Blackstone Inc (BX) 2009 Q3 法說會逐字稿

Welcome to the Blackstone Group third quarter 2009 earnings conference call. Our speakers today are Stephen A. Schwarzman, Chairman, CEO and Co-Founder, Tony James, President and Chief Operating Officer, Laurence Tosi, Chief Financial Officer, and Joan Solotar, Senior Managing Director, Public Markets, and now I'd like to turn the call over to Joan Solotar, Senior Managing Director, Public Markets. Please proceed.

Thank you. And welcome everyone to our third quarter 2009 conference call. Earlier today we issued a press release announcing third quarter results, 2009 results and that's available on our website. And we plan to release our 10-Q later this afternoon.

So I'd like to remind you that today's call may include forward-looking statements which are based on current expectations and assumptions and are by their nature uncertain and outside of the firm's control and actual results may differ materially from the forward-looking statements due to many factors. For a discussion of some of the major risk factors, please see that section in our 10-K report. All of our statements are qualified by those and other disclosures in our reports filed with the SEC. We don't undertake any duty to update our forward-looking statements and we will refer to some non-GAAP measures on the call, and for reconciliation of those, you should refer to the press release that we issued this morning.

This audio cast is copyrighted material for the Blackstone Group and may not be duplicated, reproduced or rebroadcast without consent. Okay. So we reported economic net income or ENI of $0.25 per unit for the third quarter 2009, that compares with $0.16 per unit in the second quarter of 2009, and a loss of $0.45 in the third quarter of last year. A notable driver of positive ENI this quarter really relates to the increase in performance fees and also investment income in private equity, BAAM and GSO and then fewer negative marks in our real estate fund. Adjusted cash flow from operations totaled $131.9 million or $0.12 per unit, that was up about 29% from $102.3 million in the second quarter of this year, which was $0.09 per unit, and up substantially from a loss of $9 million or about flat to $0.01 per unit in the third quarter of 2008, and most of the cash flow difference was driven by realized investment gains in the quarter.

We will be paying the $0.30 per unit distribution that relates to public unit holders and if you have any questions on anything in the release or otherwise, you can follow up with me or Weston Tucker after the call. With that, all turn it over to Laurence Tosi.

Thank you, Joan. Good morning, everyone, and thank you for joining the call. I'd like to share with you some highlight financials and a few observations about Blackstone's liquidity position and balance sheet.

In private equity, both ENI and cash flow generation exhibited favorable trends in the quarter. ENI totaled $135.7 million compared with $123.8 million in the second quarter of 2009, and a negative $126.5 million in the year-ago third quarter. Management fees were stable since, as you know, these are locked in for the life of each fund. The driver of positive change was performance fees. The total portfolio recognize 4.9% contributing to both unrealized performance fees, investment income, which also included $11 million of realized gain from exits. In the second quarter of 2009, the portfolio had appreciated by a value of 3%. In our real estate business, ENI turned to a positive position of $44.2 million as compared with a loss of $25.1 million in the second quarter of 2009. And a loss of $310 million in the third quarter of last year. Total portfolio valuations in real estate were approximately flat with declines of 0.4% in the quarter. As compared with declines of 18.7% in the second quarter of this year. The positive performance fees in the quarter-related to Blackstone's new real estate debt strategies fund as well as $4 million of realized investment gains.

Our credit and marketable alternative business, or CAMA, had ENI of $81.5 million, up 22% from $66.5 million in the second quarter of 2009, and compared with a loss of $134 million in the third quarter of 2008. The biggest driver of the positive performance comparison in CAMA was performance fees and investment income. Which predominantly came from our credit platform but were also realized in BAAM our fund-to-funds as more assets moved above their high water marks. We had $23 million in realized investment gains in CAMA for the third quarter. Our advisory business produced revenue of $97.3 million for the quarter, up from $83.5 million in the second quarter of 2009 and down from $161 million in the third quarter of 2008. Restructuring in particular has performed extremely well, had a record nine months so far this year.

In the third quarter, Blackstone completed its first ever bond offering. Blackstone's periods of our greatest outperformance and growth typically come after a market dislocation. We believe this current cycle will not be an exception as our cash earnings and solid performance across all segments demonstrates. Given the firm's strong and consistent cash flow generation, we thought the timing was opportune to take advantage of the capital markets and current interest rate environment to issue $600 million of 10-year notes at a 6.625% coupon. The issuance was 6 times oversubscribed. We believe this is the right time to further strengthen our balance sheet and cash position while maintaining our conservative positioning of no net debt.

Both S&P and Fitch reiterated their A, A plus ratings respectively with a stable outlook after the firm's offering. Blackstone currently has $2 billion of cash and liquid investments against $600 million in bonds we recently issued which gives us a liquidity position of over $2 billion or $1.80 a unit. We intend to use the bond proceeds for general corporate purposes including funding growth in our existing business and aggressively seeking opportunities for future growth from acquisition or development of new business lines and fund offerings. The cash generated from the bond offering is invested in our treasury fund, which primarily consists of highly liquid high grade diversified investments. The yield from our liquid investments in treasury funds which was $28 million this quarter exceeds the interest on the notes so we do not anticipate any net impact to our cash profitability over the near term. I'll now turn it over to Steve.

Good morning. Continuation of the healing of global markets and economy that is we discussed last quarter. Debt and equity markets around the world extend their gains from the lows in March. The notable difference between the second and third quarters is the tangible evidence we're seeing of economic recovery. Fueled by inventory restocking and government stimulus programs including Cash for Clunkers and housing subsidies, positive GDP growth improved to 3.5% in the third quarter in the United States. Corporate profits were surprisingly strong, and Europe is moving closer to bottoming out but with relatively weak future growth prospects.

Combined with economic stimulus programs currently being implemented by various governmental entities, the growth trajectory is likely to continue in the United States and into early 2010. Though the magnitude of growth as next year unfolds is uncertain, unemployment remains quite high in the United States, reported at 10.2% this morning. And that excludes an additional estimated 5% of the work force no longer even seeking a job. This very high level of unemployment needs to improve for the recovery to continue in a sustained fashion. However, a weak and still overleveraged consumer, along with divisive rhetoric directed at the business community could retard job growth longer than many market participants anticipate.

Emerging markets are faring much better with continued growth in high levels in much of Asia and Latin America. This has been reflected in the relatively strong performance of those equity markets. Capital markets globally were liquid and companies were able to access meaningful amounts of both debt and equity. High yield bond issuance through the third quarter totaled $120 billion compared with $53 billion for all of 2008. Bond spreads narrowed dramatically in the junk area to 764 basis points from their peak of over 1900 basis points in late 2008. Receptive credit markets have allowed us to either buy back, amend or extend more than $18 billion of debt across our private equity and real estate portfolios. The fundraising environment in general has of course been very difficult over the past year. Investors are now talking seriously about putting more money to work.

Government pension funds in particular recognize that they cannot rely as previously on municipal or state funding in an era of constrained budgets so they need to maximize investment returns to meet their obligations to constituents. This should result over time in increasing asset allocation focus on private equity and other historically higher return alternative assets. The first indication of this revitalized trend became apparent to us over the last several months.

If there is a trend across all of our businesses, it's that our business is picking up and that our portfolio companies and assets are stabilized with most of our companies experiencing flat or growing revenue and EBITDA. Across the board we're seeing early signs of positive momentum. Recent months in private equity have been seeing activity pick up in both acquisitions and realizations. At the moment, most realizations are occurring as sales to strategic buyers, sales this quarter included Orangina, Stiefel and a subsidiary of Sithe are examples of this type of exit. Orangina is expected to close the fourth quarter of this year or the first quarter of 2010.

If equity markets remain stable, we can see up to eight of our companies initiate initial public offering over the next 12 to 18 months. Importantly, we are not indicating a view that the market is peaking. We have filed for an IPO of portfolio companies Team Health and Graham Packaging, that's part of the number 8, and Blackstone is likely to remain a large holder of these companies for years to come. Our intention is to realize those investments which are mature where we believe we've created real and lasting value.

With the new investment front, we see the pickup in attractive and often exclusive opportunities. These are primarily deleveraging events and we would own most of the equity. We have approximately $12.6 billion of available capital in private equity, and believe the next several years will provide an unusual opportunity to invest in high-return assets. Example of such opportunities is our recently announced agreement to purchase Busch Entertainment which operates Sea World and Busch Gardens Theme parks. We believe this is an attractive entry point at a multiple below historic trading levels during a time of depressed attendance with the expectation of benefiting from the eventual recovery of consumer leisure spending. We also closed our first deal for Summit Materials with the goal of creating a platform of scale in the heavy building, asphalt and aggregate sector, with a strong experienced management team. We intend to fund up to $750 million of additional equity in this effort over the next couple of years and have a strong pipeline of additional transactions.

We've invested additional equity into All Cargo, the largest private logistics company in India and we initiated a new investment in Nuziveedu, India's largest seed company. Nuziveedu holds a leadership position in the high barrier to entry cotton seed market which we believe has attractive growth prospects. We have recently announced the launching of an RMB fund in China where we were selected by the government of Shanghai to be their partner. This fund will give our core private equity and real estate businesses a local entree into the Chinese market which is very important and drive additional deal flow. Just as we've begun to see investors move from the sidelines, so have we seen the banks begin to lend. It's slow, but financing for good company has improved in terms of rates and level of debt. While it varies tremendously by the transaction, a typical leveraged transaction today can have approximately 4.5 times debt to EBITDA, perhaps even 5 sometimes, and a weighted-average cost of debt around 10%. A few months ago, these standards were roughly 2 to 3 times EBITDA, and 12% cost of money.

While debt financing remains constrained, we continue to be a preferred client of banks and have not had an issue funding our transactions. Our portfolio companies continue to perform as expected. We continue to believe two-thirds will achieve stable or growing EBITDA this year versus last year. Real estate activity levels have picked up, particularly on the acquisition front and we're seeing positive signs in fundamentals. Industry-wide in the lodging sector, US REVPAR growth to date is a negative 18%, a greater decline than was exhibited in prior recessions, reflecting the severity of this recession, industry estimates suggest that bottoming of fundamentals in 2010.

We're seeing the rate of decline of demand begin to moderate. One positive factor in both lodging and office properties is the relatively limited supply of new building leading up to the peak. Within office, cash flows remain relatively stable, although vacancies are still rising, and rents have declined significantly. Over the past 90 days, we've seen a meaningful pickup in leasing activity in markets such as New York and London and the dumping of subleased office space that took place in prior quarters has abated.

Similar to prior real estate cycles, activity pickup is the first sign of recovery, eventually followed by firmer pricing. Current market rents are significantly below replacement cost levels in many markets though they've stabilized, which should result in meaningful rent growth once office markets recover, however, this will take time. Our real estate debt funds on the other hand performed well in the quarter, up 9.2% in the quarter reflecting improvement in real estate debt markets. We continue to find attractive opportunities in this class. In terms of investments, we're seeing a greater number of attractive opportunities. Financial institutions appear more willing to reduce their commercial loan exposure through sales.

After two years of waiting patiently on the sidelines, we now have several transactions that we're comfortable doing that are in the pipeline. We recently announced the acquisition of 50% of Broadgate, the largest portfolio of office buildings in London, owned by British Land. We believe this is a terrific opportunity to buy into one of the best collections of real estate in London with a great partner and at what we hope is towards a cyclical bottom. Our competitive position in real estate remains extremely strong. Our aggressive sales program in 2005 to 2007 and patience in investing over the last couple of years leave us as the preferred investor in many of the largest and most complex real estate investment opportunities around the globe. We currently have over $12 billion in dry powder across our real estate funds.

Our credit and marketable alternatives business which we call CAMA is performing extremely well. BAAM, our fund-to-funds business had an increase in fee earning assets up to $25.2 billion from $23.2 billion. A combination of favorable performance and $790 million in net positive external inflows. We remain one of the few, not the only, fund of hedge funds that is seeing positive inflows this year. Industry trends are turning more favorable and outflows for the industry have slowed significantly from previous quarters. BAAM's performance has also been favorable, returning 12.9% net through September of this year.

Our business continues to build as investors recognize the value of the meaningful investment we've made in our due diligence and risk management processes. Which have allowed us to avoid all of the controversies that have entangled many of our peers. Within our credit platform, we have strong performance across multiple products with most incentive fee eligible assets now above their high water marks and earning incentive fees. Capital markets liquidity and credit spread trends were significantly more favorable. As a result, the portfolios generated strong positive performance. Some of the best performers were our bank debt positions which had both appreciation and meaningful cash flow from interest income. GSO also had strong gains from several distressed and high yield investments as lower quality borrowers saw some of the strongest returns in the market.

Moving credit provided some unique realization opportunities. In the beginning of the third quarter, GSO liquidated its Jackson Square CLO portfolio which was set up in March 2009 locking in a 1.4 times multiple of investment capital and an IRR of 157%. Repeat that, an IRR of 157% over a four-month period of time. We had an initial closing of $1.15 billion in our new Blackstone GSO Capital Solutions fund. We closed our first investment in that fund, on September 30. The fund provided a second lien financing for transportation company facing a near term maturity in its capital structure.

GSO was able to structure the loan on very attractive terms including modest leverage of 2 times debt to EBITDA, a very high coupon, fees, call protection, and free warrants for equity in the Company. We expect to be able to capitalize on several similar opportunities.

Our advisory business is also performing well this year. Corporate advisory restructuring continued to be extremely busy with good backlogs. Revenue in our restructuring and corporate advisory business will continue to be lumpy, it's their nature. Corporate advisory is 23% sequentially while restructuring declined 3% in the quarter. However, restructuring is performing at record levels this year.

Park Hill, our third-party distribution business which raises funds for private equity, real estate and hedge funds, continues to be negatively impacted by a highly challenged fundraising climate. Similar to our more general comments about fundraising, we believe the bottom may have passed and we are seeing modest signs of recovery in this business.

In terms of broader trends, while levels of activity and restructuring remain historically high, we expect the backlog to slowly decline. At the same time, we believe the corporate advisory and M&A deal flow will accelerate. These trends are similar to those exhibited in previous economic cycles. In conclusion, we're seeing the economic world slowly by demonstrably improve with an increased number of positive signs pointing to a more constructive environment for acquisitions, realizations and fundraising. Our goal is to capitalize on these favorable trends but to be patient and not move too quickly. Our cost of borrowed money to fund acquisitions has gone down significantly. We've seen an increase in the amount of available credit.

We believe Blackstone will be able to deploy substantial amounts of capital at high historic returns during each of the next several years. Fundamentals in our portfolio companies are also improving and through our group purchasing and healthcare programs we expect to generate more than $250 million in annual savings this year expected to increase to $450 million in three years. Based on current views, we believe we could see 8 IPOs in addition to exit through sales of our portfolio companies. In the third quarter and subsequently we announced or closed four of these realizations. We're finding a greater number of attractive real estate opportunities, typically those are looking for equity to put into current highly leveraged transactions. Our new capital solutions fund at GSO is well positioned in this environment to help healthy companies who have financing issues.

Our competitive position at the firm has never been stronger. The knowledge and relationships we have across private equity, real estate, leveraged debt, venture capital, M&A and restructuring coupled with over $2 billion of liquidity at BX and our access to debt capital through our A plus and A ratings make us unique in the alternative asset business.

As LT mentioned, we recently completed a highly successful $600 million bond transaction and our liquidity and balance sheet are very strong. We remain operationally and financially strong and we continue to evaluate opportunities to extend our various business lines. We have considered several acquisitions but we've not found any that meet our exacting criteria. With $40 billion of carry-eligible investments in the ground already, an additional $27 billion of available capital to deploy over the next several years, we are highly optimistic about the future for both our fund investors and our public unit investors. Thank you for joining our call. We look forward to answering any questions you might have.

(Operator Instructions) Your first question comes from the line of Howard Chen with Credit Suisse.

Thanks for taking my question. Steve, you provided really interesting color on your change in financing terms in your prepared remarks. As you and the team look to ramp up capital deployment, I'm curious how have your leverage assumptions and IR targets evolved versus what we may have seen historically for the franchise?

I think and Tony could supplement this, that this is the time in the cycle where your returns will be higher than they were at the top of the cycle by a lot. And I think we expect investments to easily be in the 20 to 25% range when we set them up but the upside case ends up being appreciably higher. And so we're not allowed to make projections on these types of phone calls in a public setting of what we can do, but the upside on these types of investments historically coming out of recessions can easily reach 30 to 40% kinds of rates of return. They have historically.. And for our funds it's been closer to 40 now.

You don't know what's going to happen in the future and I'm sure my lawyers would tell me to put every possible caveat into that, but we believe those types of things are logical in certain types of economic environments to occur, certainly as one eventuality. And it's not a function of leverage, it's really a question of buy right and the type of economic recovery we have and what kind of value we can bring to those investments to improve the operations of the companies. And 65 to 70% of the value of what our investors have earned in our private equity businesses have come from improving the companies and operating earnings, not from leverage. And leverage is a misunderstood concept in terms of private equity, and usually the more leverage you have, comes the latest in the cycle and it enables you to pay higher and higher prices, which then result often in stranded equity. So we are seeing an improvement, particularly for the relatively few firms like ourselves who have had quite a good investment record and have had a record of preserving capital for the banking system. And as we have not had any bankruptcies in our latest fund, and that marks us as pretty unusual, I think. And so the banking system is prepared to lend to us on a favorable basis. So I don't know whether that was too wandering an answer for your question, but I--.

Let me just chime in, Howard. Traditionally we've a 20% return, it's up to a premium of that, 25% today, something like that. Traditionally, we've looked for something in the low two-time multiple of money, up in the high two's. But so the return have been raised but more important than that, we find in these parts of cycles that the hit ratio of successful deals goes way up. We anticipate that almost, if we look back in the past cycles almost every deal we've done in these kinds of cycles works out. So when you take these higher return hurdles on an individual deal and aggregate it into a portfolio where you have fewer misses, the portfolio returns actually are even more disparate and even more favorable.

That's very helpful and makes a lot of sense. Tony, you said in the past you were planning for recession and the portfolio was pretty defensively positioned. Is that viewpoint beginning to shift now and are you positioning more towards cyclical businesses with Busch as one example of that?

Not really. All the deals we're doing today, we're getting the returns that I mentioned premised on no real improvement in the world. Now, we do expect that there will be some improvement in the world one of these days but we want to get our return hurdles, if the status quo is maintained, and then if -- when things get better that's when we make a lot more money than what's in our underwriting case, so to speak. We do play cyclicals pretty actively, as you know, and we did that very actively last cycle and I think there will be a time for it. We are starting to look at some of them.

I actually think Busch is a fairly defensive business, it's come off because of the balance between fly-in and local customers, so you get fewer fly-in but the local customers don't fly out so much so you have a fair amount of balanced business. Clearly it's come off the peak, but I think it's at a sustainable level now even if there's to improvement, and even if there's no improvement in the world we'll get a very nice return on that deal, I believe. But we are looking at -- so it's not a terribly cyclical business frankly, it really held its EBITDA very well in this environment. But we are starting to look at some decidedly more difficult businesses. But we think it's a little too early to bet on a turn.

Okay. And thanks. Finally, maybe one for LT on the numbers, LT, within real estate performance fees going forward, how should we think about the potential contribution from the newer debt strategy product versus the more legacy products?

Well, I think that because it's a, what I describe as a more medium to shorter term obviously investment strategy, you're more likely to see performance fees, in fact we did accrue performance fees out that have business of about $12 million for the quarter. As that continues to move forward, you'll see that, performance out of that business before you will out of the rest of the portfolio.

Great, thanks so much for taking my questions.

Your next question comes from the line of Roger Freeman with Barclays Capital. Please proceed.

Hi good morning. I guess Tony on the early media call, you mentioned that LPs are pushing for realizations, you said they like to get money back, obviously also are pushing you to invest, I look, you filed 3 IPOs, you're talking about possibly 8 more over the next 12 to 18 months. Last quarter at least my take away was that you were probably looking to not do that so soon because you thought there was maybe more long-term value down the road. Is that -- maybe that shift, is that driven by the LP's at all or just changing view around more Company economy?

We're not getting pressure at all from LP's to liquidate. As I said, they like getting gains distributed, who doesn't, I do, too. I think you would, too. What we're seeing, though, is since we've -- what we've seen has been a historic run in the market over the last six months. Let's face it, the stock market has had a heck of a run. Frankly, I think the stock market's had a heck of a lot more of a run than the basic economy, we still feel like the economy has some basic challenges, witness today's unemployment number.

So I'd say we've gotten -- we haven't changed really the -- our view and it's very deal by deal, some deals were early and we're holding, some we're more apt to exit. It's dialed a little more towards exit from 90 days ago when we talked because of the run of the stock market and getting a little ahead of the economic development. So I'd say we've accelerated some of our plans and we're getting some pretty interesting valuations from investment bankers coming in, and it doesn't seem to us imprudent to derisk some of these companies, delever them, take some money off the table and send some money back to our LP's. For the most part though on the IPOs, we're still holding almost all the shares that we had predeal.

Right. Okay. And I guess sort of putting some of those comments together, it sounds like there may be a bit of a push here, and given it sounds like you're more intermediate to long term cautious given, longer term economic challenges, deficit issues, et cetera, that you maybe see a bit of a lull again after this.

Well, I think we're going to have a little recovery but I don't think that this 3.5% GDP growth that we saw in the third quarter is the long-term sustainable level. I think it will, after -- we'll have a couple of quarters of nice growth then it will settle down into something much slower and unemployment will be stubbornly high and it won't feel great.

Right. And of course for that IPO window to stay open, IPO's need to perform, what are your thoughts around that? Because while there's been a pickup, the aftermarket performance has been -- has actually been pretty weak, surprisingly.

Yes, and that's of concern to us because as I think I mentioned before, we try to price all of our deals to go to premiums. And I think any kind of responsible private fee firm would do that. The momentum in the companies, though, their earnings is pretty good. And when you get a little bit of the cost -- and this is true of American industry as a whole, I think, the cost of American industry have been so battened down, it's remarkable what American industry has done to cut costs. And a little bit of revenue pickup, a lot of that falls to the bottom line. You see a lot of what economists will say productivity pickup, labor costs per unit are down, and that's -- so I think that you could have even modest economic pickup here, will drive some pretty good earnings, both private equity portfolios and non-private equity companies.

Right. Variable contribution margins are probably the highest they've been in a while.

Yes.

The -- okay, that's great. And separately on -- you made some interesting comments earlier around leverage, actually both this call and the last, relative to historic norms being back in those ranges but this interesting dichotomy where banks are not necessarily willing to lend for large deals and then the smaller ones the smaller banks who would lend to those are still somewhat constrained. So it's sort of interesting the GSO opportunity you have and you talked about one deal and I guess there's a couple or three more, for them to come in and provide financing. Is this something you think can persist for some period of time? Is this a real sizable opportunity for you?

Yes, I think it's. I think the banking system is constrained and I think the whole credit markets will be constrained for the better part of three to five years. If you look at the, I think maybe we've talked about this on some past calls, but if you look at a normalized leverage finance market, bank and bond, it's probably about $200 billion a year and just the refinancing of the echo effect, if you will, of the excessive issuances in '05, '06 and '07, the refinancing of that which starts to hit in 2011, 2012, 2013, will absorb more than all of the -- what's the normal leverage finance market then you'll have normal demand for capital, for less investor companies to grow and you'll have new deals and one thing and another. So we think we're going to be, this country will be in a constrained leverage finance environment for most of the next three or four years and as a result, being a provider of credit, being a provider of leveraged finance credit and i.e. less investment in credit will be a very profitable place to be. And that will be sustained.

Okay. Great. And last question, you talked about the CLO opportunity earlier given your size and economies of scale and that there's a number of smaller players that had scale inefficiencies. You haven't done any of those transactions yet. What's been the constraining factor so far?

I guess as much as anything, there have been a couple that have been very low quality portfolios that we've looked at where, frankly, it would be a lot of mess to clean up. So even though we wouldn't need the added costs, we wouldn't need the infrastructure we could take the business on with the revenues, if it's a real messy portfolio, we have a responsibility to investors to do the best we can. And some of those are just big, big tax to fix up. And we're -- we wouldn't shine glory on anyone associated with it shall we say. So a couple we rejected on that basis, there have been a couple where frankly someone else has offered a more attractive career, future career role to the teams involved. As I mentioned, we have a great team, we don't really need to add to it all that much. So for different reasons. But there are a lot more out there and we're hoping that some of these break our way.

All right. Great. Thanks.

Your next question comes from the line of Guy Mozkowski with Banc of America. Please proceed.

Thank you, good morning. I was wondering if you could first give us is some kind of a breakdown of CAMA in terms of asserts under management between fund-to-funds, credit and MEZ.

Sure, Guy, it's LT, if you look at, I'll give you fee earnings, AUM.

And as is part of credit, Guy

Right. So the way we look at it it's about $25 billion is in BAAM, and then the balance of that is split between our closed end mutual fund, it's about $1.5 billion and then the remainder being what we refer to as our corporate complex which would include MEZ, the GSO hedge fund and the CLOs.

Thanks. And is there some sense that you can give us of the revenue weights?

Sure. Roughly on a management fee basis they're roughly equal in size between BAAM and GSO as a whole. And has been that way for the last several quarters.

And in the most recent quarter, the GSO side had higher performance fees.

That's correct.

Yes, GSO--.

But those will swing around, Guy, as you know, quarter-to-quarter.

The GSO, one way to think about it, is the CLO assets are typically just management fee assets and credits, and then within BAAM about half of the assets are incentive fee eligible, those incentive fees will generally be lower, more like 10%.

Great, that's helpful. Thank you. The tax rate in the quarter was certainly very low. Can you help us understand what's keeping taxes at that level and how to think about the number as we forecast?

Well, I think, Guy, first of all, it's the way we're structured internally, we do you use some inner Company leverage so you'll see some protection from that and we look to keep tax leakage to a minimum. I think over time though, we've given guidance that it would normalize in the 10 to 15% range.

Okay. So we should just keep using that?

Yes. Near term it will probably stay around where it is.

Okay. So maybe for a couple quarters out and then kind of ramp it to the 10 to 15?

Yes, over time.

Okay. The unrealized value that you report for both corporate PE and real estate remains well below cost, although you are talking about harvest opportunities. Would it be fair though to assume that exits aren't really going to be all that meaningful until the unrealized value is well above cost?

Well, if you think about it, all of our realizations have actually been well above their carrying value. So it's not necessarily that way. I would say the realizations that we've seen most recently, a couple of them have been double the mark. So it really varies but, yes, obviously you're going to, over time, fill into stronger markets with stronger values. But as we've talked about in the past, our carrying values are based on a lot of different factors, cash flows, what's happening in the markets, et cetera. We don't believe those will ultimately be our realized values are based on a lot of different factors, cash flows, what's happening in the market, et cetera. We don't believe those will ultimately be our realized value, which we think will be much higher.

Guy, this gets to one of the flaws of FAS 157, we own controlling positions in many of these companies so FAS 157 doesn't accord any value to the control position and a minority position. When you have a controlling position of a company, you can do things with that company, most particularly, when you're doing the strategic buyers to create a lot of value that's not reflected in the mark. So where those opportunities come up, and as I think we mentioned, we have in the last, maybe it was the other call, the last quarter we have, we signed or closed on four deals with strategic buyers to buy the portfolio companies at well above our marks. So that's one of the fatal flaws of the accounting policy.

Yes, those are good points. Let me just ask the final question on distribution plans. I think the language in the release indicates that the priority for outside shareholders is still expected to terminate at the end of this year. Is that correct?

Yes.

And that cash of $0.12 a quarter, which I think is this quarter, rather, which is really just the adjusted cash flow from operations divided by the fully diluted share count, that's really the right way to think about what it would be if in fact there were no priority right now, right?

Yes.

Okay. Great. Thanks very much, I appreciate your taking my questions.

Your next question comes from the line of Dan Fannon with Jefferies. Please proceed.

Dan, are you on? You may be muted.

Sorry about that. In terms of fundraising, you guys talked about the environment getting better. Can you just give a little bit more color as to where you're actually seeing some demand for raising new capital and maybe which pockets are probably still the weakest that you historically have been able to gather assets from?

In terms of -- when you say pockets, you mean parts of the LP community?

Correct.

Okay. Sure. I mean, the weakest are clearly the endowments and we had commissioned our people to do a study I think of the top 20 endowments or something. Most of them, believe it or not, have over 80% of their endowments in a combination of illiquid plus undrawn commitments to illiquid funds. A couple of them were over 100%, hard to believe. So those guys are sort of out of the market right now and they're either trying to sell LP interests in the secondary market or more frequently because those values are not very good, they're actually raising debt at the endowment level to give themselves some liquidity. So that's the most damaged sector.

Then you get into the most vibrant sector is clearly the Sovereign Wealth funds today, there's big cash flows still going to a lot of the major Sovereign Wealth funds in the world and they are aggressively investing still, as you've seen from some of the recent articles, particularly about CIC ramping up its investment pace across the board, both direct and in funds. In the middle, I'd say you have the pension funds and the insurance companies and whatnot and that varies by individual player, but in general, I would say they're making commitments to the fund, to two funds today, although not as aggressively as they did in 2006 and '07.

Great, that's helpful. And then one technical question on CAMA, is it safe to assume now that you guys are above all high water marks across your portfolios, or at least the majority of them?

No, it's not. High water mark is both, you got to look at it two ways. Some of our accounts are -- it's gone. So we've come a long way on high water marks on all the funds for all investors. For some investors for example in BAAM, we're already over the high water mark for about a third of the investors, and the remaining two-thirds, much of that has been eaten up. In GSO we're already over the high water marks for two-thirds of the investors and much of it has been eaten up on the remaining third. We're getting through most of that which is why you're seeing the performance fees coming through.

Great. Thank you.

Your next question comes from the line of Chris Kotowski with Oppenheimer and Company.

There was an article in the Wall Street Journal a couple days ago that weighed on your stock for a while on the Hilton refinance and I guess I didn't think what the market was worried about was that it's such a substantial position that on a recapitalization you might be diluted so substantially that it would weigh on the ability to earn funds -- to earn performance fees from the more recent funds. I wonder if you could help us handicap the danger of that at all?

This is Steve, I don't think we could really comment on that, this is like a live set of discussions going on with a group of lenders, and it wouldn't serve our purposes in that sense to talk about that. And it's not hatched to the point where we could give you an accurate read in any case. So I think we have to leave that in the uncertain category. But everybody appears to be working together on that in good faith. Both on the lender side as well as ourselves.

Okay. Fair enough. And then secondly, I know you don't disclose -- on the private equity and real estate side, I know you don't disclose fund by fund where you are relative to high water marks but is it a fair assumption that all the fees, all the performance fees in private equity and real estate this quarter were earned by the funds from before 2005, and that that's really -- that it's -- that the funds that are under water are mainly the '05, '06 vintages?

This is LT. That's correct. I think when private equity, it was the older funds or the BCP4 where you saw that, and then in real estate, it was as I referred to before, the real estate debt strategies fund, so a combination of those two.

Okay. And when Steve referred to, I think you said $40 billion of carry-eligible funds, is that roughly the way we should think about that out of the combined total of, say, $48 billion in fee-earning AUM between real estate and private equity, should we think of it as $40 billion roughly being above the water mark?

No, that was referring -- he was referring to the amount of assets that we have that are eligible to earn performance fees, not where they are relative to high water marks. It's not technically a high water mark in real estate and private equity, it's more of a preferred return. So you're right in assuming that the older funds which have had more time to season and we've had more of an operational impact are the ones that you'll see performance fees accruing on. So you have to let them play out over time. There's not a relation between the $40 billion that Steve gave you, that's just all our assets that are eligible for performance fees, not relative to high water mark.

Okay, fair enough. Then on the balance sheet we noticed investments went up by roughly $1 billion and you referenced I guess the $600 million from the debt offering that went in there. Was there another significant special or notable fund commitment or something that drove the rest of that?

No, the way to think about that is correct, that it is partly the bond offering and the other portion of it was that we moved at the beginning last in the fourth quarter of last year we started to move investments out of some of our liquid investments, i.e. BAAM, they then appeared on the December 31, balance sheet as due from affiliates and then showed up in the investment line over time as we put them in what we refer to as our treasury fund. It's the bond deal plus effectively our liquid redemptions out of BAAM because as a corporate finance strategy it makes more sense to have it in a treasury fund although BAAM has been a terrific investment.

Out of the $3.8 billion of total corporate investments how much of that is roughly the treasury fund?

Give me one second.

Well, total liquids are $2 billion including cash.

So the way to think about that is $2 billion in total liquidity, about $500 million in cash, about $450 million in our liquid funds and the remainder are in what we refer to as our treasury or bond fund.

Thank you. That's all for me.

Your next question comes from the line of Marc Irizarry with Goldman Sachs.

Steve, question on LP fundraising. Can you just talk about what you're in the market with? I think you touched on it a little, maybe you can put a little more flavor around how fundraising's going for performing funds and then also can you speak specifically about fees and monitoring and transaction fees and what LP's are now expecting relative to maybe what happened, what they were paying for fees in the past?

Sure. Each of our areas is raising different funds, we have different products. So we've got our private equity fund, BCP6 is in the market, and we've detected a real change in attitudes. I mean, the markets were pretty frozen since Lehman went bankrupt and certainly through that March period where markets were down globally really close to 50% or more, that's enough to freeze anybody. And it's taken a while for people to become more and more comfortable as markets rallied but we're seeing some real genuine engagement with potential limited partners in that area.

We also are in the process of talking with people about our infrastructure fund and that appears to be getting more momentum at the moment. As does our clean tech fund. More meetings, more discussions, more people who want to know what's going on in both of those areas. That's sort of in the general private equity bucket. In real estate, we've got our debt fund there. And that has got a lot of enthusiasm. The whole debt area in real estate is really a terrific area now. And it's terrific because with the collapse of real estate values generally and the lack of money for refinancing, that a lot of good properties are going to hit the wall and taking positions in the debt of those properties can yield by historic terms, very high returns with very high levels of safety. And what we're finding is that investors all over the world are really responding extremely positively to that product. And that runs the range, as Tony was saying, from the Sovereign Wealth area to frankly individual investors, we just did a big fund raise through one of the private banks and it was exceptionally well received by customers. In fact, they asked us to come back a second time for a little bit more. And actually, one of the things in private equity is we use this group and just to show you when we say something's changing, we were in the process of doing like a road show and what they're telling us is that we're getting attendance levels at these road shows that are double what they've ever gotten for any product.

Now, the idea that that's happening in private equity shows you that this particular private bank didn't even want us to go out on the road when scheduled in the first quarter this year. And they called us two months ago and said we think this might be interesting. And to be getting double the number of attendees that they've ever gotten at the top of the market for anything, tells you that there's been like a change out there. Now, so I was finishing with the real estate product that there's very wide interest in that. In GSO the -- we've been out in the market with the corporate recovery fund and I think we noted in my remarks that the first closing was $1.50 billion and there seems to be good interest in that as well, it's good risk return kind of product, and GSO continues to market their hedge fund as well. And BAAM is getting a lot of interest.

The fund-to-funds area, and I guess Bob Friedman, our lawyer doesn't allow me to say this, but I say these things anyhow, we think thatwe're the largest funded hedge funds in the world right now, that's what we think, and I guess we can't write that or something in a legal document but we think we are. And what's happening is that -- I was with one of the largest funds in the world last night for dinner and what they were saying is that they wanted to switch more of their money into hedge funds through fund-to-fund operations because they realize that the hedge funds, average hedge fund performed extremely well compared to long-only equities. And even though the return was viewed as disappointing by the hedge fund managers and by peoples' expectation, the loss was still really half of what long-only investors lost. And that most of the hedge funds are -- have gone a long way in making up their high water mark. What that means in English is that they've about got the money back that people started with before Lehman. And if you can have all your money, if you can have your net worth back today that you had before Lehman went down, that's a really good thing. And most people in the world would buy into that.

And so what we're seeing because we have a very professional and thorough and risk control oriented fund-to-funds operation, is that we're getting a lot of institutional inquiries on that. We've been fortunate, we've missed Madoff, we've missed all the investigation, we've missed all these things thus far. And time may tell on that, but at the moment we've had a good record. And so we expect to get increasing flows into that business. We're going to market with our strategic alliance fund, which has been a very strong performer. Historically in our BAAM area. And we expect to have a lot of response from both existing investors and strategic alliance, and some others. So Bob, I'm asking Bob Friedman whether I've gone too far here in terms of saying anything, but I think that gives you some idea. I may have forgotten some other thing that we're marketing but that gives you some idea of how the market's responding to us.

Great, just in terms of monitoring and transaction fees, I don't know if maybe LT, when we think about how to put that into our models going forward, do you think--?

Well, I think on that type of stuff we have contractual arrangements with our investors on each of our funds and we're not expecting any material changes in that regard.

Okay, great. Thanks.

Your next question comes from the line with Michael Hecht with JMP Securities.

Hi, this is [Steven Shuvek] on behalf of Michael Hecht. I have one quick question, I saw the fee paying AUM was up about 6% year-to-date and 2 to 3% in the quarter and yet net fee earnings from operations have been flat. It was $0.08 for the last three-quarters and I was hoping I can get some color as to why fee earnings have not been able to keep pace with the rising fee paying AUM. Well, I think when you're looking at the total fee paying number, you're including businesses that are not driven by AUM.

Steven, that's probably the way to think about it so you have to back out some of the impact of advisory Steve highlighted some of the issues in the fundraising group et cetera, that are having an off year. If you look at just the funds like for example CAMA, real estate and private equity, if you look at just those businesses relative to their fee earnings, the AUM flows have followed through to the fee-earning AUM.

Okay, that's helpful. That's it. Thank you for answering my question.

Sure.

Your next question comes from the line of Roger Freeman with Barclays Capital, please proceed.

Hi, some follow-up questions. The real estate strategies fund, how big is that? What's the AUM on that line?

It right now is approaching -- give me one second -- right now it's at $813 million in fee-earning AUM and it's a fund that really launched earlier this year. As Steve--.

Yes, that's the fee earning. Because the fee structure is that they only start charging as they invest, so when we consider fee earning, we only count in that fund and some of the GSO funds the invested capital whereas if you looked at the total AUM on that, it's a little bit above $1 billion.

Okay. So 800 of it has been, 813 or whatever, at least at the current carrying value?

Correct.

And what was the return on that in past quarter?

It was a little over 9%, 9.2.

Is that all in commercial real estate debt or is that resi as well?

No, it's all commercial. All commercial. Okay. Great.

Then just in terms of the embedded losses in private equity and real estate, sounds like it's fair to say that basically only BCP5 is below cost at this point, in aggregate? And then I guess probably the same on the latest real estate fund?

Well, they're not embedded losses, just to be clear there.

They're temporary.

On the FAS 157.

They're carrying values.

Mark-to-market losses.

I know, I know.

But I would say just looking at it, yes, BCP5 is below cost, it's about $0.70 on the $1 and we also have a BCOM fund which has been very successful but what's remaining in there is also below cost, and then the rest would be above.

But all those old funds, it's a little hard to unscramble Roger, because you have a lot of distributions or gains so all you're left with is a tag on investment. So the fund as a whole can be above costs but the remaining portfolio can be below cost.

Correct.

Right. Okay.

And yes, the -- sorry, go ahead.

No, no, go ahead.

So those old funds are in the carry, so to speak still.

Exactly. Okay.

Real estate, it's actually a little bit different, I'd say in real estate most of the funds are below cost.

Okay, got it. And then in terms of the flows, in BAAM, I guess, the better net, the positive net flows, is it a function of the redemptions coming down versus inflows going up or can you give us gross inflows?

Sure.

Over the last quarter, it was 790 in net inflows in terms of redemptions versus new accounts. And it was about $1.2 billion of performance appreciation.

On a fee-earning basis.

I guess I was curious about gross flows, so flows and less redemptions, how that's been trending--?

Grows flows in were about $1.3 billion, and then about $500 million out.

Okay. Great. And then let's see, in terms of the high water mark there, so just the two-thirds of BAAM that are below, and then the third of GSO, how close are those, just so we can think about it from a modeling perspective?

You really can't do that because it's account-by-account, it depends when they came in, and when they left which is why you have either one-third or two-thirds over and one or two-thirds below, it's all a question of the investors' basis. Also because these are multiple products, BAAM had something like 16 different products, GSO has a bunch of different products and there's no way to generalize.

Okay. And then just on Hilton, can you remind us what the split on that was between how you allocated between real estate and private equity?

Something like two-thirds real estate, one-third private equity. In terms of the original investment.

All right. Just a couple more. The -- in terms -- bigger picture question, as you think about private equity going forward, do you think that you'll -- do you anticipate seeing less competition from the banks and dealers and their allocating capital to private equity deals and maybe in the past kept the period ones for themselves?

Well, I don't know that they kept the better ones for themselves. If you look at the investment record of the private equity groups of the captive to the investment banks, I don't think any of them are above median for the industry. So I wouldn't say they kept the best ones for themselves so much. However, notwithstanding that, we're seeing a lot less -- they weren't ever our prime competitors but a lot less competition coming out of the sector. Essentially, Merrill Lynch is gone, Lehman Brothers is gone, First Boston's cut way back or gone, and Goldman remains an active player, but I haven't -- I don't know what their level of activity -- Morgan Stanley is small, and so we don't see much activity there.

And we also see in the real estate area a big cutback from those firms. And so the real estate area has had severe cutbacks from those firms. And I think it positions firms like ourselves over time in a much stronger position.

Right, okay. And byte way, on real estate, you made a comment earlier that your -- that cash flows remain stable, vacancies are going up and rents are coming down, is it your cash flows are stable, but the industry may not be because of that dynamic?

So, what happens is when you sign 10-year leases, the reason why you're relatively stable over a quarterly period or even over a year is because there's very slow leakage down in the office space, unlike hotels, which of course are empty every night, and they have a one-day lease compared to a 10-year lease. And so the actual cash flows from a good office portfolio are pretty stable. It takes years for them to actually change one way or another.

One of the things we look at obviously, Roger, is the in-place rents versus what the market rents would be, and the upswings of the cycle, your in-place rents are typically below your market rents if you could re-lease all that space overnight and in the downcycle, your in-place rates are above often the market rents if you had to re-lease it all overnight. But so obviously we spend a lot of time when we're valuing a building, looking at market rates, not just in-place rents. But that lag has a dampening effect both ways.

Okay, makes sense. Last question, Tony, I was looking at the slide from -- that you showed at our conference a couple months ago, your institutional client base 70% North America now, Middle East 9, I guess Europe 15, Asia, Australia, 7. As you look and talking about where you've got interest from LPs, Sovereign Wealth you said is sort of at the top on the list, if you were to try to project on three years out, how do you think that mix might look? North America, I presume, shrinks?

I'm not -- I can't quantify that, but North America's share will be shrinking and both -- and the shares of Asia, Middle East and Europe will all being go up. But for slightly different reasons. Asia and the Middle East will be going up because of the accumulation of assets and wealth in that part of the world, and eventually and, therefore, the amount of investing that they do. Europe for us will be going up because we were understaffed in our marketing efforts in Europe and we've recently taken some steps to rebuild that. We expect greater penetration of the existing base in Europe.

One other thing, I would say, in terms of understanding the firm, we've gone through a major look at our distribution and we're adding significant people to that, we're putting in some systems for measurement of account contact and penetration, we're putting in more incentives for cross-selling, and I think in that regard that there's a lot of opportunity for us to penetrate better in Europe, Asia and Latin America. And so--.

And the Middle East.

And the Middle East. And so we see the whole distribution of our products as being a truly important thing and one that's getting more resources and more focus here at the firm.

Last time we looked at the US, we had some huge share of all of the institutional investors that invest in alternatives, something like 70, 80%. So we're kind of maxed out in terms of penetration in these -- in the most mature market and some of these other markets are less mature and so that's a trend and then as Steve says we're building distribution capability heavily to tackle those.

And those other markets are basically going to be increasing their percent of alternatives at a faster rate because they're underallocated at the moment.

Okay, great. Thanks for indulging me.

Our final question comes from the line of Marc Irizarry with Goldman Sachs.

Tony, just a quick follow-up, maybe you can talk about your exits via M&A versus the IPO market, so if we do see some more exits coming out of strategic deals, what's sort of the historical multiple invested capital for those types of deals versus IPO's.

Actually, interestingly they've been about the same but there's a cyclical pattern to it. The last few years, particularly in the hot markets of '06/'07 an awful lot of those were IPO exits because the public equity markets were fully valued. We got out in this cycle of liquidations the first four were basically, or four of the first five at least, were basically strategic because we were getting valuations from a strategic buyer that you couldn't get in the public markets. The public markets have sort of caught up to that now, and now you're seeing a swing back to more of IPO's and secondaries as a percentage of the total.

There is another fact you see sometimes in that secondar buyout, and that is you're not seeing much of either way but in a hot credit market, you might see a that come take a lot of share of the exits. But the (inaudible) historically have been about the same because given that we have control of the Company, we can go where we get the best price. And so we're always sort of arbitraging that and it's sort of like in a crowded highway, people are switching lanes all the time and they all seem to actually move about the same pace, that's sort of how we drive the car.

Strategic buyers tend to be more consistent in their price. So they'll -- equity markets go up and down a lot, and at times they'll be -- so if you think of strategic buyers as a much more modulated curve in the way of valuation, when equity markets get hot they tend to run above the strategic value curve, when they get low, they tend to run below that strategic value curve, but the strategic guys are always there, pretty consistent values are looking at synergies, building their companies are taking more of a long-term view than a short-term valuation view, and that, as I say, gives a more stable valuation.

Great, thank you

Now I'd like to turn the call over to Joan Solotar for closing remarks.

Great. Thank you, and thanks everyone for joining and just feel free to call if you have any follow-ups.

Thank you for joining today's conference. That concludes the presentation. You may now disconnect and have a wonderful day.