The reasoning behind Blackstone’s move from partnership to corporation

April saw the behemoth private equity group Blackstone announce a dramatic, yet not unprecedented, change in its legal structure. While previously a publicly traded partnership, the corporation, from July 1, is precisely that in US legality: a corporation! The move follows the same shift in structure from rivals KKR & Co Inc and Ares Management Corp last year [1]. Not surprisingly, as with most financial changes occurring in the US right now, the shift has a lot to do with changes implemented by the Trump administration.

Since Blackstone went public in 2007, it persisted with the now disowned partnership structure. In a nutshell, this structure means that Blackstone’s performance fees were not charged as corporate income. This allowed them to save money that would have otherwise been taxed. The change which occurred now, however, is that when the Trump administration reduced the corporation tax rate from 35% to 21%, the benefits of this scheme dwindled. [2] Moreso, the structure presents inherent complexity for investors year-on-year (with a 30-page file having to be filed by investors to the IRS every year). Major stock index trackers and mutual funds have thus refrained from adding Blackstone to their holdings. 

Given that passive funds comprise around $10tn of market capitalisation [3], the argument Blackstone and its legendary founder Stephen Schwarzman present is that given diminished tax consequences of the switch, and the fact that a pop in the share price would be likely, the time has come to switch structure. Schwarzman himself came out stating that the number of potential buyers of Blackstone stock would double with the change, in which case the appreciation in share price would more than compensate for increased tax payable. Investors no longer have to navigate as dense a mountain of legal paraphernalia to invest in Blackstone, thus, in theory, bringing their shares closer to fundamental, or intrinsic, value.

So, what happened?

To put it simply, investors loved the news. [2] In its best trading performance since January of 2016, shares surged in the group to $38.62/share, an uptick of 7.5% from the previous trading day. While the rise in share price was almost definitely driven in part by sound results (with a record $126 billion raised by the firm), the technical veracity of Schwarzman’s argument definitely resonated with investors. Even as of 20 July, Blackstone’s share price sits at $45.63, a noticeable uptick from the April announcement. 

However, while Blackstone’s performance has mirrored KKR’s at least in the short term, it is also true that KKR saw a decrease in its share price to around its original price point in the December 2018 market rout. While Blackstone are right to be optimistic, it is necessary to tread weary of history when analysing the long-term impact of such a move. A probable benefit in terms of attracting funding at lower cost (in terms of equity) will only be realised with sustained adoption of the shares by passive funds. 

A drawback of the move, also, is that it occurred in response to a current US administration whose personnel seem to be operating on a proverbial merry-go-round and whose grasp to power is at best tenuous approaching the 2020 election cycle. Should, for instance, a Democrat president be elected, and the corporation tax decrease was reversed, it would be extremely difficult (in terms of the legal work required) and expensive (in terms of a decrease in share price) to shift back to a public limited partnership structure. Such short-termism may prove costly in a future which is by definition unknowable and whose trajectory varies wildly from one day to the next. Blackstone’s estimates of an ultimate dilution of earnings of around 13% [3] will almost certainly prove inaccurate in the future, and the tax impact of the change in structure may well have been understated.

To conclude, the recent change in legal structure has solidified a change which has been in the works in the private equity for a while now. Apollo Global Management in May also followed Blackstone and KKR by changing structure [5], strengthening the domination of the “corporation” moniker in the industry. As with so many responses to Trumpian aggression, the response may prove far-fetched in future once it has been realised just how much of an outlier this current administration’s tax policy is. If this move is an example of the group counting their chickens before they’ve hatched, their strategic position in the industry is unlikely to be in much danger. As this has been an industry-wide change, we would be likely to see regret in many major private equity funds, not only Blackstone. For this reason, this change, while expected, is interesting precisely because no one can tell whether it is the right decision or not at this point. As with so many things, that can only be answered by time.

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Bibliography

[1] Reuters (2019). Blackstone to switch from a partnership to a corporation. [online] Available at: https://www.reuters.com/article/us-blackstone-group-results/blackstone-to-switch-from-a-partnership-to-a-corporation-idUSKCN1RU196 [Accessed 20 Jul. 2019]. 

[2] CNBC. (2019). Blackstone is converting to a corporation from a publicly traded partnership. [online] Available at: https://www.cnbc.com/2019/04/18/blackstone-is-converting-to-a-corporation-from-a-publicly-traded-partnership-effective-july-1.html [Accessed 20 Jul. 2019].

[3] Ft.com. (2019). Blackstone to shift from partnership to a corporation | Financial Times. [online] Available at: https://www.ft.com/content/1eb7afcc-61ca-11e9-a27a-fdd51850994c [Accessed 20 Jul. 2019].

[4] Nytimes.com. (2019). Blackstone Will Ditch Partnership Structure to Draw More Investors. [online] Available at: https://www.nytimes.com/2019/04/18/business/dealbook/blackstone-corporate-structure.html [Accessed 20 Jul. 2019].

[5] Ft.com. (2019). Apollo to ditch partnership status and become a corporation | Financial Times. [online] Available at: https://www.ft.com/content/77c022ea-6ccc-11e9-a9a5-351eeaef6d84 [Accessed 20 Jul. 2019].