Blackstone co-founder Stephen Schwarzman.
© 2017 Bloomberg Finance LP
Blackstone Group, led by billionaires Stephen Schwarzman and Jonathan Gray, has just completed the next step in its conquest of Wall Street. On Thursday morning, Blackstone, the world’s largest private equity firm with nearly $600 billion in assets under management, eclipsed investment banks Goldman Sachs and Morgan Stanley in market value, making it the most valuable standalone financial firm on Wall Street.
Around 10:45 a.m ET, Blackstone’s market capitalization was $69.4 billion, while Goldman Sachs fell below $69.3 billion in market value. Morgan Stanley, after its February deal for online broker Etrade, changes hands at a market value of about $66 billion. Thursday’s move is an extraordinary stock market regime change, which offers yet more evidence that a handful of relatively young and lean equity firms, with businesses that trace to the go-go days of the 1980s, are upending the financial system and taking power away from the banks that once dominated Wall Street. Just two years ago, Goldman’s shares were worth more than twice as much as Blackstone. Before the financial crisis hit in 2008, Goldman was worth more than four times as much as Blackstone.
Blackstone was co-founded by Schwarzman in 1985 and has been publicly traded for just over a dozen years. With just 2,905 employees worldwide, Blackstone is mite-sized compared to the typical investment bank. However, since the 2008 crisis, it has grown assets fivefold, while Goldman and Morgan Stanley have shrunk dramatically in size. Now, when it comes to the world’s most lucrative financial businesses such as private equity takeovers, real estate investments, hedge funds, and credit funds, Blackstone dominates.
It means that despite Goldman’s history and size—it was founded in 1869 and has 38,300 workers worldwide=—stock market investors now believe Blackstone is a more valuable business. Morgan Stanley, created by Henry Sturgis Morgan and Harold Stanley in 1935 in the wake of the Depression-era Glass Steagall Act, has some 60,431 employees globally.
Blackstone Overtakes Goldman And Morgan Stanley
Blackstone is now worth more than Goldman Sachs and Morgan Stanley
Since the crisis, which nearly felled Goldman and Morgan, long-term trends have favored Blackstone. The Dodd Frank Act heavily regulated investment banks and forced them out of many lucrative proprietary businesses. It’s meant that risk taking has moved from to alternative firms like Blackstone, which are structurally better designed to handle risk due to their lack of leverage and ability to hold assets in fund locked up for the long-term. The recent Coronavirus outbreak has helped to accelerate the shifting balance of power.
As the outbreak escalated, investors generally held onto their holdings of stock in private equity firms like Blackstone, which sits on $151 billion of dry powder to do deals amid the current chaos. But investment banks like Goldman Sachs and Morgan Stanley have seen their shares plunge in recent weeks. Surging volatility is leading to a major slowdown in deal activity for investment banks and the Federal Reserve’s emergency 50 basis point interest rate cut on Monday means these firms are also poised to suffer large drops in interest rate-related income. If a recession or continued market drop takes hold, investors may also believe Blackstone is in a better position to capitalize on the panic.
It has an A+ rated balance sheet with hardly any leverage and carries over a hundred billion dollars in undrawn capital from its institutional investors, which is ready to invest if bargains abound. Investment banks like Goldman, on the other hand, are still levered over 10-times and don’t have the same wherewithal they once did to take advantage of distressed prices.
Blackstone and its peers are now conceiving of new ways to make money from infrastructure, life sciences, and technology investments and they continue to raise record-sized pools of capital from investors around the world. Goldman and Morgan, meanwhile, continue to pivot away from their former swashbuckling ways and are paring trading desks in favor of safer and less glamorous businesses such as lending and wealth management.
Goldman has invested heavily in building a consumer lending platform, called Marcus, while Morgan Stanley recently paid $13 billion in stock for online brokerage Etrade as CEO James Gorman continues to bet the firm’s future on safe and low cost wealth management operations.
Part of Blackstone’s ascendance has been the result of a somewhat technical entrance into the stock market mainstream. Assets and fee earnings have been growing for years at firms like Blackstone, but last year was by far the best year on record for private equity firms. Most publicly traded firms like Blackstone, KKR, Apollo Global, Carlyle and Ares saw their shares skyrocket when they converted from public partnerships and into corporations, attracting many new investors. The move collectively yielded tens of billions of dollars in new wealth for dealmakers like Schwarzman, KKR’s Henry Kravis and George Roberts and Apollo’s Leon Black.
Here’s what we wrote in December, describing why 2019 was the best ever for the buyout industry:
For the better part of the current roaring bull run in stocks, as Schwarzman corralled billions of dollars from the most discerning pension and sovereign wealth funds on the planet, when it came to getting stock investors to buy shares in his own company, demand was lukewarm and fleeting. The firm’s structure as a partnership, distributing its profits in a tax-efficient manner every quarter, meant its value was anchored to short-term dividend payouts earned from fees and the realization of investment profits. In a market dominated by fast-growing technology platforms, Schwarzman missed out on the current investor zeitgeist, where fund managers and passive indexes apply ever higher valuations to companies with broadening competitive advantages, business momentum and high, recurring profit margins.
Then came Donald Trump’s tax overhaul and with it Schwarzman’s decision in April 2019 to change Blackstone’s structure. This technical flip of the switch has yielded one of the biggest wealth gains in Wall Street history. Since then, Schwarzman’s net worth has increased from $13.2 billion to $19 billion. That’s $5.8 billion of additional personal wealth in nine months.
Blackstone shares have returned 91% in 2019, reaching a record high market capitalization of $66 billion after Schwarzman restructured the firm from a tax-efficient partnership into a corporation, opening the firm’s shares to many index funds and mutual funds, who had been precluded from buying the stock previously. As investors like Nick Schommer of the Janus Forty Fund and passive ETFs linked to the S&P Total Market and MSCI indexes built holdings in Blackstone, stock analysts began to value the firm on par with corporate titans like Visa, Amazon and Home Depot, propelling it from a deep discount to the S&P 500’s going multiple to a premium.
The world’s biggest publicly traded private equity firms have all made the move to become corporations over the past 18 months, and investors have responded by anointing them as some of the best-performing companies on the market. Apollo Global Management’s stock has returned 106% in 2019, and Carlyle Group’s stock returned 111%. Include Brookfield Asset Management, KKR & Co and Ares Management and the publicly traded private equity firms are worth nearly a quarter trillion dollars. In sum, the big publicly traded private equity firms have gained some $75 billion in value.
Of this feat, Schwarzman, on a cold afternoon in Manhattan, offers a confident shrug. “It made no sense because it made no sense,” he says of his firm’s once stagnant stock. “Since the financial crash almost all financial institutions shrunk—we grew six times.”
For about a dozen years, Schwarzman has manned Wall Street’s dominant institution, earning many hecklers along the way for both the sheer size of Blackstone’s ambition and his own penchant to wade into politics, inviting controversy. During that time, banks failed and hedge funds flamed out. Wall Street’s swashbuckling trading desks were replaced by algorithms and electronic markets. Low-cost Vanguard and BlackRock funds, together with a few financial technology companies, eliminated the vig charged by throngs of brokers and funds.
As this era got going, just days before the failure of investment bank Bear Stearns in March 2008, Schwarzman decided to dial into his first earnings call as the head of a publicly traded company. Blackstone had listed its shares months before, and its stock quickly fell by half as competitors on Wall Street began revealing nine- and ten-figure trading losses, causing global markets to erupt in turmoil. Even then, Schwarzman could see how the contours of finance would be redrawn.
“One of the great things about the private equity and real estate businesses is that investors commit their capital through the life of the fund. There is no conceivable run on the bank, and we are never forced to sell any assets at the wrong time,” he said. “Investors may be throwing securities, including Blackstone, with its $1.20 a share cash distribution policy, out the door in a panic. We are contrarian investors. We do the opposite.”
Still, it was frustrating for private equity’s biggest firms to watch their stocks stagnate for years. With interest rates low and the stock market rising, money poured into private equity strategies in the last decade as returns soared. By the end of the decade, private equity firms controlled 8,000 U.S. corporations. Here they were, the kings of capital, but they couldn’t get any respect in the stock market.
With the election of Donald Trump, however, came his signature piece of legislation late in 2017 that pushed through lower corporate tax rates from 35% to 21%. The cut was so drastic that firms like Blackstone could potentially trade their partnership tax rate for a corporate rate and only see their taxes rise modestly, two-to-five percentage points. The upside of doing so was lowering paperwork burdens on shareholders, eliminating the need to file K-1 tax returns and opening shares to index funds hovering up retirement assets.
Henry Kravis and George Roberts knew what to do next. Both were pioneers in the leveraged buyout business, cofounding their investment firm KKR in 1976, which a dozen years later forged the dealmakers as figures in American culture with the $25 billion buyout of RJR Nabisco in 1988. The deal became the most famous private equity takeover in history thanks to the bestselling Barbarians at the Gate, which was adapted into a movie starring James Garner.
At the age of 75, both yet again led the way, this time with a seemingly arcane move far too boring to yield a Netflix series, but which has perhaps been more lucrative and consequential than any buyout negotiation ever. In the summer of 2018, KKR became the first publicly traded private equity firm to execute a conversion to a corporation under Delaware law from a limited partnership.
“A very large preponderance of our investors were hedge funds,” Kravis told Forbes in May. “We just thought we’d have a larger following and more people could buy the stock, which we hoped would inure to the benefit of all shareholders.”
A few month later, in November 2018, billionaire Antony Ressler’s Ares Management followed with its own corporate conversion, and its stock has returned more than 100% since. With the KKR and Ares conversions going well, the dominoes quickly fell as the other big private equity firms like Apollo Global Management and Blackstone followed suit in a span of months. Carlyle Group is slated to complete its conversion within days. Now, with their stock market capitalization flush and their competitors from investment banks and hedge funds still reeling, the private equity firms rule Wall Street.
“We were unable to be a shareholder until they converted,” says Ian Ferry, a portfolio manager at $21 billion in assets Jackson Square Partners, a longtime admirer of private equity asset management firms, particularly KKR. “The day of the conversion we were in the market buying shares.” Eventually Ferry’s investment firm built a stake in KKR now worth nearly $700 million. “These firms are filling a void that banks stepped out of, partly because of regulatory issues from the financial crisis,” says Ferry. “And they’re [now] on their way to stealing their shareholders.”
If things keep going the way they did this year, Wall Street might soon wake up to find Blackstone Group, a private equity firm with just 2,600 employees and founded in 1985, holding a larger market capitalization than Goldman Sachs, whose 36,000 employees just celebrated the 150th anniversary of the nation’s preeminent investment bank. For now, Goldman’s market valuation remains at $81 billion versus Blackstone’s $66 billion, but the chasm is getting as narrow as the scaffold-clad streets surrounding the New York Stock Exchange.
“I don’t know if I can point to an investor in the last 12 months who told us they want to decrease their allocation to private markets,” says billionaire Jonathan Gray, president of Blackstone and the heir apparent to Schwarzman, who is building mammoth-sized real estate investment portfolios with permanent lives and has overseen teams of dealmakers who are going after the growth sectors of the 21st century, targeting logistics hubs, software and data.
It’s no surprise to practitioners on Wall Street, who each year turn more and more to firms like Blackstone and less towards old-guard investment banks. Entire markets from real estate finance, structured lending vehicles and the management of illiquid high yielding assets are moving from trading desks at Goldman and Morgan Stanley to firms like Blackstone, Apollo and KKR. What’s long been an obvious trend on Wall Street is now being reflected in the stock market.
“Within the changing financial landscape, I think we are perfectly positioned,” says Schwarzman. “Finance is a big business—a big business! Just think about how much money is printed every year around the world. It keeps getting to be a bigger business.”