Category: Financial Advisory
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Chopping the roots

Recently, Blackstone (NYSE:BX) announced its intention to sell off its advisory division. For those who are unfamiliar with the companys history, Blackstone started out as a pure advisory business, specializing in mergers and acquisitions. Over the past two decades, the company has ventured into the asset management business and grown into one of the worlds largest private equity firms and the worlds largest alternative assets manager.

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Source: SEC Filings

Looking at its segments, revenue from financial advisory amounts to a mere $118 million, which is approximately 5% of the companys total revenue. However, given the internal conflicts of interests, by being a part of Blackstone, the advisorys group revenue and profit opportunities are greatly hindered. Hence, the above numbers do not represent the true potential of the advisory group.

Conflicts of interests

In order to understand how the advisory group is being throttled by being under the Blackstone umbrella, we need to first understand how the private equity, fund management and the advisory side of investment banking work.

For example, lets assume that two private equity firms, Blackstone and Kohlberg Kravis Roberts, are looking to acquire a company. Thus, the two rival firms are on the opposite side of the transaction. Both parties will then hire advisors to advise on the deal. After some back and forth by the rival firms, KKR manages to outsmart Blackstone and acquires the target company. The letter of intent is drawn up, signed and the deal is closed. Fees are paid to the advisors that the two rival firms hired.

Astute readers would notice the glaring disadvantage that Blackstones advisory group faces here. Suppose KKR initially wanted to hire Blackstones advisory group to advise on the deal. Being logical, KKR would obviously choose not to hire Blackstones advisory group; one would be foolish to hire ones competitors. After all, conflicts of interests are apparent. As a result, the advisory group misses out on an opportunity to advise on a deal, an opportunity that could have resulted in fee revenue for the group. Given the large deal success fees that investment banks and their advisory groups are paid, significant potential revenue is essentially lost.

To make matters worse, as I have outlined above, Blackstone manages a huge volume of assets, with total AUM amounting to $279 billion as of June 2014. Given the asset managements division sheer size, it is able to participate in principal investing across many markets, ranging across private equity, real estate, credit and other asset classes. As a result, the asset management division would surely show up on one side or another of many potential deals that its advisory group would like to get hired for. As evident from my earlier example, this effectively severely limits the advisory groups potential. Furthermore, given the asset management divisions large size, it would naturally participate in large deals, most notably the recent Hilton Hotel deal. Large deals beget large fees, which are valuable revenue that the advisory group is missing out on, solely due to its affiliation with Blackstone. It does not take a genius to figure out how severely crippled Blackstones advisory division must feel when it cannot advise on a majority of deals simply because of its attachment to the asset management division.

Now, suppose the advisory group is separated from Blackstone, a situation that would become a fact post-spin off. These conflicts of interest are no longer a problem. The advisory group can freely advise on whatever transactions it could get hired for, and pocket the large fees that these deals pay. Considering the prowess of the advisory group, evident from its well-known clients such as Microsoft, Procter amp; Gamble, Verizon, Comcast, and many more, it is clear that it has the ability to take on deals of any size and complexity.

Joining Paul Taubman

In addition to the spin-off announcement, the company also acknowledged that its advisory group would join forces with PJT Partners, an investment banking kiosk headed by Paul Taubman, a renowned investment banker. Paul Taubman is a name that is well known in the industry. After leaving Morgan Stanley, the banker took on large solo deal assignments, such as the monstrous $130 billion Verizon-Vodafone deal last year. Clearly, Mr. Taubman has no problem holding his own as a solo banker.

The combined entity of PJT Partners and Blackstones advisory group would certainly be a force to be reckoned with in the industry. As I emphasized in an earlier article, investment banking is a business rooted on relationships, and I have no doubt that the combined entity would be able to realize synergies where its bankers would be able to broaden their network of clients, which would in turn, result in increased probability of advising on large deals. Given the current near-perfect economic conditions for capital and Mamp;A market activity, such as cheap access to funding and increased management confidence, I have no doubt that the combined entity would be able to capitalize on the situation in the future. I look forward to investing on the new PJT-BSs advisory publicly traded entity, and I dont see why you should not.