Saudi dollars overexcite Blackstone's investors

(The author is a Reuters Breakingviews columnist. The opinions expressed are his own.)

By Richard Beales

NEW YORK, May 23 (Reuters Breakingviews) - Blackstone's owners are getting prematurely excited. They have added 9 percent to the private-equity firm's market capitalization since SaudiArabia's main sovereign-wealth fund made a commitment to invest $20 billion in a Blackstone-managed fund aimed at U.S. infrastructure. The valuation uplift looks overdone.

In Saturday's statement announcing the non-binding initial agreement, the $38 billion Blackstone suggested that along with the Saudi Public Investment Fund's cash, other investors would commit a similar amount. With leverage, the total firepower could reach $100 billion.

The challenge will be finding good deals to invest in. There are already plenty of investors looking for public-private partnerships and other opportunities in U.S. infrastructure. But state and local governments are often unable or unwilling to cede control of assets. Meanwhile, the $4 trillion municipal bond market is a formidable rival to other private-sector sources of funds. If President Donald Trump can marshal support federal initiatives could help streamline projects, but there's no certainty of that.

Over the past 15 years, Blackstone has invested less than $3 billion a year in infrastructure on average. With fresh momentum – but also recognizing the Saudis' long-term outlook – suppose that ramps up to $10 billion annually, meaning the fund is fully invested in about a decade.

Then assume that, overall, investments return 8 percent a year – reasonable in today's competitive market for infrastructure assets – with debt costing 4.5 percent. Further assume that a third of the return, after interest, is distributed to PIF and other investors, with the rest rolling up into the fund's net asset value. For relatively low-yielding assets, Blackstone may charge perhaps a 1 percent management fee on the net asset value, plus 10 percent of gains. That’s half the headline fees on traditional private-equity vehicles.

Suppose Blackstone's profit margin on those fees averages 50 percent, ignoring tax. The firm's incremental earnings in 2019 then work out at a little under $100 million. Apply the roughly 15 times trailing price-to-earnings ratio on which the company's units traded on Friday, and the new fund business is worth $1.4 billion – 4 percent of Blackstone's market cap on Friday.

Looked at another way, Breakingviews calculates the present value of potential fees over a decade, discounted by Morningstar's estimated cost of capital for Blackstone of 11 percent, at a figure that's a tad lower but in the same ballpark. Either method justifies less than half the increase since Friday in the firm's value. There may be other reasons to favor the shares but on the Saudi numbers, investors have gotten ahead of themselves.

On Twitter https://twitter.com/richardbeales1

CONTEXT NEWS

- U.S. private-equity firm Blackstone and Saudi Arabia's main sovereign-wealth fund said on May 20 they plan to create a $40 billion vehicle to invest in infrastructure projects, mainly in the United States.

- The Saudi Public Investment Fund would commit $20 billion, with a similar amount raised from other investors. With leverage, Blackstone said it expected to invest more than $100 billion altogether through what it called a "permanent capital vehicle."

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(Editing by Antony Currie and Kate Duguid)