Chit Chat Stocks - Is Blackstone a Misunderstood Compounder? With John Rotonti (Ticker: BX)

Episode Date: December 15, 2022

Blackstone Inc. is an alternative asset management firm. The company is the largest alternative asset manager in the world and the largest real estate investor in the world. Listen as Brett and Ryan ask questions about the company, its business model, and valuation. Enjoy the show! ***************************** Interested in becoming a member of 7investing? Subscribe with code “MONEY” and get $100 off your annual subscription for life: https://7investing.com/checkout/ ***************************** Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney  Subscribe to our Substack to receive free show notes and charts that go along with every episode: https://chitchatmoney.substack.com/ Interested to see more of John's work? Check out their Twitter here: https://twitter.com/JRogrow?s=20&t=3h_QT9eAJOY-GRPDzuH3BA Contact us: [e-mail] Timestamps Blackstone | (4:57) How Do They Make Money? | (11:49) What is a BREIT? | (31:53) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. This is our Thursday deep dive interview where we have on an analyst to discuss a single stock. And today we have probably one of my favorites on John Rotante. John's been a recurring guest on the show. And I have to say, he's definitely been a listener favorite, but he does such a great job articulating difficult investing concepts that he's probably one of my favorite investing teachers that I know. So love this episode. We're talking about Blackstone, a alternative asset manager, which he gets into, and it's the largest alternative asset manager in the world. We'll let him talk about it. Do you have any highlights from the interview?

I think the highlights, as people are listening to this, they're getting in the news a bit because of the BREIT thing, and there's some complications with that. And he kind of explains why Blackstone could be right there. And again, you know, who knows what will happen there, but that's not even the biggest part of the story. It's really just adding more clients, having a great reputation, putting up solid returns, diversifying all these assets, offering things and funds that various, you know, I guess they're not for the retail investors like ourselves, but for various rich individuals, pensions. But it is all across the stock. I mean, well, yeah, I guess people like us can buy the stock and maybe that's how you take advantage of that. But it was a great overview of why they have such strong operating leverage, why these business models scale extremely well, and why the stock has a great opportunity right now because people are worried about certain things that we don't need to spoil that John thinks are unwarranted. Again, we're not saying he's guaranteed to be right, but there's some great information here for any investor that's interested in these companies to take a look at.

Okay. And before we get to the interview, let's talk about our exclusive sponsor. we've now said this a couple of times on the show, but if you're new, it's 7investing and they have a free trial going through the end of the year. It's one week, it's a dollar, but if you use our code money, you don't have to pay the dollar. So you literally get the full service for free for a week. You can see if you like it, see the reports that maybe you're most interested in. If you have an analyst that you want to see what he's been recommending, you can easily go and do that too. And they will have just had their year in review,

which goes through all of their holdings or all of their recommendations since the very beginning and updates all readers on how they think about the business today. So this is a perfect time to add 7investing to your research list or list of services that you use for stock research and just at least go check them out. You get a free week, use that code money. And you can also use it for the annual, the second time around, if you decide to re-up and do the full year. Brett, anything else? Yeah. So not to confuse the listeners, Brian, because I think I'll try to explain it better. Use the code money and you get the free trial. Plus if you stick around, you get a hundred dollars off your annual subscription. So use the

code, you get the free trial. And if you stick around after the seven days, you get a hundred dollars off your annual subscription every year for life. So fantastic deal. The year's about to end. So try them out before the code expires. Code money. All right. Well, without further ado, here's our interview on Blackstone with John Rotante. Welcome to Chit Chat Money. On this show, hosts Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast.

Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guest is not formal advice or recommendation. Now, please enjoy this episode. All right. Welcome in. Today, we are joined again by recurring guests at this point. I can't say how many times because I think you've been on a couple of times, but our last episode that we talked about KKR was a fan favorite. That was a listener favorite. People love that show. And so we're going back down the alternative asset manager route today with Blackstone. But I guess before we get into that, John, how are you? How have things been? I'm doing well. Thanks for having me on the show, Ryan and Brett. Always love coming on

my favorite investing podcast. But yeah, doing well out here in Colorado, getting ready for ski season. Just got back from New York City, saw three Broadway shows in two days. So it was a fun but quick trip. All right. All right. Let's talk Blackstone. Maybe just start with the overview. What's your thesis on Blackstone? So Blackstone is the largest alternative asset manager in the world and the largest real estate investor in the world with about $950 million in AUM. Its Brandon scale enabled it to raise $45 billion in AUM in Q3 alone and $183 billion year-to-date. It deployed $31 billion in the third quarter and $168 billion over the trailing 12 months. These numbers and this scale is astronomical, and it's not expected to slow

down much. Prequin estimates that alternative AUM will grow at a roughly 12% CAGR through 2027. Also, I don't know if many, if any businesses where economic earnings, we're talking about true economic value added here, EVA, is consistently higher than GAAP earnings with 40% to 50% NOPAT margins and 20% to 30% returns on invested capital. These numbers are coming from new constructs, and that is growing free cash flow or distributable earnings at roughly 15% compounded annually over the last several years. It pays out 100% of that cash flow to investors, 85% as a dividend, and then the rest as buybacks. Because it has an 85% payout ratio, the dividend grows almost perfectly in line with distributable earnings. Over the last

five years, let's see, the dividend has grown at a roughly 18% CAGR, almost perfectly in line with distributable earnings growth. The dividend currently yields over 5%. So you get 5% right there. It has an A-plus credit rating, and it's pretty much net debt neutral. But then if you go to the balance sheet and you add back investments and net accrued performance revenue, then it actually has a large net cash position. It has a culture of never losing money, Ryan and Brett, and that was implemented by Steve Schwartzman, its founder and CEO. It has $182 billion in undrawn capital or dry powder. So it's perfectly positioned to deploy large amounts of capital in a downturn to plant the seeds for higher growth and even higher returns coming out of the down

cycle. I can't think of a firm, including Berkshire Hathaway, Alphabet, you name it, that has more capital available to invest counter-cyclically in distressed assets in a downturn. It's a highly diversified, predictable business with about two-thirds of the business recurring in nature, either from management fee earnings or perpetual capital. And the business requires almost no capital to grow. And as Buffett has said, the best businesses generate high returns on invested capital and do not require a lot of new capital to grow. Regarding valuation, 5% dividend yield, we already said, 5% free cash flow yield. And using new constructs reverse DCF, it's priced to never grow profitably again. I think of the long-term, we can grow distributable

earnings at roughly 12% to 13% per year. But let's assume earnings are completely flat in the next 12 months. Let's assume we have a mild recession. Earnings are flat. That means in the next 12 months, it'll do $5.81 in distributable earnings. So at $80 per share, trading at a forward price to DE of less than 14 times. That compares to its three-year average of well over 20 times. So it's trading at a steep discount to its historical average and a discount to the market, which according to FactSet is at 17 times right now. So some of the best business economics I've ever seen, one of the widest, most I've seen, perfectly positioned to get stronger through the adversity of a possible recession, yet trading at a discount. So a lot

to like. Yes, that was a great start, great overview. And we'll get into why you think they have a competitive advantage and some of the recent news later. But first, I think for more context, what's the history of Blackstone? How did they compare to, you know, there's so many asset managers out there. Why did they become the world's largest alternative asset manager? Great question. So it was founded in 1985 by Steve Schwarzman and Pete Peterson, both of whom were experienced investment bankers and leaders at Lehman Brothers. This was Lehman, you know, before the global financial crisis when it was a leading investment bank. After Lehman Brothers was sold to American Express, Steve Schwarzman and Pete Peterson decided to go out on their own

and create a private equity fund they named Blackstone. They started in traditional private equity and leveraged buyouts. And they had a lot of early successes that allowed Blackstone to build a brand and reputation and to raise capital necessary to then expand into credit, real estate, infrastructure, hedge funds, and more. Steve Schwartzman was a real visionary and a real business builder and a very shrewd dealmaker from the very early days. And the first few vintages of their early private equity funds did very well, helped them really build that brand for subsequent vintages. And that then helped them expand outside of PE, like we said, into credit and infrastructure hedge funds. And then one other thing I'll mention, when the firm hit troubled

periods, such as the global financial crisis, it was always positioned in a very low-risk way with a very conservative balance sheet and lots of uncalled capital or dry powder. So that allowed them to act counter-cyclically, to really invest aggressively at the bottom, and then they would exit the recession with even stronger competitive position, higher market share, and better assets to plant the seeds for long-term, highly profitable growth. We should call out that under the leadership of John Gray, Blackstone's president, Blackstone successfully built the largest real estate investment company in the world from a standing start of zero.

And they also built a very successful credit business and a very successful industry-leading hedge fund of funds business. But the real estate business was really a game changer, as it is roughly one-third of AUM and over half of distributable earnings today. If you want exposure to the highest quality real estate in the best locations and a firm that has now survived three major recessions and has proven resilient and has proven it can invest counter-cyclically and always come out stronger, I can't think of a better investment than Blackstone. I guess let's talk the business today. What does it look like? What are the bulk of the assets in? And then it isn't super obvious. So how does Blackstone actually make money? What is that revenue line item made up of? It's not super obvious. So I appreciate this

question. So just like when we discussed KKR, Blackstone is a highly diversified, one-stop shop financial firm, financial and investing firm. Its fee streams or its revenue include management fees, performance fees, capital market fees, and carried interest fees. Remember, carried interest is performance fees that are realized only when they exit a holding through a sale or an IPO. Blackstone also generates investment income from the balance sheet. In the last 12 months, 60% of distributable earnings came from real estate, 23% from private equity, 11% from credit and insurance, and 6% from their hedge fund-to-fund business. that's pretty typical, a pretty typical breakdown for a normal year.

A couple of things to point out here. First, they have a large infrastructure business, but that falls under private equity. So it's not broken out separately. But investors should not forget about their very durable infrastructure investments. For example, Blackstone owns the biggest port operator in the US. They own a midstream gas pipeline business. They own a toll road operator, and much more. I've already mentioned they have the largest real estate business in the world, but they also have the largest hedge fund-to-fund business in the world. Their hedge fund solutions business picks the best managers and negotiates lower fees for Blackstone clients. And they do this in a customized way for their specific LPs.

So the point is that this is a highly diversified financial and investing firm. Investors need to think far beyond traditional private equity LBOs when looking at Blackstone or KKR. And then Blackstone also has a tactical opportunities team. Excuse me. This falls under private equity on the line item, but it has its own separate investing team. And these are a set of opportunities that don't fit neatly into PE or infrastructure or real estate. These tend to be... They're not control PE style positions. So they're smaller positions and they are not super correlated with the market. So not correlated with the market and not control investing. And that's their tactical opportunities team. All right. Yeah. Let's move on to...

So we looked at KKR and for anyone that's listening, go check out that episode we did earlier in 2022. So if you're interested in alternative asset managers, go check that out But what are the differences between KKR and Blackstone? Because I think when someone is just looking at an alternative asset manager or anyone like Blackstone, KKR, there's a few others out there. They really see them as all the same. But what makes Blackstone different from other alternative asset managers and KKR from your seat? so there are a lot of similarities uh both blackstone and kkr are highly diversified stable predictable extremely well run wide moat businesses with low to mid-teens free cash flow per share growth trading at discounted multiples so far above average businesses very predictable, high margin, high return, trading at below average multiples. At a high level, these companies are very similar. They are both leading alternative

asset managers. They both invest across the growth spectrum with a growing percentage of AUM coming from perpetual capital and capital that is locked up for nearly a decade. The big difference is that Blackstone is extremely risk-averse and maintains a very asset-light balance sheet. If you remember from our KKR discussion, KKR aggressively invests in its own funds through its balance sheet. Blackstone does not do this. Blackstone may take a 1% or even less position in one of its funds because they want to keep a very asset-light balance sheet. Their brand is so strong, they don't need to cede their own funds. Their brand, the Blackstone brand, can raise third-party capital and then just manage that capital.

Also, second difference, KKR acquired an insurance company for the perpetual capital and the float. Blackstone has not yet bought an insurance company like a lot of its competitors have, including KKR. They've resisted doing that so far. What they do do is they partner with insurance companies to be that insurance company's preferred asset manager. And then they take small minority positions in insurance companies. I think the most they have invested in insurance companies so far is like 10%. And they've done this on a couple of occasions. They'll take like a 10% position in an insurance company and then get some dividend income. So Blackstone's strategy and business model is to be asset light, but brand heavy. Makes sense. It's crazy to think

that so much of their invests, it sounds like they're incredible at raising funds. Like you said, I think a lot of that just comes from the brand and the reputation. Let's talk a little bit about carried interest. I think this is a topic that a lot of people have heard of, but it isn't always – it's not necessarily clear what exactly it is. So could you explain carried interest and then why you think it's a negative for alternative asset managers? Of course. So, carried interest is an overhang on the alternative asset managers because some politicians are pushing for a change in the tax law to eliminate the carried interest tax exemption. Some investors think this is a risk to Blackstone's earnings, but this is a misunderstanding because Blackstone is taxed at the corporate rate.

so that is the relevant tax rate that impacts Blackstone's distributable earnings, the corporate tax rate. Carried interest is a personal tax issue, not a corporate tax issue. And that's where a lot of the market, I think, misunderstands this. If carried interest taxation increases, then the after-tax pay that a Blackstone employee who receives carried interest Not all Blackstone employees receive carried interest, but of those Blackstone employees who receive carried interest, their after-tax pay would decline as they, as an individual, would have to pay higher taxes. But that would not impact the earnings that Blackstone would report as a public company. So maybe this impacts employee recruitment and retention a bit. But I doubt it because Blackstone has the biggest brand and a very unique culture among the alternative asset managers, and the buy side pays way more than the sell side already by a lot.

I mean, buy side employees make more than the sell side. Buy side CEOs and presidents make more than investment banking CEOs and presidents. So it's something an investor in Blackstone would not like to see happen, this change in the tax code, but I don't think it's existential. And I think it's already more than discounted in the stock prices. Maybe it's a slight negative, Ryan and Brett, but I don't think it's anything more than that. I do think the stocks would sell off in the short term because it is so misunderstood by the market. But then I think the stocks would bounce back because of what we discussed, below market multiples and low teens annualized expected earnings per share growth over the long

term. All right. Yeah. And before, at the end, we'll kind of maybe talk about why people are not expecting that earnings growth and why maybe you disagree and why there's the opportunity there for these companies to continue growing their earnings at such high pace. But when we look at Blackstone, the revenue can be volatile, and that might not make sense at first glance because you look at them and you say, oh, they have all this AUM. They're going to earn these steady fees on that. But why is their revenue volatile? Excuse me. Another really great point.

So I think that in order to be a great investor, you have to understand accounting and financial statement analysis at an almost expert level. And I think this is especially true when you're looking at alternative asset managers. In Blackstone's case, management fees, which is one part of the revenue line, which we discussed already, management fees grow every single year. but revenue is still volatile because performance fees from selling assets out of funds is much more cyclical. Now, over longer periods of time, performance fees also trend up into the right just as management fees do. Investors also need to realize that Blackstone starts earning management fees, even on uncalled capital, even on dry powder, as long as the fund is both raised and activated. So that's why revenue is volatile. But while we're talking about

alternative asset manager accounting, another area that investors need to be astute about is when looking at the share count. If you just scan S&P Cap IQ, you'll see the share count is increasing every year. But that's extremely misleading. The total share count is not growing. It's been flat for the last five years. And it's not a coincidence that that is when John Gray started his position as president, because he is committed to a flat share count. What's going on is that within the share count, there are the common shares, and then there are partnership units. The common shares are increasing, and partnership units are decreasing, precisely because partners convert their partnership units into common shares. And that is why the common

shares are growing and the partnership units are decreasing. Why do they do that? Because if the partners want to sell out, have a liquidity event, sell some of their shares, those partnership units must first be converted to common before they can sell. That's why partnership shares are decreasing, common shares are increasing, but the offset is a flat share count overall. It's important to note, and I hope everyone is listening, Steve Schwartzman and John Gray have never converted or sold any of their partnership units in Blackstone. Never. Finally, you have to be able to understand distributable earnings from an accounting point of view, because that's really the measure of free cash flow for alternative asset managers. Distributable earnings is made

up of fee-related earnings, so that's 60% to 70% of the total. Then about one-third comes from what's called net realizations or the performance fee they take when assets are sold from a fund at a gain. Those fee-related earnings, as we said, are very stable. A lot of investors focus on the fee-related earnings growth. They don't even look at the distributable earnings because that's basically subscription-based recurring, almost annuity-like revenue, and it tracks AUM pretty darn closely over time. So if you're looking at the alts, you need to understand why revenue is volatile, but you also need to understand why the share count is volatile. And you also need to understand how to calculate distributable earnings,

which is really free cashflow. So speaking of earnings, you look at Blackstone and probably one of the things that pops up on the screen is the profit margins. They're quite high. Can you explain a little bit about the business model that allows them to have such high margins? And then I guess, what are the main costs at sort of the corporate level for Blackstone? Yep. It has some of the highest pre-tax margins I've ever seen. And there's several reasons for that. So at Blackstone, there's a big focus on each individual business running its own P&L. That's a big part of the culture. And every new business must be margin accretive to the overall firm in a very short amount of time. They do not subsidize money-losing businesses. They do not

take cash from one business line to support a money-losing business line. Steve Schwarzman, Remember, rule number one for him was never lose money. They do not support money losing businesses. The second thing is they tend to focus on businesses that scale very, very quickly. Blackstone, because of their brand and their size and their scale, they don't do $2 billion funds. They just don't do it. They pass on smaller niche areas and niche strategies that can't scale big quickly. And scale is the name of the game to achieving operating leverage in the asset management industry. It's much more attractive from a margin standpoint to have one $20 billion fund than to have 10 $2 billion funds. That's just how the math of operating leverage works

in the asset management industry. And then finally, there's inherent operating leverage in the asset manager business model because the same number of investment team members can manage more AUM and more strategy. So the same number of team members can manage $10 billion in AUM as can manage $50 billion in AUM. You don't need to scale the number of employees up. And that's where the operating leverage comes from. And you ask the biggest cost center, it's people. These are asset, people-heavy businesses. So people are the main assets. Gotcha. Yeah. When it comes down to it, it's not too complicated a business model. Although like we mentioned earlier, there are some accounting quirks. But I think listeners,

they understand that the stock is cheap if the business can grow in the future like it has in the past. Where do you think the growth is going to come from? And how important is that dry powder number? I forget the number. Was it 180 billion? You'll probably have some numbers to share with the listeners, but how important is the dry powder to Blackstone's growth story, say, over the next three, five years and beyond? Yeah, I think the dry powder is 180 billion. That's a record for them. It's the most in the industry as well. Dry powder is a consequence of growth more than an output of growth. Sorry, it's a consequence of growth, more of an output of growth than it is an input to growth. So what is Shrive Power? It's uninvested capital.

It's at a record level. It will keep growing as the company grows. We should talk about, and you asked about where growth will come from, from Blackstone. So first, we mentioned frequent estimates that global alternative AUM will double in the next five years through 2027 to $18.3 trillion, up from $9.3 trillion today. Trillion. This is a massive, massive market. As we said, Blackstone has about almost a trillion in AUM itself. So that doubling at the industry level in AUM, that will drive management fee growth at Blackstone, I think, let's say in the low teens, let's say 11%, 12%, 13%, 14%, somewhere in there. I don't try to get too precise with these things because that's just a fool's game.

Growth will also come from what they call their core plus strategies, such as real estate. So Core Plus at Blackstone means lower return hurdles in the 10% to 14% per year range. So they set a lower return hurdle, but that means it's lower on the risk profile, uses less leverage, and generates steady, predictable free cash flows. So that's their Core Plus strategy. It's growing like a weed. and also with core plus that investor money gets deployed immediately because they're not blackstone is not waiting to opportunistically deploy it in much higher return investments remember they set a lower hurdle lower risk less leverage and so they can deploy it immediately

um also infrastructure and direct lending or credit are absolutely huge opportunities right now because the U.S. underinvested in infrastructure for the last decade. I mean, our roads and bridges and other internal improvements are crumbling before our eyes, right? So infrastructure is huge. And then can you imagine the high-yield credit opportunities that are going to emerge in an economic downturn? I mean, I think that's going to be one of Blackstone's best-performing strategies over the next five to 10 years is credit. So these are really big markets with good growth profiles. Looking at a high level, their number of strategies at Blackstone has roughly doubled in the last five years. Also, the investors that they serve,

these institutional, sovereign wealth, very large investors, those are also growing. Those investors are growing in size. So they are sending more funds over to Blackstone over time. So that's just like organic growth from an existing client base. Very predictable, y'all. Very, very stable and predictable. And then they earn higher management fees on those growing funds from their existing clients over time. And then finally, they are expanding into retail investors with high net worth individual strategies. Oh, okay. I was going to say, when you say retail investors, do you mean like the individual high net worth investors? Yes. Individuals that are accredited high net

worth individuals. Makes sense. I've got a couple of follow-up questions, but I think a lot of people that are listening to this are hoping for us to ask about the B-R-E-I-T news that came out recently. It will have been probably two weeks prior to this airing. But I guess there's been a lot of news around this. Blackstone stock's been selling off on apparently the BREIT, which maybe you can explain in a second. It's receiving redemption requests. Can you explain what all's actually going on there? Yes. Very important. Current event. So I'm going to try to tell you why I think the market is wrong about B-REIT. But let me first give you a brief overview of what B-REIT is. So as of September

30th, 2022, it had roughly $70 billion in net asset value. So it is a huge fund. And up until recently, it was getting roughly $500 million in inflows every two weeks, or about $1 billion in inflows every month. So it is a growth engine for Blackstone. October 1st inflows were in that billion-dollar range. I think they were $910 million. Some sell-side reports estimate that B-REIT accounts for a low double-digit percentage of Blackstone's distributable earnings. 75% of B-REIT is invested in rental housing and individual warehouses and logistics facilities in growing markets with population inflows and great demographics in places like Florida and Texas and other Sunbelt states. It is only available to accredited investors and investors

can buy and sell shares monthly. So there's monthly liquidity. Cash flows and B-REIT are up 13% year-to-date, which is incredible. And B-REIT, its NAV, is up 9% year-to-date, while public REITs are down about 20%. And the S&P 500 is down 15%-ish. So the question is, why the recent redemptions? And I think the answer is that retail investors buying and selling fund shares at the perfectly wrong time is a story as old as the hills, y'all, as old as the hills. Anytime you have periods of market volatility, you're going to see investors put in redemption requests and investors tend to buy and sell at the wrong time. There's tons of mutual fund data on this from Dow Bar and Fidelity and other places as well. Also, 70% of the

redemptions, of the outflows came from Asian clients, even though those Asian clients only represent only represent about 20% of B REITs fund investor base. So the vast majority of the fund redemption requests have come from a small percentage of the investor base. And keep in mind, there's immense volatility in Asian markets right now. And the average Asian investor has much more leverage and much more exposure to margin. So they were getting margin called up the wazoo. so that made it even worse. And I think what we're seeing is the fund is also a victim of its own success because the fund is up 9% year to date, as we said. For many investors, that's the only thing that's up for them in their whole investing portfolio this year. So there's some

profit taking going on. And then they also sold because they need to cover those margin calls. I think the next important question investors need to ask is, why did B-REIT sell those two Vegas casinos that they owned 50% of? I think there are four reasons for this. One, Vegas has been benefiting from a travel recovery, so asset values are rising, so it was a good time to sell. Two, selling the Vegas casino allowed B-REIT to now pivot into faster-growing sectors with more pricing power. I believe the rent on those Vegas properties were capped at 2% per year, I think. Don't quote me on that, but I think that's what it was. And they want to go into things that have more pricing power above and beyond just 2% per year when inflation is running

much higher. Three, Blackstone got a great price because it sold to an existing strategic shareholder that owned the other 50%. And Blackstone doubled its money in those two casinos in three years. And then fourth, this just adds additional liquidity for B-REIT to do deals and shift into faster growing real estate sectors with faster rent resets and better pricing power. So the next question is, what is the market missing about B-REIT? And the answer is that investors see outflows and assume bad performance, but nothing could be further from the truth. The fund is up 9% year to date. It's by far the best performer in most investors' portfolios. The only thing that is maybe performing better is energy. The fund was designed for liquidity

events because real estate is illiquid. It's not like stocks and bonds. You can't sell real estate like you can stocks or bonds to meet redemption requests. That's why the cap was in place. Investors signed fund documents agreeing to a liquidity cap, and now those same fund investors are freaking out when they can't take their money out whenever they want. So the redemptions are working just as the fund designed, specifically because real estate is illiquid. Finally, John Gray built Blackstone Real Estate Business from zero, and he invested $100 million of his own money in B-REIT since July of this year. Not a typo, $100 million. Guess who else did? Steve Schwarzman. He invested $100 million of his own money in B-REIT since

July of this year. You cannot make these numbers up. Yeah, that makes sense. And for anyone that's wondering about the fund structure around liquidity, that is pretty standard, especially when you have an illiquid asset base. I think what some people would probably be concerned about, and maybe the pushback would be that the NAV that Blackstone reports in the B REIT isn't as accurate, or they wouldn't be able to sell the assets at that value given the recent rise in rates and the disparity between their NAV, which has accelerated, and the public REITs NAV, which has decelerated as of late. Do you think there's any chance that Blackstone's NAV comes down over the next couple of years in the B-REIT section?

Sure. So look, Blackstone, other alternative asset managers have no benefit to not marking down assets in a timely fashion because eventually the truth is going to come out when they try to sell these assets. Eventually the truth is going to come out. The real number is going to come out. That's the first thing. The second thing is, Ryan and Brett, public stocks are down. Some of these software companies are down 90%, some of them. Now, do you think the businesses have fallen 90% in value? Not the stocks, the businesses. I don't know, but I bet a lot of public software investors would say, hell no. These businesses have not fallen 90% in value. This is just Mr. Market being manic. The benefit of private investing is you don't have to deal with manic Mr. Market. So you can mark those funds to market as you see fit. And there's less swing in underlying

intrinsic asset value than you see in public markets. That's the second thing. But we will find out at some point what the true asset values of these are when they sell. Because private equity firms don't hold in perpetuity. They sell out at some point. That's the private equity model. So we're going to find out. I see almost zero reason to not mark to mark these things as accurately and quickly as they can because the truth will come out when they sell. Now, you mentioned interest rates. So we could talk about how higher interest rates affects Blackstone's real estate business. It is true that higher rates mean that financing for real estate deals is more expensive and that discount rates go up. So valuation or properties go down, all else equal. That's just basic discounting. That's the math of investing. But Blackstone real estate leases are short duration. So they can reprice with higher rents, pricing power,

which means they can offset a lot of the valuation decrease from higher interest rates with higher cash flows that come from pricing power. So yes, interest rate brings down the valuation, but they can offset that by resetting rents higher and getting more cash flows. also hotels reprice uh hotels reprice nightly and blackstone still owns a bellagio and the cosmo in vegas they own other hotels as well and they reprice nightly right so others they own they own the crown resorts in australia they own a huge resort in hawaii those reprice nightly So they own short-duration leases that reprice very, very quickly. I think housing reprices every year, for example, not nightly, but every year for their rental housing portfolio.

Blackstone has disclosed that their warehouses and residential leases are well below market rates. So Blackstone has disclosed that they have a lot of pricing power left in their rental housing prices and their logistics, which makes up 75% of B-REIT. So they're going to reprice those properties significantly higher. There's pent-up pricing power in those properties. Also, higher inflation means higher replacement costs to build a competing property from scratch. So that makes the value of existing properties more attractive. Finally, higher rates could mean that some potential target assets go on sale, and that would be good for Blackstone long-term so that they can do deals to plant the seeds for future growth and higher returns. So there are puts and takes to

this. And it's simply not as simple as saying that higher rates are bad for real estate across the board, especially not when you are talking about Blackstone, which is the largest real estate investor in the world. Also, I think it's also important that we talk about how interest rate affects Blackstone's business as a whole, how it affects Blackstone's other businesses beyond just real estate. Higher rates do make debt financing more expensive to do LBOs, but interest rates don't affect the return on a deal as much as you might think. Just like interest rates shouldn't be the main driver of a DCF model for equities in most cases. A much bigger effect comes from improving the operations when they buy a business and improving the cash flows

of that business. And that's something that Blackstone excels at. Also, its credit business is over 90% floating rate debt. So investors in its credit funds actually make more money when interest rates go up. And then finally, Blackstone's balance sheet could benefit a little by earning higher rates on its treasury portfolio. So I do think there's a misunderstanding that higher interest rates are just bad for real estate at Blackstone and bad for Blackstone as a whole.

I just don't think it's that simple. Okay, with Blackstone generally, what would you, how would you characterize? I keep thinking like, how did it get here? Like what makes them better than everyone? There's tons of asset managers out there, and there's so many places you could put your money if you're a high net worth individual. What makes Blackstone better? What are their competitive advantages? So we talked about their unique business model. Every business unit runs its

own P&L. That's just huge. We talked about the culture of never losing money, being asset light, not investing in its funds through its balance sheet, not buying insurance companies outright, rather than just taking small stakes and partnering with insurance companies. So there's a lot that they do differently on the business model front, the strategy front. But when you ask about competitive advantages, Blackstone has massive scale and operating leverage. You can manage more AUM with the same employee base when you have that scale. Scale also gives Blackstone access to deal flow and allows it to do larger deals. Small deals tend to require the same amount of work as large deals do. But larger deals provide much higher

return potential. So that's the first thing is scale and operating leverage. Blackstone also benefits from institutional process knowledge and data sharing across business units. When it's doing a deal to buy a business, its credit business can analyze the balance sheet. It's institutional business, can analyze the value of the assets from a CapEx property plant and equipment standpoint. It shares knowledge across teams as well as any investing company that I'm aware of. Blackstone has the biggest alternative asset manager brand in the world. So brand is the third one.

You're not going to get fired for investing with Blackstone. And that mentality helps them raise larger and larger funds. But it's not only that you're not going to get fired. Their performance has been exceptional over extremely large periods of time. So we talked about brand. Unique culture, we talked about their ability to pay very large pay packages also helps them attract the very best and the very brightest talent. Another competitive advantage is its global network of business professionals that has built up over decades. This helps them source deals. Often, this network will contract Blackstone exclusively and deal with Blackstone exclusively. Their network also helps them with their research and due diligence process. When Blackstone is analyzing a deal, it uses internal resources such as its own analysts and its own experts in business operations, but they also rely on a network of advisors and consultants that have intimate knowledge of a particular business and industry, such as former industry CEOs, CFOs, or chairpersons of an industry. And then they benefit from learning curves and investing knowledge, which we've talked about.

They've done hundreds of private equity deals, and each deal adds to the compounded investing knowledge of the firm. Its current private equity portfolio, just right now, they own over 200 companies. This is almost an insurmountable advantage, in my opinion. The only way for an upstart to gain this knowledge and this experience is by learning from their own investment successes and failures over a multi-decade period. Good luck with that. It's going to take multi-decades to catch up with Blackstone, in my opinion. All right. That's a fantastic overview of their competitive advantages.

I know you have to go. So answer this however long you want. Why do you think or how could an investment in Blackstone go poorly, do a little pre-mortem as we wrap things up here? So it depends on – if we go through an extended economic downturn and Blackstone decides not to sell assets in its funds and hold them longer than they planned, then their IRRs will be lower than planned. IRR is a function of the price at which you buy and sell, so the capital gain, the return you earn, but also over the time period you earn that return. So the longer they hold their assets, the lower their IRRs will be. So an extended economic downturn would lower fund performance, would probably hurt with fundraising, and could lead to maybe high single-digit – let's say mid-to-high single-digit returns over the next five to ten years as opposed to what I'm expecting, which is low-to-mid-teens returns. So, and then, you know, it's, in management is so important. Steve Schwartzman and John Gray are so important. If John Gray decided, I can't imagine a world in which he would, but if he decided to do something else, that, you know, that could probably lead to lower forward rates of return.

maybe one last question before you go uh you mentioned that the the scale advantages and i think that's you're probably totally right but there's kind of the double-edged sword there which is at some point it's harder to generate you're you're fishing in a much smaller pond at that size does the law of large numbers ever come into play here for blackstone It's possible. I mean, it's a trillion dollars in AUM. The thing is, though, frequent is estimating alternative AUM doubles in the next five years, and that private equity compounds at – AUM compounds at 13% or 14%. I still see a massive flood of fund flows into private equity because the business models are so well diversified, and these firms are such good at investing, and they deliver performance over a long period of time. However, at 14 times distributable earnings, the market's at 17 times, these stocks are priced like they're never going to grow again. And so I don't think they need to grow high teens to do well from here. At Blackstone,

you get 5% dividend yield. So that means earnings only need to grow 5% to earn a 10% return. I think they're going to grow much more than 5%. I think from today's prices, you can earn 12% to 15% annualized returns. And the reverse DCF analysis I've done has suggested that as well. All right. Well, that is all the questions we have. Now, I think listeners are probably familiar with you, but for anyone that is not, what is the best place to keep up with you and see more of your work? I'm publishing occasionally when I'm lucky, some articles on fool.com. And then you can find me on Twitter at jrogrose. All right, perfect. Well, we want to remind our listeners that Brett and I are not financial advisors. Anything we say or discuss here on

Chet Chat Money is not formal advice or recommendation. We are, however, general partners at Arch Capital. So clients may have positions in the securities discussed in this podcast. Thank you all for listening. Thanks again, John, for coming on the show. It's always a pleasure. And we will see you all next time. Chitchat money is one of my favorite things to do, not only in investing, but also just in the world. So I always love coming on. Thank you for having me. Hey, Simon, we wanted to ask you a few questions about 7investing so listeners could get an idea of what they're getting. What inspired you to start the company and what exactly is 7investing? Well, hey, Ryan, thanks again for having me. From years of working in the investing industry,

it was inspired by conversations with people that would just always have kind of the same negative perception of the stock market, right? It's too hard, or I don't have time for this, for this to stack against me. And those conversations kind of led me to say, hey, we need to create a site that actually does inspire people to say, you can take control of your financial future. You can invest in stocks. You can find good stocks to buy and hold for long periods of time. And at the end of the day, too, we know that everybody is different. We don't believe that there is one stock that fits for everyone, right? Maybe you're a dividend and loving paycheck cashing income investor that might want an option that's going to be a lower

risk dividend paying stock, especially right now with the economy being what it is. And then other people might say, hey, I'm ready to hold on for 20 or 30 years. I want to take some swings for the fences. Let's go after those high growth opportunities. And so I said, this would be something that would be even more fun rather than just doing educational and by myself. I said, what if I brought together a team of seven advisors, all with a diverse background and a diverse perspective of the stock market so we could uncover more stones and look at a bunch of different stocks with a bunch of different investing styles and a whole bunch of different industries. And so 7investing is kind of the genesis of all of those that we started in March of 2020. And we said, let's look at a whole bunch of different stocks. Let's do the legwork of the analysis.

And let's present our seven favorite actionable ideas every month for investors to choose from. And let's start the conversation about which of these stocks is right for you and which one might be the right fit for your portfolio. Knowing that investing is a very personal thing. All right. if you are a subscriber of 7investing, what do you get? Can you give an overview of what subscribers get? On the very first of every month, Brett, we release our seven new recommendations. So we are coming up on October 1st here, at least in the recording of this. And on October 1st, we'll release seven recommendation reports. Some of them will be

low risk. Some of them will be high risk. Some of them will be biotech. Some of them will be financial services. We run the full gamut. And as a member, you get immediate access to all of the new reports. But you also get access to all of our old recommendations as well. We track all of them in real time on our scorecard at 7investing.com slash recommendations. And we also provide company updates on all of those previous recommendations as well. We check in on how things are going. And sometimes we even see red flags that we think people should be aware of. There's risks for any opportunity at the time that you recommend it. And sometimes it's really needed for investors to kind of understand the risk and reward relationship.

And then the last part of it is, in addition to issuing new recommendations and providing updates on them, is we know that this is a long-term journey. We know that investing is something that we want to take years, if not decades, to accomplish whatever we want to get to as the end goal. And so we always, every month, make it a point to be very available for our subscribers to ask us questions. We have a members-only call right in the middle of every single month. We have a community discussion forum that we have available 24-7 to not only talk to our advisors, but also other investors.

I think that's one of the key differentiators for 7investing is that we know this is a long-term journey. We know it's a very personal thing. We know they're going to have questions along the way. We don't want to just broadcast stock picks and disappear. We want to be here with you throughout this entire journey. And you mentioned seven recommendations each month. sometimes those might be repeats, but obviously there's a lot of companies now in the 7investing universe. So how do members get a grasp on the advisor's conviction around certain ideas? Like

which ones do they, do they have a way of knowing which, whether advisors like certain ones more? That's the most common question we've gotten actually, since we started is what's your favorite ideas right now? We've done the diligence on almost 200 unique companies now and put them on the scorecard and people would say, hey, this is too much to keep up with. How do I even know where to start? And so we've kind of evolved as a company. One thing that we've started doing is best buys every month. Each advisor gets to pick any of their or another advisor's previous recommendations and put the flag on it that says, this is my best buy for October. And we publish shows for subscribers. The other thing that we've started doing is issuing conviction ratings on

companies that are also right there on the scorecard. So if you see a previous recommendation, we go everything from potential sell, which is the most negative flag we can put on a stock, to strong buy, which is the most positive bullish flag that we can mark things with. And you can filter through all of those to really quickly see here's some of our favorite opportunities. And we've taken this even one step further now, Ryan, which is we've created a strong buy portfolio where every quarter now we've gone ahead and self-selected as a team through a pretty methodical process our 20 favorite ideas our 20 highest scoring companies that we've collectively come up with our favorites of the entire scorecard and we put these into

what we're calling a strong buy portfolio that we publish each quarter also available as an added benefit for no extra charge for seven investing members all right last question here what does it cost to become a seven investing subscriber uh and as a you know we'll talk about or we have talked about before if you're a listener use code money to get a hundred dollars off your annual subscription that's right yeah we do have a monthly option you know you can come in and check out the entire scorecard for a month just to see what you're looking at for 49 a month but our most popular plan is actually the annual option because it's at a discount to that in fact we've got a a discount on the discount, like you mentioned, Brett, $399 for the year is our annual option

price. But if you use money, the Chit Chat Money promo code, it's down to $300. So you're basically getting the subscription for half price if you sign up for the annual offer with that promo code. That does not expire after the first year. As long as you remain an active subscriber, you get to lock in that $100 off a year benefit. All right. Well, as he mentioned, use that code money. Thanks for joining us, Simon. Thanks very much for having me.