, lender liability and a bankruptcy court’s discretionary power to disallow, subordinate or disenfranchise particular claims. Investments in securities and private claims of troubled companies made in connection with an attempt to influence a restructuring proposal or plan of reorganization in a bankruptcy case may also involve substantial litigation. Because there is substantial uncertainty concerning the outcome of transactions involving financially troubled companies, there is a potential risk of loss by a fund of its entire investment in such company. Moreover, a major economic recession could have a materially adverse impact on the value of such securities. In addition, adverse publicity and investor perceptions, whether or not based on fundamental analysis, may also decrease the value and liquidity of securities rated below investment grade or otherwise adversely affect our reputation.
Certain of our fund investments may be concentrated in certain asset types or in a geographic region, which could exacerbate any negative performance of those funds to the extent those concentrated investments perform poorly.
The governing agreements of our investment funds contain only limited investment restrictions and only limited requirements as to diversification of fund investments, either by geographic region or asset type. For example, over 92% of the investments of our real estate funds are in office building and hotel assets. During periods of difficult market conditions or slowdowns in these sectors, the decreased revenues, difficulty in obtaining access to financing and increased funding costs experienced by our real estate funds may be exacerbated by this concentration of investments, which would result in lower investment returns for our real estate funds.
35
Hedge fund investments are subject to numerous additional risks.
Investments by our funds of hedge funds in other hedge funds, as well as investments by our hedge funds, are subject to numerous additional risks, including the following:
| • | Certain of the funds are newly established funds without any operating history or are managed by management companies or general partners who may not have as significant track records as an independent manager. |
| • | Generally, there are few limitations on the execution of the hedge funds’ investment strategies, which are subject to the sole discretion of the management company or the general partner of such funds. |
| • | Hedge funds may engage in short selling, which is subject to the theoretically unlimited risk of loss because there is no limit on how much the price of a security may appreciate before the short position is closed out. A fund may be subject to losses if a security lender demands return of the lent securities and an alternative lending source cannot be found or if the fund is otherwise unable to borrow securities that are necessary to hedge its positions. |
| • | Hedge funds are exposed to the risk that a counterparty will not settle a transaction in accordance with its terms and conditions because of a dispute over the terms of the contract (whether or not bona fide) or because of a credit or liquidity problem, thus causing the fund to suffer a loss. Counterparty risk is accentuated for contracts with longer maturities where events may intervene to prevent settlement, or where the fund has concentrated its transactions with a single or small group of counterparties. Generally, hedge funds are not restricted from dealing with any particular counterparty or from concentrating any or all of their transactions with one counterparty. Moreover, the funds’ internal consideration of the creditworthiness of their counterparties may prove insufficient. The absence of a regulated market to facilitate settlement may increase the potential for losses. |
| • | Credit risk may arise through a default by one of several large institutions that are dependent on one another to meet their liquidity or operational needs, so that a default by one institution causes a series of defaults by the other institutions. This “systemic risk” may adversely affect the financial intermediaries (such as clearing agencies, clearing houses, banks, securities firms and exchanges) with which the hedge funds interact on a daily basis. |
| • | The efficacy of investment and trading strategies depend largely on the ability to establish and maintain an overall market position in a combination of financial instruments. A hedge fund’s trading orders may not be executed in a timely and efficient manner due to various circumstances, including systems failures or human error. In such event, the funds might only be able to acquire some but not all of the components of the position, or if the overall position were to need adjustment, the funds might not be able to make such adjustment. As a result, the funds would not be able to achieve the market position selected by the management company or general partner of such funds, and might incur a loss in liquidating their position. |
| • | Hedge funds are subject to risks due to potential illiquidity of assets. Hedge funds may make investments or hold trading positions in markets that are volatile and which may become illiquid. Timely divestiture or sale of trading positions can be impaired by decreased trading volume, increased price volatility, concentrated trading positions, limitations on the ability to transfer positions in highly specialized or structured transactions to which they may be a party, and changes in industry and government regulations. It may be impossible or costly for hedge funds to liquidate positions rapidly in order to meet margin calls, withdrawal requests or otherwise, particularly if there are other market participants seeking to dispose of similar assets at the same time or the relevant market is otherwise moving against a position or in the event of trading halts or daily price movement limits on the market or otherwise. Moreover, these risks may be exacerbated for our funds of hedge funds. For example, if one of our funds of hedge funds were to invest a significant portion of its assets in two or more hedge funds that each had illiquid positions in the same issuer, the illiquidity risk for our funds of hedge funds would be compounded. In 2008, many hedge funds, including certain of our hedge funds, experienced significant declines in value. In many cases, these declines in value were both provoked and exacerbated by margin calls and forced selling of assets. Moreover, certain of our |
36
| funds of hedge funds were invested in third party hedge funds that halted redemptions in the face of illiquidity and other issues, which precluded those funds of hedge funds from receiving their capital back on request. |
| • | Hedge fund investments are subject to risks relating to investments in commodities, futures, options and other derivatives, the prices of which are highly volatile and may be subject to the theoretically unlimited risk of loss in certain circumstances, including if the fund writes a call option. Price movements of commodities, futures and options contracts and payments pursuant to swap agreements are influenced by, among other things, interest rates, changing supply and demand relationships, trade, fiscal, monetary and exchange control programs and policies of governments and national and international political and economic events and policies. The value of futures, options and swap agreements also depends upon the price of the commodities underlying them. In addition, hedge funds’ assets are subject to the risk of the failure of any of the exchanges on which their positions trade or of their clearinghouses or counterparties. Most U.S. commodities exchanges limit fluctuations in certain commodity interest prices during a single day by imposing “daily price fluctuation limits” or “daily limits,” the existence of which may reduce liquidity or effectively curtail trading in particular markets. |
Risks Related to Our Financial Advisory Business
Financial advisory fees are not long-term contracted sources of revenue and are not predictable.
The fees earned by our financial advisory business are typically payable upon the successful completion of a particular transaction or restructuring. A decline in our financial advisory engagements or the market for advisory services would adversely affect our business. Our financial advisory business operates in a highly competitive environment where typically there are no long-term contracted sources of revenue. Each revenue generating engagement typically is separately solicited, awarded and negotiated. In addition, many businesses do not routinely engage in transactions requiring our services. As a consequence, our fee-paying engagements with many clients are not predictable and high levels of financial advisory revenue in one quarter are not necessarily predictive of continued high levels of financial advisory revenue in future periods. In addition to the fact that most of our financial advisory engagements are single, non-recurring engagements, we lose clients each year as a result of a client’s decision to retain other financial advisors, the sale, merger or restructuring of a client, a change in a client’s senior management and various other causes. As a result, our financial advisory revenue could decline materially due to such changes in the volume, nature and scope of our engagements.
The fees earned by Park Hill Group, our fund placement business, are generally recognized by us for accounting purposes, upon the successful subscription by an investor in a client’s fund and/or the closing of that fund. However, those fees are typically actually paid by a Park Hill Group client over a period of time (e.g., two to three years) following such successful subscription by an investor in a client’s fund and/or the closing of that fund with interest. There is a risk that during that period of time, Park Hill Group may not be able to collect on all or a portion of the fees Park Hill is due for the placement services it has already provided to such client. For instance, Park Hill client’s fund may be liquidated prior to the time that all or a portion of the fees due to Park Hill for its placement services are due to be paid. Moreover, to the extent fewer assets are raised for funds or interest by investors in alternative asset funds declines, the fees earned by Park Hill Group would be adversely affected.
We face strong competition from other financial advisory firms.
The financial advisory industry is intensely competitive, and we expect it to remain so. We compete on the basis of a number of factors, including the quality of our employees, transaction execution, our products and services, innovation and reputation and price. We have always experienced intense competition over obtaining advisory mandates, and we may experience pricing pressures in our financial advisory business in the future as some of our competitors seek to obtain increased market share by reducing fees. Our primary competitors in our
37
financial advisory business are large financial institutions, many of which have far greater financial and other resources and much broader client relationships than us and (unlike us) have the ability to offer a wide range of products, from loans, deposit taking and insurance to brokerage and a wide range of investment banking services, which may enhance their competitive position. They also have the ability to support investment banking, including financial advisory services, with commercial banking, insurance and other financial services revenue in an effort to gain market share, which puts us at a competitive disadvantage and could result in pricing pressures that could materially adversely affect our revenue and profitability. In the current market environment, we are also seeing increased competition from independent boutique advisory firms focused primarily on mergers and acquisitions advisory and/or restructuring services. In addition, Park Hill Group operates in a highly competitive environment and the barriers to entry into the fund placement business are low.
Risks Related to Our Organizational Structure
Our common unitholders do not elect our general partner or vote on our general partner’s directors and have limited ability to influence decisions regarding our business.
Our general partner, Blackstone Group Management L.L.C., which is owned by our senior managing directors, manages all of our operations and activities. Blackstone Group Management L.L.C. has a board of directors that is responsible for the oversight of our business and operations. Our general partner’s board of directors is elected in accordance with its limited liability company agreement, where our senior managing directors have agreed that our founder, Stephen A. Schwarzman, will have the power to appoint and remove the directors of our general partner. The limited liability company agreement of our general partner provides that at such time as Mr. Schwarzman should cease to be a founder, Hamilton E. James will thereupon succeed Mr. Schwarzman as the sole founding member of our general partner, and thereafter such power will revert to the members of our general partner (our senior managing directors) holding a majority in interest in our general partner.
Our common unitholders do not elect our general partner or its board of directors and, unlike the holders of common stock in a corporation, have only limited voting rights on matters affecting our business and therefore limited ability to influence decisions regarding our business. Furthermore, if our common unitholders are dissatisfied with the performance of our general partner, they have little ability to remove our general partner. Our general partner may not be removed unless that removal is approved by the vote of the holders of not less than two-thirds of the voting power of our outstanding common units and special voting units (including common units and special voting units held by the general partner and its affiliates) and we receive an opinion of counsel regarding limited liability matters. Blackstone Partners L.L.C., an entity wholly owned by our senior managing directors, has 84.0% of the voting power of The Blackstone Group L.P. limited partners. Therefore, our senior managing directors have the ability to remove or block any removal of our general partner and thus control The Blackstone Group L.P.
Blackstone personnel collectively own a controlling interest in us and will be able to determine the outcome of those few matters that may be submitted for a vote of the limited partners.
Our senior managing directors generally have sufficient voting power to determine the outcome of those few matters that may be submitted for a vote of the limited partners of the Blackstone Group L.P., including any attempt to remove our general partner.
Our common unitholders’ voting rights are further restricted by the provision in our partnership agreement stating that any common units held by a person that beneficially owns 20% or more of any class of The Blackstone Group L.P. common units then outstanding (other than our general partner and its affiliates, or a direct or subsequently approved transferee of our general partner or its affiliates) cannot be voted on any matter. In addition, our partnership agreement contains provisions limiting the ability of our common unitholders to call meetings or to acquire information about our operations, as well as other provisions limiting the ability of our
38
common unitholders to influence the manner or direction of our management. Our partnership agreement also does not restrict our general partner’s ability to take actions that may result in our being treated as an entity taxable as a corporation for U.S. federal (and applicable state) income tax purposes. Furthermore, the common unitholders are not entitled to dissenters’ rights of appraisal under our partnership agreement or applicable Delaware law in the event of a merger or consolidation, a sale of substantially all of our assets or any other transaction or event. In addition, we have the right to acquire all our then-outstanding common units if not more than 10% of our common units are held by persons other than our general partner and its affiliates.
As a result of these matters and the provisions referred to under “—Our common unitholders do not elect our general partner or vote on our general partner’s directors and have limited ability to influence decisions regarding our business”, our common unitholders may be deprived of an opportunity to receive a premium for their common units in the future through a sale of The Blackstone Group L.P., and the trading prices of our common units may be adversely affected by the absence or reduction of a takeover premium in the trading price.
We are a limited partnership and as a result fall within exceptions from certain corporate governance and other requirements under the rules of the New York Stock Exchange.
We are a limited partnership and fall within exceptions from certain corporate governance and other requirements of the rules of the New York Stock Exchange. Pursuant to these exceptions, limited partnerships may elect not to comply with certain corporate governance requirements of the New York Stock Exchange, including the requirements (1) that a majority of the board of directors of our general partner consist of independent directors, (2) that we have a nominating/corporate governance committee that is composed entirely of independent directors and (3) that we have a compensation committee that is composed entirely of independent directors. In addition, we are not required to hold annual meetings of our common unitholders. We will continue to avail ourselves of these exceptions. Accordingly, common unitholders generally do not have the same protections afforded to equityholders of entities that are subject to all of the corporate governance requirements of the New York Stock Exchange.
Potential conflicts of interest may arise among our general partner, its affiliates and us. Our general partner and its affiliates have limited fiduciary duties to us and our common unitholders, which may permit them to favor their own interests to the detriment of us and our common unitholders.
Conflicts of interest may arise among our general partner and its affiliates, on the one hand, and us and our common unitholders, on the other hand. As a result of these conflicts, our general partner may favor its own interests and the interests of its affiliates over the interests of our common unitholders. These conflicts include, among others, the following:
| • | our general partner determines the amount and timing of our investments and dispositions, indebtedness, issuances of additional partnership interests and amounts of reserves, each of which can affect the amount of cash that is available for distribution to our common unitholders; |
| • | our general partner is allowed to take into account the interests of parties other than us in resolving conflicts of interest, which has the effect of limiting its duties (including fiduciary duties) to our common unitholders. For example, our subsidiaries that serve as the general partners of our investment funds have fiduciary and contractual obligations to the investors in those funds and certain of our subsidiaries engaged in our advisory business have contractual duties to their clients, as a result of which we expect to regularly take actions that might adversely affect our near-term results of operations or cash flow; |
| • | because our senior managing directors hold their Blackstone Holdings Partnership Units directly or through entities that are not subject to corporate income taxation and The Blackstone Group L.P. holds Blackstone Holdings Partnership Units through wholly owned subsidiaries, some of which are subject to corporate income taxation, conflicts may arise between our senior managing directors and The Blackstone Group L.P. relating to the selection and structuring of investments; |
39
| • | other than as set forth in the non-competition and non-solicitation agreements to which our senior managing directors are subject, which may not be enforceable, affiliates of our general partner and existing and former personnel employed by our general partner are not prohibited from engaging in other businesses or activities, including those that might be in direct competition with us; |
| • | our general partner has limited its liability and reduced or eliminated its duties (including fiduciary duties) under the partnership agreement, while also restricting the remedies available to our common unitholders for actions that, without these limitations, might constitute breaches of duty (including fiduciary duty). In addition, we have agreed to indemnify our general partner and its affiliates to the fullest extent permitted by law, except with respect to conduct involving bad faith, fraud or willful misconduct. By purchasing our common units, common unitholders will have agreed and consented to the provisions set forth in our partnership agreement, including the provisions regarding conflicts of interest situations that, in the absence of such provisions, might constitute a breach of fiduciary or other duties under applicable state law; |
| • | our partnership agreement does not restrict our general partner from causing us to pay it or its affiliates for any services rendered, or from entering into additional contractual arrangements with any of these entities on our behalf, so long as the terms of any such additional contractual arrangements are fair and reasonable to us as determined under the partnership agreement; |
| • | our general partner determines how much debt we incur and that decision may adversely affect our credit ratings; |
| • | our general partner determines which costs incurred by it and its affiliates are reimbursable by us; |
| • | our general partner controls the enforcement of obligations owed to us by it and its affiliates; and |
| • | our general partner decides whether to retain separate counsel, accountants or others to perform services for us. |
See “Part III. Item 13. Certain Relationships, Related Transactions and Director Independence” and “Part III. Item 10. Directors, Executive Officers and Corporate Governance—Partnership Management and Governance—Conflicts Committee.”
Our partnership agreement contains provisions that reduce or eliminate duties (including fiduciary duties) of our general partner and limit remedies available to common unitholders for actions that might otherwise constitute a breach of duty. It will be difficult for a common unitholder to successfully challenge a resolution of a conflict of interest by our general partner or by its conflicts committee.
Our partnership agreement contains provisions that waive or consent to conduct by our general partner and its affiliates that might otherwise raise issues about compliance with fiduciary duties or applicable law. For example, our partnership agreement provides that when our general partner is acting in its individual capacity, as opposed to in its capacity as our general partner, it may act without any fiduciary obligations to us or our common unitholders whatsoever. When our general partner, in its capacity as our general partner, is permitted to or required to make a decision in its “sole discretion” or “discretion” or that it deems “necessary or appropriate” or “necessary or advisable,” then our general partner is entitled to consider only such interests and factors as it desires, including its own interests, and has no duty or obligation (fiduciary or otherwise) to give any consideration to any interest of or factors affecting us or any limited partners and will not be subject to any different standards imposed by the partnership agreement, the Delaware Limited Partnership Act or under any other law, rule or regulation or in equity. These modifications of fiduciary duties are expressly permitted by Delaware law. Hence, we and our common unitholders only have recourse and are able to seek remedies against our general partner if our general partner breaches its obligations pursuant to our partnership agreement. Unless our general partner breaches its obligations pursuant to our partnership agreement, we and our common unitholders do not have any recourse against our general partner even if our general partner were to act in a manner that was inconsistent with traditional fiduciary duties. Furthermore, even if there has been a breach of the
40
obligations set forth in our partnership agreement, our partnership agreement provides that our general partner and its officers and directors are not liable to us or our common unitholders for errors of judgment or for any acts or omissions unless there has been a final and non-appealable judgment by a court of competent jurisdiction determining that the general partner or its officers and directors acted in bad faith or engaged in fraud or willful misconduct. These modifications are detrimental to the common unitholders because they restrict the remedies available to common unitholders for actions that without those limitations might constitute breaches of duty (including fiduciary duty).
Whenever a potential conflict of interest exists between us and our general partner, our general partner may resolve such conflict of interest. If our general partner determines that its resolution of the conflict of interest is on terms no less favorable to us than those generally being provided to or available from unrelated third parties or is fair and reasonable to us, taking into account the totality of the relationships between us and our general partner, then it will be presumed that in making this determination, our general partner acted in good faith. A common unitholder seeking to challenge this resolution of the conflict of interest would bear the burden of overcoming such presumption. This is different from the situation with Delaware corporations, where a conflict resolution by an interested party would be presumed to be unfair and the interested party would have the burden of demonstrating that the resolution was fair.
Also, if our general partner obtains the approval of the conflicts committee of our general partner, the resolution will be conclusively deemed to be fair and reasonable to us and not a breach by our general partner of any duties it may owe to us or our common unitholders. This is different from the situation with Delaware corporations, where a conflict resolution by a committee consisting solely of independent directors may, in certain circumstances, merely shift the burden of demonstrating unfairness to the plaintiff. Common unitholders, in purchasing our common units, are deemed as having consented to the provisions set forth in the partnership agreement, including provisions regarding conflicts of interest situations that, in the absence of such provisions, might be considered a breach of fiduciary or other duties under applicable state law. As a result, common unitholders will, as a practical matter, not be able to successfully challenge an informed decision by the conflicts committee. See “Part III. Item 10. Directors, Executive Officers and Corporate Governance—Partnership Management and Governance—Conflicts Committee.”
The control of our general partner may be transferred to a third party without common unitholder consent.
Our general partner may transfer its general partner interest to a third party in a merger or consolidation without the consent of our common unitholders. Furthermore, at any time, the members of our general partner may sell or transfer all or part of their limited liability company interests in our general partner without the approval of the common unitholders, subject to certain restrictions as described elsewhere in this annual report. A new general partner may not be willing or able to form new investment funds and could form funds that have investment objectives and governing terms that differ materially from those of our current investment funds. A new owner could also have a different investment philosophy, employ investment professionals who are less experienced, be unsuccessful in identifying investment opportunities or have a track record that is not as successful as Blackstone’s track record. If any of the foregoing were to occur, we could experience difficulty in making new investments, and the value of our existing investments, our business, our results of operations and our financial condition could materially suffer.
We intend to pay regular distributions to our common unitholders, but our ability to do so may be limited by our holding partnership structure, applicable provisions of Delaware law and contractual restrictions.
Our current intention is to distribute to our common unitholders substantially all of our net after-tax share of our annual Adjusted Cash Flow from Operations in excess of amounts determined by our general partner to be necessary or appropriate to provide for the conduct of our business, to make appropriate investments in our business and our funds, to comply with applicable law, any of our debt instruments or other agreements, or to provide for future distributions to common unitholders for any ensuing quarter. The declaration and payment of
41
any distributions will be at the sole discretion of our general partner, which may change our distribution policy at any time. The Blackstone Group L.P. is a holding partnership and has no material assets other than the ownership of the partnership units in Blackstone Holdings held through wholly owned subsidiaries. The Blackstone Group L.P. has no independent means of generating revenue. Accordingly, we intend to cause Blackstone Holdings to make distributions to its partners, including The Blackstone Group L.P.’s wholly-owned subsidiaries, to fund any distributions The Blackstone Group L.P. may declare on the common units. If Blackstone Holdings makes such distributions, the limited partners of Blackstone Holdings will be entitled to receive equivalent distributions pro rata based on their partnership interests in Blackstone Holdings, except that The Blackstone Group L.P.’s wholly-owned subsidiaries will be entitled to priority allocations of income through December 31, 2009.
Our ability to make cash distributions to our unitholders will depend on a number of factors, including among others general economic and business conditions, our strategic plans and prospects, our business and investment opportunities, our financial condition and operating results, working capital requirements and anticipated cash needs, contractual restrictions and obligations including fulfilling our current and future capital commitments, legal, tax and regulatory restrictions, restrictions and other implications on the payment of distributions by us to our common unitholders or by our subsidiaries to us and such other factors as our general partner may deem relevant. Under the Delaware Limited Partnership Act, we may not make a distribution to a partner if after the distribution all our liabilities, other than liabilities to partners on account of their partnership interests and liabilities for which the recourse of creditors is limited to specific property of the partnership, would exceed the fair value of our assets. If we were to make such an impermissible distribution, any limited partner who received a distribution and knew at the time of the distribution that the distribution was in violation of the Delaware Limited Partnership Act would be liable to us for the amount of the distribution for three years. In addition, the terms of our revolving credit facility require that the ratio of recourse debt of the Blackstone Holdings partnerships on a combined basis to partners’ capital of the Blackstone Holdings partnerships on a combined basis be no greater than 4.5 to 1, which may prohibit us from making certain distributions. Subject to a notice period and a cure period, distributions in violation of the terms of our revolving credit facility would result in a default under our revolving credit facility. In addition, Blackstone Holdings’ cash flow from operations may be insufficient to enable it to make required minimum tax distributions to its partners, in which case Blackstone Holdings may have to borrow funds or sell assets, and thus our liquidity and financial condition could be materially adversely affected. Furthermore, by paying cash distributions rather than investing that cash in our businesses, we risk slowing the pace of our growth, or not having a sufficient amount of cash to fund our operations, new investments or unanticipated capital expenditures, should the need arise.
We expect to record significant net losses for a number of years as a result of the amortization of finite lived intangible assets and non-cash equity based compensation.
As part of the reorganization related to our initial public offering we acquired interests in our business from our predecessor owners. This transaction has been accounted for partially as a transfer of interests under common control and partially as an acquisition of non-controlling interests. We accounted for the acquisition of the non-controlling interests using the purchase method of accounting, and reflected the excess of the purchase price over the fair value of the tangible assets acquired and liabilities assumed as goodwill and other intangible assets on our statement of financial condition. We have recorded $876.3 million of finite lived intangible assets (in addition to $1.52 billion of goodwill). We are amortizing these finite lived intangibles over their estimated useful lives, which range between five and fifteen years, using the straight-line method. In addition, as part of the reorganization, Blackstone personnel received an aggregate of 827,516,625 Blackstone Holdings Partnership Units, of which 439,711,537 were unvested. The grant date fair value of the unvested Blackstone Holdings Partnership Units (which was $31) is being charged to expense as the Blackstone Holdings Partnership Units vest over the assumed service periods, which range up to eight years, on a straight-line basis. The amortization of these finite lived intangible assets and of this non-cash equity based compensation will increase our expenses substantially during the relevant periods and, as a result, we expect to record significant net losses for a number of years.
42
We are required to pay our senior managing directors for most of the benefits relating to any additional tax depreciation or amortization deductions we may claim as a result of the tax basis step-up we received as part of the reorganization we implemented in connection with our IPO or receive in connection with future exchanges of our common units and related transactions.
As part of the reorganization we implemented in connection with our IPO, we purchased interests in our business from our pre-IPO owners. In addition, holders of partnership units in Blackstone Holdings (other than The Blackstone Group L.P.’s wholly owned subsidiaries), subject to the vesting and minimum retained ownership requirements and transfer restrictions set forth in the partnership agreements of the Blackstone Holdings partnerships, may up to four times each year (subject to the terms of the exchange agreement) exchange their Blackstone Holdings Partnership Units for The Blackstone Group L.P. common units on a one-for-one basis. A Blackstone Holdings limited partner must exchange one partnership unit in each of the five Blackstone Holdings partnerships to effect an exchange for a common unit. The purchase and subsequent exchanges are expected to result in increases in the tax basis of the tangible and intangible assets of Blackstone Holdings that otherwise would not have been available. These increases in tax basis may increase (for tax purposes) depreciation and amortization and therefore reduce the amount of tax that The Blackstone Group L.P.’s wholly owned subsidiaries that are taxable as corporations for U.S. federal income tax purposes, which we refer to as the “corporate taxpayers,” would otherwise be required to pay in the future, although the IRS may challenge all or part of that tax basis increase, and a court could sustain such a challenge.
The corporate taxpayers have entered into a tax receivable agreement with our senior managing directors and other pre-IPO owners that provides for the payment by the corporate taxpayers to the counterparties of 85% of the amount of cash savings, if any, in U.S. federal, state and local income tax or franchise tax that the corporate taxpayers actually realize as a result of these increases in tax basis and of certain other tax benefits related to entering into the tax receivable agreement, including tax benefits attributable to payments under the tax receivable agreement. In addition, additional tax receivable agreements have been executed, and will continue to be executed, with newly admitted Blackstone senior managing directors and certain others who acquire Blackstone Holdings Partnership Units. This payment obligation is an obligation of the corporate taxpayers and not of Blackstone Holdings. While the actual increase in tax basis, as well as the amount and timing of any payments under this agreement, will vary depending upon a number of factors, including the timing of exchanges, the price of our common units at the time of the exchange, the extent to which such exchanges are taxable and the amount and timing of our income, we expect that as a result of the size of the increases in the tax basis of the tangible and intangible assets of Blackstone Holdings, the payments that we may make under the tax receivable agreements will be substantial. The payments under a tax receivable agreement are not conditioned upon a tax receivable agreement counterparty’s continued ownership of us. We may need to incur debt to finance payments under the tax receivable agreement to the extent our cash resources are insufficient to meet our obligations under the tax receivable agreements as a result of timing discrepancies or otherwise.
Although we are not aware of any issue that would cause the IRS to challenge a tax basis increase, the tax receivable agreement counterparties will not reimburse us for any payments previously made under the tax receivable agreement. As a result, in certain circumstances payments to the counterparties’ under the tax receivable agreement could be in excess of the corporate taxpayers’ actual cash tax savings. The corporate taxpayers’ ability to achieve benefits from any tax basis increase, and the payments to be made under the tax receivable agreements, will depend upon a number of factors, as discussed above, including the timing and amount of our future income.
If The Blackstone Group L.P. were deemed an “investment company” under the 1940 Act, applicable restrictions could make it impractical for us to continue our business as contemplated and could have a material adverse effect on our business.
An entity will generally be deemed to be an “investment company” for purposes of the 1940 Act if: (a) it is or holds itself out as being engaged primarily, or proposes to engage primarily, in the business of investing,
43
reinvesting or trading in securities; or (b) absent an applicable exemption, it owns or proposes to acquire investment securities having a value exceeding 40% of the value of its total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis. We believe that we are engaged primarily in the business of providing asset management and financial advisory services and not in the business of investing, reinvesting or trading in securities. We also believe that the primary source of income from each of our businesses is properly characterized as income earned in exchange for the provision of services. We hold ourselves out as an asset management and financial advisory firm and do not propose to engage primarily in the business of investing, reinvesting or trading in securities. Accordingly, we do not believe that The Blackstone Group L.P. is an “orthodox” investment company as defined in section 3(a)(1)(A) of the 1940 Act and described in clause (a) in the first sentence of this paragraph. Furthermore, The Blackstone Group L.P. does not have any material assets other than its equity interests in certain wholly owned subsidiaries, which in turn will have no material assets (other than intercompany debt) other than general partner interests in the Blackstone Holdings partnerships. These wholly owned subsidiaries are the sole general partners of the Blackstone Holdings partnerships and are vested with all management and control over the Blackstone Holdings partnerships. We do not believe the equity interests of The Blackstone Group L.P. in its wholly owned subsidiaries or the general partner interests of these wholly owned subsidiaries in the Blackstone Holdings partnerships are investment securities. Moreover, because we believe that the capital interests of the general partners of our funds in their respective funds are neither securities nor investment securities, we believe that less than 40% of The Blackstone Group L.P.’s total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis are comprised of assets that could be considered investment securities. Accordingly, we do not believe The Blackstone Group L.P. is an inadvertent investment company by virtue of the 40% test in section 3(a)(1)(C) of the 1940 Act as described in the second bullet point above. In addition, we believe The Blackstone Group L.P. is not an investment company under section 3(b)(1) of the 1940 Act because it is primarily engaged in a non-investment company business.
The 1940 Act and the rules thereunder contain detailed parameters for the organization and operation of investment companies. Among other things, the 1940 Act and the rules thereunder limit or prohibit transactions with affiliates, impose limitations on the issuance of debt and equity securities, generally prohibit the issuance of options and impose certain governance requirements. We intend to conduct our operations so that The Blackstone Group L.P. will not be deemed to be an investment company under the 1940 Act. If anything were to happen which would cause The Blackstone Group L.P. to be deemed to be an investment company under the 1940 Act, requirements imposed by the 1940 Act, including limitations on our capital structure, ability to transact business with affiliates (including us) and ability to compensate key employees, could make it impractical for us to continue our business as currently conducted, impair the agreements and arrangements between and among The Blackstone Group L.P., Blackstone Holdings and our senior managing directors, or any combination thereof, and materially adversely affect our business, financial condition and results of operations. In addition, we may be required to limit the amount of investments that we make as a principal or otherwise conduct our business in a manner that does not subject us to the registration and other requirements of the 1940 Act.
Risks Related to Our Common Units
Our common unit price may decline due to the large number of common units eligible for future sale and for exchange.
The market price of our common units could decline as a result of sales of a large number of common units in the market in the future or the perception that such sales could occur. These sales, or the possibility that these sales may occur, also might make it more difficult for us to sell common units in the future at a time and at a price that we deem appropriate. We had a total of 157,618,895 voting common units outstanding as of February 20, 2009. Subject to the lock-up restrictions described below, we may issue and sell in the future additional common units. Limited partners of Blackstone Holdings own an aggregate of 819,981,930 Blackstone Holdings Partnership Units outstanding as of February 20, 2009. In connection with our initial public offering, we entered into an exchange agreement with holders of Blackstone Holdings Partnership Units (other than The Blackstone Group L.P.’s wholly owned subsidiaries) so that these holders, subject to the vesting and minimum
44
retained ownership requirements and transfer restrictions set forth in the partnership agreements of the Blackstone Holdings partnerships, may up to four times each year (subject to the terms of the exchange agreement) exchange their Blackstone Holdings Partnership Units for The Blackstone Group L.P. common units on a one-for-one basis, subject to customary conversion rate adjustments for splits, unit distributions and reclassifications. A Blackstone Holdings limited partner must exchange one partnership unit in each of the five Blackstone Holdings partnerships to effect an exchange for a common unit. The common units we issue upon such exchanges would be “restricted securities,” as defined in Rule 144 under the Securities Act, unless we register such issuances. However, we have entered into a registration rights agreement with the limited partners of Blackstone Holdings that would require us to register these common units under the Securities Act. See “Part III. Item 13. Certain Relationships, Related Transactions and Director Independence—Transactions with Related Persons—Registration Rights Agreement”. While the partnership agreements of the Blackstone Holdings partnerships and related agreements contractually restrict the ability of Blackstone personnel to transfer the Blackstone Holdings Partnership Units or The Blackstone Group L.P. common units they hold and require that they maintain a minimum amount of equity ownership during their employ by us, these contractual provisions may lapse over time or be waived, modified or amended at any time.
In addition, in June 2007, we entered into an agreement with Beijing Wonderful Investments, an investment vehicle established and controlled by The People’s Republic of China, pursuant to which we sold to it 101,334,234 non-voting common units for $3.00 billion at a purchase price per common unit of $29.605. Beijing Wonderful Investments will be able to sell these common units subject to certain transfer restrictions. We have agreed to provide the Beijing Wonderful Investments with registration rights to effect certain sales.
As of February 20, 2009, we had granted 29,425,972 outstanding deferred restricted common units and 11,677,769 outstanding deferred restricted Blackstone Holdings Partnership Units, which are subject to specified vesting requirements, to our non-senior managing director professionals and senior managing directors, respectively, under our 2007 Equity Incentive Plan. The aggregate number of common units and Blackstone Holdings Partnership Units covered by our 2007 Equity Incentive Plan is increased on the first day of each fiscal year during its term by a number of units equal to the positive difference, if any, of (a) 15% of the aggregate number of common units and Blackstone Holdings Partnership Units outstanding on the last day of the immediately preceding fiscal year (excluding Blackstone Holdings Partnership Units held by The Blackstone Group L.P. or its wholly-owned subsidiaries) minus (b) the aggregate number of common units and Blackstone Holdings Partnership Units covered by our 2007 Equity Incentive Plan as of such date (unless the administrator of the 2007 Equity Incentive Plan should decide to increase the number of common units and Blackstone Holdings Partnership Units covered by the plan by a lesser amount). An aggregate of 157,697,669 additional common units and Blackstone Holdings Partnership Units were available for grant under our 2007 Equity Incentive Plan as of February 20, 2009. We have filed a registration statement and intend to file additional registration statements on Form S-8 under the Securities Act to register common units covered by our 2007 Equity Incentive Plan (including pursuant to automatic annual increases). Any such Form S-8 registration statement will automatically become effective upon filing. Accordingly, common units registered under such registration statement will be available for sale in the open market.
In addition, our partnership agreement authorizes us to issue an unlimited number of additional partnership securities and options, rights, warrants and appreciation rights relating to partnership securities for the consideration and on the terms and conditions established by our general partner in its sole discretion without the approval of any limited partners. In accordance with the Delaware Limited Partnership Act and the provisions of our partnership agreement, we may also issue additional partnership interests that have certain designations, preferences, rights, powers and duties that are different from, and may be senior to, those applicable to common units. Similarly, the Blackstone Holdings partnership agreements authorize the wholly owned subsidiaries of The Blackstone Group L.P. which are the general partners of those partnerships to issue an unlimited number of additional partnership securities of the Blackstone Holdings partnerships with such designations, preferences, rights, powers and duties that are different from, and may be senior to, those applicable to the Blackstone Holdings partnerships units, and which may be exchangeable for our common units.
45
The market price of our common units may be volatile, which could cause the value of your investment to decline.
Securities markets worldwide experience significant price and volume fluctuations. This market volatility, as well as general economic, market or political conditions, could reduce the market price of common units in spite of our operating performance. In addition, our operating results could be below the expectations of public market analysts and investors, and in response the market price of our common units could decrease significantly. You may be unable to resell your common units at or above the price you paid for them.
Risks Related to United States Taxation
Our structure involves complex provisions of U.S. federal income tax law for which no clear precedent or authority may be available. Our structure also is subject to potential legislative, judicial or administrative change and differing interpretations, possibly on a retroactive basis.
The U.S. federal income tax treatment of common unitholders depends in some instances on determinations of fact and interpretations of complex provisions of U.S. federal income tax law for which no clear precedent or authority may be available. The U.S. federal income tax rules are constantly under review by persons involved in the legislative process, the U.S. Internal Revenue Service, or “IRS,” and the U.S. Treasury Department, frequently resulting in revised interpretations of established concepts, statutory changes, revisions to regulations and other modifications and interpretations. The IRS pays close attention to the proper application of tax laws to partnerships. The present U.S. federal income tax treatment of an investment in our common units may be modified by administrative, legislative or judicial interpretation at any time, and any such action may affect investments and commitments previously made. Changes to the U.S. federal income tax laws and interpretations thereof could make it more difficult or impossible to meet the exception for us to be treated as a partnership for U.S. federal income tax purposes that is not taxable as a corporation (referred to as the “Qualifying Income Exception”), affect or cause us to change our investments and commitments, affect the tax considerations of an investment in us, change the character or treatment of portions of our income (including, for instance, the treatment of carried interest as ordinary income rather than capital gain) and adversely affect an investment in our common units. For example, as discussed above under “—Legislation has been introduced in the U.S. Congress that would, if enacted, preclude us from qualifying as a partnership for U.S. federal income tax purposes or otherwise increase our tax liability. If this or any similar legislation or regulation were to be enacted and apply to us, we would incur a material increase in our tax liability that could result in a reduction in the value of our common units”, the U.S. Congress has recently considered various legislative proposals to treat all or part of the capital gain and dividend income that is recognized by an investment partnership and allocable to a partner affiliated with the sponsor of the partnership (i.e., a portion of the carried interest) as ordinary income to such partner for U.S. federal income tax purposes.
Our organizational documents and governing agreements permit our general partner to modify our amended and restated limited partnership agreement from time to time, without the consent of the common unitholders, to address certain changes in U.S. federal income tax regulations, legislation or interpretation. In some circumstances, such revisions could have a material adverse impact on some or all common unitholders. Moreover, we will apply certain assumptions and conventions in an attempt to comply with applicable rules and to report income, gain, deduction, loss and credit to common unitholders in a manner that reflects such common unitholders’ beneficial ownership of partnership items, taking into account variation in unitholder ownership interests during each taxable year because of trading activity. More specifically, our allocations of items of taxable income and loss between transferors and transferees of our units will be determined annually, will be prorated on a monthly basis and will be subsequently apportioned among the unit holders in proportion to the number of units owned by each of them determined as of the opening of trading of our units on the New York Stock Exchange on the first business day of every month. As a result, a unitholder transferring units may by allocated income, gain, loss and deduction realized after the date of transfer. However, those assumptions and conventions may not be in compliance with all aspects of applicable tax requirements. It is possible that the IRS will assert successfully that the conventions and assumptions used by us do not satisfy the technical requirements
46
of the Internal Revenue Code and/or Treasury regulations and could require that items of income, gain, deductions, loss or credit, including interest deductions, be adjusted, reallocated or disallowed in a manner that adversely affects common unitholders.
If we were treated as a corporation for U.S. federal income tax or state tax purposes, then our distributions to our common unitholders would be substantially reduced and the value of our common units would be adversely affected.
The value of our common units depends largely on our being treated as a partnership for U.S. federal income tax purposes, which requires that 90% or more of our gross income for every taxable year consist of qualifying income, as defined in Section 7704 of the Internal Revenue Code and that The Blackstone Group L.P. not be registered under the 1940 Act. Qualifying income generally includes dividends, interest, capital gains from the sale or other disposition of stocks and securities and certain other forms of investment income. We may not meet these requirements or current law may change so as to cause, in either event, us to be treated as a corporation for U.S. federal income tax purposes or otherwise subject to U.S. federal income tax. Moreover, the anticipated after-tax benefit of an investment in our common units depends largely on our being treated as a partnership for U.S. federal income tax purposes. We have not requested, and do not plan to request, a ruling from the IRS on this or any other matter affecting us.
If we were treated as a corporation for U.S. federal income tax purposes, we would pay U.S. federal income tax on our taxable income at the corporate tax rate. Distributions to our common unitholders would generally be taxed again as corporate distributions, and no income, gains, losses, deductions or credits would flow through to you. Because a tax would be imposed upon us as a corporation, our distributions to our common unitholders would be substantially reduced, likely causing a substantial reduction in the value of our common units.
Current law may change, causing us to be treated as a corporation for U.S. federal or state income tax purposes or otherwise subjecting us to entity level taxation. See “—Legislation has been introduced in the U.S. Congress that would, if enacted, preclude us from qualifying as a partnership for U.S. federal income tax purposes or otherwise increase our tax liability. If this or any similar legislation or regulation were to be enacted and apply to us, we would incur a material increase in our tax liability that could result in a reduction in the value of our common units”. For example, because of widespread state budget deficits, several states are evaluating ways to subject partnerships to entity level taxation through the imposition of state income, franchise or other forms of taxation. If any state were to impose a tax upon us as an entity, our distributions to our common unitholders would be reduced.
Our common unitholders may be subject to U.S. federal income tax on their share of our taxable income, regardless of whether they receive any cash distributions from us.
As long as 90% of our gross income for each taxable year constitutes qualifying income as defined in Section 7704 of the Internal Revenue Code and we are not required to register as an investment company under the 1940 Act on a continuing basis, we will be treated, for U.S. federal income tax purposes, as a partnership and not as an association or a publicly traded partnership taxable as a corporation. As a result, our common unitholders may be subject to U.S. federal, state, local and possibly, in some cases, foreign income taxation on their allocable share of our items of income, gain, loss, deduction and credit (including our allocable share of those items of any entity in which we invest that is treated as a partnership or is otherwise subject to tax on a flow through basis) for each of our taxable years ending with or within your taxable year, regardless of whether or not a common unitholder receives cash distributions from us.
Our common unitholders may not receive cash distributions equal to their allocable share of our net taxable income or even the tax liability that results from that income. In addition, certain of our holdings, including holdings, if any, in a Controlled Foreign Corporation, or “CFC,” and a Passive Foreign Investment Company, or “PFIC,” may produce taxable income prior to the receipt of cash relating to such income, and common
47
unitholders that are U.S. taxpayers will be required to take such income into account in determining their taxable income. In the event of an inadvertent termination of our partnership status for which the IRS has granted us limited relief, each holder of our common units may be obligated to make such adjustments as the IRS may require to maintain our status as a partnership. Such adjustments may require persons holding our common units to recognize additional amounts in income during the years in which they hold such units.
The Blackstone Group L.P.’s interest in certain of our businesses are held through Blackstone Holdings I/II GP Inc. or Blackstone Holdings IV L.P., which are treated as corporations for U.S. federal income tax purposes; such corporations may be liable for significant taxes and may create other adverse tax consequences, which could potentially adversely affect the value of your investment.
In light of the publicly traded partnership rules under U.S. federal income tax law and other requirements, The Blackstone Group L.P. holds its interest in certain of our businesses through Blackstone Holdings I/II GP Inc. or Blackstone Holdings IV L.P., which are treated as corporations for U.S. federal income tax purposes. Each such corporation could be liable for significant U.S. federal income taxes and applicable state, local and other taxes that would not otherwise be incurred, which could adversely affect the value of our common units.
Complying with certain tax-related requirements may cause us to invest through foreign or domestic corporations subject to corporate income tax or enter into acquisitions, borrowings, financings or arrangements we may not have otherwise entered into.
In order for us to be treated as a partnership for U.S. federal income tax purposes and not as an association or publicly traded partnership taxable as a corporation, we must meet the Qualifying Income Exception discussed above on a continuing basis and we must not be required to register as an investment company under the 1940 Act. In order to effect such treatment, we (or our subsidiaries) may be required to invest through foreign or domestic corporations subject to corporate income tax, or enter into acquisitions, borrowings, financings or other transactions we may not have otherwise entered into. This may adversely affect our ability to operate solely to maximize our cash flow.
Tax gain or loss on disposition of our common units could be more or less than expected.
If a holder of our common units sells the common units it holds, it will recognize a gain or loss equal to the difference between the amount realized and the adjusted tax basis in those common units. Prior distributions to such common unitholder in excess of the total net taxable income allocated to such common unitholder, which decreased the tax basis in its common units, will in effect become taxable income to such common unitholder if the common units are sold at a price greater than such common unitholder’s tax basis in those common units, even if the price is less than the original cost. A portion of the amount realized, whether or not representing gain, may be ordinary income to such common unitholder.
If we were not to make, or cause to be made, an otherwise available election under Section 754 of the Internal Revenue Code to adjust our asset basis or the asset basis of certain of the Blackstone Holdings partnerships, a holder of common units could be allocated more taxable income in respect of those common units prior to disposition than if such an election were made.
We currently do not intend to make, or cause to be made, an election to adjust asset basis under Section 754 of the Internal Revenue Code with respect to us, Blackstone Holdings III L.P. or Blackstone Holdings IV L.P. If no such election is made, there will generally be no adjustment to the basis of the assets of Blackstone Holdings III L.P. or Blackstone Holdings IV L.P. upon our acquisition of interests in Blackstone Holdings III L.P. or Blackstone Holdings IV L.P. in connection with our initial public offering, or to our assets or to the assets of Blackstone Holdings III L.P. or Blackstone Holdings IV L.P. upon a subsequent transferee’s acquisition of common units from a prior holder of such common units, even if the purchase price for those interests or units, as applicable, is greater than the share of the aggregate tax basis of our assets or the assets of Blackstone Holdings
48
III L.P. or Blackstone Holdings IV L.P. attributable to those interests or units immediately prior to the acquisition. Consequently, upon a sale of an asset by us, Blackstone Holdings III L.P. or Blackstone Holdings IV L.P., gain allocable to a holder of common units could include built-in gain in the asset existing at the time we acquired those interests, or such holder acquired such units, which built-in gain would otherwise generally be eliminated if a Section 754 election had been made.
Non-U.S. persons face unique U.S. tax issues from owning common units that may result in adverse tax consequences to them.
In light of our investment activities, we will be treated as engaged in a U.S. trade or business for U.S. federal income tax purposes, which may cause some portion of our income to be treated as effectively connected income with respect to non-U.S. holders, or “ECI.” Moreover, dividends paid by an investment that we make in a real estate investment trust, or “REIT,” that are attributable to gains from the sale of U.S. real property interests and sales of certain investments in interests in U.S. real property, including stock of certain U.S. corporations owning significant U.S. real property, may be treated as ECI with respect to non-U.S. holders. In addition, certain income of non-U.S. holders from U.S. sources not connected to any such U.S. trade or business conducted by us could be treated as ECI. To the extent our income is treated as ECI, non-U.S. holders generally would be subject to withholding tax on their allocable shares of such income, would be required to file a U.S. federal income tax return for such year reporting their allocable shares of income effectively connected with such trade or business and any other income treated as ECI, and would be subject to U.S. federal income tax at regular U.S. tax rates on any such income (state and local income taxes and filings may also apply in that event). Non-U.S. holders that are corporations may also be subject to a 30% branch profits tax on their allocable share of such income. In addition, certain income from U.S. sources that is not ECI allocable to non-U.S. holders may be reduced by withholding taxes imposed at the highest effective applicable tax rate.
Tax-exempt entities face unique tax issues from owning common units that may result in adverse tax consequences to them.
In light of our investment activities, we will be treated as deriving income that constitutes “unrelated business taxable income,” or “UBTI.” Consequently, a holder of common units that is a tax-exempt organization may be subject to “unrelated business income tax” to the extent that its allocable share of our income consists of UBTI. A tax-exempt partner of a partnership could be treated as earning UBTI if the partnership regularly engages in a trade or business that is unrelated to the exempt function of the tax-exempt partner, if the partnership derives income from debt-financed property or if the partnership interest itself is debt-financed.
We cannot match transferors and transferees of common units, and we have therefore adopted certain income tax accounting positions that may not conform with all aspects of applicable tax requirements. The IRS may challenge this treatment, which could adversely affect the value of our common units.
Because we cannot match transferors and transferees of common units, we have adopted depreciation, amortization and other tax accounting positions that may not conform with all aspects of existing Treasury regulations. A successful IRS challenge to those positions could adversely affect the amount of tax benefits available to our common unitholders. It also could affect the timing of these tax benefits or the amount of gain on the sale of common units and could have a negative impact on the value of our common units or result in audits of and adjustments to our common unitholders’ tax returns.
The sale or exchange of 50% or more of our capital and profit interests will result in the termination of our partnership for U.S. federal income tax purposes. We will be considered to have been terminated for U.S. federal income tax purposes if there is a sale or exchange of 50% or more of the total interests in our capital and profits within a 12-month period. Our termination would, among other things, result in the closing of our taxable year for all common unitholders and could result in a deferral of depreciation deductions allowable in computing our taxable income.
49
Common unitholders will be subject to state and local taxes and return filing requirements as a result of investing in our common units.
In addition to U.S. federal income taxes, our common unitholders are subject to other taxes, including state and local taxes, unincorporated business taxes and estate, inheritance or intangible taxes that are imposed by the various jurisdictions in which we do business or own property now or in the future, even if our common unitholders do not reside in any of those jurisdictions. Our common unitholders are likely to be required to file state and local income tax returns and pay state and local income taxes in some or all of these jurisdictions. Further, common unitholders may be subject to penalties for failure to comply with those requirements. It is the responsibility of each common unitholder to file all U.S. federal, state and local tax returns that may be required of such common unitholder. Our counsel has not rendered an opinion on the state or local tax consequences of an investment in our common units.
We do not expect to be able to furnish to each unitholder specific tax information within 90 days after the close of each calendar year, which means that holders of common units who are U.S. taxpayers should anticipate the need to file annually a request for an extension of the due date of their income tax return.
It will most likely require longer than 90 days after the end of our fiscal year to obtain the requisite information from all lower-tier entities so that K-1s may be prepared for the Partnership. For this reason, holders of common units who are U.S. taxpayers should anticipate the need to file annually with the IRS (and certain states) a request for an extension past April 15 or the otherwise applicable due date of their income tax return for the taxable year.
| ITEM 1B. UNRESOLVED | STAFF COMMENTS |
Not applicable.
| ITEM 2. | PROPERTIES |
Our principal executive offices are located in leased office space at 345 Park Avenue, New York, New York. We also lease other office space in New York for GSO and we lease our offices in Atlanta, Boston, Chicago, Dallas, Houston, Los Angeles, San Francisco, London, Paris, Mumbai, Beijing, Tokyo and Hong Kong. We do not own any real property. We consider these facilities to be suitable and adequate for the management and operations of our business.
| ITEM 3. | LEGAL PROCEEDINGS |
We may from time to time be involved in litigation and claims incidental to the conduct of our business. Our businesses are also subject to extensive regulation, which may result in regulatory proceedings against us. See “Item 1A. Risk Factors” above. We are not currently subject to any pending judicial, administrative or arbitration proceedings that we expect to have a material impact on our consolidated financial statements.
In December 2007, a purported class of shareholders in public companies acquired by one or more private equity firms filed a lawsuit against sixteen private equity firms and investment banks, including The Blackstone Group L.P., in the United States District Court in Massachusetts. The suit alleges that from mid-2003 defendants have violated antitrust laws by allegedly conspiring to rig bids, restrict the supply of private equity financing, fix the prices for target companies at artificially low levels, and divide up an alleged market for private equity services for leveraged buyouts. The complaint seeks injunctive relief on behalf of all persons who sold securities to any of the defendants in leveraged buyout transactions. The amended complaint also includes five purported sub-classes of plaintiffs seeking damages and/or restitution and comprised of shareholders of five companies.
In May 2007, Aladdin Solutions, Inc. (“Aladdin”), an acquisition vehicle set up by Blackstone Capital Partners V (“BCP”), entered into a merger agreement with Alliance Data Systems Corporation (“ADS”) providing for BCP’s acquisition of ADS (the “Merger Agreement”). Among the preconditions to the closing of
50
this transaction was receipt of the required approval by the Office of the Comptroller of the Currency (the “OCC”) of the change in control of an important subsidiary of ADS, a credit card bank (the “Bank”). The Merger Agreement obligated Aladdin to use its “reasonable best efforts” to obtain OCC approval. Aladdin made extensive efforts to secure that approval, but as a condition to providing its approval, the OCC insisted on various demands that in BCP’s opinion would be materially harmful to BCP’s investment in ADS. Therefore, in April, 2008 Aladdin exercised its right to terminate the Merger Agreement due to the failure to obtain the required OCC approval. ADS filed an action against BCP claiming that Aladdin failed to use its reasonable best efforts to obtain OCC approval and therefore breached the provisions of the Merger Agreement and is seeking to collect a $170 million business interruption fee which was payable to ADS by Aladdin (and guaranteed by BCP) if Aladdin breaches its obligations under the Merger Agreement. (Under the terms of BCP’s limited partnership agreement, Blackstone would ultimately bear approximately 50% of any payment made in respect of such business interruption fee.) In January 2009 a Delaware Chancery Court judge granted Blackstone’s motion to dismiss ADS’s complaint in its entirety. ADS has filed a notice to appeal that decision to the Supreme Court of Delaware.
In April and May 2008, five substantially identical complaints were brought in the United States District Court for the Southern District of New York and a sixth complaint was brought in the Northern District of Texas against Blackstone and some of its executive officers. These suits, which purport to be class actions on behalf of purchasers of common units in Blackstone’s June 21, 2007 initial public offering, were subsequently consolidated into one suit in the Southern District of New York. In October 2008, a consolidated and amended complaint was filed naming as defendants Blackstone, Stephen A. Schwarzman (Blackstone’s Chairman and Chief Executive Officer), Peter G. Peterson (Blackstone’s former Senior Chairman), Hamilton E. James (Blackstone’s President and Chief Operating Officer) and Michael A. Puglisi (Blackstone’s Chief Financial Officer at the time of the IPO). The amended complaint alleges that (1) the IPO prospectus was false and misleading for failing to disclose that (a) certain investments made by Blackstone’s private equity funds were performing poorly at the time of the IPO and were materially impaired and (b) prior to the IPO the U.S. real estate market had started to deteriorate, adversely affecting the value of Blackstone’s real estate investments; and (2) the financial statements in the IPO prospectus were materially inaccurate principally because they overstated the value of the investments referred to in clause (1).
Blackstone believes that the foregoing suits are totally without merit and intends to defend them vigorously.
| ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
Not applicable.
51
| ITEM 5. | MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |
Our common units representing limited partner interests are traded on the New York Stock Exchange (“NYSE”) under the symbol “BX.” Our common units began trading on the NYSE on June 22, 2007.
The following table sets forth the high and low intra-day sales prices per unit of our common units, for the periods indicated, as reported by the NYSE.
| Sales Price | ||||||
| 2008 |
High | Low | ||||
| First Quarter |
$ | 22.59 | $ | 13.40 | ||
| Second Quarter |
$ | 20.98 | $ | 15.91 | ||
| Third Quarter |
$ | 19.50 | $ | 14.00 | ||
| Fourth Quarter |
$ | 15.95 | $ | 4.15 | ||
The number of holders of record of our common units as of February 20, 2009 was 49. This does not include the number of unitholders that hold shares in “street-name” through banks or broker-dealers.
Cash Distribution Policy
With respect to fiscal 2008, we have paid distributions of $0.90 per common unit to record holders of common units. We are not paying any distribution to common unitholders in respect of the fourth quarter of 2008. No distributions were or are being paid in respect of 2008 to Blackstone personnel and others with respect to their Blackstone Holdings partnership units.
Our current intention is to distribute to our common unitholders substantially all of The Blackstone Group L.P.’s net after-tax share of our annual Adjusted Cash Flow from Operations in excess of amounts determined by our general partner to be necessary or appropriate to provide for the conduct of our business, to make appropriate investments in our business and our funds, to comply with applicable law, any of our debt instruments or other agreements, or to provide for future distributions to our common unitholders for any ensuing quarter. The declaration and payment of any distributions will be at the sole discretion of our general partner, which may change our distribution policy at any time.
Because The Blackstone Group L.P. is a holding partnership and has no material assets other than its ownership of partnership units in Blackstone Holdings held through wholly-owned subsidiaries, we fund distributions by The Blackstone Group L.P., if any, in three steps:
| • | first, we cause Blackstone Holdings to make distributions to its partners, including The Blackstone Group L.P.’s wholly-owned subsidiaries. If Blackstone Holdings makes such distributions, the limited partners of Blackstone Holdings will be entitled to receive equivalent distributions pro rata based on their partnership interests in Blackstone Holdings (except as set forth in the following paragraph); |
| • | second, we cause The Blackstone Group L.P.’s wholly-owned subsidiaries to distribute to The Blackstone Group L.P. their share of such distributions, net of the taxes and amounts payable under the tax receivable agreement by such wholly-owned subsidiaries; and |
| • | third, The Blackstone Group L.P. distributes its net share of such distributions to our common unitholders on a pro rata basis, subject to the priority distribution arrangements described below. |
52
The partnership agreements of the Blackstone Holdings partnerships provide that until December 31, 2009, the income (and accordingly distributions) of Blackstone Holdings are to be allocated each year:
| • | first, to The Blackstone Group L.P.’s wholly-owned subsidiaries until sufficient income has been so allocated to permit The Blackstone Group L.P. to make aggregate distributions to our common unitholders of $1.20 per common unit on an annualized basis for such year; |
| • | second, to the other partners of the Blackstone Holdings partnerships until an equivalent amount of income on a partnership interest basis has been allocated to such other partners for such year; and |
| • | thereafter, pro rata to all partners of the Blackstone Holdings partnerships in accordance with their respective partnership interests. |
In addition, the partnership agreements of the Blackstone Holdings partnerships will provide for cash distributions, which we refer to as “tax distributions,” to the partners of such partnerships if the wholly-owned subsidiaries of The Blackstone Group L.P. which are the general partners of the Blackstone Holdings partnerships determine that the taxable income of the relevant partnership will give rise to taxable income for its partners. Generally, these tax distributions will be computed based on our estimate of the net taxable income of the relevant partnership allocable to a partner multiplied by an assumed tax rate equal to the highest effective marginal combined U.S. federal, state and local income tax rate prescribed for an individual or corporate resident in New York, New York (taking into account the nondeductibility of certain expenses and the character of our income). The Blackstone Holdings partnerships will make tax distributions only to the extent distributions from such partnerships for the relevant year were otherwise insufficient to cover such tax liabilities.
Accordingly, as we have previously reported, until December 31, 2009, Blackstone personnel and others who hold Blackstone Holdings partnership units (and who own approximately 75% of all outstanding units, with common unitholders holding the remaining 25%) will not receive any distributions (other than tax distributions in the circumstances specified above) for a year unless and until our common unitholders receive aggregate distributions of $1.20 per common unit for such year. We do not intend to maintain this priority allocation after December 31, 2009.
Under the Delaware Limited Partnership Act, we may not make a distribution to a partner if after the distribution all our liabilities, other than liabilities to partners on account of their partnership interests and liabilities for which the recourse of creditors is limited to specific property of the partnership, would exceed the fair value of our assets. If we were to make such an impermissible distribution, any limited partner who received a distribution and knew at the time of the distribution that the distribution was in violation of the Delaware Limited Partnership Act would be liable to us for the amount of the distribution for three years. In addition, the terms of our revolving credit facility require that the ratio of recourse debt of the Blackstone Holdings partnerships on a combined basis to partners’ capital or cash of the Blackstone Holdings partnerships on a combined basis be no greater than 4.5 to 1, which may prohibit us from making certain distributions. Subject to a notice period and a cure period, distributions in violation of the terms of our revolving credit facility would result in a default under our revolving credit facility.
Common Unit Repurchases in the Fourth Quarter of 2008
In January 2008, the Board of Directors authorized the repurchase of up to $500 million of Blackstone common units and Blackstone Holdings Partnership Units. Under this unit repurchase program, units may be repurchased in open market transactions, in privately negotiated transactions or otherwise. The unit repurchase program may be suspended or discontinued at any time and does not have a final specified date. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Our Sources of Cash and Liquidity Needs” for further information regarding this unit repurchase program.
53
The following table below sets forth information regarding repurchases of our common units during the quarter ended December 31, 2008. All of the repurchases shown in the table below were made pursuant to the repurchase program described above.
| Period |
Total Number of Units Purchased |
Average Price Paid per Unit |
Total Number of Units Purchased as Part of Publicly Announced Plans or Programs |
Approximate Dollar Value of Units that May Yet Be Purchased Under the Program (Dollars in Millions) | ||||||
| Oct. 1 — Oct. 31, 2008 |
— | $ | — | — | $ | — | ||||
| Nov. 1 — Nov. 30, 2008 |
430,062 | $ | 5.89 | 430,062 | $ | 372.5 | ||||
| Dec. 1 — Dec. 31, 2008 |
462,812 | $ | 5.56 | 462,812 | $ | 369.9 | ||||
| Total |
892,874 | 892,874 | ||||||||
54
| ITEM 6. | SELECTED FINANCIAL DATA |
The consolidated and combined statements of financial condition and income data as of and for the years ended December 31, 2008, 2007, 2006, 2005, and 2004 have been derived from our consolidated and combined financial statements. The audited Consolidated and Combined Statements of Financial Condition as of December 31, 2008 and 2007 and Consolidated and Combined Statements of Operations for the years ended December 31, 2008, 2007 and 2006 are included elsewhere in this Form 10-K. The audited Consolidated and Combined Statements of Financial Condition as of December 31, 2006, 2005 and 2004 and Consolidated and Combined Statements of Operations for the years ended December 31, 2005 and 2004 are not included in this Form 10-K. Historical results are not necessarily indicative of results for any future period.
The selected consolidated and combined financial data should be read in conjunction with “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated and combined financial statements and related notes included elsewhere in this Form 10-K.
| Year Ended December 31, | ||||||||||||||||
| 2008 | 2007 | 2006 | 2005 | 2004 | ||||||||||||
| (Dollars in Thousands) | ||||||||||||||||
| Revenues |
||||||||||||||||
| Management and Advisory Fees |
$ | 1,476,357 | $ | 1,566,047 | $ | 1,077,139 | $ | 478,908 | $ | 496,195 | ||||||
| Performance Fees and Allocations |
(1,247,320 | ) | 1,126,640 | 1,267,764 | 880,906 | 973,496 | ||||||||||
| Investment Income (Loss) and Other |
(578,398 | ) | 357,461 | 272,526 | 208,418 | 255,455 | ||||||||||
| Total Revenues |
(349,361 | ) | 3,050,148 | 2,617,429 | 1,568,232 | 1,725,146 | ||||||||||
| Expenses |
||||||||||||||||
| Compensation and Benefits (1) |
3,859,787 | 2,256,647 | 250,067 | 182,604 | 139,513 | |||||||||||
| Interest |
23,008 | 32,080 | 36,932 | 23,830 | 16,239 | |||||||||||
| General, Administrative and Other |
440,776 | 324,200 | 122,395 | 87,413 | 78,126 | |||||||||||
| Fund Expenses |
63,031 | 151,917 | 143,695 | 67,972 | 43,123 | |||||||||||
| Total Expenses |
4,386,602 | 2,764,844 | 553,089 | 361,819 | 277,001 | |||||||||||
| Other Income (Loss) |
||||||||||||||||
| Net Gains (Losses) from Fund Investment Activities |
(872,336 | ) | 5,423,132 | 6,090,145 | 4,071,046 | 4,992,837 | ||||||||||
| Income (Loss) Before Non-Controlling Interests in Income (Loss) of Consolidated Entities and Provision (Benefit) for Taxes |
(5,608,299 | ) | 5,708,436 | 8,154,485 | 5,277,459 | 6,440,982 | ||||||||||
| Non-Controlling Interests in Income (Loss) of Consolidated Entities |
(4,404,278 | ) | 4,059,221 | 5,856,345 | 3,934,536 | 4,901,547 | ||||||||||
| Income Before Provision (Benefit) for Taxes |
(1,204,021 | ) | 1,649,215 | 2,298,140 | 1,342,923 | 1,539,435 | ||||||||||
| Provision (Benefit) for Taxes |
(40,989 | ) | 25,978 | 31,934 | 12,260 | 16,120 | ||||||||||
| Net Income (Loss) |
$ | (1,163,032 | ) | $ | 1,623,237 | $ | 2,266,206 | $ | 1,330,663 | $ | 1,523,315 | |||||
55
| Year Ended December 31, | ||||||||||||||
| 2008 | 2007 | 2006 | 2005 | 2004 | ||||||||||
| (Dollars in Thousands) | ||||||||||||||
| June 19, 2007 through December 31, 2007 |
||||||||||||||
| Net Loss Per Common Unit—Basic and Diluted (2) |
||||||||||||||
| Common Units Entitled to Priority Distributions |
$ | (4.36 | ) | $ | (1.29 | ) | N/A | N/A | N/A | |||||
| Common Units Not Entitled to Priority Distributions |
$ | (3.09 | ) | N/A | N/A | N/A | N/A | |||||||
| Priority Distributions Declared (3) |
$ | 1.20 | $ | 0.30 | N/A | N/A | N/A | |||||||
| (1) | Prior to the IPO in June 2007, our compensation and benefits expense reflected compensation (primarily salary and bonus) paid or accrued solely to our non-senior managing director employees. Subsequent to our IPO, our compensation and benefits expense reflects (1) employee compensation and benefits expense paid and payable to our employees, including our senior managing directors, (2) equity-based compensation associated with grants of equity-based awards to senior managing directors, other employees and selected other individuals engaged in our businesses, including the amortization of all equity granted to existing employees at the time of the IPO, and (3) performance payment arrangements for Blackstone personnel and profit sharing interests in carried interest. |
| (2) | Prior to our IPO in June 2007, we did not have any Blackstone common units. Accordingly, we had no earnings per common unit for the prior periods. Please refer to “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Significant Transactions— Reorganization” for further discussion. |
| (3) | Distributions declared reflects the calendar date of declaration for each distribution; the fourth quarter distribution, if any, for any fiscal year will be declared and paid in the subsequent fiscal year. For fiscal 2007 we declared and paid distributions per common unitholder of $0.60 and for fiscal year 2008 we have declared and paid distributions per common unitholder of $0.90. |
| As of December 31, | |||||||||||||||
| 2008 | 2007 | 2006 | 2005 | 2004 | |||||||||||
| (Dollars in Thousands) | |||||||||||||||
| Statement of Financial Condition Data |
|||||||||||||||
| Total Assets (a) |
$ | 9,257,911 | $ | 13,174,200 | $ | 33,891,044 | $ | 21,121,124 | $ | 21,253,939 | |||||
| Total Liabilities |
$ | 3,363,789 | $ | 2,868,199 | $ | 2,373,271 | $ | 2,082,771 | $ | 1,930,001 | |||||
| Non-Controlling Interests in Consolidated Entities |
$ | 2,384,965 | $ | 6,079,156 | $ | 28,794,894 | $ | 17,213,408 | $ | 17,387,507 | |||||
| Partners’ Capital |
$ | 3,509,157 | $ | 4,226,845 | $ | 2,722,879 | $ | 1,824,945 | $ | 1,936,431 | |||||
| (a) | The decrease in total assets from December 31, 2006, 2005 and 2004 to December 31, 2008 and 2007 is due to the deconsolidation of the Blackstone Funds as described in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Significant Transactions—Consolidation and Deconsolidation of Blackstone Funds”. |
56
| ITEM 7. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
The following discussion and analysis should be read in conjunction with The Blackstone Group L.P.’s consolidated and combined financial statements and the related notes included within this Annual Report on Form 10-K.
On March 3, 2008, we acquired GSO Capital Partners L.P. and certain of its affiliates (“GSO”). GSO is an alternative asset manager specializing in the leveraged finance marketplace. GSO manages various credit-oriented funds and collateralized loan obligation (“CLO”) vehicles. GSO’s results from the date of acquisition are included in our Marketable Alternative Asset Management segment.
During 2007 we consummated a number of significant transactions, including the reorganization on June 18, 2007, the concurrent completion of our initial public offering and sale of non-voting common units to Beijing Wonderful Investments on June 27, 2007, and the deconsolidation of a number of Blackstone Funds (effective June 27, 2007 and July 1, 2007). These transactions have had significant effects on many of the items within our consolidated and combined financial statements and affect the comparison of our results for periods following these transactions with those of prior years.
Our Business
Blackstone is one of the largest independent alternative asset managers in the world. We also provide a wide range of financial advisory services, including corporate and mergers and acquisitions advisory, restructuring and reorganization advisory and fund placement services.
Our business is organized into four business segments:
| • | Corporate Private Equity. We are a world leader in private equity investing, having managed five general private equity funds, as well as one specialized fund focusing on media and communications-related investments, since we established this business in 1987. In addition, we are in the process of raising our seventh private equity fund and are seeking to launch new investment funds to make infrastructure and clean technology investments. Through our corporate private equity funds we pursue transactions throughout the world, including leveraged buyout acquisitions of seasoned companies, transactions involving growth equity or start-up businesses in established industries, minority investments, corporate partnerships, distressed debt, structured securities and industry consolidations, in all cases in strictly friendly transactions. |
| • | Real Estate. Our real estate segment is diversified geographically and across a variety of sectors. We launched our first real estate fund in 1994 and have managed six general real estate funds, two internationally focused real estate funds, a European focused real estate fund and a special situations real estate fund. Our real estate funds have made significant investments in lodging, major urban office buildings and a variety of real estate operating companies. In addition, our real estate special situations fund targets global non-controlling debt and equity investment opportunities in the public and private markets. |
| • | Marketable Alternative Asset Management. Established in 1990, our marketable alternative asset management segment is comprised of our management of funds of hedge funds, credit-oriented funds, CLO vehicles and publicly-traded closed-end mutual funds. These products are intended to provide investors with greater levels of current income and for certain products, a greater level of liquidity. |
| • | Financial Advisory. Our financial advisory segment serves a diverse and global group of clients with corporate and mergers and acquisitions advisory services, restructuring and reorganization advisory services and fund placement services for alternative investment funds. |
57
We generate our revenue from fees earned pursuant to contractual arrangements with funds, fund investors and fund portfolio companies (including management, transaction and monitoring fees), and from corporate and mergers and acquisitions advisory services, restructuring and reorganization advisory services and fund placement services for alternative investment funds. We invest in the funds we manage and, in most cases, receive a preferred allocation of income (i.e., a “carried interest”) or an incentive fee from an investment fund in the event that specified cumulative investment returns are achieved. The composition of our revenues will vary based on market conditions and the cyclicality of the different businesses in which we operate. Net investment gains and resultant investment income generated by the Blackstone Funds, principally corporate private equity and real estate funds, are driven by value created by our strategic initiatives as well as overall market conditions. Our funds initially record fund investments at cost and then such investments are subsequently recorded at fair value. Fair values are affected by changes in the fundamentals of the portfolio company, the portfolio company’s industry, the overall economy as well as other market conditions.
Business Environment
World markets and economies deteriorated in the fourth quarter of 2008, bringing the full year market and economic performance to some of the worst experienced since the Great Depression. In the United States, a GDP decline in the fourth quarter of 3.8% represented the greatest decline in more than 25 years. Developed nation economies generally are experiencing sharp contraction, while many emerging nations are experiencing slowing growth.
A combination of asset pricing declines and investor withdrawals reduced the value of equity and fixed income mutual fund and hedge fund holdings globally. In addition to concerns over weak economic trends, a combination of de-levering by institutional investors and a need for liquidity further pressured already stressed market pricing. Equity markets across North America, Europe and Asia declined in a range of 40-60% during 2008, with a broad-based sell-off across not only all regions but also all sectors. Commodity prices, which increased to record highs in mid-2008, dropped precipitously in the second half as demand declines caused excess supply. For example, oil prices increased to $145 per barrel in July and ended the year at $45 per barrel. Credit indices experienced similar trends, declining 25-30% to levels not experienced since the indices were initiated. Leveraged loan prices dropped from an average of 94.4% at the end of 2007 to 62.3% at year-end 2008, reaching new lows. High yield credit spreads widened by 1,100 basis points during the year. The U.S. dollar rose against each of the Euro and Pound Sterling by 4% and 36%, respectively. Demand for the 10-year U.S. treasuries drove the yield down to 2.1% at year end, a historic low. Interest rates globally have traded around historic lows.
Economic weakness also impacted real estate fundamentals and values globally. Hotels experienced a global slowdown in occupancy, culminating in a decline in the fourth quarter of 2008. Office fundamentals tend to lag those of other real estate categories and the broader economy due to the long-term nature of lease arrangements. Vacancy trends worsened in several markets in 2008. Securitization markets were very limited in 2008, heavily constraining availability of debt for new transactions.
Government intervention in the U.S., Europe and Asia continued in the fourth quarter and to date in 2009. Several financial and other institutions required government support in the form of guarantees or capital injections. Additionally, banks which have received Troubled Assets Relief Program (“TARP”) funds from the U.S. government are being encouraged to lend. Further, a stimulus package to be implemented in the U.S. in 2009 is intended to reverse the weak economic trends, including unemployment rate and a decline in consumer spending. The effectiveness of the above measures is still unknown.
The external shocks to the financial services industry have, and likely will continue, to reshape the competitive landscape. Some of the largest financial institutions have been acquired, required government bailouts or are shedding businesses. The largest brokerage firms have become bank holding companies.
58
Lenders continue to severely restrict commitments to new debt, limiting industry-wide leveraged acquisition activity levels in both corporate and real estate markets. General acquisition activity has continued to decline, which has had a significant impact on several of our investment businesses.
The duration of current economic and market conditions is unknown. Blackstone’s businesses are materially affected by conditions in the financial markets and economic conditions in the United States, Western Europe, Asia and to some extent elsewhere in the world.
Significant Transactions
Reorganization
The Blackstone Group L.P. was formed as a Delaware limited partnership on March 12, 2007. The Blackstone Group L.P. is managed and operated by its general partner, Blackstone Group Management L.L.C., which is in turn wholly-owned by Blackstone’s senior managing directors and controlled by Stephen A. Schwarzman.
Blackstone’s business was historically conducted through a large number of entities as to which there was no single holding entity but which were separately owned by its predecessor owners. In order to facilitate the initial public offering, as described in further detail below, the predecessor owners completed a reorganization (the “Reorganization”) as of the close of business on June 18, 2007 whereby, with certain limited exceptions, each of the operating entities of the predecessor organization and the intellectual property rights associated with the Blackstone name, were contributed to five newly-formed holding partnerships (Blackstone Holdings I L.P., Blackstone Holdings II L.P., Blackstone Holdings III L.P., Blackstone Holdings IV L.P. and Blackstone Holdings V L.P.) or sold to wholly-owned subsidiaries of The Blackstone Group L.P. (which in turn contributed them to the five Blackstone Holdings described above). The Blackstone Group L.P., through wholly-owned subsidiaries, is the sole general partner of each of the Blackstone Holdings partnerships.
On January 1, 2009, in order to simplify Blackstone’s structure and ease the related administrative burden and costs, Blackstone effected an internal restructuring to reduce the number of holding partnerships from five to four by causing Blackstone Holdings III L.P. to transfer all of its assets and liabilities to Blackstone Holdings IV L.P. In connection therewith, Blackstone Holdings IV L.P. was renamed Blackstone Holdings III L.P. and Blackstone Holdings V L.P. was renamed Blackstone Holdings IV L.P. The economic interests of The Blackstone Group L.P. in Blackstone’s business remains entirely unaffected. “Blackstone Holdings” refers to the five holding partnerships prior to the January 2009 reorganization and the four holdings partnerships subsequent to the January 2009 reorganization.
The Reorganization was accounted for as an exchange of entities under common control for the interests in the Contributed Businesses which were contributed by the founders and the other senior managing directors (collectively, the “Control Group”) and as an acquisition of non-controlling interests using the purchase method of accounting for all the predecessor owners other than the Control Group pursuant to Statement of Financial Accounting Standard (“SFAS”) No. 141, Business Combinations (“SFAS No. 141”).
Blackstone also entered into an exchange agreement with holders of Blackstone Holdings Partnership Units (other than The Blackstone Group L.P.’s wholly-owned subsidiaries) so that these holders, subject to the vesting and minimum retained ownership requirements and transfer restrictions set forth in the partnership agreements of the Blackstone Holdings partnerships, may up to four times each year, exchange their Blackstone Holdings Partnership Units for our common units on a one-for-one basis, subject to customary conversion rate adjustments for splits, unit distributions and reclassifications. A Blackstone Holdings limited partner must exchange one partnership unit in each of the five Blackstone Holdings partnerships to effect an exchange for a common unit in Blackstone.
59
Initial Public Offering
On June 27, 2007, The Blackstone Group L.P. completed the initial public offering (“IPO”) of its common units representing limited partner interests. Upon the completion of the IPO, public investors owned approximately 14.1% of Blackstone’s equity. Concurrently with the IPO, The Blackstone Group L.P. completed the sale of non-voting common units, representing approximately 9.3% of Blackstone’s equity, to Beijing Wonderful Investments, an investment vehicle subsequently transferred to China Investment Corporation. On October 28, 2008, the agreement with Beijing Wonderful Investments was amended whereby it, and certain of its affiliates, are restricted in the future from engaging in the purchase of Blackstone common units that would result in its aggregate beneficial ownership in Blackstone on a fully-diluted (as-converted) basis exceeding 12.5%, an increase from 10% at the date of the IPO. In addition, Blackstone common units that Beijing Wonderful Investments or its affiliates own in excess of 10% aggregate beneficial ownership in Blackstone on a fully-diluted (as-converted) basis are not subject to any restrictions on transfer but are non-voting while held by Beijing Wonderful Investments or its affiliates.
The Blackstone Group L.P. contributed the proceeds from the IPO and the sale of non-voting common units to Beijing Wonderful Investments to its wholly-owned subsidiaries, which in turn used these proceeds to (1) purchase interests in the Contributed Businesses from the predecessor owners (and contribute these interests to Blackstone Holdings in exchange for a number of newly-issued Blackstone Holdings Partnership Units) and (2) purchase a number of additional newly-issued Blackstone Holdings Partnership Units from Blackstone Holdings.
The net proceeds retained by Blackstone from the IPO, totaling approximately $2.93 billion, were used to repay $1.21 billion of indebtedness outstanding under Blackstone’s revolving credit agreement, with the balance being invested and/or committed as general partner investments in Blackstone sponsored funds, including its corporate private equity funds, real estate funds, mezzanine funds, funds of hedge funds and proprietary hedge funds, and invested in temporary interest bearing investments.
Consolidation and Deconsolidation of Blackstone Funds
In accordance with accounting principles generally accepted in the United States of America (“GAAP”), a number of the Blackstone funds were historically consolidated into Blackstone’s combined financial statements.
Concurrently with the Reorganization, the Contributed Businesses that act as a general partner of a consolidated Blackstone fund (with the exception of Blackstone’s then existing proprietary hedge funds and five of the funds of hedge funds) took the necessary steps to grant rights to the unaffiliated investors in each respective fund to provide that a simple majority of the fund’s unaffiliated investors will have the right, without cause, to remove the general partner of that fund or to accelerate the liquidation date of that fund in accordance with certain procedures. The granting of these rights resulted in the deconsolidation of such investment funds from the Partnership’s consolidated financial statements and the accounting of Blackstone’s interest in these funds under the equity method. With the exception of certain funds of hedge funds, these rights became effective on June 27, 2007 for all Blackstone funds where these rights were granted. The effective date of these rights for the applicable funds of hedge funds was July 1, 2007. The consolidated results of these funds have been reflected in the Partnership’s consolidated and combined financial statements up to the effective date of these rights.
Acquisition of GSO Capital Partners LP
In March 2008, the Partnership completed the acquisition of GSO Capital Partners LP and certain of its affiliates. GSO is an alternative asset manager specializing in the credit markets. GSO manages various credit-oriented funds and various CLO vehicles. GSO’s results from the date of acquisition have been included in the Marketable Alternative Asset Management segment. The purchase consideration of GSO was $635 million, comprised of $355 million in cash and $280 million in Blackstone Holdings Partnership Units, plus up to an
60
additional targeted $310 million to be paid over the next five years contingent upon the realization of specified earnings targets over that period. The Partnership also incurred $6.9 million of acquisition costs. Additionally, performance and other compensatory payments subject to performance and vesting may be paid to the GSO personnel.
Key Financial Measures and Indicators
Our key financial measures and indicators are discussed below.
Revenues
Revenues consist of primarily management and advisory fees, performance fees and allocations and investment income and other.
Management and Advisory Fees. Management and advisory fees consist of (1) fund management fees and (2) advisory fees.
| (1) | Fund Management Fees. Fund management fees are comprised of: |
| (a) | Base Management Fees. Base management fees are fees charged directly to the fund or fund investors. |
| (b) | Transaction and Other Fees. Transaction and other fees (including monitoring fees) are comprised of fees charged directly to funds and fund portfolio companies. Our investment advisory agreements generally require that the investment advisor share a portion of certain fees with the limited partners of the fund. Transaction and other fees are net of amounts, if any, shared with limited partners. |
| (c) | Management Fee Offsets. Our investment advisory agreements generally require that the investment advisor share a portion of certain expenses with the limited partners of the fund. These shared items (“management fee reductions”) reduce the management fees received from the limited partners. Management fee offsets are comprised principally of broken deal and placement fee expenses. |
| (2) | Advisory Fees. Advisory fees consist of advisory retainer and transaction-based fee arrangements related to mergers, acquisitions, restructurings, divestitures and fund placement services for alternative investment funds. |
Performance Fees and Allocations. Performance fees and allocations represent the preferential allocations of profits (“carried interest”) which are a component of our general partner interests in the carry funds. We are entitled to carried interest from an investment carry fund in the event investors in the fund achieve cumulative investment returns in excess of a specified rate. In certain performance fee arrangements related to funds of hedge funds and some credit-oriented funds in our Marketable Alternative Asset Management segment, we are entitled to receive performance fees and allocations when the return on assets under management exceeds certain benchmark returns or other performance targets. In all cases, each fund is considered separately in that regard and for a given fund, performance fees and allocations can never be negative over the life of the fund.
Investment Income. Blackstone invests in corporate private equity funds, real estate funds, funds of hedge funds and credit-oriented funds that are not consolidated. The Partnership accounts for these investments under the equity method of accounting. Blackstone’s share of operating income generated by these investments is recorded as a component of Investment Income and Other.
61
Expenses
Compensation and Benefits Expense. Prior to the IPO in June 2007, our compensation and benefits expense reflected compensation (primarily salary and bonus) paid or accrued solely to our non-senior managing director employees with all payments for services rendered by our senior managing directors and selected other individuals engaged in our businesses accounted for as partnership distributions rather than as employee compensation and benefits expense. Subsequent to our IPO, compensation and benefits expense reflects (1) employee compensation and benefits expense paid and payable to our employees, including our senior managing directors, (2) equity-based compensation associated with grants of equity-based awards to senior managing directors, other employees and selected other individuals engaged in our businesses and (3) performance payment arrangements for Blackstone personnel and profit sharing interests in carried interest.
Other Operating Expenses. The balance of our expenses represent general and administrative expenses including interest expense, occupancy and equipment expenses and other expenses, which consist principally of professional fees, public company costs, travel and related expenses, communications and information services and depreciation and amortization.
Fund Expenses. The expenses of our consolidated Blackstone Funds consist primarily of interest expense, professional fees and other third-party expenses.
Non-Controlling Interests in Income of Consolidated Entities
Prior to the IPO, non-controlling interests in income of consolidated entities has primarily consisted of interests of unaffiliated third-party investors and AIG’s investments in Blackstone Funds pursuant to AIG’s mandated limited partner capital commitments, on which we receive carried interest allocations and which we refer to collectively as “Limited Partners” or “LPs” as well as discretionary investments by Blackstone personnel and employees. Non-controlling interests related to carry funds are subject to on-going realizations and distributions of proceeds therefrom during the life of a fund with a final distribution at the end of each respective fund’s term, which could occur under certain circumstances in advance of or subsequent to that fund’s scheduled termination date. Non-controlling interests related to our funds of hedge funds and certain of our credit-oriented funds are generally subject to annual, semi-annual or quarterly withdrawal or redemption by investors in these funds following the expiration of a specified period of time (typically between one and three years) when capital may not be withdrawn or may only be withdrawn subject to a redemption fee. When redeemed amounts become legally payable to investors in these funds on a current basis, they are reclassified as a liability. On the date of the Reorganization, such non-controlling interests were initially recorded at their historical carry-over basis as those interests remained outstanding and were not being exchanged for Blackstone Holdings Partnership Units.
Following the IPO, we are no longer consolidating most of our investment funds, as we granted to the unaffiliated investors the right, without cause, to remove the general partner of each applicable fund or to accelerate the liquidation of each applicable fund in accordance with certain procedures and accordingly non-controlling interests in income of consolidated entities related to the Limited Partner interests in the deconsolidated funds were subsequently no longer reflected in our financial results. However, we record significant non-controlling interests in income of consolidated entities relating to the ownership interests of the limited partners of the Blackstone Holdings Partnerships and the limited partner interests in our investment funds that remain consolidated. The Blackstone Group L.P. is, through wholly-owned subsidiaries, the sole general partner of each of the Blackstone Holdings partnerships. The Blackstone Group L.P. consolidates the financial results of Blackstone Holdings and its consolidated subsidiaries, and the ownership interest of the limited partners of Blackstone Holdings is reflected as a non-controlling interest in The Blackstone Group L.P.’s consolidated and combined financial statements.
62
Income Taxes
Prior to the IPO, we operated as a partnership or limited liability company for U.S. federal income tax purposes and primarily as a corporate entity in non-U.S. jurisdictions. As a result, our income was not subject to U.S. federal and state income taxes. Generally, the tax liability related to income earned by these entities represents obligations of the individual partners and members. Income taxes shown on The Blackstone Group’s historical combined income statements are attributable to the New York City unincorporated business tax and other income taxes on certain entities located in non-U.S. jurisdictions.
Following the IPO, the Blackstone Holdings partnerships and certain of their subsidiaries continue to operate in the United States as partnerships for U.S. federal income tax purposes and generally as corporate entities in non-U.S. jurisdictions. Accordingly, these entities in some cases will continue to be subject to New York City unincorporated business taxes or non-U.S. income taxes. In addition, certain of the wholly-owned subsidiaries of The Blackstone Group L.P. and the Blackstone Holdings partnerships are subject to corporate federal, state and local income taxes that are reflected in our consolidated and combined financial statements.
There remains some uncertainty regarding Blackstone’s future taxation levels. In June 2007, a bill was introduced in the U.S. Senate that would preclude Blackstone from qualifying for treatment as a partnership for U.S. federal income tax purposes under the publicly traded partnership rules. In addition, the U.S. Congress has recently considered other bills relating to the taxation of investment partnerships. In June 2008, the U.S. House of Representatives passed a bill that would generally (1) treat carried interest as non-qualifying income under the tax rules applicable to publicly traded partnerships, which would require Blackstone to hold interests in entities earning such income through taxable subsidiary corporations, and (2) tax carried interest as ordinary income for U.S. federal income tax purposes, rather than in accordance with the character of income derived by the underlying fund, which is in many cases capital gain. The Obama Administration’s budget proposals released on February 26, 2009 include a proposal to tax carried interest as ordinary income. (See “Item 1A. Risk Factors – Legislation has been introduced in the U.S. Congress that would, if enacted, preclude us from qualifying as a partnership for U.S. federal income tax purposes or otherwise increase our tax liability. If this or any similar legislation or regulation were to be enacted and apply to us, we would incur a material increase in our tax liability that could result in a reduction in the value of our common units.”) If any such legislation or similar legislation were to be enacted and it applied to us, it would materially increase the amount of taxes payable by Blackstone and/or its unitholders.
Economic Net Income
Economic Net Income (“ENI”) represents segment net income excluding the impact of income taxes and transaction-related items, including charges associated with equity-based compensation, the amortization of intangibles and corporate actions including acquisitions. Blackstone’s historical combined financial statements for periods prior to the IPO do not include these transaction-related charges, nor do such financial statements reflect certain compensation expenses including performance payment arrangements associated with senior managing directors, departed partners and other selected employees. Those compensation expenses were accounted for as partnership distributions prior to the IPO but are included in the financial statements for periods following the IPO as a component of compensation and benefits expense. ENI is used by management primarily in making resource deployment and compensation decisions across Blackstone’s four segments. (See Note 14. “Segment Reporting” in the “Notes to the Consolidated and Combined Financial Statements” in Part II. Item 8. Financial Statements and Supplementary Data.)
Net Fee Related Earnings from Operations
Net Fee Related Earnings from Operations, which is a component of Adjusted Cash Flow from Operations, is a measure that highlights our earnings from operations excluding the income related to the performance fees and allocations and income earned from Blackstone’s investments in the Blackstone Funds. See “—Liquidity and Capital Resources—Liquidity and Capital Resources” below for a detailed discussion on Net Fee Related Earnings from Operations.
63
Adjusted Cash Flow from Operations
Adjusted Cash Flow from Operations, which is derived from our segment reported results, is a supplemental non-GAAP measure we use to assess liquidity and amounts available for distribution to owners. Adjusted Cash Flow from Operations is intended to reflect the cash flow attributable to Blackstone without the effects of the consolidation of the Blackstone Funds. The equivalent GAAP measure is Net Cash Provided by (Used in) Operating Activities. See “—Liquidity and Capital Resources—Liquidity and Capital Resources” below for our detailed discussion on Adjusted Cash Flow from Operations.
Operating Metrics
The alternative asset management business is a complex business that is primarily based on managing third party capital and does not require substantial capital investment to support rapid growth. However, there also can be volatility associated with its earnings and cash flow. Since our inception, we have developed and used various key operating metrics to assess and monitor the operating performance of our various alternative asset management businesses in order to monitor the effectiveness of our value creating strategies.
Assets Under Management. Assets Under Management refers to the assets we manage. Our Assets Under Management equal the sum of:
| (1) | the fair value of the investments held by our carry funds plus the capital that we are entitled to call from investors in those funds pursuant to the terms of their capital commitments to those funds (plus the fair value of co-investments arranged by us that were made by limited partners of our funds in portfolio companies of such funds and as to which we receive fees or a carried interest allocation); |
| (2) | the net asset value of our hedge funds and our closed-end mutual funds; and |
| (3) | the amount of capital raised for our CLOs. |
Our carry funds are commitment-based drawdown structured funds that do not permit investors to redeem their interests at their election and therefore do not have any advance notice obligations. Interests related to our funds of hedge funds and certain of our credit-oriented funds are generally subject to annual, semi-annual or quarterly withdrawal or redemption by investors upon advance written notice with the majority of our funds requiring from 60 days up to 95 days depending on the fund and the liquidity profile of the underlying assets.
Fee-Earning Assets Under Management. Fee-Earning Assets Under Management refers to the assets we manage on which we derive management fees. Our Fee-Earning Assets Under Management equal the sum of:
| (1) | for our carry funds where the investment period has not expired, the amount of capital commitments; |
| (2) | for our carry funds where the investment period has expired, the remaining amount of invested capital; |
| (3) | the fair value of co-investments arranged by us that were made by limited partners of our funds in portfolio companies of such funds and as to which we receive fees; |
| (4) | the net asset value of our hedge funds and our closed-end mutual funds; and |
| (5) | the gross amount of assets of our CLOs. |
Our calculations of assets under management and fee-earning assets under management may differ from the calculations of other asset managers, and as a result this measure may not be comparable to similar measures presented by other asset managers. In addition, our calculation of assets under management includes commitments to and the fair value of invested capital in our funds from Blackstone and our personnel regardless of whether such commitments or invested capital are subject to fees. Our definitions of assets under management or fee-earning assets under management are not based on any definition of assets under management or fee-earning assets under management that is set forth in the agreements governing the investment funds that we manage.
64
For our carry funds, total assets under management includes the fair value of the investments held whereas fee-earning assets under management includes the amount of capital commitments or the remaining amount of invested capital at cost depending on whether the investment period has or has not expired. As such, fee-earning assets under management may be greater than total assets under management when the aggregate fair value of the remaining investments is less than the cost of those investments.
Limited Partner Capital Invested. Limited Partner Capital Invested represents the amount of Limited Partner capital commitments which were invested by our carry funds during each period presented, plus the capital invested through co-investments arranged by us that were made by limited partners in investments of our carry funds as to which we receive fees or a carried interest allocation. Over the 21-year period ending December 31, 2008, we earned average gross multiples of invested capital for realized and partially realized investments of 2.4x in both of our corporate private equity and real estate funds.
We manage our business using traditional financial measures and our key operating metrics since we believe that these metrics measure the productivity of our investment activities.
Consolidated and Combined Results of Operations
Following is a discussion of our consolidated and combined results of operations for each of the years in the three year period ended December 31, 2008. For a more detailed discussion of the factors that affected the results of our four business segments (which are presented on a basis that deconsolidates the investment funds we manage) in these periods, see “—Segment Analysis” below.
The following table sets forth information regarding our consolidated and combined results of operations and certain key operating metrics for the years ended December 31, 2008, 2007, and 2006.
| Year Ended December 31, | ||||||||||
| 2008 | 2007 | 2006 | ||||||||
| (Dollars in Thousands) | ||||||||||
| Revenues |
||||||||||
| Management and Advisory Fees |
$ | 1,476,357 | $ | 1,566,047 | $ | 1,077,139 | ||||
| Performance Fees and Allocations |
(1,247,320 | ) | 1,126,640 | 1,267,764 | ||||||
| Investment Income (Loss) and Other |
(578,398 | ) | 357,461 | 272,526 | ||||||
| Total Revenues |
(349,361 | ) | 3,050,148 | 2,617,429 | ||||||
| Expenses |
||||||||||
| Compensation and Benefits |
3,859,787 | 2,256,647 | 250,067 | |||||||
| Interest |
23,008 | 32,080 | 36,932 | |||||||
| General, Administrative and Other |
440,776 | 324,200 | 122,395 | |||||||
| Fund Expenses |
63,031 | 151,917 | 143,695 | |||||||
| Total Expenses |
4,386,602 | 2,764,844 | 553,089 | |||||||
| Other Income (Loss) |
||||||||||
| Net Gains (Losses) from Fund Investment Activities |
(872,336 | ) | 5,423,132 | 6,090,145 | ||||||
| Income (Loss) Before Non-Controlling Interests in Income (Loss) of Consolidated Entities and Provision (Benefit) for Taxes |
(5,608,299 | ) | 5,708,436 | 8,154,485 | ||||||
| Non-Controlling Interests in Income (Loss) of Consolidated Entities |
(4,404,278 | ) | 4,059,221 | 5,856,345 | ||||||
| Income (Loss) Before Provision (Benefit) for Taxes |
(1,204,021 | ) | 1,649,215 | 2,298,140 | ||||||
| Provision (Benefit) for Taxes |
(40,989 | ) | 25,978 | 31,934 | ||||||
| Net Income (Loss) |
$ | (1,163,032 | ) | $ | 1,623,237 | $ | 2,266,206 | |||
65
The following table presents certain operating metrics for the years ended December 31, 2008, 2007 and 2006. For a description of how assets under management is determined, please see “—Key Financial Measures and Indicators—Operating Metrics—Assets Under Management.”
| Year Ended December 31, | ||||||||||||
| 2008 | 2007 | 2006 | ||||||||||
| (Dollars in Thousands) | ||||||||||||
| Fee-Earning Assets Under Management (End of Period) |
$ | 91,041,057 | $ | 83,152,253 | $ | 54,795,460 | ||||||
| Assets Under Management |
||||||||||||
| Balance, Beginning of Period |
$ | 102,427,372 | $ | 69,512,202 | $ | 51,098,827 | ||||||
| Inflows (a) |
30,273,768 | 31,624,346 | 19,242,243 | |||||||||
| Outflows (b) |
(10,952,364 | ) | (10,427,666 | ) | (10,035,144 | ) | ||||||
| Market Appreciation (Depreciation) (c) |
(27,189,559 | ) | 11,718,490 | 9,206,276 | ||||||||
| Balance, End of Period |
$ | 94,559,217 | $ | 102,427,372 | $ | 69,512,202 | ||||||
| Capital Deployed |
||||||||||||
| Limited Partner Capital Invested |
$ | 6,548,651 | $ | 14,771,359 | $ | 10,812,140 | ||||||
| (a) | Inflows represent contributions by limited partners and Blackstone and its employees in our funds of hedge funds, credit-oriented funds and closed-end mutual funds and increases in available capital for our carry funds (capital raises, recallable capital and increased side-by-side commitments) and CLOs. For 2008, this also includes the assets under management of GSO at the closing date of the acquisition. |
| (b) | Outflows represent redemptions by limited partners and Blackstone and its employees in our funds of hedge funds, credit-oriented funds and closed-end mutual funds, decreases in available capital for our carry funds (expired capital, expense drawdowns and decreased side-by-side commitments) and realizations from the disposition of assets by our carry funds. |
| (c) | Market appreciation (depreciation) includes realized and unrealized gains (losses) on portfolio investments and the impact of foreign exchange rate fluctuations. |
Year Ended December 31, 2008 Compared to Year Ended December 31, 2007 and Year Ended December 31, 2007 Compared to Year Ended December 31, 2006
Revenues
Management and Advisory Fees were $1.48 billion for the year ended December 31, 2008, a decrease of $89.7 million, or 6%, as compared to $1.57 billion for the year ended December 31, 2007. A decrease in transaction fees reflected a reduction in the size and volume of consummated transactions in 2008 as compared to 2007 when we earned substantial transaction fees from our funds’ acquisitions of Equity Office Properties Trust and Hilton Hotels. This decrease was partially offset by an increase in base management fees of $254.2 million, or 34%, as a result of an increase in Fee-Earning Assets Under Management for 2008 as compared with 2007, as well as an increase in fees generated by our restructuring and reorganization and our corporate and mergers and acquisitions advisory services businesses.
Performance Fees and Allocations were $(1.25) billion for the year ended December 31, 2008, a decrease of $2.37 billion as compared to $1.13 billion for the year ended December 31, 2007. The change was due principally to a net depreciation in the fair value of the underlying portfolio investments of our funds compared to a net appreciation during the year ended December 31, 2007. The net depreciation in the fair value of the underlying portfolio investments was caused by a net reduction in the fair value of certain investments in our real estate and corporate private equity funds. Specifically, the fair value of our real estate and corporate private equity funds had a net depreciation of approximately 39% and 32%, respectively, as compared with a net appreciation of 35% and 16%, respectively in the prior year. The net reduction in the fair value of these investments was driven primarily by a decrease in projected exit multiples, lower operating projections for some
66
portfolio investments, a reduction in share prices of various publicly held investments consistent with the general declines in the global equity markets and the decrease of the value of foreign currencies versus the U.S. dollar. Additionally, declines in Blackstone’s investments in certain of our funds of hedge funds, then-existing proprietary hedge funds and debt funds contributed to the decrease.
Investment Income (Loss) and Other was $(578.4) million for the year ended December 31, 2008, as compared to a gain of $357.5 million for the year ended December 31, 2007. The change was primarily attributable to a decrease in the fair value of our investments in our funds of hedge funds, then-existing proprietary hedge funds and credit-oriented funds, consistent with overall declines in the global equity and debt markets. In addition, our investments in our real estate, corporate private equity and certain credit-oriented funds decreased due to net depreciation in the fair value of underlying portfolio investments.
Management and Advisory Fees were $1.57 billion for the year ended December 31, 2007, an increase of $488.9 million, or 45%, as compared with $1.08 billion for the year ended December 31, 2006. The change was primarily due to an increase in transaction fees driven by our funds’ acquisitions of Hilton Hotels and Equity Office Properties Trust, as well as an increase in base management fees due to an increase in Fee-Earning Assets Under Management. Additionally, an increase in fees earned by our fund placement business and restructuring and reorganization advisory services businesses contributed to the overall increase.
Performance Fees and Allocations were $1.13 billion for the year ended December 31, 2007, a decrease of $141.1 million, or 11%, as compared to $1.27 billion for the year ended December 31, 2006. The change in Performance Fees and Allocations resulted primarily from a lower net appreciation in the fair value of the underlying portfolio investments of our real estate and corporate private equity funds compared to the prior year. Specifically, the fair value of our real estate and corporate private equity funds had a net appreciation of approximately 35% and 16%, respectively, as compared with 85% and 30%, respectively in the prior year. These decreases were substantially offset by strong performance in certain of our funds of hedge funds, credit-oriented funds and certain of our proprietary hedge funds.
Investment Income and Other was $357.5 million for the year ended December 31, 2007, an increase of $84.9 million, or 31%, as compared to $272.6 million for the year ended December 31, 2006. The increase was primarily attributable to returns earned on a $1.00 billion investment of a portion of our IPO proceeds in our funds of hedge funds, as well as returns earned on our investment in certain of our proprietary hedge funds. Fund level increases in the fair value of investments in our real estate funds due to accretive sales within our existing office and limited hospitality sector portfolios also contributed to the overall increase.
Expenses
Expenses were $4.39 billion for the year ended December 31, 2008, an increase of $1.62 billion, or 59%, as compared to $2.76 billion for the year ended December 31, 2007. The change reflected higher Compensation and Benefits of $1.60 billion, principally resulting from the incremental amortization of equity-based compensation of $1.53 billion as well as compensation including performance payment arrangements associated with our senior managing directors and other selected employees which were accounted for as partnership distributions prior to our IPO. The year ended December 31, 2008 reflects a full year of equity-based compensation and performance payment arrangements versus only approximately one half year in 2007. The net addition of personnel to support the growth of each of our business segments, including expansion into Asia and our hedge fund businesses, also contributed to the increase in Compensation and Benefits. These increases were partially offset by a reduction in compensation costs of $202.0 million resulting from the reversal of prior period carried interest allocations to certain personnel due to a net reduction in the fair value of underlying funds’ investments. General, Administrative and Other increased $116.6 million compared to the year ended December 31, 2007, primarily due to $35.6 million of incremental amortization expense associated with intangible assets related to our IPO, acquisition of GSO, as well as an increase of costs associated with being a public company. Our expenses are primarily driven by levels of business activity, revenue growth and headcount expansion.
67
Expenses were $2.76 billion for the year ended December 31, 2007, an increase of $2.21 billion compared to $553.1 million for the year ended December 31, 2006. The change was driven by an increase in Compensation and Benefits of $2.01 billion, principally resulting from an increase in equity-based compensation of $1.77 billion arising from an equity-based compensation plan that did not exist prior to our IPO. Additionally, $128.8 million of the increased compensation expenses was due to performance payment arrangements associated with our senior managing directors, departed partners and other selected employees which were accounted for as partnership distributions prior to our IPO. The net addition of personnel to support the growth of each of our business segments, including office openings and expansion in London, Hong Kong, Japan and India, also contributed to the increase in Compensation and Benefits. General, Administrative and Other increased $201.8 million as compared to the year ended December 31, 2006 primarily due to $117.6 million of amortization expense associated with intangible assets which did not exist in the period prior to our IPO as well as due to an increase of $47.9 million of professional fees due to the costs of being a public company.
Other Income (Loss)
Other Income (Loss) was $(872.3) million for the year ended December 31, 2008, a decrease of $6.39 billion as compared to $5.42 billion for the year ended December 31, 2007. The change was due to the deconsolidation of certain of our funds in our Corporate Private Equity, Real Estate and Marketable Alternative Asset Management segments as described above in “—Consolidation and Deconsolidation of Blackstone Funds.” These losses arose at the Blackstone Funds level, of which $(833.0) million of losses and $5.14 billion of gains were allocated to non-controlling interest holders for the years ended December 31, 2008 and December 31, 2007, respectively.
Other Income was $5.42 billion for the year ended December 31, 2007, a decrease of $667.0 million, or 11%, compared with $6.09 billion for the year ended December 31, 2006. The change was due to the deconsolidation of certain of our funds in our Corporate Private Equity, Real Estate and Marketable Alternative Asset Management segments at the IPO date. These gains arose at the Blackstone funds level, of which $5.14 billion and $5.86 billion were allocated to non-controlling interest holders for the years ended December 31, 2007 and December 31, 2006, respectively.
Fee-Earning Assets Under Management
Fee-Earning Assets Under Management were $91.04 billion at December 31, 2008, an increase of $7.89 billion, or 9%, compared with $83.15 billion at December 31, 2007. The increase was primarily driven by additional capital raised for our European focused real estate fund, contributions to our funds of hedge funds, the acquisition of GSO and the deployment of capital in funds which charge a fee based upon invested capital. These increases were partially offset by redemptions.
Fee-Earning Assets Under Management were $83.15 billion at December 31, 2007, an increase of $28.36 billion, or 52%, compared with $54.80 billion at December 31, 2006. The increase was primarily driven by additional capital raised for our fifth general corporate private equity fund, our sixth global real estate fund and contributions to our funds of hedge funds and proprietary hedge funds.
Assets Under Management
Assets Under Management were $94.56 billion at December 31, 2008, a decrease of $7.87 billion, or 8%, as compared with $102.43 billion at December 31, 2007. The change was principally due to a net depreciation in the fair value of portfolio investments of $27.19 billion. This was partially offset by the addition of $12.25 billion of Assets Under Management associated with our acquisition of GSO and $5.63 billion of inflows into our real estate funds, primarily our European focused real estate fund.
Assets Under Management were $102.43 billion at December 31, 2007, an increase of $32.92 billion, or 47%, from $69.51 billion at December 31, 2006. The change was primarily due to a net appreciation in the fair value of portfolio investments in our corporate private equity and real estate funds and $10.11 billion of capital
68
raised for our sixth global real estate fund. Additionally, significant inflows from clients, as well as our $1.25 billion investment of a portion of our IPO proceeds in our funds of hedge funds and proprietary hedge funds, contributed to the overall increase.
Capital Deployed
Limited Partner Capital Invested was $6.55 billion for the year ended December 31, 2008, a decrease of $8.22 billion, or 56%, as compared to $14.77 billion for the year ended December 31, 2007. The change reflected a decrease in the size and volume of consummated transactions, compared to the prior year that most notably reflected our funds’ investments to acquire Equity Office Properties Trust and Hilton Hotels.
Limited Partner Capital Invested was $14.77 billion for the year ended December 31, 2007, an increase of $3.96 billion, or 37%, compared with $10.81 billion for the prior year. The change was due to an increase in our real estate funds of $5.04 billion, offset by a decrease in our corporate private equity funds of $1.22 billion.
Segment Analysis
Discussed below is our ENI for each of our reportable segments. This information is reflected in the manner utilized by our senior management to make operating decisions, assess performance and allocate resources. References to “our” sectors or investments may also refer to portfolio companies and investments of the underlying funds that we manage.
For segment reporting purposes, revenues and expenses are presented on a basis that deconsolidates the investment funds we manage. As a result, segment revenues are greater than those presented on a consolidated and combined GAAP basis because fund management fees recognized in certain segments are received from the Blackstone Funds and eliminated in consolidation when presented on a consolidated and combined GAAP basis. Furthermore, segment expenses are lower than related amounts presented on a consolidated and combined GAAP basis due to the exclusion of fund expenses that are paid by Limited Partners and the elimination of non-controlling interests.
Corporate Private Equity
The following table presents our results of operations for our Corporate Private Equity segment:
| Year Ended December 31, | ||||||||||||
| 2008 | 2007 | 2006 | ||||||||||
| (Dollars in Thousands) | ||||||||||||
| Segment Revenues |
||||||||||||
| Management Fees |
||||||||||||
| Base Management Fees |
$ | 268,961 | $ | 254,843 | $ | 222,509 | ||||||
| Transaction and Other Fees |
80,950 | 178,071 | 199,455 | |||||||||
| Management Fee Offsets |
(34,016 | ) | (65,035 | ) | (17,668 | ) | ||||||
| Total Management Fees |
315,895 | 367,879 | 404,296 | |||||||||
| Performance Fees and Allocations |
(430,485 | ) | 379,917 | 594,494 | ||||||||
| Investment Income (Loss) and Other |
(171,580 | ) | 117,533 | 128,787 | ||||||||
| Total Revenues |
(286,170 | ) | 865,329 | 1,127,577 | ||||||||
| Expenses |
||||||||||||
| Compensation and Benefits |
16,206 | 96,402 | 61,882 | |||||||||
| Other Operating Expenses |
90,130 | 78,473 | 55,841 | |||||||||
| Total Expenses |
106,336 | 174,875 | 117,723 | |||||||||
| Economic Net Income (Loss) |
$ | (392,506 | ) | $ | 690,454 | $ | 1,009,854 | |||||
69
The following operating metrics are used in the management of this business segment:
| Year Ended December 31, | ||||||||||||
| 2008 | 2007 | 2006 | ||||||||||
| (Dollars in Thousands) | ||||||||||||
| Fee-Earning Assets Under Management (End of Period) |
$ | 25,509,163 | $ | 25,040,513 | $ | 21,122,326 | ||||||
| Assets Under Management |
||||||||||||
| Balance, Beginning of Period |
$ | 31,802,951 | $ | 29,808,110 | $ | 27,263,416 | ||||||
| Inflows, including Commitments |
127,930 | 5,456,134 | 4,984,750 | |||||||||
| Outflows, including Distributions |
(964,182 | ) | (5,917,520 | ) | (5,581,864 | ) | ||||||
| Market Appreciation (Depreciation) |
(7,033,188 | ) | 2,456,227 | 3,141,808 | ||||||||
| Balance, End of Period |
$ | 23,933,511 | $ | 31,802,951 | $ | 29,808,110 | ||||||
| Capital Deployed |
||||||||||||
| Limited Partner Capital Invested |
$ | 3,760,262 | $ | 6,331,304 | $ | 7,549,449 | ||||||
Year Ended December 31, 2008 Compared to Year Ended December 31, 2007 and Year Ended December 31, 2007 Compared to Year Ended December 31, 2006
Revenues
Revenues were $(286.2) million for the year ended December 31, 2008, a decrease of $1.15 billion as compared to $865.3 million for the year ended December 31, 2007. The negative Performance Fees and Allocations and Investment Income (Loss) and Other were driven by a net depreciation in the fair value of certain portfolio investments resulting from reduced exit multiples, lower operating projections for some portfolio companies, decreased share prices of various publicly held investments and the decrease of the value of foreign currencies versus the U.S. dollar. Overall, the fair value of the segment’s underlying portfolio investments depreciated by approximately 32% for 2008 compared to a net appreciation in fair value of approximately 16% in 2007. Transaction and Other Fees decreased $97.1 million primarily due to a reduction in the number and size of closed fee-earning transactions in 2008, as well as a substantial transaction fee earned from our fund’s acquisition of Hilton Hotels together with our real estate funds in 2007. The $31.0 million decrease in Management Fee Offsets was primarily due to $24.2 million related to a reverse termination fee incurred in 2007 in connection with the termination of our planned acquisition of a subsidiary of PHH Corporation. Base Management Fees increased $14.1 million primarily due to the full-year impact of management fees on the $5.46 billion of inflows to Assets Under Management in 2007, driven by $4.68 billion of additional capital raised for our fifth general corporate private equity fund.
Revenues were $865.3 million for the year ended December 31, 2007, a decrease of $262.2 million, or 23% compared with $1.13 billion for the prior year. The change in both Performance Fees and Allocations and Investment Income and Other were driven primarily by lower net appreciation in the fair value of the underlying portfolio investments as compared to 2006. Specifically, in 2007 the fair value of the segment’s underlying portfolio investments appreciated by approximately 16% as compared to net appreciation in the fair value of approximately 30% in 2006. The weighted-average base on which this increase was calculated was approximately 57% greater in 2007 than the comparable base in 2006. Most significantly, due to the adverse conditions in the credit markets in the fall of 2007 which affected monoline financial guarantors, the carrying value of our portfolio investment in Financial Guaranty Insurance Company was reduced and accounted for $110.2 million or 51% of the decline in Performance Fees and Allocations. Base Management Fees increased $32.3 million as a result of $4.68 billion of additional capital raised for our fifth general corporate private equity fund during 2007. Management Fee Offsets increased $47.4 million due principally to an increase of $38.2 million in broken deal expenses, which included $24.2 million related to a reverse termination fee incurred in connection with the termination of our fifth general corporate private equity fund’s planned acquisition of a
70
subsidiary of PHH Corporation and $9.2 million of placement fees paid for additional capital raised by our fifth general corporate private equity fund. The change in Transaction and Other Fees was due to fewer closed fee-earning transactions during 2007.
Expenses
Expenses were $106.3 million for the year ended December 31, 2008, a decrease of $68.5 million, or 39%, as compared to $174.9 million for the year ended December 30, 2007. The decrease in Compensation and Benefits of $80.2 million resulted principally from the reversal of prior period carried interest allocations to certain personnel of $126.9 million, primarily due to the depreciation in fair value of certain portfolio investments. These decreases were partially offset by the impact of performance payment arrangements associated with our senior managing directors and other selected employees which were accounted for as partnership distributions prior to our IPO. Other Operating Expenses increased $11.7 million principally due to increases in professional fees, occupancy costs and foreign exchange losses, partially offset by a decrease in interest expense.
Expenses were $174.9 million for the year ended December 31, 2007, an increase of $57.2 million, or 49%, compared with $117.7 million for the prior year. The increase was primarily due to an increase in Compensation and Benefits of $34.5 million, principally resulting from compensation expenses including performance payment arrangements associated with our senior managing directors and other selected employees which were accounted for as partnership distributions prior to our IPO. Additionally, Other Operating Expenses increased $22.6 million primarily due to an $18.1 million increase in professional fees primarily related to the costs of being a public company.
Fee-Earning Assets Under Management
Fee-Earning Assets Under Management were $25.51 billion at December 31, 2008, an increase of $468.7 million compared with $25.04 billion at December 31, 2007. The increase was driven primarily by the deployment of capital in funds which charge a fee based upon invested capital.
Fee-Earning Assets Under Management were $25.04 billion at December 31, 2007, an increase of $3.92 billion, or 19%, compared with $21.12 billion at December 31, 2006. The increase was driven by additional capital raised for our fifth general corporate private equity fund.
Assets Under Management
Assets Under Management were $23.93 billion at December 31, 2008, a decrease of $7.87 billion, or 25%, compared with $31.80 billion at December 31, 2007. The decrease was primarily due to a net depreciation in the fair value of our portfolio investments of $7.03 billion and realizations of $456.9 million.
Assets Under Management were $31.80 billion at December 31, 2007, an increase of $1.99 billion, or 7%, compared with $29.81 billion at December 31, 2006. The increase was primarily due to $5.46 billion of inflows, primarily related to additional capital raised for our fifth general corporate private equity fund and a $2.46 billion net appreciation in the fair value of our portfolio investments. These increases were partially offset by realizations.
Capital Deployed
Limited Partner Capital Invested was $3.76 billion for the year ended December 31, 2008, a decrease of $2.57 billion, or 41%, as compared to $6.33 billion for the year ended December 31, 2007. This decrease reflected a reduction in the number and size of investments closed during 2008 as asset values declined, sellers of businesses withdrew from the market and lenders continued to severely restrict commitments to new debt, as discussed above in “—Business Environment.”
71
Limited Partner Capital Invested was $6.33 billion for the year ended December 31, 2007, a decrease of $1.22 billion, or 16%, compared with $7.55 billion for the prior year. This decrease reflected reduced investment activity during the year ended December 31, 2007 due to a substantial tightening of credit which significantly reduced funding availability to initiate new, large-sized leveraged transactions.
Real Estate
The following table presents our results of operations for our Real Estate segment:
| Year Ended December 31, | ||||||||||||
| 2008 | 2007 | 2006 | ||||||||||
| (Dollars in Thousands) | ||||||||||||
| Segment Revenues |
||||||||||||
| Management Fees |
||||||||||||
| Base Management Fees |
$ | 295,921 | $ | 233,072 | $ | 128,041 | ||||||
| Transaction and Other Fees |
36,046 | 348,410 | 144,541 | |||||||||
| Management Fee Offsets |
(4,969 | ) | (11,717 | ) | (9,452 | ) | ||||||
| Total Management Fees |
326,998 | 569,765 | 263,130 | |||||||||
| Performance Fees and Allocations |
(819,023 | ) | 623,951 | 633,596 | ||||||||
| Investment Income (Loss) and Other |
(225,984 | ) | 135,827 | 102,444 | ||||||||
| Total Revenues |
(718,009 | ) | 1,329,543 | 999,170 | ||||||||
| Expenses |
||||||||||||
| Compensation and Benefits |
76,793 | 145,146 | 67,767 | |||||||||
| Other Operating Expenses |
55,782 | 54,829 | 28,659 | |||||||||
| Total Expenses |
132,575 | 199,975 | 96,426 | |||||||||
| Economic Net Income (Loss) |
$ | (850,584 | ) | $ | 1,129,568 | $ | 902,744 | |||||
The following operating metrics are used in the management of this business segment:
| Year Ended December 31, | ||||||||||||
| 2008 | 2007 | 2006 | ||||||||||
| (Dollars in Thousands) | ||||||||||||
| Fee-Earning Assets Under Management (End of Period) |
$ | 22,970,438 | $ | 18,637,673 | $ | 9,084,168 | ||||||
| Assets Under Management |
||||||||||||
| Balance, Beginning of Period |
$ | 26,128,049 | $ | 12,796,999 | $ | 6,927,990 | ||||||
| Inflows, including Commitments |
5,626,201 | 12,384,277 | 5,667,599 | |||||||||
| Outflows, including Distributions |
(146,877 | ) | (2,722,013 | ) | (3,060,190 | ) | ||||||
| Market Appreciation (Depreciation) |
(7,452,731 | ) | 3,668,786 | 3,261,600 | ||||||||
| Balance, End of Period |
$ | 24,154,642 | $ | 26,128,049 | $ | 12,796,999 | ||||||
| Capital Deployed |
||||||||||||
| Limited Partner Capital Invested |
$ | 968,684 | $ | 8,171,854 | $ | 3,130,945 | ||||||
72
Year Ended December 31, 2008 Compared to Year Ended December 31, 2007 and Year Ended December 31, 2007 Compared to Year Ended December 31, 2006
Revenues
Revenues were $(718.0) million for the year ended December 31, 2008, a decrease of $2.05 billion compared to $1.33 billion for the year ended December 31, 2007. Performance Fees and Allocations and Investment Income (Loss) and Other decreased from the comparable 2007 period due principally to a net depreciation in the fair value of underlying portfolio investments of 39% for the year ended December 31, 2008, as compared with net appreciation of the underlying portfolio investments of 35% for the year ended December 31, 2007. The decline in 2008 was primarily the result of depreciation in the fair value of certain investments in our office and hospitality portfolios driven by both increases in capitalization rates and revised operating projections. Transaction and Other Fees decreased $312.4 million in 2008 primarily due to a substantial transaction fee earned from our funds’ acquisitions of Equity Office Properties Trust and Hilton Hotels in 2007. The increase in Base Management Fees of $62.8 million was primarily due to $5.63 billion of inflows, primarily related to additional capital raised for our European focused real estate fund, as well as a full twelve months of management fees from our sixth global real estate fund which commenced in February 2007.
Revenues were $1.33 billion for the year ended December 31, 2007, an increase of $330.4 million, or 33%, compared to $999.2 million for the year ended December 31, 2006. The change in Transaction and Other Fees was primarily due to the acquisitions of Hilton Hotels and Equity Office Properties Trust during 2007. Base Management Fees increased $105.0 million attributable to $114.3 million of fees generated from $10.11 billion of capital raised for our sixth global real estate fund, which commenced in February 2007. The increase in Investment Income and Other was attributable to net appreciation in the fair value of underlying portfolio investments due to accretive sales within our existing office and limited service hospitality portfolios. Overall, for the year ended December 31, 2007, the fair value of the segment’s underlying portfolio investments appreciated by approximately 35% as compared to net appreciation of approximately 85% in the prior year. The weighted-average base on which this increase was calculated was approximately three times greater in 2007 than the comparable base in the prior year. Our related Performance Fees and Allocations in 2007 were slightly lower compared with 2006 due to the increased amount of certain fees and expenses that must be deducted which had the effect of reducing our carried interest share of such increases in value.
Expenses
Expenses were $132.6 million for the year ended December 31, 2008, a decrease of $67.4 million, or 34%, as compared to $200.0 million for the year ended December 31, 2007. Compensation and Benefits decreased $68.4 million, principally from the reversal of prior period carried interest allocations to certain personnel of $70.6 million primarily due to the depreciation in fair value of certain fund investments.
Expenses were $200.0 million for the year ended December 31, 2007, an increase of $103.5 million compared with $96.4 million for the prior year. The change was primarily driven by an increase in Compensation and Benefits of $77.4 million, principally resulting from compensation expenses including performance payment arrangements associated with our senior managing directors and other selected employees which were accounted for as partnership distributions prior to our IPO. Headcount additions required to meet our increased investment activity, due to expansion into Asia and the launch of our sixth global real estate fund, also contributed to the increase in Compensation and Benefits. Other Operating Expenses increased $26.2 million, primarily related to an increase in professional fees of $17.5 million due to the costs of being a public company.
Fee-Earning Assets Under Management
Fee-Earning Assets Under Management were $22.97 billion at December 31, 2008, an increase of $4.33 billion, or 23%, compared with $18.64 billion at December 31, 2007. The increase was primarily driven by additional capital raised for our European focused real estate fund since December 31, 2007.
73
Fee-Earning Assets Under Management were $18.64 billion at December 31, 2007, an increase of $9.55 billion compared with $9.08 billion at December 31, 2006. The increase was primarily driven by capital raised for our sixth global real estate fund.
Assets Under Management
Assets Under Management were $24.15 billion at December 31, 2008, a decrease of $1.97 billion, or 8%, compared with $26.13 billion at December 31, 2007. The change was primarily due to net depreciation in the fair value of underlying portfolio investments, partially offset by $5.63 billion of inflows, primarily related to additional capital raised for our European focused real estate fund since December 31, 2007.
Assets Under Management were $26.13 billion at December 31, 2007, an increase of $13.33 billion compared with $12.80 billion at December 31, 2006. The change was primarily due to $12.38 billion of inflows, principally from $10.11 billion of capital raised for our sixth global real estate fund and net appreciation of the fair value of portfolio investments, primarily in our office and hospitality sectors.
Capital Deployed
Limited Partner Capital Invested was $968.7 million for the year ended December 31, 2008, a decrease of $7.20 billion, or 88%, from $8.17 billion for the year ended December 31, 2007. This decrease reflected a reduction in the volume and size of closed transactions as a result of the market conditions in 2008.
Limited Partner Capital Invested was $8.17 billion for the year ended December 31, 2007, an increase of $5.04 billion compared with $3.13 billion for the prior year. The change reflected an increase in size and volume of investment activity in 2007, most notably our funds’ acquisitions of Hilton Hotels for $3.71 billion and Equity Office Properties Trust for $3.27 billion.
Marketable Alternative Asset Management
The following table presents our results of operations for our Marketable Alternative Asset Management segment:
| Year Ended December 31, | ||||||||||||
| 2008 | 2007 | 2006 | ||||||||||
| (Dollars in Thousands) | ||||||||||||
| Segment Revenues |
||||||||||||
| Management Fees |
||||||||||||
| Base Management Fees |
$ | 476,836 | $ | 316,337 | $ | 183,027 | ||||||
| Transaction and Other Fees |
8,516 | 6,630 | 6,581 | |||||||||
| Management Fee Offsets |
(6,606 | ) | (33 | ) | (1,215 | ) | ||||||
| Total Management Fees |
478,746 | 322,934 | 188,393 | |||||||||
| Performance Fees and Allocations |
2,259 | 156,980 | 67,322 | |||||||||
| Investment Income (Loss) and Other |
(329,485 | )* | 148,082 | 64,751 | ||||||||
| Total Revenues |
151,520 | 627,996 | 320,466 | |||||||||
| Expenses |
||||||||||||
| Compensation and Benefits |
240,955 | 150,330 | 74,855 | |||||||||
| Other Operating Expenses |
106,027 | 74,728 | 53,942 | |||||||||
| Total Expenses |
346,982 | 225,058 | 128,797 | |||||||||
| Economic Net Income (Loss) |
$ | (195,462 | ) | $ | 402,938 | $ | 191,669 | |||||
| * | $(322.2) million of this loss was related to Blackstone’s equity invested in liquid Marketable Alternative Assets Management funds. |
74
The following operating metrics are used in the management of this business segment:
| Year Ended December 31, | ||||||||||||
| 2008 | 2007 | 2006 | ||||||||||
| (Dollars in Thousands) | ||||||||||||
| Fee-Earning Assets Under Management (End of Period) |
$ | 42,561,456 | $ | 39,474,067 | $ | 24,588,966 | ||||||
| Assets Under Management |
||||||||||||
| Balance, Beginning of Period |
$ | 44,496,372 | $ | 26,907,093 | $ | 16,907,421 | ||||||
| Inflows, including Commitments |
24,519,637 | 13,783,935 | 8,589,894 | |||||||||
| Outflows, including Distributions |
(9,841,305 | ) | (1,788,133 | ) | (1,393,090 | ) | ||||||
| Market Appreciation (Depreciation) |
(12,703,640 | ) | 5,593,477 | 2,802,868 | ||||||||
| Balance, End of Period |
$ | 46,471,064 | $ | 44,496,372 | $ | 26,907,093 | ||||||
| Capital Deployed |
||||||||||||
| Limited Partner Capital Invested |
$ | 1,819,705 | $ | 268,201 | $ | 131,746 | ||||||
Year Ended December 31, 2008 Compared to Year Ended December 31, 2007 and Year Ended December 31, 2007 Compared to Year Ended December 31, 2006
Revenues
Revenues were $151.5 million for the year ended December 31, 2008, a decrease of $476.5 million, or 76%, as compared to $628.0 million for the year ended December 31, 2007. The decrease in Investment Income (Loss) and Other was due to declines in Blackstone’s investments in certain of our funds of hedge funds, then-existing proprietary hedge funds and credit-oriented funds. The decrease in Performance Fees and Allocations was attributable to net depreciation of the investment portfolios principally in certain of our funds of hedge funds, then-existing proprietary hedge funds and credit-oriented funds as compared to the year ended December 31, 2007. Base Management Fees increased $160.5 million due to an increase in the Fee-Earning Assets Under Management in 2008 as compared with 2007. Additionally, our acquisition of GSO in the first quarter of 2008 contributed $102.5 million of the overall increase.
Revenues were $628.0 million for the year ended December 31, 2007, an increase of $307.5 million, or 96%, compared to $320.5 million for the year ended December 31, 2006. Base Management Fees increased $133.3 million, or 73%, primarily due to an increase of $14.89 billion in Fee-Earning Assets Under Management, resulting from significant net inflows from institutional investors in new and existing funds, an increase in net appreciation of the portfolio and the launch of our equity hedge fund in the fourth quarter of 2006. The increase in Performance Fees and Allocations was primarily attributable to favorable investment performance in certain of our funds of hedge funds, our corporate debt funds and certain of our proprietary hedge funds. Investment Income and Other increased principally driven by returns earned on a $1.00 billion investment of a portion of our IPO proceeds in our funds of hedge funds, as well as returns earned on our investment in certain of our proprietary hedge funds.
Expenses
Expenses were $347.0 million for the year ended December 31, 2008, an increase of $121.9 million, or 54%, as compared to $225.1 million for the year ended December 31, 2007. The increase in Compensation and Benefits of $90.6 million was principally related to the acquisition of GSO which contributed $70.9 million of the overall increase. Additionally, compensation including performance payment arrangements associated with our senior managing directors and other selected employees which were accounted for as partnership distributions prior to our IPO were a factor in the increase. To a lesser extent, headcount additions due to expansion into Asia and the launch of new funds contributed to the increase in Compensation and Benefits. Other Operating Expenses increased $31.3 million, primarily due to the acquisition of GSO, partially offset by a
75
decrease in interest expense as a result of decreased investment activity. Included in our 2008 expenses were $10.3 million of restructuring accruals related to the restructuring of two of our single manager proprietary hedge funds and our credit-oriented funds.
Expenses were $225.1 million for the year ended December 31, 2007, an increase of $96.3 million, or 75%, compared to $128.8 million for the year ended December 31, 2006. The increase in Compensation and Benefits of $75.5 million was principally related to compensation expenses including performance payment arrangements associated with our senior managing directors and other selected employees which were accounted for as partnership distributions prior to our IPO. Personnel additions to support asset growth, expansion into new business initiatives and the creation of new investment products contributed to the increase in compensation expenses. Other Operating Expenses increased $20.8 million, primarily due to an increase in professional fees associated with raising capital and the cost of being a public company.
Fee-Earning Assets Under Management
Fee-Earning Assets Under Management were $42.56 billion at December 31, 2008, an increase of $3.09 billion, or 8%, compared $39.47 billion at December 31, 2007. The increase was primarily driven by the acquisition of GSO and capital raised in our funds of hedge funds, partially offset by redemptions.
Fee-Earning Assets Under Management were $39.47 billion at December 31, 2007, an increase of $14.89 billion compared with $24.59 billion at December 31, 2006. The increase was driven primarily by contributions to our funds of hedge funds and proprietary hedge funds.
Assets Under Management
Assets Under Management were $46.47 billion at December 31, 2008, an increase of $1.97 billion, or 4%, compared to $44.50 billion at December 31, 2007. The change was driven by the acquisition of GSO, which contributed $12.25 billion to Assets Under Management, as well as capital raised in our funds of hedge funds of $7.72 billion. These increases were substantially offset by reductions in fair value of portfolio investments of $12.70 billion and total outflows of $9.84 billion primarily comprised of redemptions and realizations.
Assets Under Management were $44.50 billion at December 31, 2007, a net increase of $17.59 billion, or 65%, compared to $26.91 billion at December 31, 2006. The increase was due to significant inflows from a globally diverse base of clients, as well as our $1.25 billion investment of a portion of our IPO proceeds in our funds of hedge funds and proprietary hedge funds. Additionally, an increase in net appreciation in the fair value of portfolio investments contributed to the total increase. Our funds of hedge funds contributed $11.93 billion, or 68%, to the overall increase, primarily arising from new contributions from pension funds and financial institutions worldwide as well as a $1.00 billion investment of some of our IPO proceeds. Our proprietary hedge funds and our corporate debt vehicles contributed $2.64 billion and $2.13 billion, respectively, of the overall increase.
Capital Deployed
Limited Partner Capital Invested was $1.82 billion for the year ended December 31, 2008, an increase of $1.55 billion compared to $268.2 million for the year ended December 31, 2007. This increase principally reflected investments made by certain of our credit-oriented funds launched in 2008.
Limited Partner Capital Invested was $268.2 million for the year ended December 31, 2007, an increase of $136.5 million compared to $131.7 million for the year ended December 31, 2006.
76
Financial Advisory
The following table presents our results of operations for our Financial Advisory segment:
| Year Ended December 31, | |||||||||
| 2008 | 2007 | 2006 | |||||||
| (Dollars in Thousands) | |||||||||
| Segment Revenues |
|||||||||
| Advisory Fees |
$ | 397,519 | $ | 360,284 | $ | 256,914 | |||
| Investment Income and Other |
13,047 | 7,374 | 3,408 | ||||||
| Total Revenues |
410,566 | 367,658 | 260,322 | ||||||
| Expenses |
|||||||||
| Compensation and Benefits |
234,755 | 132,633 | 45,563 | ||||||
| Other Operating Expenses |
67,277 | 39,037 | 20,886 | ||||||
| Total Expenses |
302,032 | 171,670 | 66,449 | ||||||
| Economic Net Income |
$ | 108,534 | $ | 195,988 | $ | 193,873 | |||
Year Ended December 31, 2008 Compared to Year Ended December 31, 2007 and Year Ended December 31, 2007 Compared to Year Ended December 31, 2006
Revenues
Revenues were $410.6 million for the year ended December 31, 2008, an increase of $42.9 million, or 12%, as compared to $367.7 million for the year ended December 31, 2007. The change was driven by an increase in fees of $50.8 million, or 81%, generated by our restructuring and reorganization advisory services business as continued credit market turmoil and low levels of available liquidity led to increased bankruptcies, debt defaults and debt restructurings. Additionally, fees earned from our corporate and mergers and acquisitions advisory services business increased $22.2 million, or 17% as clients increasingly looked to us for independent advice in complicated transactions. These increases were partially offset by a decrease of $35.7 million in fees generated from our fund placement business as compared to 2007 which included a substantial fee earned from one transaction in the first quarter of the year.
Revenues were $367.7 million for the year ended December 31, 2007, an increase of $107.3 million, or 41%, compared to $260.3 million for the year ended December 31, 2006. The change was driven by an increase in fees of $111.0 million generated from our fund placement business principally related to a substantial fee earned from one transaction in the first quarter of 2007. Additionally, a $13.0 million increase in fees earned from our restructuring and reorganization advisory services business was partially offset by a decrease of $20.6 million in fees generated from our corporate and mergers and acquisitions advisory services business.
The revenues generated by each of the businesses in our financial advisory segment are transactional in nature and therefore results can fluctuate significantly from period to period.
Expenses
Expenses were $302.0 million for the year ended December 31, 2008, an increase of $130.3 million, or 76%, as compared to $171.7 million for the year ended December 31, 2007. Compensation and Benefits increased $102.1 million principally related to compensation associated with our senior managing directors which was accounted for as partnership distributions prior to our IPO. Additionally, the change in Compensation and Benefits was due to an increase in Advisory Fees revenues as a portion of compensation is directly related to the profitability of each of the service businesses. Other Operating Expenses increased $28.2 million, principally
77
due to costs related to the expansion of our London and Hong Kong-based corporate and mergers and acquisitions advisory services business and an increase in bad debt expense.
Expenses were $171.7 million for the year ended December 31, 2007, an increase of $105.2 million compared with $66.4 million for the year ended December 31, 2006. Compensation and Benefits increased $87.1 million principally related to compensation expenses associated with our senior managing directors and other selected employees which were accounted for as partnership distributions prior to our IPO. Personnel additions in our fund placement and corporate and mergers and acquisitions businesses also contributed to the overall increase in compensation expense. Other Operating Expenses increased $18.2 million, principally due to $9.1 million of costs related to the expansion of our London-based fund placement and corporate and mergers and acquisitions advisory services businesses and increased professional fees of $8.8 million due to the cost of being a public company.
Liquidity and Capital Resources
Liquidity and Capital Resources
Blackstone’s business model derives revenue primarily from third party assets under management and from advisory businesses. Blackstone is not a capital or balance sheet intensive business and targets operating expense levels such that total management and advisory fees exceed total operating expense each period. As a result, Blackstone requires limited capital resources to support the working capital or operating needs of our businesses to fund growth in our business. Blackstone draws primarily on the long term committed capital of our limited partner investors to fund the investment requirements of the Blackstone Funds and uses its own realizations and cash flows to invest in growth initiatives or make commitments to its own funds which are typically less than 5% of the assets under management.
Fluctuations in our balance sheet result primarily from activities of the Blackstone Funds which are consolidated. The majority economic ownership interests of these Blackstone Funds are reflected as Non-controlling Interests in Consolidated Entities in the consolidated and combined financial statements. The consolidation of these Blackstone Funds has no net effect on the Partnership’s Net Income or Partners’ Capital. Additionally, fluctuations in our balance sheet also include appreciation or depreciation in Blackstone investments in the Blackstone Funds, additional investments and redemptions of such interests in the Blackstone Funds and the collection of receivables related to management and advisory fees. For the year ended December 31, 2008, we had total management and advisory fees and interest income of $1.56 billion and total cash expenses of $1.13 billion, generating Net Fee Related Earnings from Operations of $427.7 million for the year.
Blackstone has multiple sources of liquidity to meet its capital needs, including annual cash flow, accumulated earnings in the businesses, investments in its own liquid funds and access to the committed credit facility described below. At December 31, 2008, we had $503.7 million in cash, $297.0 million invested in liquid Blackstone funds and pending redemptions from our liquid funds of $692.5 million against only $250.0 million in unsecured debt under our revolving credit facility as described further below. The Consolidated and Combined Statements of Cash Flows reflect the cash flows of the Blackstone operating businesses as well as those of the consolidated Blackstone Funds.
We use Adjusted Cash Flow from Operations as a supplemental non-GAAP measure to assess our cash flow and amounts available for distribution to unitholders. In accordance with GAAP, certain of the Blackstone Funds are consolidated into the consolidated and combined financial statements of Blackstone, notwithstanding the fact that Blackstone has only a minority economic interest in these funds. Consequently, Blackstone’s consolidated and combined financial statements reflect the cash flow of the consolidated Blackstone Funds on a gross basis rather than the cash flow attributable to Blackstone. Adjusted Cash Flow from Operations is therefore intended to reflect the cash flow attributable to Blackstone and is equal to operating activities presented in accordance with
78
GAAP, adjusted for cash flow relating to changes in our operating assets and liabilities, Blackstone Funds’ related investment activity, differences in the timing of realized gains between Blackstone and Blackstone Funds, non-controlling interest related to departed partners and non-controlling interests in income of consolidated entities and other non-cash adjustments. Management assesses Adjusted Cash Flow from Operations, which is derived from our segment reported results, by monitoring its key components, defined by management to be (1) Net Fee Related Earnings from Operations, (2) Performance Fees and Allocations net of related profit sharing interests that are included in compensation and (3) Blackstone investment income related to its investments in liquid funds and its net realized investment income on its illiquid investments.
On May 12, 2008, we renewed our existing credit facility by entering into a new $1.0 billion revolving credit facility (“New Credit Facility”). The New Credit Facility provides for revolving credit borrowings, with a final maturity date of May 11, 2009. Interest on the borrowings is based on an adjusted LIBOR rate or alternate base rate, in each case plus a margin, and undrawn commitments bear a commitment fee. The New Credit Facility is unsecured and unguaranteed. We are currently engaged in discussions with lenders seeking to renew all or part of our existing revolving credit facility or find alternate financing on commercially reasonable terms.
The following table is a reconciliation of Net Cash Provided by (Used In) Operating Activities presented on a GAAP basis to Adjusted Cash Flow from Operations:
| Year Ended December 31, | ||||||||||||
| 2008 | 2007 | 2006 | ||||||||||
| (Dollars in Thousands) | ||||||||||||
| Net Cash Provided by (Used in) Operating Activities |
$ | 1,890,435 | $ | (850,296 | ) | $ | (4,396,614 | ) | ||||
| Changes in Operating Assets and Liabilities |
(957,110 | ) | 188,582 | 1,154,680 | ||||||||
| Blackstone Funds Related Investment Activities |
(469,693 | ) | 1,699,433 | 3,776,325 | ||||||||
| Net Realized Gains (Losses) on Investments |
(164,726 | ) | 3,800,137 | 5,054,995 | ||||||||
| Non-controlling Interests in Income of Consolidated Entities |
3,723,723 | (1,521,303 | ) | (3,950,664 | ) | |||||||
| Realized Gains (Losses)—Blackstone Funds |
(197,426 | ) | 87,373 | 28,687 | ||||||||
| Pro Forma | ||||||||||||
| Cash Flow from Operations—Adjustments (a) |
||||||||||||
| Elimination of Non-Contributed Entities (b) |
— | (46,523 | ) | (134,442 | ) | |||||||
| Increase in Compensation Expense (c) |
— | (255,426 | ) | (315,573 | ) | |||||||
| Interests Held by Blackstone Holdings Limited Partners (d) |
(3,611,955 | ) | (1,080,015 | ) | — | |||||||
| Eliminate Interest Expense (e) |
— | 26,302 | 35,767 | |||||||||
| Realized Gains (Losses)—Blackstone Funds |
— | (275,333 | ) | 60,828 | ||||||||
| Incremental Cash Tax Effect (f) |
(84,447 | ) | (256,327 | ) | (216,712 | ) | ||||||
| Adjusted Cash Flow from Operations |
$ | 128,801 | $ | 1,516,604 | $ | 1,097,277 | ||||||
79
The following table provides the details of the components of Adjusted Cash Flow from Operations. Adjusted Cash Flow from Operations is the principal factor in determining the amount of distributions to unitholders.
| Year Ended December 31, | ||||||||||
| 2008 | 2007 | 2006 | ||||||||
| (Dollars in Thousands) | ||||||||||
| Pro Forma | ||||||||||
| Fee Related Earnings |
||||||||||
| Total Management and Advisory Fees (g) |
$ | 1,561,768 | $ | 1,638,947 | $ | 1,121,006 | ||||
| Total Expenses (h) |
1,134,100 | 1,252,250 | 922,166 | |||||||
| Net Fee Related Earnings from Operations |
427,668 | 386,697 | 198,840 | |||||||
| Performance Fees and Allocations Net of Related Compensation (i) |
33,210 | 829,568 | 710,861 | |||||||
| Blackstone Investment Income (j) |
||||||||||
| Liquid |
(327,453 | ) | 138,203 | 39,360 | ||||||
| Illiquid |
(4,624 | ) | 162,136 | 148,216 | ||||||
| (332,077 | ) | 300,339 | 187,576 | |||||||
| Adjusted Cash Flow from Operations |
$ | 128,801 | $ | 1,516,604 | $ | 1,097,277 | ||||
| (a) | Adjusted Cash Flow from Operations is based upon historical results of operations and gives effect to the pre-initial public offering reorganization and the initial public offering as if they were completed as of January 1, 2007. These pro forma adjustments are consistent with Rule 11-01 of Regulation S–X at the time of the IPO. |
| (b) | Represent adjustments to eliminate from Adjusted Cash Flow from Operations the cash flows of the businesses that were not contributed as part of the reorganization. |
| (c) | Represent adjustments to reflect in Adjusted Cash Flow from Operations the cash portion of expenses related to employee compensation that were not effective prior to the reorganization as well as vested carried interest for departed partners. |
| (d) | Represents an adjustment to add back net income (loss) allocable to interest holders of Blackstone Holdings Limited Partners after the Reorganization recorded as Non-Controlling Interests. |
| (e) | Represent adjustments to eliminate interest expense in Adjusted Cash Flow from Operations for 2007 and 2006 on the assumption that the revolving credit facility was repaid in full from the proceeds of the offering. |
| (f) | Represent the provisions for and/or adjustments to income taxes that were calculated using the same methodology applied in calculating such amounts for the period after the reorganization. |
| (g) | Comprised of total reportable segment Management and Advisory Fees plus Interest Income. |
| (h) | Comprised of total reportable segment compensation expense (excluding compensation expense related to Performance Fees and Allocations pursuant to Blackstone’s profit sharing plans related to carried interest and incentive fees which are included in (i) below), other operating expenses and Blackstone’s estimate of cash taxes currently due. |
| (i) | Represents realized Performance Fees and Allocations net of corresponding actual amounts due under Blackstone’s profit sharing plans related thereto. |
| (j) | Comprised of Blackstone’s investment income (realized and unrealized) on its liquid investments from its Marketable Alternative Asset Management segment as well as its net realized investment income on its illiquid investments, principally from its Corporate Private Equity and Real Estate Segments and permanent impairment charges on certain illiquid investments. |
80
Our Sources of Cash and Liquidity Needs
We expect that our primary liquidity needs will be cash to (1) provide capital to facilitate the growth of our existing businesses which principally includes funding our general partner and co-investment commitments to our funds, (2) provide capital to facilitate our expansion into new businesses that are complementary, (3) pay operating expenses, including cash compensation to our employees and other obligations as they arise, (4) fund modest capital expenditures, (5) repay borrowings and related interest costs, (6) pay income taxes and (7) make distributions to our unitholders and the holders of Blackstone Holdings Partnership Units. Our own capital commitments to our funds and funds we invest in as of December 31, 2008, consisted of the following:
| Fund |
Original Commitment |
Remaining Commitment | ||||
| (Dollars in Thousands) | ||||||
| Corporate Private Equity and Related Funds |
||||||
| BCP VI |
$ | 500,000 | $ | 500,000 | ||
| BCP V |
629,356 | 206,700 | ||||
| BCP IV |
150,000 | 19,308 | ||||
| BCOM |
50,000 | 6,578 | ||||
| Real Estate Funds |
||||||
| BREP VI |
750,000 | 444,418 | ||||
| BREP V |
52,545 | 9,206 | ||||
| BREP International II |
28,189 | 5,215 | ||||
| BREP IV |
50,000 | — | ||||
| BREP International |
20,000 | 3,293 | ||||
| BREP Europe III |
100,000 | 100,000 | ||||
| Real Estate Special Situations |
50,000 | 36,286 | ||||
| Marketable Alternative Asset Management |
||||||
| BMEZZ II |
17,692 | 3,626 | ||||
| BMEZZ |
41,000 | 2,609 | ||||
| Strategic Alliance |
50,000 | 28,158 | ||||
| Blackstone Credit Liquidity Partners |
32,244 | 13,043 | ||||
| Value Recovery |
25,000 | 8,793 | ||||
| GSO Capital Opportunities |
1,000 | 642 | ||||
| GSO Liquidity Partners |
601 | — | ||||
| GSO Liquidity Sidecar |
250 | — | ||||
| Total |
$ | 2,547,877 | $ | 1,387,875 | ||
For some of the general partner commitments shown in the table above we require our senior managing directors and certain other professionals to fund a portion of the commitment even though the ultimate obligation to fund the aggregate commitment is ours pursuant to the governing agreements of the respective funds. For BCP VI, BREP VI and BREP Europe III it is intended that our senior managing directors and certain other professionals will fund $250 million, $150 million and $35 million of the aggregate applicable general partner commitment shown above, respectively. We expect our commitments to be drawn down over time and to be funded by available cash and cash generated from operations and realizations. Taking into account prevailing market conditions and both the liquidity and cash or liquid investment balances, we believe that the sources of liquidity described below will be more than sufficient to fund our working capital requirements.
In addition to the cash we received in connection with our IPO, we receive (1) cash generated from operating activities, (2) carried interest and incentive income realizations, and (3) realizations on the carry fund investments that we make. Blackstone’s investment income on our liquid investments (whether or not realized) from our Marketable Alternative Asset Management segment is also included in our Adjusted Cash Flow from Operations. The amounts received from the latter three sources in particular may vary substantially from year to
81
year and quarter to quarter depending on the frequency and size of realization events or net returns experienced by our investment funds. Our available capital could be adversely affected if there are prolonged periods of few substantial realizations from our investment funds accompanied by substantial capital calls from those investment funds. Therefore, Blackstone’s commitments to our funds are taken into consideration when managing our overall liquidity and cash position.
We expect to use our Adjusted Cash Flow from Operations to make cash distributions to our common unitholders in accordance with our distribution policy. As we have previously reported, our current intention is to distribute to our common unitholders substantially all of our net after-tax share of our annual Adjusted Cash Flow from Operations in excess of amounts determined by our general partner to be necessary or appropriate to provide for the conduct of our business, to make appropriate investments in our business and our funds, to comply with applicable law, any of our debt instruments or other agreements, or to provide for future distributions to common unitholders for any ensuing quarter. The declaration and payment of any distributions will be at the sole discretion of our general partner, which may change our distribution policy at any time. As we have previously reported, until December 31, 2009, Blackstone personnel and others who hold Blackstone Holdings partnership units (and who own approximately 75% of all outstanding units, with common unitholders holding the remaining 25%) will not receive any distributions with respect to their Blackstone Holdings partnership units, (other than tax distributions in the circumstances specified in “—Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities”) for a year unless and until our common unitholders receive aggregate distributions of $1.20 per common unit for such year. We do not intend to maintain this priority allocation after December 31, 2009.
As we have previously indicated, our ability to make cash distributions to our unitholders will depend on a number of factors, including among others general economic and business conditions, our strategic plans and prospects, our business and investment opportunities, our financial condition and operating results, working capital requirements and anticipated cash needs, contractual restrictions and obligations including fulfilling our current and future capital commitments, legal, tax and regulatory restrictions, restrictions and other implications on the payment of distributions by us to our common unitholders or by our subsidiaries to us and such other factors as our general partner may deem relevant. A significant component of our Cash Flow from Operations available for distributions has been the investment income that we receive from our Marketable Alternative Asset Management segment and our realized investment income received by our carry funds in respect of our investments in those segments’ investment funds. As noted above under “—Segment Analysis”, that component decreased in all three segments in 2008 due to a slowing global economy and overall declines in the global equity and debt markets.
The specific amount of this priority allocation of distributions to common unitholders prior to December 31, 2009 is governed by the amount of Blackstone’s Adjusted Cash Flow from Operations available for distributions, as determined in the manner specified in the preceding two paragraphs. The distribution paid on December 12, 2008 in respect of the third quarter of 2008 brought the total amount of distributions to common unitholders paid to date in respect of 2008 to approximately $240 million ($0.90 per common unit), exceeding Blackstone’s Adjusted Cash Flow from Operations of $128.8 million for the year ended December 31, 2008. Given these circumstances, there will not be any distribution paid to common unitholders in respect of the fourth quarter of 2008.
Public common unitholders will continue to receive a priority distribution ahead of Blackstone personnel and others through 2009, but the amount of those distributions in respect of 2009 will be based on the amount of Adjusted Cash Flow from Operations in 2009 available for distributions and could again fall below $1.20.
In January 2008, the Board of Directors of our general partner, Blackstone Group Management L.L.C., authorized the repurchase of up to $500 million of our common units and Blackstone Holdings Partnership Units. Under this unit repurchase program, units may be repurchased from time to time in open market transactions, in privately negotiated transactions or otherwise. The timing and the actual number of Blackstone common units
82
and Blackstone Holdings Partnership Units repurchased will depend on a variety of factors, including legal requirements, price and economic and market conditions. This unit repurchase program may be suspended or discontinued at any time and does not have a specified expiration date. In 2008, we repurchased a combination of 9,221,979 vested and unvested Blackstone Holdings Partnership Units and Blackstone Common Units as part of the unit repurchase program for a total cost of $130.1 million.
We may under certain circumstances use leverage opportunistically and over time to create the most efficient capital structure for Blackstone and our public common unitholders. At December 31, 2008, we had partners’ equity of $3.51 billion, including $503.7 million in cash, $297.0 million in investments in liquid funds and pending redemptions from our liquid funds of $692.5 million, supporting debt drawn under our revolving credit facility of only $250.0 million excluding consolidated non-operating entities. We do not anticipate approaching significant leverage levels over the foreseeable future since the positive cash flows and the net proceeds from the IPO and sale of non-voting common units to the Beijing Wonderful Investments are expected to be our principal source of financing for our businesses. However, our debt-to-equity ratio may increase in the future.
Our corporate private equity funds, real estate funds and funds of hedge funds have not historically utilized substantial leverage at the fund level other than for short-term borrowings between the date of an investment and the receipt of capital from the investing fund’s investors. Our corporate private equity funds and real estate funds make direct or indirect investments in companies that utilize leverage in their capital structure. The degree of leverage employed varies among portfolio companies.
Our Marketable Alternative Asset Management entities use leverage within their funds in order to obtain additional market exposure, enhance returns on invested capital and/or to bridge short-term cash needs. We also use leverage to enhance returns in some of our credit-oriented funds. The forms of leverage primarily employed by these funds include purchasing securities on margin, utilizing collateralized financing and using derivative instruments.
Critical Accounting Policies
We prepare our consolidated and combined financial statements in accordance with accounting principles generally accepted in the United States. In applying many of these accounting principles, we need to make assumptions, estimates and/or judgments that affect the reported amounts of assets, liabilities, revenues and expenses in our consolidated financial statements. We base our estimates and judgments on historical experience and other assumptions that we believe are reasonable under the circumstances. These assumptions, estimates and/or judgments, however, are often subjective. Actual results may be affected negatively based on changing circumstances. If actual amounts are ultimately different from our estimates, the revisions are included in our results of operations for the period in which the actual amounts become known. We believe the following critical accounting policies could potentially produce materially different results if we were to change underlying assumptions, estimates and/or judgments. (See Note 2. “Summary of Significant Accounting Policies” in the “Notes to the Consolidated and Combined Financial Statements” in “Part II. Item 8. Financial Statements and Supplementary Data” of this filing.)
Principles of Consolidation
Our policy is to combine, or consolidate, as appropriate, those entities in which, through Blackstone personnel, we have control over significant operating, financial or investing decisions of the entity.
For entities that are determined to be VIE’s, we consolidate those entities where we absorb a majority of the expected losses or a majority of the expected residual returns, or both, of such entity pursuant to the requirements of Financial Accounting Standards Board (“FASB”) Interpretation No. 46 (Revised December 2003), Consolidation of Variable Interest Entities-an interpretation of ARB No. 51 (“FIN 46(R)”). The evaluation of
83
whether a fund is subject to the requirements of FIN 46(R) as a VIE and the determination of whether we should consolidate such a VIE requires management’s judgment. In addition, we consolidate those entities we control through a majority voting interest or otherwise, including those Blackstone Funds in which the general partners are presumed to have control over them pursuant to Emerging Issues Task Force (“EITF”) Issue No. 04-5, Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights (“EITF 04-5”). The provisions under both FIN 46(R) and EITF 04-5 have been applied retrospectively to prior periods. All intercompany transactions and balances have been eliminated.
For operating entities over which we may exercise significant influence but which do not meet the requirements for consolidation, we use the equity method of accounting whereby we record our share of the underlying income or losses of these entities.
Revenue Recognition
Management and Advisory Fees. Management fees consist of (1) Fund Management Fees and (2) Advisory Fees. Our revenue recognition policies are as follows:
| (1) | Fund Management Fees. Fund management fees are comprised of: |
| (a) | Base Management Fees. Base management fees are fees charged directly to the fund or fund investors. Such fees are based upon the contractual terms of investment advisory and related agreements and are recognized as earned over the specified contract period. |
| (b) | Transaction and Other Fees. Transaction and other fees (including monitoring fees) are comprised of fees charged directly to funds and fund portfolio companies. Our investment advisory agreements generally require that the investment advisor share a portion of certain fees with the limited partners of the fund. Transaction and Other Fees are net of amounts, if any, shared with limited partners. |
| (c) | Management Fee Offsets. Our investment advisory agreements generally require that the investment advisor share a portion of certain expenses with the limited partners of the fund. These shared items (“management fee reductions”) reduce the management fees received from the limited partners. Management fee offsets are comprised primarily of broken deal and placement fee expenses. |
| (2) | Advisory Fees. Advisory Fees consist of advisory retainer and transaction-based fee arrangements related to mergers, acquisitions, restructurings, divestitures and fund placement services for alternative investment funds. Advisory retainer fees are recognized when services are rendered. Transaction fees are recognized when (i) there is evidence of an arrangement with a client, (ii) agreed upon services have been provided, (iii) fees are fixed or determinable and (iv) collection is reasonably assured. Fund placement services revenue is recognized as earned upon the acceptance by a fund of capital or capital commitments. |
Performance Fees and Allocations. Performance fees and allocations represent the preferential allocations of investment gains (“carried interest”) which are a component of our general partner interests in the corporate private equity, real estate and certain of our credit-oriented funds. We are entitled to carried interest from an investment fund in the event investors in the fund achieve cumulative investment returns in excess of a specified rate. We record as revenue (and/or adjust previously recorded revenue to reflect) the amount that would be due to us pursuant to the fund agreements at each period end as if the fair value of the investments were realized as of such date, whether or not such amounts have actually been realized. In certain performance fee arrangements related to funds of hedge funds and certain of our credit-oriented funds in our Marketable Alternative Asset Management segment, we are entitled to receive performance fees and allocations when the return on assets under management exceeds certain benchmark returns or other performance targets. In such arrangements,
84
performance fees and allocations are accrued monthly or quarterly based on measuring account / fund performance to date (whether or not such amounts have actually been realized) versus the performance benchmark stated in the investment management agreement. In all cases, each fund is considered separately in that regard and for a given fund, performance fees and allocations can never be negative over the life of the fund.
Investment Income. Blackstone invests in corporate private equity funds, real estate funds, funds of hedge funds and credit-oriented funds that are not consolidated. The Partnership accounts for these investments under the equity method of accounting. Blackstone’s share of operating income generated by these investments is recorded as a component of Investment Income and Other. That amount reflects the fair value gains and losses of the associated funds’ underlying investments as we retain the specialized investment company accounting of these funds pursuant to EITF 85-12. These funds generate realized and unrealized gains from underlying corporate private equity and real estate investments and investments in marketable alternative asset management funds which reflect a combination of internal and external factors as described below. In addition, third-party hedge fund managers provide information regarding the valuation of hedge fund investments.
Expenses
Our expenses include compensation and benefits expense and general and administrative expenses. Our accounting policies related thereto are as follows:
Compensation and Benefits Expense. Prior to the IPO in June 2007, our compensation and benefits expense reflected compensation (primarily salary and bonus) paid or accrued solely to our non-senior managing director employees. Subsequent to our IPO, compensation and benefits expense reflects (1) employee compensation and benefits expense paid and payable to our employees, including our senior managing directors, (2) equity-based compensation associated with grants of equity-based awards to senior managing directors, other employees and selected other individuals engaged in our businesses and (3) performance payment arrangements for Blackstone personnel and profit sharing interests in carried interest.
| (1) | Employee Compensation and Benefits. Our compensation costs reflect the increased investment in people as we expand geographically and create new products and businesses. Prior to the IPO, all payments for services rendered by our senior managing directors and selected other individuals engaged in our businesses have been accounted for as partnership distributions rather than as employee compensation and benefits expense. As a result, our employee compensation and benefits expense had not reflected amounts for services rendered by these individuals. Following the IPO, we have included all payments for services rendered by our senior managing directors as employee compensation and benefits expense. |
| (2) | Equity-based Compensation. Represents non-cash equity-based compensation expense associated with the issuance of equity-based awards to our senior managing directors, other employees and selected other individuals engaged in some of our businesses, primarily associated with our IPO. The expense is recognized over the corresponding service period of the underlying grant. |
| (3) | Performance Payment Arrangements. We have implemented what we generally refer to as “performance payment arrangements” for our personnel working in our businesses across our different operations that are designed to appropriately align performance and compensation. These performance payment arrangements generally provide annual cash payments to Blackstone personnel (including our senior managing directors) that are determined at the discretion of our senior management and are tied to the performance of our firm’s businesses and may, in certain cases, be based on participation interests in the earnings derived from the performance of the applicable business. In addition, Blackstone personnel working in our businesses, other professionals and selected other individuals who work on our carry funds have a profit sharing interest which we include within compensation as the related performance fees are recognized in relation to these funds in order to better align their interests with our own and with those of the investors in these funds. To the extent previously recorded revenues are adjusted to reflect decreases in the performance fees based on underlying funds’ valuations at period end, related profit sharing interests previously accrued are also adjusted and reflected as a credit |
85
| to current period compensation. Departed partners are also entitled to their vested share of carried interest distributions received and (as other partners) may be subject to a recontribution of previously received carried interest from our carry funds and are also liable for their applicable share of losses on carry funds subject to a cap related to the carried interest distributions they received from a carry fund. Therefore, as our net revenues increase, our compensation costs also rise; as our net revenues decrease, our compensation costs may decrease. |
General, Administrative and Other. The balance of our expenses include interest expense, occupancy and equipment expenses and general, administrative and other expenses, which consist of professional fees, public company costs, travel and related expenses, communications and information services, depreciation and amortization and other operating expenses.
Investments, at Fair Value
The Blackstone Funds are, for GAAP purposes, investment companies under the AICPA Audit and Accounting Guide Investment Companies that reflect their investments, including majority-owned and controlled investments (the “Portfolio Companies”) as well as Securities Sold, Not Yet Purchased at fair value. We have retained the specialized accounting for the Blackstone Funds pursuant to EITF Issue No. 85-12, Retention of Specialized Accounting for Investments in Consolidation. Thus, such consolidated funds investments are reflected on the Consolidated Statements of Financial Condition at fair value, with unrealized gains and losses resulting from changes in fair value reflected as a component of Net Gains (Losses) from Fund Investment Activities in the Consolidated and Combined Statements of Operations. Fair value is the amount that would be received to sell an asset or paid to transfer a liability, in an orderly transaction between market participants at the measurement date (i.e., the exit price).
Effective January 1, 2007 we, as well as our carry funds, adopted Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements (“SFAS No. 157”), which among other things, requires enhanced disclosures about financial instruments carried at fair value. See Notes 2 and 4 to the consolidated and combined financial statements for the additional information about the level of market observability associated with investments carried at fair value.
We have valued our investments, including our carry fund investments, in the absence of observable market prices, using the valuation methodologies described below applied on a consistent basis. For some investments little market activity may exist; management’s determination of fair value is then based on the best information available in the circumstances, and may incorporate management’s own assumptions and involves a significant degree of management’s judgment taking into consideration a combination of internal and external factors, including the appropriate risk adjustments for non-performance and liquidity risks. Internal factors that are considered are described below. The additional external factors associated with our valuations vary by asset class but are broadly driven by the market considerations discussed at “—Business Environment” above.
Investments for which market prices are not observable include private investments in the equity of operating companies or real estate properties. Fair values of private investments are determined by reference to projected net earnings, earnings before interest, taxes, depreciation and amortization (“EBITDA”) and balance sheets, public market or private transactions, valuations for comparable companies and other measures which, in many cases, are unaudited at the time received. With respect to real estate investments, in determining fair values we considered projected operating cash flows and balance sheets, sales of comparable assets, if any, and replacement costs among other measures. The methods used by us to estimate the fair value of private investments include the discounted cash flow method and/or capitalization rates (“cap rates”) analysis. Valuations may also be derived by reference to observable valuation measures for comparable companies or assets (e.g., multiplying a key performance metric of the investee company or asset, such as EBITDA, by a relevant valuation multiple observed in the range of comparable companies or transactions), adjusted by management for differences between the investment and the referenced comparables and in some instances by reference to option pricing models or other similar methods. Private investments may also be valued at cost for a
86
period of time after an acquisition as the best indicator of fair value. These valuation methodologies involve a significant degree of management judgment.
Blackstone Funds’ direct investments in hedge funds (“Investee Funds”) are stated at fair value, based on the information provided by the Investee Funds which reflects the Partnership’s share of the fair value of the net assets of the investment fund. If the Partnership determines, based on its own due diligence and investment procedures, that the valuation for any Investee Fund based on information provided by the Investee Fund’s management does not represent fair value, the Partnership will estimate the fair value of the Investee Fund in good faith and in a manner that it reasonably chooses, in accordance with its valuation policies.
In certain cases debt and equity securities are valued on the basis of prices from an orderly transaction between market participants provided by reputable dealers or pricing services. In determining the value of a particular investment, pricing services may use certain information with respect to transactions in such investments, quotations from dealers, pricing matrixes, market transactions in comparable investments and various relationships between investments.
After our adoption of SFAS No.157, investments measured and reported at fair value are classified and disclosed in one of the following categories:
| • | Level I—Quoted prices are available in active markets for identical investments as of the reporting date. The type of investments in Level I include listed equities and listed derivatives. As required by SFAS No.157, we do not adjust the quoted price for these investments, even in situations where we hold a large position and a sale could reasonably affect the quoted price. |
| • | Level II—Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reporting date, and fair value is determined through the use of models or other valuation methodologies. Investments which are generally included in this category include corporate bonds and loans, less liquid and restricted equity securities and certain over-the-counter derivatives. |
| • | Level III—Pricing inputs are unobservable for the investment and includes situations where there is little, if any, market activity for the investment. The inputs into the determination of fair value require significant management judgment or estimation. Investments that are included in this category generally include general and limited partnership interests in corporate private equity and real estate funds, funds of hedge funds, distressed debt and non-investment grade residual interests in securitizations and collateralized debt obligations. |
In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the determination of which category within the fair value hierarchy is appropriate for any given investment is based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the investment.
Goodwill and Identifiable Intangible Assets
As a result of our June 2007 reorganization and March 2008 acquisition of GSO, we have obtained goodwill and identifiable intangible assets. Goodwill is the cost of acquired business interests in excess of the fair value of the net assets, including identifiable intangible assets, at the acquisition date. Our intangible assets consist of the contractual right to future fee income from management, advisory and incentive fee contracts and the contractual right to earn future carried interest from certain Blackstone Funds.
Goodwill. We test the goodwill in each of our reporting units for impairment at least annually in accordance with SFAS No. 142, Goodwill and Other Intangible Assets, by comparing the estimated fair value of each
87
reporting unit with its estimated net book value. We derive the fair value of each of our reporting units primarily utilizing a discounted cash flow methodology that incorporates reporting unit cash earnings projections adjusted for nonperformance, liquidity and other risks. We derive the net book value of our reporting units by estimating the amount of shareholders’ equity required to support the activities of each reporting unit.
Identifiable Intangible Assets. We amortize our identifiable intangible assets over their estimated lives in accordance with SFAS No. 142. Identifiable intangible assets are tested for impairment whenever events or changes in circumstances suggest that an asset’s or asset group’s carrying value may not be fully recoverable in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. An impairment loss, calculated as the difference between the estimated fair value and the carrying value of an asset or asset group, is recognized if the sum of the estimated undiscounted cash flows relating to the asset or asset group is less than the corresponding carrying value.
No impairments have been identified as of December 31, 2008. However, a prolonged period of weakness in the Blackstone Funds’ performance or in our ability to earn fee income from management, advisory and incentive fee contracts could adversely impact our businesses and impair the value of our goodwill and/or identifiable intangible assets.
Off-Balance Sheet Arrangements
In the normal course of business, we engage in off-balance sheet arrangements, including establishing certain special purpose entities (“SPEs”), owning securities or interests in SPEs and providing investment and collateral management services to SPEs. There are two main types of SPEs—qualifying special purposes entities (“QSPEs”), which are entities whose permitted activities are limited to passively holding financial interests in distributing cash flows generated by the assets, and VIEs. Certain combined entities of the Blackstone Funds transact regularly with VIEs which do not meet the QSPE criteria due to their permitted activities not being sufficiently limited or because the assets are not deemed qualifying financial instruments. Under FIN 46(R), we consolidate those VIEs where we absorb either a majority of the expected losses or residual returns (as defined) and are therefore considered the primary beneficiary. Our primary involvement with VIEs consists of investments in corporate private equity, real estate, funds of hedge funds and credit-oriented funds. For additional information about our involvement with VIEs, see Note 4, “Investments—Investment in Variable Interest Entities” in the Notes to the consolidated and combined financial statements.
In addition to VIEs, in the ordinary course of business certain combined entities of the Blackstone Funds issue various guarantees to counterparties in connection with investments, debt, leasing and other transactions. See Note 13, “Commitments and Contingencies” in Notes to the consolidated and combined financial statements for a discussion of guarantees.
88
Contractual Obligations, Commitments and Contingencies
The following table sets forth information relating to our contractual obligations as of December 31, 2008 on a consolidated basis and on a basis deconsolidating the Blackstone funds:
| Contractual Obligations |
2009 | 2010–2011 | 2012–2013 | Thereafter | Total | ||||||||||||||
| (Dollars in Thousands) | |||||||||||||||||||
| Operating Lease Obligations (1) |
$ | 43,697 | $ | 97,793 | $ | 89,975 | $ | 325,962 | $ | 557,427 | |||||||||
| Purchase Obligations |
13,937 | 4,854 | 7 | — | 18,798 | ||||||||||||||
| Blackstone Revolving Credit Facility (2) |
250,000 | — | — | — | 250,000 | ||||||||||||||
| Interest on Blackstone Revolving Credit Facility (3) |
424 | — | — | — | 424 | ||||||||||||||
| Blackstone Operating Entities Loan and Credit Facilities Payable (4) |
54,084 | 56,644 | 13,773 | 10,117 | 134,618 | ||||||||||||||
| Interest on Blackstone Operating Entities Loan and Credit Facilities Payable (5) |
1,761 | 2,372 | 1,295 | 260 | 5,688 | ||||||||||||||
| Blackstone Funds Debt Obligations Payable (6) |
1,057 | — | 1,325 | — | 2,382 | ||||||||||||||
| Interest on Blackstone Funds Debt Obligations Payable (7) |
46 | 92 | 35 | — | 173 | ||||||||||||||
| Blackstone Fund Capital Commitments to Investee Funds (8) |
33,779 | — | — | — | 33,779 | ||||||||||||||
| Due to Predecessor Owners in Connection with Tax Receivable Agreement (9) |
17,019 | — | — | 770,388 | 787,407 | ||||||||||||||
| Blackstone Operating Entities Capital Commitments to Blackstone Funds (10) |
1,387,875 | — | — | — | 1,387,875 | ||||||||||||||
| Consolidated Contractual Obligations |
1,803,679 | 161,755 | 106,410 | 1,106,727 | 3,178,571 | ||||||||||||||
| Blackstone Funds Debt Obligations Payable (6) |
(1,057 | ) | — | (1,325 | ) | — | (2,382 | ) | |||||||||||
| Interest on Blackstone Funds Debt Obligations Payable (7) |
(46 | ) | (92 | ) | (35 | ) | — | (173 | ) | ||||||||||
| Blackstone Fund Capital Commitments to Investee Funds (8) |
(33,779 | ) | — | — | — | (33,779 | ) | ||||||||||||
| Blackstone Operating Entities Contractual Obligations |
$ | 1,768,797 | $ | 161,663 | $ | 105,050 | $ | 1,106,727 | $ | 3,142,237 | |||||||||
| (1) | We lease our primary office space and certain office equipment under agreements that expire through 2024. In connection with certain lease agreements, we are responsible for escalation payments. The contractual obligation table above includes only guaranteed minimum lease payments for such leases and does not project potential escalation or other lease-related payments. These leases are classified as operating leases for financial statement purposes and as such are not recorded as liabilities on the Consolidated Statement of Financial Condition as of December 31, 2008. |
| (2) | Represents borrowings under our revolving credit facility. |
| (3) | Represents interest to be paid over the maturity of the revolving credit facility which has been calculated assuming no prepayments are made and debt is held until its final maturity date. The future interest payments are calculated using rates in effect as of December 31, 2008, at spreads to market rates pursuant to the revolver agreement, and is 1.97%. |
| (4) | Represents borrowings for employee term facilities program, a corporate debt investment program and a capital asset facility. |
| (5) | Represents interest to be paid over the maturity of the related debt obligation which has been calculated assuming no prepayments are made and debt is held until its final maturity date. The future interest payments are calculated using variable rates in effect as of December 31, 2008, at spreads to market rates pursuant to the financing agreements, and range from 1.50% to 5.45%. |
89
| (6) | These obligations are those of the Blackstone Funds. |
| (7) | Represents interest to be paid over the maturity of the related Blackstone Funds’ debt obligations which has been calculated assuming no prepayments will be made and debt will be held until its final maturity date. The future interest payments are calculated using variable rates in effect as of December 31, 2008, at spreads to market rates pursuant to the financing agreements, and range from 2.00% to 6.83%. The majority of the borrowings are due on demand and for purposes of this schedule are assumed to mature within one year. Interest on the majority of these borrowings rolls over into the principal balance at each reset date. |
| (8) | These obligations represent commitments of the consolidated Blackstone Funds to make capital contributions to investee funds and portfolio companies. These amounts are generally due on demand and are therefore presented in the less than one year category. |
| (9) | Represents obligations by the Partnership’s corporate subsidiaries’ to make payments under the Tax Receivable Agreement to the predecessor owners for the tax savings realized from the taxable purchases of their interests in connection with the Reorganization. The timing of the payments is dependent on the tax savings actually realized as determined annually. |
| (10) | These obligations represent commitments by us to provide general partner capital funding to the Blackstone Funds and limited partner capital funding to other funds. These amounts are generally due on demand and are therefore presented in the less than one year category; however, the capital commitments are expected to be called substantially over the next three years. We expect to continue to make these general partner capital commitments as we raise additional amounts for our investment funds over time. |
Guarantees
We had approximately $12.0 million of letters of credit outstanding to provide collateral support related to a credit facility at December 31, 2008.
Certain real estate funds guarantee payments to third parties in connection with the on-going business activities and/or acquisitions of their Portfolio Companies. At December 31, 2008, such guarantees amounted to $5.0 million.
Indemnifications
In many of its service contracts, Blackstone agrees to indemnify the third party service provider under certain circumstances. The terms of the indemnities vary from contract to contract and the amount of indemnification liability, if any, cannot be determined and has not been included in the table above or recorded in our consolidated and combined financial statements as of December 31, 2008.
Clawback Obligations
At December 31, 2008, none of the general partners of our corporate private equity, real estate or credit-oriented funds had an actual cash clawback obligation to any limited partners of the funds. For financial reporting purposes at period end, the general partner has reflected a clawback obligation to the limited partners of certain funds due to changes in unrealized value of a fund on which there have been previously distributed carried interest realizations; however, the settlement of a potential obligation is not due until the end of the life of the respective fund except in the case of our real estate funds, which have a provision for interim clawback. Since the inception of the funds, the general partners have not been required to make a cash clawback payment. (See Note 12. “Related Party Transactions” and Note 13. “Commitments and Contingencies” in the “Notes to the Consolidated and Combined Financial Statements” in “Part II. Item 8A. Financial Statements and Supplementary Data” of this filing.)
90
| ITEM 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Our predominant exposure to market risk is related to our role as general partner or investment advisor to the Blackstone Funds and the sensitivities to movements in the fair value of their investments, including the effect on management fees, performance fees and allocations and investment income.
Although the Blackstone Funds share many common themes, each of our alternative asset management operations runs its own investment and risk management processes, subject to our overall risk tolerance and philosophy:
| • | The investment process of our carry funds involves a detailed analysis of potential investments, and asset management teams are assigned to oversee the operations, strategic development, financing and capital deployment decisions of each portfolio investment. Key investment decisions are subject to approval by the applicable investment committee, which is comprised of Blackstone senior managing directors and senior management. |
| • | In our capacity as advisor to certain of our marketable alternative asset management funds, we continuously monitor a variety of markets for attractive trading opportunities, applying a number of traditional and customized risk management metrics to analyze risk related to specific assets or portfolios. In addition, we perform extensive credit and cash-flow analyses of borrowers, credit-based assets and underlying hedge fund managers, and have extensive asset management teams that monitor covenant compliance by, and relevant financial data of, borrowers and other obligors, asset pool performance statistics, tracking of cash payments relating to investments and ongoing analysis of the credit status of investments. |
Effect on Fund Management Fees
Our management fees are based on (1) third parties’ capital commitments to a Blackstone Fund, (2) third parties’ capital invested in a Blackstone Fund or (3) the net asset value, or NAV, of a Blackstone Fund, as described in our consolidated and combined financial statements. Management fees will only be directly affected by short-term changes in market conditions to the extent they are based on NAV or represent permanent impairments of value. These management fees will be increased (or reduced) in direct proportion to the effect of changes in the market value of our investments in the related funds. The proportion of our management fees that are based on NAV is dependent on the number and types of Blackstone Funds in existence and the current stage of each fund’s life cycle. As of December 31, 2008 and after considering the effect of the deconsolidation of certain funds of hedge funds on July 1, 2007, approximately 36% of our fund management fees were based on the NAV of the applicable funds. For the year ended December 31, 2007 and after considering the effect of the deconsolidation of certain funds of hedge funds on July 1, 2007, approximately 28% of our fund management fees were based on the NAV of the applicable funds.
Market Risk
The Blackstone Funds hold investments and securities sold not yet purchased, both of which are reported at fair value. Based on the fair value as of December 31, 2008, we estimate that a 10% decline in fair value of the investments and securities would have the following effects: (1) management fees would decrease by $33.4 million on an annual basis, (2) performance fees and allocations would decrease by $169.1 million, after allocations to non-controlling interest holders and (3) investment income would decrease by $118.2 million. Based on the fair value as of December 31, 2007, we estimated that a 10% decline in fair value of the investments and securities would have the following effects: (1) management fees would decrease by $29.3 million on an annual basis, (2) performance fees and allocations would decrease by $544.4 million, after allocations to non-controlling interest holders and (3) investment income would decrease by $213.1 million.
Total assets under management, excluding undrawn capital commitments and the amount of capital raised for our CLO’s, by segment, and the percentage amount classified as Level III investments as defined within
91
SFAS No. 157, are: Corporate Private Equity $17.15 billion (94% Level III), Real Estate $10.99 billion (100% Level III), and Marketable Alternative Asset Management $30.38 billion (87% Level III), respectively. The fair value of our investments and securities can vary significantly based on a number of factors that take into consideration the diversity of the Blackstone Funds’ investment portfolio and on a number of factors and inputs such as similar transactions, financial metrics, and industry comparatives, among others. (See “Part I, Item 1A. Risk Factors” above. Also see “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies—Investments, at Fair Value.”) We believe these estimated fair value amounts should be utilized with caution as our intent and strategy is to hold investments and securities until prevailing market conditions are beneficial for investment sales.
Investors in all of our carry funds (and certain of our credit-oriented funds) make capital commitments to those funds that we are entitled to call from those investors at any time during prescribed periods. We depend on investors fulfilling their commitments when we call capital from them in order for those funds to consummate investments and otherwise pay all their related obligations when due, including management fees. We have not had investors fail to honor capital calls to any meaningful extent and any investor that did not fund a capital call would be subject to having a significant amount of its existing investment forfeited in that fund. But if investors were to fail to satisfy a significant amount of capital calls for any particular fund or funds, those funds could be materially and adversely affected.
Exchange Rate Risk
The Blackstone Funds hold investments that are denominated in non-U.S. dollar currencies that may be affected by movements in the rate of exchange between the U.S. dollar and non-U.S. dollar currencies. Additionally, a portion of our management fees are denominated in non-US dollar currencies. We estimate that as of December 31, 2008, a 10% decline in the rate of exchange of all foreign currencies against the U.S. dollar would have the following effects: (1) management fees would decrease by $6.9 million on an annual basis, (2) performance fees and allocations would decrease by $37.3 million, after allocations to non-controlling interest holders and (3) investment income would decrease by $17.2 million.
As of December 31, 2007, we estimated that a 10% decline in the rate of exchange against the U.S. dollar would have the following effects: (1) management fees would decrease by $6.8 million on an annual basis, (2) performance fees and allocations would decrease by $179.8 million, after allocations to non-controlling interest holders and (3) investment income would decrease by $21.6 million.
Interest Rate Risk
Blackstone has debt obligations payable that accrue interest at variable rates. Interest rate changes may therefore affect the amount of interest payments, future earnings and cash flows. Based on our debt obligations payable as of December 31, 2008, we estimate that interest expense relating to variable rate debt obligations payable would increase by $3.9 million on an annual basis, in the event interest rates were to increase by one percentage point.
Based on our debt obligations payable as of December 31, 2007, we estimated that interest expense relating to variable rate debt obligations payable would increase by $1.3 million on an annual basis, in the event interest rates were to increase by one percentage point.
Credit Risk
Certain Blackstone Funds and the Investee Funds are subject to certain inherent risks through their investments.
Our entities generally invest substantially all of their excess cash in an open-end money market fund and a money market demand account, which are included in cash and cash equivalents. The money market fund invests
92
primarily in government and government agency securities and other short-term, highly liquid instruments with a low risk of loss. We continually monitor the fund’s performance in order to manage any risk associated with these investments.
Certain of our entities hold derivative instruments that contain an element of risk in the event that the counterparties may be unable to meet the terms of such agreements. We minimize our risk exposure by limiting the counterparties with which we enter into contracts to banks and investment banks who meet established credit and capital guidelines. We do not expect any counterparty to default on its obligations and therefore do not expect to incur any loss due to counterparty default.
Because our carry funds have preferred return thresholds to investors that need to be met prior to Blackstone receiving any carried interest, substantial declines in the carrying value of the investment portfolios of a carry fund can significantly delay or eliminate any carried interest distributions paid to us in respect of that fund since the value of the assets in the fund would need to recover to their aggregate cost basis plus the preferred return over time before we would be entitled to receive any carried interest from that fund. For this reason, due to declines in the carrying values of their underlying portfolio assets, our most recent corporate private equity fund and real estate fund are not expected to generate any carried interest in the near future.
93
| ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA |
INDEX TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
| 95 | ||
| Consolidated and Combined Statements of Financial Condition as of December 31, 2008 and 2007 |
96 | |
| 97 | ||
| 98 | ||
| 100 | ||
| 102 | ||
94
Report of Independent Registered Public Accounting Firm
To the General Partner and Unitholders of The Blackstone Group L.P.:
We have audited the accompanying consolidated and combined statements of financial condition of The Blackstone Group, L.P. and subsidiaries (“Blackstone”) as of December 31, 2008 and 2007, and the related consolidated and combined statements of operations, changes in partners’ capital, and cash flows for each of the three years in the period ended December 31, 2008. We also have audited Blackstone’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Blackstone’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on Blackstone’s internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated and combined financial statements referred to above present fairly, in all material respects, the financial position of The Blackstone Group L.P. and subsidiaries as of December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, Blackstone maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
| /s/ Deloitte & Touche LLP |
| New York, New York |
| February 27, 2009 |
95
Consolidated and Combined Statements of Financial Condition
(Dollars in Thousands, Except Unit Data)
| December 31, 2008 |
December 31, 2007 | ||||||
| Assets |
|||||||
| Cash and Cash Equivalents |
$ | 503,737 | $ | 868,629 | |||
| Cash Held by Blackstone Funds and Other |
907,324 | 163,696 | |||||
| Investments |
2,830,942 | 7,145,156 | |||||
| Accounts Receivable |
312,067 | 213,086 | |||||
| Due from Brokers |
48,506 | 812,250 | |||||
| Investment Subscriptions Paid in Advance |
1,916 | 36,698 | |||||
| Due from Affiliates |
861,434 | 855,854 | |||||
| Intangible Assets, Net |
1,077,526 | 604,681 | |||||
| Goodwill |
1,703,602 | 1,597,474 | |||||
| Other Assets |
165,434 | 99,366 | |||||
| Deferred Tax Assets |
845,423 | 777,310 | |||||
| Total Assets |
$ | 9,257,911 | $ | 13,174,200 | |||
| Liabilities and Partners’ Capital |
|||||||
| Loans Payable |
$ | 387,000 | $ | 130,389 | |||
| Amounts Due to Non-Controlling Interest Holders |
1,103,423 | 269,901 | |||||
| Securities Sold, Not Yet Purchased |
894 | 1,196,858 | |||||
| Due to Affiliates |
1,285,577 | 831,609 | |||||
| Accrued Compensation and Benefits |
413,459 | 188,997 | |||||
| Accounts Payable, Accrued Expenses and Other Liabilities |
173,436 | 250,445 | |||||
| Total Liabilities |
3,363,789 | 2,868,199 | |||||
| Commitments and Contingencies |
|||||||
| Non-Controlling Interests in Consolidated Entities |
2,384,965 | 6,079,156 | |||||
| Partners’ Capital |
|||||||
| Partners’ Capital (common units: 273,891,358 issued and 272,998,484 outstanding as of December 31, 2008; 260,471,862 issued and 259,826,700 outstanding as of December 31, 2007) |
3,509,448 | 4,226,500 | |||||
| Accumulated Other Comprehensive Income (Loss) |
(291 | ) | 345 | ||||
| Total Partners’ Capital |
3,509,157 | 4,226,845 | |||||
| Total Liabilities and Partners’ Capital |
$ | 9,257,911 | $ | 13,174,200 | |||
See notes to consolidated and combined financial statements.
96
Consolidated and Combined Statements of Operations
(Dollars in Thousands, Except Unit and Per Unit Data)
| Year Ended December 31, | |||||||||||
| 2008 | 2007 | 2006 | |||||||||
| Revenues |
|||||||||||
| Management and Advisory Fees |
$ | 1,476,357 | $ | 1,566,047 | $ | 1,077,139 | |||||
| Performance Fees and Allocations |
(1,247,320 | ) | 1,126,640 | 1,267,764 | |||||||
| Investment Income (Loss) and Other |
(578,398 | ) | 357,461 | 272,526 | |||||||
| Total Revenues |
(349,361 | ) | 3,050,148 | 2,617,429 | |||||||
| Expenses |
|||||||||||
| Compensation and Benefits |
3,859,787 | 2,256,647 | 250,067 | ||||||||
| Interest |
23,008 | 32,080 | 36,932 | ||||||||
| General, Administrative and Other |
440,776 | 324,200 | 122,395 | ||||||||
| Fund Expenses |
63,031 | 151,917 | 143,695 | ||||||||
| Total Expenses |
4,386,602 | 2,764,844 | 553,089 | ||||||||
| Other Income (Loss) |
|||||||||||
| Net Gains (Losses) from Fund Investment Activities |
(872,336 | ) | 5,423,132 | 6,090,145 | |||||||
| Income (Loss) Before Non-Controlling Interests in Income (Loss) of Consolidated Entities and Provision (Benefit) for Taxes |
(5,608,299 | ) | 5,708,436 | 8,154,485 | |||||||
| Non-Controlling Interests in Income (Loss) of Consolidated Entities |
(4,404,278 | ) | 4,059,221 | 5,856,345 | |||||||
| Income (Loss) Before Provision (Benefit) for Taxes |
(1,204,021 | ) | 1,649,215 | 2,298,140 | |||||||
| Provision (Benefit) for Taxes |
(40,989 | ) | 25,978 | 31,934 | |||||||
| Net Income (Loss) |
$ | (1,163,032 | ) | $ | 1,623,237 | $ | 2,266,206 | ||||
| June 19, 2007 through December 31, 2007 |
|||||||||||
| Net Loss |
$ | (335,514 | ) | ||||||||
| Net Loss Per Common Unit—Basic and Diluted |
|||||||||||
| Common Units Entitled to Priority Distributions |
$ | (4.36 | ) | $ | (1.29 | ) | |||||
| Common Units Not Entitled to Priority Distributions |
$ | (3.09 | ) | ||||||||
| Weighted-Average Common Units Outstanding—Basic and Diluted |
|||||||||||
| Common Units Entitled to Priority Distributions |
264,046,557 | 259,979,606 | |||||||||
| Common Units Not Entitled to Priority Distributions |
1,501,373 | N/A | |||||||||
| Revenues Earned from Affiliates |
|||||||||||
| Management and Advisory Fees |
$ | 188,276 | $ | 594,967 | $ | 405,345 | |||||
See notes to consolidated and combined financial statements.
97
Consolidated and Combined Statements of Changes in Partners’ Capital
(Dollars in Thousands Except Unit Data)
| Common Units |
Partners’ Capital |
Accumulated Other Comprehensive Income (Loss) |
Total Partners’ Capital |
Other Comprehensive Income (Loss) |
|||||||||||||||
| Balance at December 31, 2005 |
— | $ | 1,818,749 | $ | 6,196 | $ | 1,824,945 | $ | 1,336,441 | ||||||||||
| Net Income |
— | 2,266,206 | 2,266,206 | $ | 2,266,206 | ||||||||||||||
| Currency Translation Adjustment |
— | — | 4,098 | 4,098 | 4,098 | ||||||||||||||
| Net Unrealized Loss on Cash Flow Hedges |
— | — | (20 | ) | (20 | ) | (20 | ) | |||||||||||
| Capital Contributions |
— | 212,594 | — | 212,594 | — | ||||||||||||||
| Capital Distributions |
— | (1,584,944 | ) | — | (1,584,944 | ) | — | ||||||||||||
| Balance at December 31, 2006 |
— | 2,712,605 | 10,274 | 2,722,879 | $ | 2,270,284 | |||||||||||||
| Net Income |
— | 1,958,751 | — | 1,958,751 | 1,958,751 | ||||||||||||||
| Currency Translation Adjustment |
— | — | (191 | ) | (191 | ) | (191 | ) | |||||||||||
| Net Unrealized Loss on Cash Flow Hedges |
— | — | (6,930 | ) | (6,930 | ) | (6,930 | ) | |||||||||||
| Capital Contributions |
— | 233,659 | — | 233,659 | — | ||||||||||||||
| Capital Distributions |
— | (2,492,352 | ) | — | (2,492,352 | ) | — | ||||||||||||
| Elimination of Non-Contributed Entities |
— | (161,103 | ) | (2,803 | ) | (163,906 | ) | — | |||||||||||
| Transfer of Non-Controlling |
|||||||||||||||||||
| Interests in Consolidated Entities |
— | (2,216,284 | ) | — | (2,216,284 | ) | — | ||||||||||||
| Balance at June 18, 2007 |
— | 35,276 | 350 | 35,626 | 1,951,630 | ||||||||||||||
| Balance at June 19, 2007 |
— | 35,276 | 350 | 35,626 | 1,951,630 | ||||||||||||||
| Issuance of Units in Initial Public Offering, net of issuance costs |
153,333,334 | 4,501,240 | — | 4,501,240 | — | ||||||||||||||
| Issuance of Units to Beijing Wonderful Investments |
101,334,234 | 3,000,000 | — | 3,000,000 | — | ||||||||||||||
| Purchase of Interests from Predecessor Owners |
— | (4,570,756 | ) | — | (4,570,756 | ) | — | ||||||||||||
| Deferred Tax Effects Resulting from Acquisition of Ownership Interests |
— | 111,876 | — | 111,876 | — | ||||||||||||||
| Transfer of Non-Controlling Interests in Consolidated Entities |
— | 1,174,367 | — | 1,174,367 | — | ||||||||||||||
| Net Loss |
— | (335,514 | ) | — | (335,514 | ) | (335,514 | ) | |||||||||||
| Distribution to Unitholders |
— | (78,794 | ) | — | (78,794 | ) | — | ||||||||||||
| Currency Translation Adjustment |
— | — | (5 | ) | (5 | ) | (5 | ) | |||||||||||
| Equity-based Compensation |
— | 404,850 | — | 404,850 | — | ||||||||||||||
| Vested Deferred Restricted Common Units |
5,804,294 | — | — | — | — | ||||||||||||||
| Repurchase of Common Units |
(645,162 | ) | (16,045 | ) | — | (16,045 | ) | — | |||||||||||
| Balance at December 31, 2007 |
259,826,700 | 4,226,500 | 345 | 4,226,845 | $ | 1,616,111 | |||||||||||||
continued...
See notes to consolidated and combined financial statements.
98
Consolidated and Combined Statements of Changes in Partners’ Capital
(Dollars in Thousands Except Unit Data)
| Common Units |
Partners’ Capital |
Accumulated Other Comprehensive Income (Loss) |
Total Partners’ Capital |
Other Comprehensive Income (Loss) |
|||||||||||||||
| Balance at December 31, 2007 |
259,826,700 | $ | 4,226,500 | $ | 345 | $ | 4,226,845 | $ | 1,616,111 | ||||||||||
| Net Loss |
— | (1,163,032 | ) | — | (1,163,032 | ) | $ | (1,163,032 | ) | ||||||||||
| Currency Translation Adjustment |
— | — | (636 | ) | (636 | ) | (636 | ) | |||||||||||
| Purchase of Interests from Predecessor Owners |
— | (74,278 | ) | — | (74,278 | ) | — | ||||||||||||
| Repurchase of Common Units |
(902,874 | ) | (5,338 | ) | — | (5,338 | ) | — | |||||||||||
| Deferred Tax Effects Resulting from Acquisition of Ownership Interests |
— | 5,164 | — | 5,164 | — | ||||||||||||||
| Distribution to Unitholders |
— | (319,897 | ) | — | (319,897 | ) | — | ||||||||||||
| Equity-based Compensation |
— | 818,076 | — | 818,076 | — | ||||||||||||||
| Net Delivery of Vested Common Units |
4,601,493 | (26,525 | ) | — | (26,525 | ) | — | ||||||||||||
| Conversion of Blackstone Holdings Partnership Units to Blackstone Common Units |
9,473,165 | 34,471 | — | 34,471 | — | ||||||||||||||
| Issuance of Blackstone Holdings Partnership Units for GSO Acquisition |
— | 14,307 | — | 14,307 | — | ||||||||||||||
| Balance at December 31, 2008 |
272,998,484 | $ | 3,509,448 | $ | (291 | ) | $ | 3,509,157 | $ | (1,163,668 | ) | ||||||||
See notes to consolidated and combined financial statements.
99
Consolidated and Combined Statements of Cash Flows
(Dollars in Thousands)
| Year Ended December 31, | ||||||||||||
| 2008 | 2007 | 2006 | ||||||||||
| Operating Activities |
||||||||||||
| Net Income (Loss) |
$ | (1,163,032 | ) | $ | 1,623,237 | $ | 2,266,206 | |||||
| Adjustments to Reconcile Net Income (Loss) to Net Cash Provided by (Used in) Operating Activities: |
||||||||||||
| Blackstone Funds Related: |
||||||||||||
| Non-Controlling Interests in Income (Loss) of Consolidated Entities |
(3,723,723 | ) | 1,521,303 | 3,950,664 | ||||||||
| Net Realized (Gains) Losses on Investments |
164,726 | (3,800,137 | ) | (5,054,995 | ) | |||||||
| Changes in Unrealized (Gains) Losses on Investments Allocable to Blackstone Group |
624,061 | (13,630 | ) | (585,555 | ) | |||||||
| Non-Cash Performance Fees and Allocations |
1,086,058 | (187,070 | ) | — | ||||||||
| Equity-Based Compensation Expense |
3,302,617 | 1,765,188 | — | |||||||||
| Intangible Amortization |
153,237 | 117,607 | — | |||||||||
| Other Non-Cash Amounts Included in Net Income |
19,688 | 11,221 | (41,929 | ) | ||||||||
| Cash Flows Due to Changes in Operating Assets and Liabilities: |
||||||||||||
| Cash Held by Blackstone Funds and Other |
(743,628 | ) | 643,410 | (447,068 | ) | |||||||
| Cash Relinquished with Deconsolidation of Partnership |
(1,092 | ) | (884,480 | ) | — | |||||||
| Due from Brokers |
763,744 | (414,053 | ) | (398,196 | ) | |||||||
| Accounts Receivable |
45,281 | 337,824 | (431,044 | ) | ||||||||
| Due from Affiliates |
(185,314 | ) | (969,055 | ) | (76,700 | ) | ||||||
| Other Assets |
(32,441 | ) | (53,602 | ) | (21,252 | ) | ||||||
| Accrued Compensation and Benefits |
157,528 | 95,059 | 20,257 | |||||||||
| Accounts Payable, Accrued Expenses and Other Liabilities |
819,572 | 242,969 | 38,470 | |||||||||
| Due to Affiliates |
182,090 | 805,687 | 47,665 | |||||||||
| Amounts Due to Non-Controlling Interest Holders |
(48,630 | ) | 7,659 | 113,188 | ||||||||
| Blackstone Funds Related: |
||||||||||||
| Investments Purchased |
(30,242,498 | ) | (33,655,862 | ) | (14,638,659 | ) | ||||||
| Cash Proceeds from Sale of Investments |
30,712,191 | 31,956,429 | 10,862,334 | |||||||||
| Net Cash Provided by (Used in) Operating Activities |
1,890,435 | (850,296 | ) | (4,396,614 | ) | |||||||
| Investing Activities |
||||||||||||
| Purchase of Furniture, Equipment and Leasehold Improvements |
(50,113 | ) | (32,307 | ) | (24,190 | ) | ||||||
| Elimination of Cash for Non-Contributed Entities |
— | (23,292 | ) | — | ||||||||
| Cash Paid for Acquisition, Net of Cash Acquired |
(336,571 | ) | — | — | ||||||||
| Changes in Restricted Cash |
5,004 | — | — | |||||||||
| Net Cash Used in Investing Activities |
(381,680 | ) | (55,599 | ) | (24,190 | ) | ||||||
| Financing Activities |
||||||||||||
| Issuance of Common Units in Initial Public Offering and to Beijing Wonderful Investments |
— | 7,501,240 | — | |||||||||
| Distributions to Non-Controlling Interest Holders in Consolidated Entities |
(2,124,621 | ) | (5,731,806 | ) | (6,653,590 | ) | ||||||
| Contributions from Non-Controlling Interest Holders in Consolidated Entities |
520,494 | 7,132,074 | 12,321,339 | |||||||||
| Contributions from Predecessor Owners |
— | 583,773 | 212,594 | |||||||||
| Distributions to Predecessor Owners |
— | (2,932,918 | ) | (1,551,957 | ) | |||||||
| Purchase of Interests from Predecessor Owners |
(109,834 | ) | (4,570,756 | ) | — | |||||||
continued...
See notes to consolidated and combined financial statements.
100
THE BLACKSTONE GROUP L.P.
Consolidated and Combined Statements of Cash Flows
(Dollars in Thousands)
| Year Ended December 31, | ||||||||||||
| 2008 | 2007 | 2006 | ||||||||||
| Net Settlement of Vested Common Units and Repurchase of Common Units |
$ | (31,863 | ) | $ | (16,045 | ) | $ | — | ||||
| Proceeds from Loans Payable |
1,172,236 | 5,254,787 | 7,634,786 | |||||||||
| Repayment of Loans Payable |
(980,162 | ) | (5,497,113 | ) | (7,499,857 | ) | ||||||
| Distributions to Common Unitholders |
(319,897 | ) | (78,794 | ) | — | |||||||
| Net Cash Provided by (Used in) Financing Activities |
(1,873,647 | ) | 1,644,442 | 4,463,315 | ||||||||
| Effect of Exchange Rate Changes on Cash and Cash Equivalents |
— | 639 | 518 | |||||||||
| Net Increase (Decrease) in Cash and Cash Equivalents |
(364,892 | ) | 739,186 | 43,029 | ||||||||
| Cash and Cash Equivalents, Beginning of Period |
868,629 | 129,443</ | ||||||||||