Fitch Affirms Blackstone at 'A+'; Outlook Stable

NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has affirmed the Long-Term Issuer Default Ratings (IDRs) of The Blackstone Group L.P. and its related entities (collectively Blackstone) at 'A+'. The Rating Outlook is Stable. Concurrently, Fitch has assigned a Long-Term IDR of 'A+' and a Short-Term IDR of 'F1' to subsidiary, Blackstone Holdings AI L.P., which has been added as a joint and several guarantor on all outstanding debt. The Rating Outlook is also Stable. A complete list of ratings is detailed at the end of this release.

Today's rating actions have been taken as part of a periodic peer review of the Alternative Investment Manager (IM) industry, which comprises seven publicly rated global firms. Fitch's outlook for the sector is stable; reflecting the relative stability of core operating fundamentals, given the locked-in nature of a large portion of fee revenue, modest but increased leverage levels, manageable near term obligations relative to available liquidity resources, increasing asset under management (AUM) diversity and investors' increasing allocation to alternative investments, particularly those managed by alternative IMs with strong franchises such as those included in Fitch's peer review.

Fee-earning AUM (FAUM) growth has slowed considerably for the rated peer group, as numerous strategies have record levels of uncalled capital to invest. Fundraising is expected to moderate to some extent, as a result, but management fees are expected to retain their resiliency as capital not-yet-earning management fees (shadow AUM) remains elevated and realizations of legacy investments have declined. While an increase in market dislocations would impact the valuations and realization of existing investments, it could also result in stronger management fee growth, as uncalled capital would be invested at a faster pace. Fitch does not expect a widespread distress cycle to emerge over the near term.

The variable cost structure of the alternative IMs has contributed to relatively steady cash flows through cycles. Fee-related earnings before interest, taxes, depreciation, and amortization (FEBITDA) margins rebounded modestly in 2015 and 2016 as many alternative IMs have begun to realize the scale benefits of follow-on funds and adjacent strategies. The FEBITDA margin for 'A' category alternative IMs averaged 41.6% for the trailing 12 months (TTM) ended Sept. 30, 2016, which compared to a 35.6% average for 2015 and Fitch's quantitative benchmark range of 30%-50% for 'A' category alternative IMs. Still, dispersion in the group is significant, with a more than 25 percentage point differential between the highest and lowest performer, driven by differences in strategy and product mix. Fitch believes higher margins provide enhanced operating flexibility through cycles.

Gross realized incentive income has steadily declined, since peaking in 2014, driven by the length of time valuations have been at elevated levels, a less supportive IPO environment, and a reduction in the average age of fund investments. Exit activity has declined in 2016 and is likely to moderate further, which points to likely reductions in distributable earnings. Incentive income accruals remain strong and Fitch believes realized incentive income may be less volatile than pre-crisis experience given the increased diversity of product platforms.

Leverage levels have increased across the industry, as issuers have taken advantage of the low interest rate environment to issue long duration funding for the purpose of funding balance sheet co-investments, acquisitions, and, in some instances, to pre-fund maturities. Average leverage, defined as debt divided by FEBITDA, was 3.16 times (x) for 'A' category firms for the TTM ending Sept. 30, 2016, which compares to Fitch's quantitative benchmark range of 0.5x-2.5x for 'A' category alternative IMs. Fitch believes the issuances have been largely opportunistic and views the reduction in refinancing risk favorably. Over time, Fitch expects leverage levels to generally decline to the benchmark range, as FEBITDA growth is driven by cost controls, increased scale, continued fundraising, and the gradual deployment of FAUM that earns fees on invested capital.

Counterbalancing the up-tick in leverage is the maintenance of strong liquidity profiles. Several firms remain in a negative net debt position and 2016 saw the introduction of perpetual preferred issuances by two issuers in the sector, with proceeds, to date, used to improve operating flexibility and liquidity. Debt maturities are negligible for the sector in 2016-2018. Payout ratios remain relatively high, but Fitch believes alternative IMs retain the ability to reduce shareholder distributions, as necessary, to meet obligations. While several share repurchase programs were announced over the last 12 months, execution of the programs is expected to remain opportunistic and is not expected to impair the sector's overall liquidity.

KEY RATING DRIVERS

IDRs AND SENIOR DEBT

The ratings affirmation for Blackstone reflects its strong competitive position as a global alternative IM, experienced management team, solid investment track record, significant FAUM, strong operating margins, incentive income-generating capability, ample liquidity, relatively low leverage, and subordination of general partner interests to outstanding indebtedness.

Rating constraints for the alternative IM space include 'key man' risk, which is institutionalized throughout many limited partnership agreements, reputational risk, which can impact the company's ability to raise future funds, and legal and regulatory risk, which could alter the alternative asset space. Rating constraints more specific to Blackstone include an above average payout ratio and modestly reduced revenue diversity following the spin-off of the firm's advisory, restructuring, and fund placement businesses on Oct. 1, 2015. Over a longer-term horizon, Fitch will also monitor the potential for overall size to constrain the ability to meet or exceed historical returns.

The new ratings assigned to Blackstone Holdings AI L.P. reflect the entity's joint and several guarantee on all outstanding debt. This entity along with Blackstone Holdings I, II, III, and IV L.P., represent the legal structures through which Blackstone earns management, transaction, and performance fees. Each entity is jointly and severally liable for any indebtedness of the company, which is generally issued from Blackstone Holdings Finance Co. LLC, a subsidiary of Blackstone Holdings I L.P.

FAUM amounted to $267.8 billion at Sept. 30, 2016, up 11.1% year-over-year, driven largely by the private equity segment, given the start of the investment period for the flagship fund, Blackstone Capital Partners VII (BCP VII), with $18.9 billion of committed capital, and the new Strategic Partners Fund VII, with $7.1 billion of committed capital. Inflows of $61.3 billion over the TTM ended Sept. 30, 2016, were only partially offset by $20.8 billion of realizations and $15.8 billion of outflows, representing the end of closed-end fund investment periods and redemptions in more liquid vehicles. In aggregate, Blackstone had $65.2 billion of AUM not currently earning fees at the third quarter of 2016 (3Q16); a record amount for the company.

Fundraising is expected to remain strong, given the diversity of Blackstone's product offerings, and the potential scalability of new product launches, including core plus real estate and core private equity. Fitch believes FAUM growth may moderate over the near term given Blackstone's absolute overall size, continued realization activity and the recent raising of flagship funds in PE and RE.

At Sept. 30, 2016, Blackstone had approximately $102.2 billion of dry powder, a record for the firm. Investing this amount of capital may be challenging in the current environment, with high equity valuations and loosening credit terms. However, Blackstone has a track record of investing through a variety of market cycles, and has a global reach and an extensive network of relationships which support deal flow. Fund investment periods also generally allow anywhere from three-to-five years to deploy the capital, which allows the firm additional deployment flexibility.

Blackstone's core operating performance remains strong due to the relative stability of management fees on a growing FAUM base and the variable cost structure. The firm's FEBITDA margin was a peer superior 43.3% for the TTM ended Sept. 30, 2016; evidence of the scalability of the business model.

FEBITDA rose 1.9% in the first nine months of 2016, year over year, despite the spin-off of the firm's advisory, restructuring, and fund placement businesses on Oct. 1, 2015 and the step-down in the fee basis of BCP VI in May 2016, given growth in FAUM, higher transaction fees, and cost controls. Fitch expects management fee growth near-term given continued fundraising and the start of the investment period for BCP VII in November 2016. Still, the rate of growth will be somewhat dependent on the magnitude and pace of investment and realization activity.

Performance fees were down 10.5% in the first nine months of 2016, year over year, due to stronger returns in 2015 and due to the sale of some large private equity investments that, given longer hold periods, did not exceed preferred return thresholds. Performance fees and investment income will be lumpy over time due to deal activity and market volatility. Accrued performance fees were a strong $3.3 billion at Sept. 30, 2016, net of associated compensation expense, and relate largely to the real estate and private equity segments. Fitch does not view the accrual as a liquid asset, but it does point to potential future income generation and cash flow.

Solid fund returns in hedge fund solutions in 3Q16 brought segment returns and incentive income to positive results for the year. At Sept. 30, 2016, 67% of incentive eligible FAUM was above its high water mark compared to 62% a year ago, but just 10% in the prior quarter. While outflows in the hedge fund industry are mounting, Blackstone still experienced net inflows on a TTM basis.

Blackstone's leverage, as measured by corporate debt divided by FEBITDA, was 2.63x at Sept. 30, 2016 on a TTM basis, compared to Fitch's quantitative benchmark range for 'A' rated alternative IMs of 0.5x-2.5x. Still, this ratio recovered more quickly than Fitch expected following the spin-off of the financial advisory business, given strong FEBITDA growth in most segments.

On Sept. 27, 2016, Blackstone announced the issuance of EUR600 million of 10-year notes with a 1.0% coupon. Debt issuance proceeds are expected to be used for general corporate purposes and for the pre-funding of 2019 debt maturities, which amount to $585 million. While gross leverage will increase to about 3.25x on a pro forma basis (using an exchange rate of $1.09/EUR) with this issuance, Fitch believes the firm will remain in a negative net debt position. Leverage, adjusting for the whole or partial refinancing of 2019 debt maturities, is not expected to change materially and will decline with continued FEBITDA growth. Blackstone expects to manage leverage at-or-below 2.5x over the long term.

Fitch believes Blackstone has a solid liquidity profile. Performance fees can be highly volatile and could be virtually zero when market conditions are stressed, so Fitch looks to FEBITDA, cash, and liquid assets as the primary sources of liquidity. At Sept. 30, 2016, balance sheet cash amounted to $1.8 billion and total investments in cash management strategies were $2.1 billion. Blackstone also recently upsized borrowing capacity on its corporate revolver to $1.5 billion from $1.1 billion and extended the maturity to August 2021.

Debt service coverage, defined as FEBITDA divided by interest expense, remained adequate at 5.6x on a TTM basis, but was below Fitch's quantitative benchmark of 8.0x-12.0x for alternative IMs in the 'A' rating category. Fitch's expects debt service coverage to improve modestly with management fee growth in 2017.

At June 30, 2016, unfunded commitments to the funds amounted to approximately $2.3 billion and the clawback obligation, assuming all positions were liquidated at their current fair values, amounted to a very modest $5.1 million, including employee obligations.

Distributions for the first nine months of 2016 were $1.05 per common unit while distributable earnings were $1.23 per unit, yielding a payout ratio of 85.4%. Blackstone's distribution policy is above the peer group average, but Fitch believes the company has the flexibility to reduce distributions, if necessary, to bolster liquidity.

The Stable Rating Outlook reflects Fitch's expectations that management will continue to generate stable management fees, maintain strong operating margins, grow/retain FAUM through the raising of new and expansion of existing funds, albeit at a more moderate pace, reduce leverage, increase interest coverage and retain a solid liquidity profile in order to fund operations and meet co-investment commitments to the funds.

RATING SENSITIVITIES

IDRs AND SENIOR DEBT

Positive rating momentum is considered relatively limited, given the nature of the business and the company's existing risk profile. However, positive momentum could develop over time with a meaningful reduction in key man risk, enhanced stability of incentive income through a variety of market cycles, and declines in leverage.

Negative rating actions could be driven by material changes in operating strategy or leverage tolerance resulting from changes in senior management or declines in investment performance which adversely impact the business franchise, meaningful FAUM and margin contraction which impairs FEBITDA, reduced product line diversity, and/or impairment of the liquidity profile as it relates to operating needs, debt maturities, and co-investment commitments. An inability to maintain leverage below 2.5x and improve interest coverage above 8.0x, over the long term, could all yield negative rating pressure.

Blackstone, a Delaware incorporated limited partnership, is a leading global alternative IM specializing in private equity, real estate, credit funds, and hedge fund solutions. As of Sept. 30, 2016 FAUM amounted to $267.8 billion and total AUM was $361.0 billion. The company's stock is listed on the NYSE under the ticker 'BX'.

Fitch has affirmed the following ratings:

The Blackstone Group L.P.

--Long-Term IDR at 'A+;

--Short-Term IDR at 'F1'.

Blackstone Holdings Finance Co. L.L.C.

--Long-Term IDR at 'A+;

--Senior unsecured debt at 'A+';

--Short-Term IDR at 'F1'.

Blackstone Holdings I, II, III, and IV L.P.

--Long-Term IDR at 'A+;

--Short-Term IDR at 'F1'.

The Rating Outlook is Stable.

Fitch has assigned the following ratings:

Blackstone Holdings AI L.P.

--Long-Term IDR 'A+;

--Short-Term IDR 'F1'.

The Rating Outlook is Stable.

Additional information is available on www.fitchratings.com

Applicable Criteria

Global Non-Bank Financial Institutions Rating Criteria (pub. 15 Jul 2016)

https://www.fitchratings.com/site/re/884128

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1014221

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1014221

Endorsement Policy

https://www.fitchratings.com/regulatory

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or
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Email: [email protected]

Source: Fitch Ratings

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