Blackstone IPO Is a Must-Miss

None of this makes it a good deal for investors. Frankly, I think it's terrible. Why? Let me count the ways (from bad to worse):

1. Investors aren't buying the funds themselves. The Blackstone Group is trading on the returns and reputation of its managed funds, but what it's selling isn't a piece of any or all of those funds but rather a piece of the company that manages that money. I doubt that everyone buying shares will understand the difference. (If they don't know what they're buying, shame on them, of course.)
2. Investors are paying a big premium. That business, to be renamed Blackstone Holdings, is certainly profitable -- at least it was last year, when the management company made $2.3 billion from management fees and other sources. But that's not as big a profit as it sounds, considering that the IPO will value Blackstone Holdings at $40 billion or so. Lehman Bros.(LEH Quote) earned $4 billion in the past 12 months, and that company's market capitalization is only $37 billion.
3. Investors are paying for past performance. Only about half of that $2.3 billion in earnings came from management fees, a relatively stable source of continuing future earnings. The bulk of the rest came from carried interest -- the Blackstone Group's slice is usually about 20% -- of any profits earned by the buyout funds.

   By its nature, carried interest represents the profits on past deals. Investors buying shares in the IPO are betting that current and future deals will earn the same profits as Blackstone has reaped during the current top of the buyout cycle. With increased competition for deals driving the prices paid for public companies ever higher, it's unlikely that the next part of the cycle will be as profitable.

4. Investors will have no say in how the company will be run. Since Blackstone Holdings will be structured as a master limited partnership, investors will be unit holders instead of shareholders.

   The difference is critical: Shareholders vote to elect company directors, and a public company with shareholders must have a majority of independent directors on its board of directors. Unit holders don't have those basic rights. They won't be entitled to vote to elect directors, and master limited partnerships aren't required to have a majority of independent directors on the board of directors.

   The rules of the Blackstone Holdings master limited partnership even allow the directors of the company to sell the business without the consent of the unit holders.

5. Investors will have no say, again, on what Peterson, Schwarzman and the other partners pay themselves. Again, because this is a master limited partnership, Blackstone Holdings isn't required to have an independent compensation committee that decides who gets paid how much.

   Admittedly, compensation committees run by independent directors haven't exactly done a great job in limiting executive paychecks at public companies such as Home Depot(HD Quote) and Pfizer(PFE Quote), but any checks on the power of managers to pay themselves whatever they want are better than no checks at all.

   Don't pay too much attention to the promise in the IPO filing that Schwarzman will take a salary of just $350,000. In buyout firms, the big compensation comes from owning a stake in the company and from receiving a cut of the carried interest earned by managed funds. The Wall Street Journal calculates that Schwarzman, now worth about $10 billion, could see his net worth double as a result of the IPO.