Blackstone Inc. (BX) Earnings Call Transcript & Summary

All right. Good morning, everyone. Thanks for joining us. For those of you that don't know me, my name is Patrick Davitt. I'm the asset manager analyst here at Autonomous. As a reminder, we're using Pigeonhole for Q&A. So if you do have any questions, put them in there, and I'll try to get to them as we go through the conversation from this pad here. So it's my pleasure to welcome Blackstone's President and Chief Operating Officer, Jon Gray, this morning, fitting to come after one of his best deals, Hilton's CEO.

This is world class, by the way.

So thanks for joining us today. We really appreciate it.

Perhaps to start, we'll start with macro given your position as one of the largest owners of assets in the world. I think it is informative to start with macro then. So there's a view that the Fed hasn't been able to tackle inflation like this without causing recession, but your portfolio continues to perform well. So through that lens, can you frame what you're seeing on the ground across your portfolio and how you expect the macro to play out from here?

Sure. Thanks for having me, Patrick. I guess I'll start with maybe a little bit of optimism. You referenced inflation. What we're seeing is inflation increasingly moving to the rearview mirror, particularly here in the U.S. So shipping costs are back down basically to pre-COVID levels, input costs at our companies were up just 2% in the first quarter. Labor, which has been the stickiest, has come down from Q3 around 7% now to around sort of 5.5%, so trending in the right direction. And if you look at the overall CPI data, what you'd see in the April numbers, which were 4.9%, if you stripped out shelter costs, which are a lagging indicator, it's 3.4%. So I think that's pretty good. Europe has been coming down but more slowly. But the overall trend seems to be a declining pace and sort of the increase of inflation. So I think that's very positive. For all of us as investors, it has a huge impact on multiples and confidence in so many things. I'd say the other positive element out there is the economic resilience we've seen. We announced in our first quarter that our portfolio companies in private equity had 13% revenue growth. Now yes, that reflects our strength in our India portfolio, our energy transition. We have a big overweight also to travel and leisure. But in general, we've seen pretty good numbers at our companies. Yes, for sale housing, slower; consumer goods, slower. But in general, better numbers than you would expect given the headlines you read out there. I think the real challenge is when you look forward to the cost of capital and the availability of capital. So the Fed has said pretty stridently we're going to keep rates at an elevated level, now 5.25%. We're going to keep at it until we get inflation down. And we take them at their word. And I think barring some sort of really big shock, they're going to do that. They remembered what happened -- remember what happened in the 1970s, where rates were cut prematurely, inflation became stickier. I think they're going to keep the cost of capital elevated. The other thing is the regional banking issues here in the U.S. are definitely making financial institutions more cautious, less likely to lend. And so cost of capital is higher, availability of capital is lower, it's tightening the circulatory system of the economy. And I think that will lead to a sequential slowdown in the economy. Now using a skiing analogy, it feels a bit more like a green run as opposed to a double black diamond some people were expecting in terms of the slowdown. And that's what we're expecting, a sequential slowdown in business activity. But this is not '08, '09. We don't have the massive overleverage we had in financial institutions that we had in the housing market or commercial real estate. So sort of a Fed-induced slowdown to eliminate inflation, that's the lens through which we're investing capital, but positive certainly on inflation coming down. So I would say a mixed picture, and we recognize the headwinds as we look forward.

Great. So on that point, it does feel like CRE is a place that people do feel like there could be a more deep recession. So obviously, a big investor focus recently and in the press. As you pointed out, not all CRE is created equal. So could you walk us through your exposures and the dynamics across the portfolio and how you think the recent bank stress plays out for the real estate sector?

Yes. So I think in real estate, there are a couple of things happening. One is as the Fed raised rates and the long bond moved up, cap rates, which the main tool, the inverse of EBITDA multiples, valuing real estate went higher. And markets have recognized that some owners of real estate have been more slow in recognizing that in their valuations. We take, I would say, a more proactive approach on these things. And that I would describe a little bit like the stock market trading at 22, 23x now at 19x, there's been an adjustment. And that has clearly happened and impacted real estate. But then once you take that into account, when you look at the operating fundamentals in real estate, it's much different than often what you're reading in the press which makes it sound like commercial real estate, all of it is in one bucket and it's very different. So if you look at traditional office buildings in the U.S., particularly older office buildings, there is unprecedented weakness. Vacancy is 20-plus percent, rents are declining, companies now are obviously thinking about their space needs in light of remote work and the economic climate that's ahead, lenders are reluctant to have exposure to office buildings, buyers are reluctant, valuations are going down. Fortunately for us, U.S. traditional office buildings which used to be more than 60% of what we owned in '07 are less than 2% of our equity portfolio in real estate today. And we've made a conscious choice really over a long period of time to deemphasize that asset class. I think when you look at the rest of real estate and you widen the aperture, the picture looks very different. So if you look at our biggest asset class, logistics, global logistics, which is 40% of what we own at Blackstone; around the world, vacancy, including in the U.S., is generally 3% or lower; rents are growing 10% to 20%; there's mark-to-market to rents in place versus the market rents anywhere from 25% to 75%, depending around the markets around the world, so huge embedded growth, and we see incredibly strong fundamentals. And if you look more broadly and you look at apartment vacancies in the U.S. around 5%; retail vacancy, 4%; data centers, 2% to 3%, you see really strong underlying fundamentals. And the reason that exists is we just didn't see the kind of building. Given what happened in the GFC and then in COVID, you didn't see the kind of overbuilding you typically see in a cycle. So what I would say is office buildings, major challenges and in the U.S. in particular; better outside the U.S., better newer buildings. But in general, there will be significant losses. Most of that will fall on the equity. By the way, the other thing that's better about this cycle for commercial real estate is leverage levels were a lot lower. If you went back to '06, '07, people were lending 75%, 80%. Here, banks were lending 55%, 60%. And as a result, most of the pain you're going to see will happen in equity investors, which is less systematically relevant, obviously, than when it happens in the credit system. So I think what you're going to see is a lot of pain in the office sector and much better-than-expected results in the rest of real estate. And just using data point, our BREIT vehicle for individual investors, which gets a ton of press, had 9% same-store cash flow growth in the first quarter. That is not consistent with what you're reading in the paper. Now it's rental housing, it's logistics, it's very concentrated in the Sun Belt in the United States, but there's definitely more strength in real estate than what you read. That said, office buildings do face real challenges. As it relates to the banking system, I think office buildings are about 3% of the U.S. banking system. Come up with whatever scenario of losses, if these are 55% loans on average, if there's a point of bank AUM essentially, that's losses and it's phased in over 5 years, it will result in losses in banks and insurance companies, but the size relative to what happened in the housing market 15 years ago is dramatically different. So I think it's very bifurcated. And for us, the idea of having large amounts of capital when sentiment is universally negative and what's happening on the ground is more nuanced, that creates real opportunity.

So you mentioned multifamily as a relative strength of the portfolio. But there's been a lot of reporting about a lot of supply coming online there even in the Sun Belt. So how does that factor into your view of supply and demand dynamics? It seems to not 100% fit with what you guys have been saying.

Yes. Well, I do think, to your point, in the apartment space, you do have a bit of a supply bulge that's working its way through the system. So that was one area where there was more building. But you need -- and so that will happen in this year through the end of the year and early next year. But once you get beyond that new housing starts, multi and single-family combined have fallen 25% in the last year or so, so the picture gets a lot better once you get through that. And then you also have to keep in mind that since the financial crisis, we've been building homes in the U.S. at about half the rate as a percentage of population as we did pre the financial crisis. And so we have this structural shortage. I think that's part of the reason most people are surprised. Home prices have held up more than expected. So I do think it's fair to say we'll continue to see this deceleration in apartment fundamentals. And we've seen them go from high teens to 3% to 4% today, and it could go slower than that. But I think once you get through this period of supply, the picture gets better. And then within multifamily, there is variance. For instance, we're the largest owner of student housing, a sector that really lagged through COVID because students didn't go to campus and now is showing real strength. We own a lot of rental housing outside the U.S., places like the U.K. and Japan, where we're seeing a lot of strength. So I still think it's a good long-term sector. And if you think about real estate through the lens of supply and demand, the fact that new building is going to go down pretty dramatically, that's a very positive sign for the longer term and the fact that we don't start with big imbalances today. But to your point, could you see some sequential softening? Sure.

Good. So I think you touched on this for real estate and I think most of your comps are in agreement that rates are going to be higher for longer. So through that lens, as we kind of expand to the broader portfolio, how should we think about much higher discount rates, lower multiples for longer through the lens of your broader portfolios?

So I would say, looking into our existing assets, what's happened over the last 15 months is we've seen very good cash flow growth. And because of that, you've also been able to pay down some debt. In many cases, your valuations of equity have held or declined a bit, which shows that we've taken the multiples down pretty meaningfully in our portfolios, reflecting what's happening out there. And I think that's a natural result. The same things obviously happened in the stock market. Particularly as you move away from the big 7 tech companies, there's been a re-rating to lower multiples. And that's sort of a -- that's a fact of life. I think the biggest hit on value has certainly been in companies that don't produce profits, fast-growing companies that tends to be a pretty small portion of what we do even in our growth area. And as a result, we're, I think, less exposed to that. We weren't crypto investors. I think where we positioned our portfolio in credit mostly in floating rate debt. We talked about real estate and private equity in some of these very successful sectors, particularly travel, energy transition, life sciences. So nobody is immune to what's happened. Multiples clearly reflect a tougher environment, and you reflect that in your valuations. I think the positive, of course, is as we look forward, the entry points are more attractive. If you look at the deals we've set up recently, there are definitely better prices relative to earnings or EBITDA than they would have been in the past. And particularly when debt is hard to come by, you tend to get lower prices. And the nice thing I often say with our people is your price is only once. If I buy something at a price, the financing today which costs a lot and is a low loan to value, you can change that out over time. And I remember, by the way, back when we had sold Extended Stay America in 2007, which had been owned by our private equity and real estate group, we sold it for almost $8 billion. The buyer financed $7.5 billion. It got into bankruptcy during '08, '09, we bought it back for $4 billion, so down 50%. We struggled to finance $2 billion. And on the numbers, it didn't look good because you were borrowing 50% and 10% back then. But of course, once you got to a more normalized environment, you were able to lower your financing costs and you had that very low entry price. And so I think the positive for us in our $200 billion of dry powder is it's going to be in better investment period. Deal volume is slower, but it's definitely a better time to deploy.

Got it. Makes sense. Let me move on to everyone's favorite topic now, private credit. It's obviously been a huge success story for you and the other managers. So as more financing goes to the private markets, how are you responding to some of the press talking heads that this growth is kind of introducing more systemic risk to the financial system?

So I guess I'd say a few things. I think the main issue to focus on is what creates systemic problems where the government has to step in to protect the financial system in the broader economy. And as I look at these things, there tend to be 3 preconditions and everything that basically failed in the post-war period. One is very high levels of leverage. So if you looked at Credit Suisse or First Republic or SVB, these institutions were anywhere from 12 to 20x leveraged. If you look at our nontraded BDC BCRED, it's 1x leverage. If you look at what we do for our insurance clients, we manage money on an unleveraged basis for them. And so that's a very different dynamic. The second precondition tends to be one very large cross-collateralized balance sheet. So if you think about large financial institutions who, by the way, are mission critical to our economy, but if something happens in their derivative book in one part of the world, it impacts the entire financial institution. If you think about the way an alternative manager sets up, we as a firm have 800 different vehicles so it's not designed to have a domino effect if something happens. The third precondition tends to be a mismatch of assets and liabilities. I mean the unfortunate irony of SVB and First Republic is they didn't have any credit losses. They owned U.S. treasuries and super-prime mortgages, right? But they had a mismatch. We don't have products with hourly deposits available. We're very conscious of how we set these things up. And ironically, BREIT, the criticism of BREIT is that we created a system that was designed to weather a storm to be semiliquid, so you weren't a foreseller of assets in an untimely way, so you could protect investor capital. And that's to me really the key. And when you sit down with regulators and you walk them through this, they get it and they understand. Today, there continue to be articles about private sector, shadow banking, these sort of things. But what is the main risk today? The main risk today is the Fed has got the cost of capital at 5.25% and banks are paying deposits at 1%. And it's likely there will continue to be some pressure as that moves out, and that creates issues in the financial system. So I feel pretty good that what we do, particularly at Blackstone where we have essentially almost no net debt at the parent company, no insurance liabilities, and then we run in this very disciplined way, I feel good about how we sit down with regulators and how they can understand how we operate this. And I think it's a really great way to diversify risk in the financial system.

That's helpful. On that point, on the bank failure point, a consistent message coming out of the first quarter earnings call was that the big incremental opportunity is probably going to be in asset-backed finance. So as banks look to push these assets to better homes like insurance balance sheets, how is Blackstone approaching the opportunity? There's been some reporting that you're looking to partner with some banks. And how should we think about the economics of that flowing through the business?

So today, in private credit and if you add in real estate credit, which is reported in our real estate segment, we have about $350 billion. And as we've talked about, we do it in a different -- we're an investment manager, we don't do this off of our balance sheet. I think we can continue to be a very helpful partner to financial institutions. Because as they're under pressure to think about the matching of their assets and liabilities, not just regional banks but larger banks, that we can be very helpful from a capital efficiency standpoint for them. So it could be home improvement flow agreement or equipment finance with a regional bank. It could be credit card portfolio with a larger bank where they just say, I'll take some fees for the origination and for managing these assets. I'll maintain, meaning the bank will maintain the privacy of the relationship with the borrowers, a new Blackstone who has, particularly with the insurance capital, long-duration, low-cost capital, that's a natural partnership. And I think this is going to continue to grow in a pretty meaningful way. And if you think about the insurance industry, they are really a hold-to-maturity business. And so they are the natural partner for some of these things because they can put a private loan on their books and hold it for 9 years because that's what they're designed to do. And the key -- and I'm not sure market participants understand this, we're really for our insurance clients focused on investment-grade credit in that case. With some of the individual investor products, it's more direct lending. And there, again, if you think about what banks do in the leveraged finance world, they play a vital role. But oftentimes, they're in that business to distribute. So they commit the capital and then they have to figure out how to place it. And in a very volatile environment, that's hard. If you think about our BDCs, they're really in the storage business as opposed to the moving business, they want to own those loans for a period of time. So I think it's asset-backed, for sure. It's real estate, particularly as the banks pull back. And it's corporate credit. And I think if you were going to say like what's the mega -- what's a major opportunity? If you think about what's happened in the public equity bucket over the last 30 years, private equity has taken a meaningful chunk of that because of the strong performance. I think the potential exists, particularly for pension funds and insurance companies who are long duration pools of capital to trade some liquidity for a higher rate of return. And so I think when you think about these alternative managers, this is a big growth area. And in some cases, what we're seeing from clients is they're saying, "Wait, I don't have to take equity risk and I can hit my 7% target." And so I do think we'll see more capital moving this way, and I definitely think we'll see more partnerships between banks and private credit.

I've heard some rumblings that regulators have stepped in the way of some of these opportunities, at least out of the receivership issue in terms of old SPAC deals. Do you think that could be a problem for this broader opportunity you're talking about?

I think these are private transactions. I think where you've heard some of this was I think regulators were more focused on some of the failed institutions bringing in depository institutions. I think this is a different story because I think this is helpful to the depository institutions which is they've got a terrific range of relationships, they'd love to find some partners to hold this who've got the right duration funding. So I think this is in line with what the regulators want is my impression.

Makes sense. Yes, okay. Let's move to the investment environment. You obviously have a lot of dry powder, your competitors have a lot of dry powder, but deal volumes remain pretty subdued. How close do you think we are to those bid-asks getting to a level where you see a big uptake there?

It takes time for a reset. I think we said on our earnings call, we don't expect a dramatic change in the near term. That being said, when market conditions improve, they tend to improve faster than we expect. It's not a linear change. And so for instance, if inflation came down much faster than people expected, that could be helpful. I think our base case is it's going to be a slower deal environment for some period of time. But eventually, companies want to sell divisions that are noncore, families have life events that force things to happen, companies and sponsors need to refinance debt and the range of capital we have means we can do a lot of things. So the private credit certainly, our tactical opportunities area, which can help companies looking for maybe senior equity, something that's more structured. Our secondaries business has begun to see a pickup activity because some of the pension funds are looking to get below their target allocations and selling is an opportunity for us. So I think it's a function of sort of market volatility. If calm returns, I think we'll see transaction activity slowly pick up. If we see more shocks to the system as we did in the spring, then it sets us back. But ultimately, this is just a question of when, not if. Transaction activity will pick up. We have $200 billion of dry powder. There will be interesting things to do. It's hard to know exactly when that happens.

It can't get much worse than where we're at?

Yes. We've been in periods that are worse if you go back to '08, '09. And ultimately, again, it comes back. These things tend to be cyclical. And the great thing about the alternative model is in so many cases we have this capital, we have a long period of time to deploy it, so we have the patience to wait for the right moment.

I suppose to the lens of your green slope versus black diamond example, it could be kind of a slow build as opposed to like a sudden...

It's very possible. And I think the problem is, as investors, public -- it's hard to know exactly when that is. But market expectations, particularly looking at us, people, I think, expected way out in the future, you don't know when that will occur.

So I think that's a good segue to fundraising and fee earnings growth, which is everyone's favorite topic. What do you see as the biggest drivers of AUM growth in the near term? And then maybe where do you see the biggest longer-term opportunities for the business from here?

Well, what's interesting is we just had our LP conference last week, so we were with all our big institutional investors. And I would say the mindset is very different than '08, '09 when there was a lot of question marks around alternatives, where this is going and so forth. Today, our investors are generally still highly favorably inclined towards alternatives. They want to do more. They, in some cases, are constrained because they're over their targets. And so that is having an impact, we've talked about that publicly. But the desire is still there, and we're also seeing a bit of a shift. So definitely a lot of interest in private credit, which we've talked about, sort of a golden moment in private credit. Lot of interest in secondaries and infrastructure. I would say a little more of a cautious outlook on private equity and open-ended real estate funds. But again, these things tend to change. And what encourages me on the institutional side is continued strong enthusiasm for the asset class. Very few to know investors saying, "I want to reduce my allocation to private." And then, of course, some very large markets in insurance, where we're in very early days of insurance companies moving a greater share of what they do into private credit. And then the individual investor, $85 trillion around the world, that's probably about 1% allocated to alternatives, again, very early stages. So I see still plenty of room for this industry to grow. And right now, we're in a period maybe of a little bit of a slowdown, consolidation. But despite all of that, we raised $217 billion the last 12 months, which by itself would be one of the largest alternative firms in the world. So I think that says something powerful about the desire for alternatives, about the strength of our brand and our performance, that through this very challenging environment, we could still raise so much capital. But it is clearly a tougher period we're in right now.