Blackstone Inc (BX) 2011 Q3 法說會逐字稿

Welcome to the Blackstone third-quarter 2011 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; Joan Solotar, Senior Managing Director, External Relations and Strategy.

And now, I'd like to turn the call over to Joan Solotar.

Thank you, Chantele.

Good morning, everybody, and welcome to Blackstone's third-quarter 2011 conference call.

I'm here today with Steve Schwarzman, Chairman and CEO; Tony James, President and Chief Operating Officer; and Laurence Tosi, our CFO.

Earlier this morning, we issued a press release announcing results, which you can find on the website, and we expect to file our 10-Q in a few weeks.

So I'd like to remind you that today's call may include forward-looking statements, which by their nature are uncertain and outside the Firm's control.

The actual results may differ materially.

For a discussion of some of the risks that could affect the Firm's results, please see the risk factors section of the 10-K.

We don't undertake any duty to update forward-looking statements and we will refer to non-GAAP measures on the call.

For reconciliations of those, you should look in the press release.

This audiocast is copyrighted material.

It cannot be duplicated, reproduced, or rebroadcast without consent.

So, we reported economic net income, or ENI, of negative $0.31 per share for the third quarter.

That is down from positive $0.31 in the third quarter of 2010.

So the negative ENI primarily reflected performance fee reversals in the businesses due to the reduction in carrying value of the portfolios.

As you may imagine, values were negatively impacted in the quarter by the sharp decline in global public markets, widening of credit spreads, and negative foreign currency adjustments.

Distributable earnings totaled $120 million, or $0.10 per common unit.

That compared with $0.15 in the third quarter of 2010.

We will be paying out a $0.10 per unit distribution to common unitholders of record as of November 15.

And as we have outlined in the past, we intend to pay a flat distribution for the first three quarters and then we will have a true-up in the fourth quarter.

I also want to take this opportunity to let you know that we'll be hosting our second investor day.

This year, we're doing it in London and it will be held on November 10.

Similar to the first investor day that we hosted last year, we're going to have the heads of the business units presenting, and I think it will be really a terrific day.

So hopefully you have received the save-the-date and have registered, but if not, just let us know and we'll send you the information.

And if you can't attend in person, you can absolutely watch it on the webcast.

As always, if you have questions on anything in the press release, feel free to follow up with me or Weston Tucker after the call.

And with that, I'm going to turn it over to Steve Schwarzman.

Good morning and thank you for joining our call.

In the third quarter, we witnessed a severe increase in market volatility, as you know, and one of the worst quarterly selloffs in the history of global markets.

The S&P slid 14%, while other equity indices in both developed and developing markets fell even more.

In credit, high-yield spreads meaningfully widened to levels well above their long-term averages.

Blackstone's stock reflected these negative market forces and declined 28% from $16.56 to $12.00, but has now rallied back 11% to $13.24 as of yesterday's close.

For much of the quarter, the primary investor concern remained Europe's escalating debt crisis and how in particular the member states would backstop any contagion to the region's banks.

In the U.S., the highly-publicized debt ceiling negotiations eroded investors' confidence globally in policymakers' ability to effectively deal with the budget and unemployment situations here in the U.S.

Yawning budget gaps have reduced the appetite for further fiscal stimulus.

Monetary policy is already very accommodative, and central banks around the world are suffering from diminishing incremental returns from their actions.

With these issues unresolved, underwhelming economic data has contributed to an increasing consensus that growth will contract or even reverse.

Corporate America has remained resilient, however, with strong cash flows and balance sheets, and the market is expecting earnings growth in both 2011 and 2012.

But companies are cautious, particularly in hiring, due to an uncertain demand outlook, eroding consumer confidence, and a hostile and uncertain political and regulatory environment.

In an environment dominated by risk aversion, few asset managers are generating organic growth and many are seeing dramatic increases in rates of investor attrition.

Equity fund outflows, for example, were at levels not seen since late 2008, adding to technical pressures in global markets.

It is exactly in times of uncertainty such as this that the diversity and stability of our business model is most apparent, as we grow market share and position our funds for future outsized returns.

In the third quarter, we had fee-earning net inflows in every one of our businesses.

I'm going to say that one again because it is highly unusual.

We had net fee-earning inflows in every one of our businesses, and we ended the quarter with record fee-earning assets of $133 billion, up nearly 30% over last year.

We include commitments which are not yet earning fees, as well as our 40% share of the assets of Patria, our partner in Latin America, which themselves grew over 100%.

Blackstone's fee-earning AUM would have been $147 billion.

Although our third-quarter earnings were negatively impacted by the turbulence in the public markets, this mostly reflected unrealized mark-to-market adjustments, as Joan mentioned.

They were non-cash and they do not reflect where we expect to exit our investments.

While public markets can be volatile in the short term, we remain patient and conservative investors.

Unlike most public market participants, we can invest to drive change and impact the outcome of returns in most of our businesses.

We identify promising businesses and provide them with capital, expertise, and operational support to maximize their potential and increase long-term value for our investors.

We were very active in the third quarter, putting $4.8 billion in capital to work across our drawdown funds and committing to another $1.4 billion, which is our highest level of investment since 2007.

On a year-to-date basis through September 30, we invested or committed $12 billion in total capital.

In private equity, key themes are energy, platform buildups, non-cyclicals, and Asia, particularly India.

In almost all cases, we rely on proprietary sourcing and transactions, or situations where we believe we have a distinct advantage.

Recent investments include two large traditional LBOs in defensive sectors at attractive valuation levels.

The first, Jack Wolfskin, is the undisputed leader in outdoor apparel in Germany.

It's just starting to tap its international growth opportunities.

The second, Emdeon, is a leading healthcare information technology company which sits at the center of virtually all commercial healthcare transactions.

Both of these investments have significant unlocked potential for value creation.

And yesterday, we announced, and today it was in the newspaper, that we bought 44% of Leica, the famous camera company, which we intend to work with the management to expand in Asia and in other emerging markets/countries.

We also closed an investment made jointly by BCP VI and our energy fund in Meerwind, which is a EUR1.2 billion German offshore wind farm project located in the North Sea.

To date, we have committed to five transactions jointly out of BCP VI and our energy funds for a total of $750 million in equity.

We have record levels of dry powder to put to work over the next several years in private equity, given our recent success in fund-raising, and we believe the environment will continue to present many attractive opportunities.

With regards to the financing environment, while investor caution has increased dramatically, there is a functioning market and deals are pricing, albeit we are seeing more muted volumes than a few months ago.

LIBOR and treasuries have remained at historic lows, but spreads have widened, resulting in an average all-in cost for debt for new LBOs in the 10% range.

While it varies by the transaction and type of company, we believe a new LBO can be set up today at a modestly lower-than-historical mid-cycle leverage multiple.

We believe multiple $1 billion debt packages can still be absorbed by the market, as evidenced by our well-subscribed $2 billion financing for Emdeon.

In terms of our current portfolio, because of mark-to-market accounting you should expect to see volatility on a quarterly basis in the carrying value of our portfolio, both to the upside and, this quarter, the downside.

In private equity, the carrying value of our contributed funds declined 11% in the quarter, following nine straight quarters of gains.

The reduction was primarily driven by the markets' impact on the value of our public holdings, as well as negative foreign exchange impact.

Our portfolio, however, is up 2% year to date through September 30, while global markets were down in double digits.

So we have significantly outperformed the public markets.

Our portfolio of companies are holding up quite well.

And although there has been some slowdown in certain sectors, we estimate aggregate revenue growth between 10% and 12% in the third quarter.

Any of these kinds of comments involve a blizzard of numbers, but the idea that we're earning revenue increases of 10% to 12% shows a certain inherent strength in our companies.

Two weeks ago, we gathered all of our portfolio-company CEOs at our annual CEO conference in New York in which we discuss trends we're seeing in the global markets and the economy and share best practices.

Together, Blackstone's 70 companies, if aggregated, would have $115 billion of revenue, employ approximately 675,000 people, and would rank number 14 on the Fortune 100.

Our management teams are cautiously optimistic and are doing a great job navigating the current environment.

Moving onto real estate, we believe we are the best-positioned investor in the developed world, both in terms of our current portfolio, as well as our capacity to make very attractive new investments on behalf of our limited partners.

The carrying value of our portfolio was flat in the third quarter.

However, we saw a modest reduction in the value of certain funds, which drove the non-cash negative performance fee accrual reflected in our financial results.

This was primarily related to the decline in the public markets once again, impacting our public stock holdings and certain of our hospitality investments, along with the negative impact of foreign exchange.

Offsetting these declines was an increase in the value of our retail portfolio.

The total portfolio was up 14% year to date, and our two largest funds, BREP V and BREP VI, are valued at 1.4 and 1.3 cost, respectively, and both are accruing full carry, whereas most people in the real estate business, similar time, the monies they've invested have lost significant amounts of money.

Despite the challenged economic climate, operating fundamentals remain healthy across all sectors.

In hospitality, although lodging stocks declined 20% to 30% on average in the third quarter, the fundamentals remain strong with U.S.

industry RevPar up 8%.

In office, new supply remains at historically low levels, and we are still seeing occupancy improvement and rental growth in most of our core markets.

Fundamentals remain strong in our industrial and retail properties.

We feel very good about the condition of our current portfolio as we believe we manage premier assets in the best markets.

In terms of new investments, conditions remain favorable for us, given significant distress in the system and the short supply of opportunistic capital.

We expect these conditions to persist for several years.

Competition on new deals is limited.

We have the largest pool of available capital in our asset class and can move quickly and with certainty to close a deal.

While lending markets have tightened and CMBS activity continues to be constrained, financing is available for prime assets and strong sponsors like ourselves.

In the third quarter, we deployed $1.8 billion from our carry funds, primarily in bankruptcies, overlevered situations, and non-core asset sales.

This amount includes approximately $700 million in Europe where pressure on the financial system is leading to increased transaction activity, and this is a new factor that the Europeans are now really starting to liquidate real estate assets.

On a year-to-date basis through September 30, we have invested in real estate or committed $5.7 billion at attractive prices relative to historical values and replacement costs.

In addition, we've signed several sizable commitments post quarter-end, actually, for roughly another $1.4 billion, for a total of $7.1 billion, reflecting the ongoing strength of our pipeline, which is actually pretty remarkable.

As a result, this will be one of the most active investment years for us since we started our real estate business 20 years ago.

We've enclosed the investment period for our BREP VI global fund in August and have an initial close of $4 billion for our seventh global real estate fund.

We currently anticipate that the seventh fund will be at least as big as our previous one.

Lastly, an update on realizations.

We've been an active seller of real estate assets so far in 2011.

We've generated $1.6 billion in realized proceeds.

Performance fees from the gains on these sales have yet to be reflected in our cash earnings numbers.

During the third quarter, we sold a portfolio of Canadian office buildings at a multiple of invested capital of 2.3 times our investors' money and at 21% IRR.

Also last month, we reached an agreement to sell a mall in Shanghai, our first sale in China, which we expect to close this quarter.

Given the recent market volatility, we've delayed certain disposition activity; however, there remains a strong bid in the market for stabilized assets, and we expect more realizations next year.

Let's move on to BAAM, our customized solutions business in hedge funds.

BAAM typically outperforms in markets of dislocation.

Our investors have come to view us as a trusted safe haven during turbulent times and a source of capital preservation.

For example, while the hedge fund industry halved in size in 2008 and 2009, actually a devastating situation, BAAM actually had net inflows.

This continued to be the case in the third quarter of 2011 as BAAM reported fee-earning net inflows of $3.6 billion just in one quarter, including our October 1 subscriptions.

About 60% of this was in customized funds.

This brings BAAM's year-to-date net inflows to $7.3 billion.

One-third of our inflows were from new client relationships.

In terms of product focus, nearly one-third was raised in BAAM's long-only commodities and equity replacement business.

So far this year, we have also invested over $700 million from our hedge fund manager seeding platform into several promising managers.

Despite what's been happening in the market, BAAM's year-to-date composite gross return is a negative 2%.

Our solid performance and significant inflows resulted in assets under management of over $40 billion as of October 1.

Over half of BAAM's fee-earning assets have performance fee structures, which can generate significant additional fees and periods of positive returns.

While it will take more stable markets for us to see realized performance fees, our asset growth is certainly positioning BAAM for meaningful future cash earnings.

On our credit platform, GSO remains one of our fastest-growing businesses, and our funds continue to execute across all strategies.

Two weeks ago, we announced our plan to acquire Harbourmaster Capital, a leading European leveraged-loan manager with approximately $11 billion in assets.

We plan to form an integrated platform with our existing European leveraged-loan business, which will have $15.5 billion in assets supported by a combined team of 40 professionals in both Dublin and London, making us one of the largest leveraged-loan investors in Europe.

We believe there is a significant growth opportunity within this asset class, given capital constraints of the banks, and this strategic acquisition is a critical part of our growth plan, as we anticipate launching several new funds and strategies in that region.

During the quarter, our mezzanine and rescue lending drawdown funds deployed significant dollars to capitalize on the dislocation in the market.

We invested $1.4 billion in these strategies, and the current backlog to provide good middle-market borrowers with much-needed capital on favorable terms has never been better, at over $1.5 billion.

Our flagship mezzanine fund is nearly fully invested.

We've raised over $2 billion through October for our second mezzanine fund.

These assets are yet to be included in the Firm's AUM.

Finally, our credit-oriented hedge fund declined modestly in the third quarter, but we're still up 5% to date, outperforming benchmarks, a good performance.

Our shorts and hedges protected the portfolio, as most long positions traded off with the market.

The vast majority of our hedge fund assets are above high-water marks and will earn performance fees with positive returns.

In our advisory segment, revenues were basically flat in the third quarter versus the same period last year.

In M&A, despite a slowdown in industry volumes, revenues were up year over year as several transactions closed, and the pipeline remains promising with over 100 active mandates.

In restructurings, revenues declined as expected, although our outlook is solid and we are winning a diverse set of mandates across industries and geographies.

Finally, at Park Hill, our placement agent business, revenues rose slightly as investors remain cautious investing in the current environment.

However, our pipeline is building as investors look to increase allocations to alternative investments, which will benefit our business.

In summary, I believe there are three tailwinds which will drive returns for our public-market investors over time.

First, we should benefit from secular tailwinds as limited partners increasingly look to strategic partners like Blackstone to provide higher returns and increase their allocations.

We are only in the earliest stages of this development.

Second, we have a clear competitive advantage, given our diverse business mix and their leading scale and outstanding performance in all the alternative classes of scale.

We are the partner of choice for most limited partners.

We seek stability and outperformance, and they continue to entrust us with a greater share of their capital.

And finally, although it may take some time to work through this current period of market dislocation and see a true cyclical upswing, we will eventually see a healthier environment for realizations, which will generate higher cash returns.

With that, I'd like to turn the call over to Laurence Tosi, who will close with some comments on our financial results.

Thank you, Steve, and good morning everyone and thank you for joining the call.

Over the past year, Blackstone had double-digit gross fee-paying asset inflows in every segment of the Firm, totaling $42 billion, against a difficult market backdrop.

Blackstone is now at a record $133 billion in fee-paying assets, up 27% year over year, despite the fact that we returned $10 billion of fee-paying capital to our investors from realizations and returns of capital.

That scale amount represents the largest, most diverse, and fastest-growing asset base of any listed alternative manager.

Blackstone's market position allows us the flexibility across a uniquely diverse set of asset classes to find and create investor value.

Our funds generated $29 billion of value in the last year.

At the same time, we deployed or committed $12 billion year to date in new deals.

We remain well positioned as our dry powder increased over $33 billion, even as transaction activity picked up considerably over the last two months.

The market volatility in the third quarter drove our first quarter of negative performance fees and ENI since the first quarter of 2009.

Our negative ENI in the quarter reflected less than half of the positive ENI we reported in the second quarter of this year.

As such, the more meaningful trend is our year-to-date results, which continued to show positive momentum.

For the year-to-date period, ENI was $929 million, or $0.84 a unit, driven by performance fees which were up 74% year over year to $817 million.

Even though realization activity remains well below normalized levels, we generated $501 million in distributable earnings year to date, up 8% from last year.

One key driver of our cash earnings is our strong growth in fee-related revenue, which rose 18% year to date.

Blackstone has now tripled its fee-paying assets and commitments over the last five years, as the world's most sophisticated institutional investors have increasingly turned to us in a period of unprecedented market dislocation.

Blackstone's continued net inflows in the toughest of markets stands in sharp contrast to the asset management industry as a whole, which has been beset by redemptions and falling revenues.

While we have heard some draw comparisons of the current market environment to the fall of 2008, we see it quite differently.

First, unlike 2008 and early 2009, our marks were driven primarily by changes in public valuations, not by deterioration in underlying portfolio company performance, which in this case remains quite solid.

And second, our GSO and BAAM businesses, which are less volatile than and less correlated to equity markets, continued to grow at a pace considerably above the industry, up 20% in the last year alone.

Those businesses were a combined $41 billion in 2008 and today manage $65 billion, giving Blackstone greater earnings power and stability.

A couple of thoughts on the balance sheet and our liquidity.

Our balance sheet remains strong as both S&P and Fitch affirmed our ratings in the quarter at A/A+, the highest rated of any listed alternative asset manager.

We ended the quarter with cash and liquid investments of $1.8 billion, illiquid investments of $2.1 billion, and net accrued performance fees of $1.2 billion, which equates collectively to approximately $4.64 per unit in combined value.

Our balance sheet and liquidity are a distinct competitive advantage that affords us operational and strategic flexibility.

This allows us to pursue opportunities to further grow and diversify our businesses, such as the Harbourmaster Capital acquisition by our GSO credit business that we announced a few weeks ago.

This deal marks our fourth strategic acquisition in the last two years during a period of sharp contraction in the financial services industry in general.

On behalf of all of us on the call and everyone here at Blackstone, thank you for joining us, and we will take any questions that you may have.

(Operator Instructions).

Bill Katz, Citigroup.

Okay, thank you.

Good morning, everybody.

Just a couple of questions.

First one, just in terms of maybe a broad question.

Obviously, Harbourmaster will feed into this.

But can you talk a little bit about southern Europe?

I think both you and some of your peers have been talking increasingly about the opportunities there.

I'm just sort of curious, from both a timing and a product perspective, what might be on the horizon.

In terms of what's on the horizon, we're seeing -- it's sort of complicated.

As you can see every day, there is a different attitude the market takes to the ability of the European countries to get the financial condition there under control.

You've got very large capital increases over time from Basel III, and that is starting to really weigh on market volatility and people's confidence in Europe generally.

That combination is starting to lead to the sale of assets, whether it is for capital reasons or confidence reasons.

And we have found over time that, at the Firm, when we can buy very good assets, good companies, at prices that we regard as more reasonable, we do quite well with that.

And we also have an advantage that we typically can finance assets when many other people cannot because we've had a very good historical performance in terms of protecting money provided to us by the banking system.

So we're seeing flows that have significantly improved in both private equity, companies for sale, really good companies.

I mean, this Leica thing is very interesting, a global great brand name that signifies quality where we can take a business like this and help the current management expand it around the world to dramatically improve the revenues potentially; to real estate where the banking system is selling assets on a much more aggressive basis where our scale both with our BREP money and our BREDS money.

BREDS looking for lower returns and BREP looking for higher returns can combine to make us a purchaser of choice for those type of assets.

We're seeing things there as well on the credit side as spreads blow out where you can buy very conservative securities at much better yields.

So we're seeing across our range of activities very interesting opportunities there with relatively low risk and very good upside.

So, one should not always just follow crowds, and we don't do things to be contrary just to prove a point.

But on a relative value basis, we're seeing much more across our range of activities -- increased mandates on restructurings, for example.

There are a variety of things that are going to be positive for us in that environment.

So the second question is, when you come back to your discussion earlier about the ability to still put some financing in place at the 10% cost of debt, excuse me, what kind of internal rate of return do you think you can target, given the financing and the leverage constraints at this point?

Well, our return hurdles are still in the 20s, consistently, and we think we're getting them actually with lower risk capital structures because there's less debt in a constrained economic environment, which we basically see as being stagnation.

So that if we -- so, in addition to lower risk, if we get some kind of economic improvement, we'll do much better than that.

Just my last question, and thank you for taking them all.

I just saw some headlines coming across as I was reading through your earnings.

Could you maybe update us on your latest thinking on carried interest?

And I'd be curious at where would you see the potential risk, at the partner level or at the partnership -- the publicly-traded partnership level?

Thank you.

Bill, it's LT.

I think -- we've addressed this a couple of times.

In the current construct, or at least what we have seen that has been proposed at various times over the last several years, it focuses on individual tax returns, so the impact will be there, not against the structure that we have as a publicly-traded partnership.

Okay, thanks for taking all my questions.

Michael Kim, Sandler O'Neill.

Hey guys, good afternoon.

Just to follow up on kind of the markdowns across your private-equity portfolio companies during the quarter, was it really just kind of a function of the public markets and the FX losses?

I know you talked about portfolio-company revenues being up kind of 10% to 12% in the third quarter, so does that suggest you didn't meaningfully adjust your EBITDA growth assumptions as you kind of looked across the private firms?

Yes, it was the public markets and the FX.

Okay, and then, just in terms of capital management, it sounds like you're still being pretty aggressive as it relates to building out your footprint and bringing new funds to market, and then you continue to take advantage of some M&A opportunities.

So just assuming kind of realizations get pushed out a bit, just given the macroenvironment, does that impact your thinking at all in terms of continuing to broaden out the franchise?

And would you maybe consider starting to pull back a bit if you weren't able to kind of self-fund some of that growth, if you will?

No.

I think we've got a really unique time in the Firm's evolution where, because of the fact that there is basically no one else in our industry that has the four basic areas of private equity, real estate, hedge funds, and credit, that we can take and should take that array of products, which each benefit from knowledge each other generate, take them on a global basis, and we're not global in every one of those businesses.

And that represents a terrific opportunity for us, provided, of course, that we continue to have outstanding performance, which is the most important thing in the management of the Firm, delivering a quality product.

To the extent that we can do that in more places in the world, which is our objective, we can do a really good job for investors all over the world, for our public shareholders, and the people who work at the Firm.

So everybody's interests are aligned, and it makes for also an interesting career for people.

One of the things we're doing now is starting to move people around the world, which is, if I were younger, I'd certainly enjoy that, and it's remarkable when you do that to see how some of the younger people at the Firm perform.

It's sort of magnificent, and it takes the Firm's culture and also moves it around.

Michael, let me comment slightly differently.

We don't think -- we think the returns will be great and as great as they ever have been.

I don't understand why we pulled back.

In fact, as I was just saying, we think they'll be higher for the risk than what we've seen for five years, anyway.

And our holding periods, we always assume pretty long holding periods and the returns hold up to that, so, yes, no change.

Just finally, I know you're focused on kind of growing organically, but how would you characterize the M&A environment more broadly?

And then, how focused are you in terms of continuing to add scale by maybe doing more CLO deals or maybe expanding geographically through some partnerships like Patria?

Look, we see a lot of things and we look at a lot of things, carefully.

We try to be selective, actually, and we've got pretty high standards.

We want only best-in-class teams because that is what we stand for and that's what we are and that's how we pride ourselves.

We want businesses that are truly synergistic with what we have.

We don't want to get bigger for being bigger -- just for the sake of being bigger.

And we want to get growth that drives the growth franchise and we don't want to pay much for it.

When you add all that up, there's not much that gets through the screen, frankly.

Selectively, we'll look and we'll continue to do things.

I don't think you should expect a lot of acquisitions or anything very transformative.

Dan Fannon, Jefferies & Company.

Good morning.

I guess starting with the real estate segment, and you talked about an additional -- I think the number was $1.4 billion invested post-quarter.

I guess if you could give a little color.

Is that mostly coming in Europe, or thinking about where the opportunity set sits today and where you're seeing capital deployment most attractive?

So, it's mostly not Europe, although we have a number of things going on there.

It's split reasonably evenly between some U.S.

assets, although they're pools of assets.

And one of the pools has a bunch of stuff globally, so it's a little hard to say where that is in our real estate equity area, and then the other about half, a little less than a half, is in our BREDS area, so our real estate debt business.

But if there's a common thread amongst those and with some of the previous assets, I would say you have distressed holders who are looking for partners not only with capital, but with expertise and with a very really favorable brand.

And so in most of these situations, we're being called directly or getting an exclusive look.

And most is in the U.S.

just because of the scale of the market.

But it's absolutely global.

Joan was talking about the sellers, and our ability -- one of the interesting things when you buy some of these assets, sometimes you can buy them outright.

Sometimes the seller, if it's a financial institution, doesn't want to sell the whole thing, but wants, in effect, a partner to work those assets out.

And we're at the top of that pile in terms of people they want to work with.

Sometimes they'll sell a quarter of what they own or half of what they own, and we'll keep the profit on that and manage those other assets for them, and that is happening in Asia as well as in Europe.

So we're looking at stuff all over the world.

It's quite interesting to be using our platform to be able to do that because we have people all over the world doing it, and the sellers know that.

That's a pretty unique human resource and reputational aspect.

One other thing is that sometimes when you buy these types of portfolios, you have to be approved by a limited partner group that owns these assets.

And that's one thing that drives a lot of deals our way because we have almost all these investors already investing in our real estate business or some other part of the firm with hopefully a favorable feeling about it all, since almost all of them keep coming back and giving us more money.

And so, we can get approved in situations where someone else might have more difficulty, which makes a complete execution mess, potentially, of a transaction.

So this is like a global activity for us.

Just to sort of -- one thing I'd add to that, which I think reinforces what Steve just said, 30% of the LP capital we've deployed this year to date in private equity and real estate has been in Europe, which is up from less than 5% last year, so there's been a marked increase.

And that reflects the fact that we have the platform to be able to take advantage of those opportunities, which we think is unique and is something that we continue to invest in.

Okay, great.

That's really helpful.

And then, I guess, LT, given the limited disclosure around the Harbourmaster deal, can you maybe help us from a modeling perspective?

I think it's expected to close first quarter of 2012, but maybe a sense of the fee rates or how we should think about the rolling into those assets.

No.

We expect to close in the first quarter.

With a smaller acquisition like that, we don't give out specifics with respect to it.

We do expect it to be accretive.

We thought it was an attractive process.

We have a lot of good synergies with that deal, so there's not only the financial synergies that we have with respect to consolidating it with our platform in London right now, which is EUR5.5 billion of CLOs, but also there are strategic synergies with respect to the assets that they invest in and, frankly, the lack of LP overlap, which is something we look at very closely with assets like this because it introduces the Firm to a new set of investors that we found very attractive.

It's $11 billion, as I think we mentioned earlier.

80% of the names in that CLO we already cover, so we already have analysts and we're already fully in research and fully down to speed on that -- up to speed on those things.

So you can see how there could be some cost synergies eventually.

And with what is happening in the European banks, I just think being the largest loan buyer in Europe has got to be an amazingly powerful position, and we're not sure yet how we will utilize that.

More than that, I think Joan and Weston will work with you on.

Chris Kotowski, Oppenheimer.

Good morning.

Knowing that the window for realization is kind of slammed shut during the quarter, you did have some early in the quarter, Universal Studios and Intelnet.

And I was just wondering why didn't any of that flow into realized performance fees for the quarter?

Some of those are not in [repeatable] funds, right?

Chris, this is LT.

Those deals -- actually, there were a couple so far.

There was Universal, there's also Graham Packaging.

Both of those are BCP III deals, which were non-contributed funds.

So the only place that they impact our financials is with respect to the investment income because the Firm's capital that are in those deals, we do get a return on, but we don't get performance fees, per se, because they're outside of the public entity.

Going back to the opportunities in Europe, on the real estate side you have a separate sleeve or a separate European fund, but as I understand it, BCP VI is primarily a domestic funds, like two-thirds has to be domestic, right?

How much of that could you, would you deploy in Europe and -- or does it make sense to have a separate European sleeve?

We have complete flexibility as to where we want to put that capital between Europe and the U.S.

And there have been times when Europe has been more than half of our activity.

One of the great things about having a global fund is you can move assets around instantly to where the opportunities are and don't have assets trapped chasing deals where opportunities are not.

Unless we get way overweighted in something, we like that flexibility.

Roger Freeman, Barclays Capital.

Hi, good morning.

I guess first on Europe, you've addressed some of this, but Tony, I think on the earlier call, you mentioned that debt financing is more challenging in Europe than in the U.S.

Does that change at all the types of opportunities you're looking at there?

Yes, sure it does.

Europe right now, you can't do a large leveraged buyout, so we're focused on more of the mid-market stuff, smaller stuff.

I think it would be tough to finance -- get more debt financing than about $500 million in Europe, whereas in this country you can get $2.5 billion, $3 billion for the right deal.

So you focus on smaller game, number one.

Number two, you try to buy companies where the returns are not driven so much by leverage.

And the two things that we've gone to on that, Steve mentioned the Leica deal, there's not one dollar of leverage on that deal.

And what that is is buying what we think is a great brand and being able to significantly grow its global footprint.

And then, the other thing that we've done quite well, I think, as you know, Roger, is these consolidations and buildups where we get a really good company, a really good platform company, a really good management, and then can roll up in reasonably small bites, actually, other people in an industry and create a really interesting company with an interesting market position, and we did a couple of tuck-in acquisitions last quarter in some of our portfolio companies, doing that as well.

What you see in real estate is liquidity is really dramatically shrinking in Europe.

When you buy things, sometimes you get seller financing.

If it's from a financial institution or a Firm like ours, it's pretty unique in this regard.

Gets to bring U.S.

financial institutions with us to do this type of financing.

And over time, that is a very, very powerful type of competitive advantage.

Okay, that's helpful.

And I guess, Steve, since you're over in Europe these days, I'm sure you're connected to a lot of the discussions around the solutions there.

A, do you think we're going to get anything meaningful this weekend out of the Finance Minister meeting?

Well, I'm back from Europe.

I spent a few months living in Paris.

It was very interesting.

I traveled a lot.

I must say that it's a lot easier on your body to launch out globally from London or Paris than it is from New York, just the way the globe works.

You also get a different feel of the world, so it's an interesting cross-cultural experience.

I wasn't invited in the room for this weekend, so I don't know what's going to happen.

It's pretty clear to me that the Europeans understand they have a real genuine problem of contagion.

Any ambiguity about that has been brushed aside during the IMF meetings in Washington and with Dexia and with other comments in the financial press, as well as the lack of rollovers from money market funds of European bank CDs.

And so, I think everybody there in a position of authority gets it, that there is a real crisis happening.

And the solutions are somewhat logical.

How exactly you mobilize 17 different governments with a variety of options of how to address the problem from using their new fund, like our U.S.

TARP, whether you leverage that, whether you use the ECB, how you use the ECB, how you use individual central banks, how you use the private financing markets, which mostly are non-functional for equity.

You start multiplying 17 times those number of options, and you'll get so many outcomes that the issue isn't what is the right solution, it's how do you get there.

And that's a process that the Europeans will have to go through.

The longer you wait, the worse the problem gets.

It's like a house that starts a small fire, and you need more fire engines and more fire trucks as the fire gets bigger.

I think they understand that, too.

So, I think it's presumptuous for anyone who is not in the room to be able to predict exactly what will happen.

At the end of the day, it's pretty clear that, just like Dexia, Dexia went down and two governments came to its rescue or stabilization, dealt off the pieces.

No depositors lost money, and as Europe continues to be under this type of pressure, these governments know they're going to have to step up.

And so, it's better to do something earlier than under the pressure of actually rescuing an institution because, as you know, that then weakens the entire perception in other financial institutions themselves that could've been better funded or healthier.

So that's a long answer for you, but it hopefully will dispose of all other questions on that topic.

Yes, all set.

Lastly, just on private equity, Tony, real quickly.

You said on the earlier call, I think, that for the six-month period, the first half of the year, that revenues for all your portfolio companies were up about 12%, EBITDA 10%.

I was wondering why the EBITDA might have been up less.

Just higher input, like commodity costs?

And then, the second thing is on the proprietary data points, especially at the meeting you just had with your company managements, you look at -- there seems to be some divergence on the economic growth trajectory.

A lot of the industrial Americas seems to be pretty strong.

A lot of production, rail traffic, et cetera.

There seems to be some divergence in terms of the broader economic indicators.

I wonder what you're picking up from there.

Okay, so, first of all on the year to date, yes, you're right.

12% revenues, 10% EBITDA, and by the way, the third-quarter revenues, I think I mentioned, were also about 12% for the portfolio.

We don't have the EBITDA yet for that quarter for all of the portfolio companies.

As you know, through most of the downturn, actually EBITDA grew faster than revenues.

And through cost cutting, right or wrong, we kind of felt that our companies had bottomed out, and the messages from us to our companies now is position yourself for growth in a stagnant environment.

It's a bit of a nuanced message, but that one we got all our CEOs in, that was the focus of the meeting.

We expect them to be investment spending in new products, in emerging markets and places like that, and -- because you can't cut forever, and we want to get the companies going again and we do expect, at some point, a recovery.

So I haven't tracked through it company by company, Roger, but in general, we were pretty pleased with the EBITDA performance and we're very pleased with the revenue performance.

And so, all in all, I think we feel they're doing the right things on that.

With respect to what they're saying now, I would say that the qualitative comment -- and by the -- well, I'll come to this, I guess, maybe the other part because it answers both questions a bit.

The qualitative comments of the CEOs are definitely more negative than the operating results that are put up on the board.

And they're all feeling a further slowing or a -- in the growth rate or, put it this way, they think that they'll grow more slowly going forward in this environment than they have in the last six to nine months.

And that really came to the fore in late summer.

They're also all feeling price pressures.

None of our CEOs feel like they have pricing power to raise prices and they're all feeling cost squeeze.

So I'm sure that is part of what you're seeing in that EBITDA margin as well.

And they're worried about protecting their margins.

So, those would be the dominant qualitative tones with the recent meetings.

Okay, thanks a lot.

I appreciate it.

Guy Moszkowski, BofA Merrill Lynch.

Hi, good morning, guys.

It's Patrick Davitt, actually.

Going back to Dan Fannon's question, could you at least, I guess, give us an idea if the Harbourmaster funds are of similar structure to the GSO funds?

Would they be meaningfully different?

They're not.

There's some attractive characteristics of the European CLO platform market that has to do with transactions, which are interesting, but other than that, the funds are structured largely the same as the existing funds that we have both in Europe and the U.S.

In general, Patrick, European CLOS have a more flexible mandate than do U.S.

ones.

They can buy more mezzanine and high-yielding stuff, but for a layman, they're pretty similar in terms of diversification requirements, the focus on senior secured lawns, the rating requirements, and other things.

Okay, great.

Thanks.

And will there be any meaningful unit issuances to pay for that?

No.

We do not expect to -- we expect to use cash on the balance sheet.

Okay, thanks.

And real estate, can you give us an idea of the dynamics where you have flat to slightly positive performance, but such a negative performance fee?

Is it really just because of the reversal of some of that catch-up you had in the first half?

First of all, we gave you an aggregate number that was largely flat to slightly down.

That depends across all the funds.

It happened to be that there was a slight negative mark in the larger funds that are also the ones that are fully into carry that have the catch up, and that related to the effect that we had.

Yes, let me just flesh that out a bit.

A lot of it was concentrated in one fund, which is mature enough that it owned some public securities.

And one of the things we've seen across the board across our asset classes is the public markets have been much more weaker than the underlying fundamentals.

So, the public stocks are down a lot.

We also took down some of the lodging investments a bit because they tend -- there tend to be more direct public comps, so we adjusted our -- our companies are doing quite well, as I think I mentioned.

They're up 6% to 8% in RevPar, but the public comps are down just along with the other public markets.

So really, most of our funds aren't driven that directly to the public markets.

They don't a lot of real estate because they don't have a lot of public stocks.

This one did, for a variety of reasons, and also a lot of, as I say, lodging investments, most particularly Hilton, where there's direct comparables.

So that pulled that down, and then that got -- that is the fund that is in the carry and in the catch-up period where we got such a big boost last quarter, and so live by the sword, die by the sword, I guess.

Right, exactly.

So instead of taking 20% now, you're taking 80% on the way down, right?

That's correct.

Okay, great.

And with BREP VII, the $4 billion coming into fee-earning assets in real estate, are there any fee waivers with that, given it's an early first close, or is it charging full fees on that $4 billion?

We haven't started charging fees on that, so I wouldn't model that until next year.

(Multiple speakers)

So, I would not assume any fees charged on that until next year.

Until the final close?

Not necessarily the final close, but until 2012.

Okay, great.

Thanks a lot.

Howard Chen, Credit Suisse.

Hi, good afternoon, everyone.

Hi.

Steve, Tony, just putting a fine (technical difficulty) your previous commentary about the portfolio companies, just as your management teams firm up 2012 business planning and budgeting, is there more specific target for revenue, EBITDA, RevPar trends across the portfolio?

No, there's not.

It's too much of a diverse group in terms of industries and regions and things like that.

We do a lot of startup investing in our business.

I mentioned on the press call like restarting a refinery, really hard to budget that.

We've got a new wind farm we're building in Germany that won't even be operational for a couple of years.

So there's no one metric I could give you that would be meaningful.

Okay, thanks, Tony.

And then, switching over to credit, I was just hoping you could elaborate what you all are seeing across the spectrum of products, given the market environment.

I think last quarter you noted the market was fairly favorable for your kind of analytical event-driven style.

Has that changed at all?

No.

I think it's gotten more favorable, if anything, here -- for new investments.

Now, obviously, what you saw in our distressed fund is that those more marginal credits, so to speak, where the ones that were hit the hardest in the markdowns, so the down draft of credit markets.

But it's the very thing that creates the new opportunity is to put money to work at not only attractive interest rates, but in instruments with call protection.

So new issuances are being done now with better call protection than they had in the past, and those funds that buy a second -- instruments in the secondary market are buying at a discount to par.

So they have sort of embedded call protection.

So we're locking in some of these returns, and it's gotten better, if anything.

And then, that has been, then, more fuel on the flames because the European banks, in particular, are starting to sell a lot of assets and a lot of credit assets to lighten up their balance sheets, and I think that'll be some really interesting opportunities as well.

But you're going to see a big demand for these credit products from institutional investors.

And the reason is is that if you've had virtually no return from equities over a 10-year period, and equities are over half of the total assets of the normal pension fund or endowment, and you have an actuarial rate of 7.5 to 8, there is no comfortable way to beat that actual rate than to use alternative products that can set you up with a yield that is significantly above your actuarial rate.

And I think that the investors, and their Boards of Trustees and so forth, are getting more and more concerned that these types of issues are on the front pages of newspapers.

And the pension fund systems have to develop better performance to protect pensioners' benefits, as well as to deal with a variety of budget issues on behalf of states, municipalities, et cetera.

So, one of the easy solutions for that is to move more of your portfolio into very high-yielding fixed-income assets that get you over that hurdle.

And so, I expect there, and we can see it already, to be significantly increased interest in credit.

It will be disguised as a discussion of distressed assets, but it's a more profound shift, I think, longer term.

That makes a lot of sense.

Thanks, Steve.

And then, clearly, that is not just a pension fund, institutional issue, but high net worth and retail as well.

So could you just update us on what you all are doing to take full advantage of that on the high net worth/retail side?

Well, we can approach that market in a variety of ways.

We don't anticipate having our own private bank or our own high net worth and retail brokers, although, I must say, we get approached with that concept often enough by the investment banks.

I think the way we'll access retail is by continuing to produce product for the big systems and wholesale it, so to speak, for them.

And then, we also have across the firm I think now four or five publicly-traded vehicles that retail investors can buy into, closed-end funds, BDCs, things like that, and we continue to see opportunities to do those.

We have a new one of those in formation as we speak, focusing on the energy sector.

Great, thanks.

And then, finally for me, just given all the disruptions we've talked about this quarter, did your portfolio companies have the chance to opportunistically buy back debt or stock?

I recall some of the companies did buy back some of the debt in 2008-2009, just curious.

We did -- I think we did something over $40 billion in 2008 and 2009.

In fact, we did so much that there isn't that much left to do, frankly.

And then, when the credit markets got hot again, we kind of pivoted and went out and extended the duration, refinanced a lot of the debt with long maturity, lower interest rate stuff, which has held up well in value.

So there hasn't, frankly, been that much opportunities to buy stuff in in this cycle.

Okay, great.

Thanks for taking all the questions.

Just one other question -- one other part of that answer.

What -- given the strength of the performance of the portfolio companies, the debt is holding up pretty darn well in terms of its price, and the creditors like what they own.

Our own success defeats us on that one.

Yes, a little different than 2008.

Well, 2008, the markets abandoned credit, regardless of the underlying credit.

They just wanted to get out of anything that was tradable and get into government bonds or cash or gold or whatever it is.

Here, the market is backed up a lot, but there isn't the same kind of investor panic, and our companies have done well and the bonds are trading well, and it is not worth buying them back right now, for the most part.

Great, make sense.

Just thought I'd check in on it.

Thanks.

Marc Irizarry, Goldman Sachs.

Great, thanks.

Just in terms of the outlook for fundraising for liquid versus illiquid strategies for you guys across credit and real estate, Steve, maybe you could give us some perspective on potential denominator effects that the LPs might be facing, you know, they're seeing their liquid market assets decline a good bit.

You guys have outperformed as an alternative industry, if you will.

Do you think the outlook here implies you'll see more fundraising in more liquid vehicles?

I think there are a number of different factors going on.

One of those factors is that generally, because the funds, pension funds and a variety of other pools of capital have had real difficulty generating return over the last sort of five years, if you will, in aggregate, sometimes 10, that there is pressure for cost reduction at these institutions.

And one way that manifests itself is to reduce the number of relationships that they are handling, which cuts down on their own needs for staff.

Now we happen to be a beneficiary of that, as a lot of institutions are looking at the array of managers and saying, basically, this just doesn't make sense.

We're not getting the performance.

We have to reassess what we're doing.

We're going to eliminate a significant number of these managers and concentrate on a much more limited core group.

So, there will be winners and losers in this game beyond liquid and illiquid.

And because of our performance and the breadth of our products, we have reason to believe, obviously, and you can see it in the numbers, that we are a winner in that game.

Also, institutions are increasing allocations to these products.

So, for example, I was at a conference and there were a lot of LPs and they did a survey, and 48% of the LPs were increasing their private-equity allocations, which may come to you as a surprise.

But a lot of private equity has performed well, and so they want more exposure.

There is an increasing emphasis on sort of the credit class being almost unified with private equity because the returns you can get are way better than other things.

So, that asset class is being increased.

So, we're seeing changed trends, which offsets the impact for certain firms like ourselves that offset the denominator impact, which used to be across the board affecting everyone equally.

Now in real estate, there's a real problem of raising money because -- for most firms because there's been a dramatic shift.

As most of the opportunity managers, the vast majority of them did a horrible job managing money.

The people who give out the money have said I don't like these people and I don't want to lose my money and I'm not going to give them more money and I'm going to reorient to core real estate.

It's more conservative, lower return, leaving very few firms that can get an allocation for opportunity real estate, of which we are by far the dominant firm.

So, the denominator effect doesn't affect that as much.

It's really the performance of the class.

But it's difficult for people, other than ourselves and very few others, to raise money in that.

So, there is more of a preference by certain people around the world for more liquid products because whenever there is uncertainty in the environment, people try and shorten maturities or go to more liquidity.

On the other hand, it's sort of an interesting debate because the more they do that, the more their returns get driven down, the more difficult it is for them to meet actuarial assumptions.

So we find that certain liquid products can sell relate well and certain of the illiquid products can also sell well, if you have superior performance and can make the senior managers at these funds, as well as their trustees, comfortable that you can deliver really superior returns.

Again, a longer answer (multiple speakers) than a snappy one.

Mark, let me give a snappy one.

We're not seeing any impact to the denominator effect, to speak of, in the United States.

In Europe, we are seeing investors pull back, but less because of the denominator effect than the fear of Europe.

Europe is really, really feeling -- their just ability to make commitments about almost anything.

And in effect, you almost can't blame them as human beings.

It may be the wrong investment decision, but as human beings it's very unsettling.

Great.

And then, you guys have done a great job of taking share of AUM from the broader world of asset management.

I don't know if this is maybe just more of an observation, but I'm curious on how you think about it.

You've grown your fee-paying AUM, call it, 26% over -- nine months over nine months, but your fee-earning AUM, so the amount of -- or your fee-earning profits, so the profits that you're dropping through from that incremental AUM don't seem to be as large or maybe have grown but at a much lower rate.

How should we think about how important the fee-related earnings are for you guys when you're thinking about the business, the types of strategies you're going to add, the acquisitions that you're going to make?

How important is that fee-related earnings metric to you guys?

Mark, it's LT.

A couple of thoughts on that.

We look at fee-related earnings -- first of all, it's important to our bondholders, of course, because it shows recurring cash flow related to long-term locked-up contracts.

But in general, we look at it as a general measure of health in the way we try to size our businesses.

I think what you're seeing is a bit of a lag effect.

So when you have a sharp increase in the amount of assets, it doesn't mean they're necessarily paying fees at the time we -- they come on, and also it takes some time with respect to you need to build up some of these businesses.

So, we still remain aggressively in the buildout phase with respect to origination, operations of assets, as well as the diversification of the platform, and that is really where you are seeing the difference between a 27% increase in fee-earning assets and a 4% increase in NFRE.

Those two will normalize closer to their levels as we go forward, plus, of course, there is operating leverage in fee-related earnings.

And we had actually a relatively muted, thus far, year in transaction fees and advisory fees, which, when those start to go up, you'll see an increase in fee-related earnings.

And there was a little quirkiness in the GSO segment.

So, that you should really look at on a year-to-date basis and that will probably normalize in the fourth quarter.

Great.

But just more generally is fee-related earnings are the lifeblood of this business.

And we are very focused on growing that as a metric and growing that organically and growing that in higher-margin products to the extent that we can.

And one of the things we have is a lot of assets that we've raised that aren't fee-earning yet because they're not put to work and the funds haven't started the investment periods and so on.

But when we raise a new fund, we've got to put in place the people and the capabilities not only to raise the money but to invest it.

So, we do build expenses ahead of the revenue impact of the fees that we raise, if you will -- sorry, for the AUM that we raise, so there is a bit of a lag effect there.

We think right now we have a lot of great growth opportunities for new products and to expand our business, our fee-earning asset, but it requires us to add people and expense.

Great, thanks.

I think that was the last question, but I just wanted to add in on the -- to qualify the geographic constraint on the latest private equity fund; it was a question that Chris asked.

So there is no European constraint, but there is a 30% limit, I think this is what you were referring to, of investments outside of Western Europe, North America, and Canada.

So it is more of an emerging-markets limit.

That was our last question in queue.

I would like to turn the call back over to Joan Solotar.

Great.

Thanks, everybody, and I look forward to speaking with you after the call.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect.

Have a wonderful day.