Fri Feb 17, 2012 11:02am EST
* Schwarzman’s 2011 dividends at least $120.6 mln
* Fee income contributed 82 percent of payout
* Investors concerned over alignment of interests
By Greg Roumeliotis and Bernard Vaughan
NEW YORK, Feb 17 (Reuters) – Stephen Schwarzman, the
boss of the world’s largest private equity firm, made his
fortune by being a financier who delivered outsized returns for
investors from buying, restructuring and then selling companies.
These days, he is getting huge rewards for being the biggest
shareholder in what is more like a souped-up asset manager.
The Blackstone Group LP head is set to receive at
least $120.6 million in 2011 dividends from his 21 percent
ownership of the firm, based on regulatory filings. That is many
times what he gets for being CEO – he received a $350,000 salary
and total compensation of $6.7 million in 2010 though it hasn’t
yet been disclosed for last year.
Fees for managing assets and advisory services accounted for
82 percent of Blackstone’s dividend payouts in 2011, up from 63
percent in 2010, the statements show. That means Schwarzman’s
payout includes a lot more from fees charged to investors for
managing their money than from Blackstone’s slice of the profits
from its buyout business, also known as carried interest.
Blackstone, co-founded by Schwarzman in 1985, has
historically made over two-thirds of its private equity revenues
from carried interest. But fees have now made up the majority of
Blackstone’s cash distributions every year since the company
went public in 2007.
The shift will increase concerns at pension funds,
university endowments and other investors, who provide the funds
for private equity firms, that public listings of firms such as
Blackstone means stockholders are being favored over them.
While these investors, or limited partners, focus on returns
on their investments, shareholders want dividends which can come
from carried interest and management fees.
FEES ALREADY SLIDING
The investors have already been able to push down the
average fee charged on asset management to 1.5 percent from the
more traditional 2 percent in the past few years but stories
like Blackstone’s will only increase the momentum for further
reductions, according to some private equity executives and
investors’ representatives.
Other publicly traded private equity firms, such as KKR & Co
LP and Apollo Global Management LLC, are also
generating more of their revenue from fees but as yet it hasn’t
reached the proportion at Blackstone.
“As the industry has matured some unintended consequences -
like nine-digit management fees – have become apparent and
problematic,” said Stephen Moseley, president of private equity
and advisory firm Rockland Management LLC. “Multiple sources of
income can produce divided loyalties and divided loyalties make
limited partners nervous.”
Blackstone’s fee-earning assets under management increased
25 percent in 2011 to a record $137 billion. On an after-tax
basis, $502 million out of $610 million in dividend payouts last
year came from fee-related income.
The large fee component of Schwarzman’s pay will “add fuel
to the fire in the argument between limited and general partners
on the structure of funds,” said Michael Moy, a managing
director at Pension Consulting Alliance Inc, which advises some
of the largest U.S. pension funds on private equity, including
California Public Employees’ Retirement System.
Blackstone spokesman Peter Rose said given the firm is the
largest and most diversified alternative asset manager, private
equity accounts for only about 25 percent of its business.
“Blackstone has a significant percentage of its businesses
which generate fee income only, similar to all long-only money
managers and financial advisory firms,” Rose said. “We manage
the business as we did before we went public, to maximize net
returns to our limited partners, and, as such, we rank as one of
the top performing managers in the world.”
KKR and Apollo declined to comment.
MAXIMIZE ASSETS OR RETURNS?
The managers of private equity funds, known as general
partners, had traditionally followed the 2/20 model, seeking a
management fee of 2 percent on committed capital and taking 20
percent of a fund’s profits. They argue that compared with
traditional asset managers, their work justifies higher
incentive fees because returns are also outsized.
Moreover, the argument goes, sharing in profits from fund
investments aligns their interest with limited partners, who
commit their money for as long as 10 years in often illiquid
assets that cannot easily be sold.
But internal rates of return from buyouts have dropped to
11.2 percent on a five-year basis in June 2011 from 29.6 percent
in September 2008, according to market research firm Preqin.
Although the impact of the financial crisis, including much
tighter financing conditions, is at least partly to blame,
critics also say it may be a sign the private equity firms are
losing some of their focus after growing much larger.
Cerberus Capital Management co-founder Stephen Feinberg, in
a rare admission for an industry insider, argued last summer
that many private equity executives were overpaid, focused too
much on fees and were hampered by the size of their assets.
“I do think there’s an issue here in funds that are too
large and funds that have acquired too many assets under
management,” Feinberg said at a conference. “If your goal is to
maximize your returns as opposed to assets under management, I
think you can be most effective with a big company
infrastructure and a little bit smaller fund size.”.
The interests of the investors and the general partners of
the firms are best aligned when the latter is making most of
their money from carried interest, said Kathy Jeramaz-Larson, an
executive director at Institutional Limited Partners
Association, which has more than 250 member organizations
representing over $1 trillion of private assets globally.
AN OUTLIER
Besides the dividend payout and his CEO compensation,
Schwarzman – whose wealth was pegged at $4.7 billion by Forbes
last year – will also receive profits from co-investments
through the firm, which are not disclosed.
The size of the dividend payout and its main source, though,
is an outlier even among the handful of publicly traded private
equity firms. At KKR, co-founders Henry Kravis and George
Roberts, who together own 25 percent of the firm, are set to
receive $64.2 million each in dividends in 2011, of which 46
percent will come from fee-related income.
At Apollo, co-founder Leon Black, who owns 24 percent of the
firm, is set to receive $103.9 million in dividends for 2011, of
which only 25 percent will come from fees.
Blackstone has diversified at a faster pace than rivals. It
had assets under management of $166 billion at the end of 2011,
up from $44.4 billion (when it was largely a buyout shop) in
1987, and it has diversified through a credit arm, real estate
business and hedge funds.
For example, BAAM, its hedge funds group manages $40 billion
and is mostly a fees business, with just half the assets
eligible for carried interest payments and the carry rate at 10
percent rather than 20 percent. GSO, Blackstone’s credit arm,
has a collateralized loan obligation business relying on fees.
Blackstone also runs advisory businesses that rely just on
fees, such as an investment banking arm and a placement agent,
which helps other private equity firms fundraise.
Other private equity firms are headed down the same path,
though some way away from Blackstone’s fee reliance. At Apollo,
which has $75 billion in assets under management, the credit
investment business is set to overtake its buyout arm in size.
And KKR, which has $59 billion in assets under management, is
moving furher into real estate, hedge funds and capital
markets .
BETTER RETURNS
It is not that Blackstone’s performance is bad, it is the
source of the returns that is the question. Blackstone said
earlier this month its private equity portfolio was up 5 percent
in 2011, its real estate portfolio was up 17 percent and
credit-oriented hedge funds were up 9 percent, all outperforming
benchmarks. The S&P 500 U.S. stocks index was flat in 2011.
These returns have come during what has been a particularly
difficult period for global financial markets, which buffeted
firms and investors. In the private equity business, exits from
investments – which are needed to turn paper profits to hard
cash – have fallen dramatically since the financial crisis, as
IPO markets have remained choppy at best and frozen at worst.
Blackstone sees its business as cyclical and argues that
carried interest will return as the global economy improves and
it starts to sell its private equity assets. “You’ll see more
(M&A) volume coming in a more traditional fashion in the private
equity area,” Schwarzman told analysts on a recent call.
NEGOTIATING LEVERAGE
Blackstone and other publicly traded private equity firms
argue that ultimately the interests of public shareholders and
limited partners are the same. They say that if the firm does
not make money for limited partners, they will stop giving it
money to manage, which will also hurt public shareholders.
“I don’t think there is a problem with the alignment of
interest,” said Steven Kaplan, a finance professor at the
University of Chicago. “The founders of these firms are not
selling their shares tomorrow and if their funds do not perform
in the long term, the value of their holdings will suffer.”
It also isn’t easy for investors to negotiate the fees down.
“A lot of pension funds believe fees charged by the major
private equity firms are too high but it’s difficult
to negotiate them down on an individual basis,” said George
Hopkins, an executive director of the Arkansas Teachers
Retirement System, an investor in Blackstone. “The ability of
these funds to charge large fees all depends on whether they
continue to perform,” Hopkins added.