That said, due to rising interest rates and commercial real estate headwinds, BX has materially underperformed the market over the past year and a half:
However, we expect that BX will likely outperform the market moving forward. In this article, we share three reasons why.
Reason #1: BX Has Enormous Competitive Advantages
The biggest reason to be bullish on BX’s long-term total return outlook is that it benefits from enormous competitive advantages.
First and foremost, it is the world’s largest alternative asset manager with an incredible ~$1 trillion in assets under management spread across a wide range of asset classes and geographies. This immense scale is a competitive advantage in itself by producing significant economies of scale. Furthermore, it produces numerous other competitive advantages such as:
- Very strong brand power: In the asset management businesses, name brand and reputation are everything. As the world’s largest player in the space, BX has tremendous credibility with potential clients, enabling it to fundraise and retain assets under management with relative ease.
- Access to exclusive deal flow: Thanks to its immense scale and global reach, BX has access to deals that – due to their size and geography – few other investors can compete for. This enables BX to command more favorable terms on the deals while also offering unique products to clients that differentiate BX from potential competitors.
- Massive trove of data: Another huge advantage that will likely only grow more prominent in the coming years and decades is BX’s massive treasure trove of industry-specific and macroeconomic data. Given its enormous size and global reach, BX possesses substantial proprietary economic data that can give it a significant edge over smaller competitors when allocating capital. As machine learning and data science techniques continue to advance and further penetrate the industries in which BX operates, BX’s ability to leverage this advantage should grow exponentially.
- Access to a lower cost of capital: Another huge advantage that BX enjoys due to its scale is a lower cost of capital than many of its smaller competitors, since debt and equity investors are much more willing to invest in BX’s ventures than smaller peers due to BX’s significant financial resources.
- Substantial portfolio cross-selling: BX also is able to cross-sell across companies within its massive portfolio, thereby enhancing the risk-adjusted returns on its investments.
Reason #2: BX Has An Alpha-Generating Business Model
While its competitive advantages in and of themselves are enough to drive a virtuous cycle that generates alpha for BX’s clients and ultimately BX shareholders themselves, BX also generates an alpha-generating business model that enabled it to build its massive scale and drive attractive total returns for shareholders in the first place. It essentially consists of this:
- BX leverages its investing skill and operational expertise to raise funds from clients. Given that its investing skill and operational expertise are mostly fixed costs (with only incremental additional expense as they add head count to accommodate AUM growth), BX has very little in the way of capital expenditure obligations. As a result, its organic growth is achieved at very high returns on invested capital, making it an exceptional long-term compounder. This is especially true today, given that its fundraising is largely driven by BX’s already built competitive advantages, which require relatively little expense to maintain outside of employee compensation to retain talent.
- Given that the organic growth largely takes care of itself with little capital investment, BX is able to return virtually all of its earnings to shareholders via dividends and/or buybacks. This makes BX a rare high yield stock that can simultaneously generate robust growth. This is why its forward yield is 4.7% while its dividend per share CAGR is expected to be a solid 7% from 2024-2027. While many businesses would not be able to pay out such a high current yield in order to support that growth rate, BX is able to do so because its AUM is very sticky since the vast majority of its capital is either long dated or perpetual in nature and its fund raising is a high return on invested capital operation.
Reason #3: BX Stock Is Undervalued
Last, but not least, BX stock is undervalued at the moment. As was already pointed out, its dividend yield is attractive at 4.7% and its dividend per share CAGR over the next several years is expected to come in at a robust 7%. Its normalized earnings per share CAGR is expected to come in at an even higher 7.4% over that same span. As a result, the yield plus growth total return profile appears likely to deliver ~12% annualized total returns through 2027, assuming a constant dividend yield.
While it is certainly possible that BX’s growth rate will likely slow over time due to the law of large numbers, its dividend yield is currently in-line with its average over the past five years, and we believe that interest rates have likely peaked or at least are very near peaking. As a result, it is highly likely that interest rates will have come down at least some by 2027, providing greater support for the current dividend yield even if the growth outlook for the company after 2027 weakens.
Another reason to feel confident in BX’s valuation holding steady – if not increasing – moving forward is that the company’s stock could very soon be added to the SPY, which would drive significantly greater passive investing demand for BX stock, boosting the stock price higher without direct evaluation of its underlying fundamentals being involved.
As a result, we think it is highly likely that BX will deliver 10-12% annualized total returns through 2027, and possibly even higher returns depending on where interest rates go and how the environment for alternative assets evolves over that span.
While we believe the risk-reward profile is highly compelling here, no investment is risk-free. In the case of BX, the most significant risks are:
- Interest rates remain at elevated levels for a prolonged period of time. This will have a two-fold negative impact on BX. First, it will make it harder for them to fundraise (since low-risk fixed income investments will be relatively more attractive compared to BX’s alternative products like commercial real estate, private lending, and private equity given their higher yields from higher interest rates). Second, it will continue to weigh on asset valuations and cash flow yields. This is because real estate cap rates and business multiples are generally very interest rate sensitive and BX’s investment model typically relies on buying real estate properties and private equity businesses with substantial leverage, making operational improvements to them, and then selling them at a profit. The leverage being applied significantly amplifies the returns on equity invested, delivering attractive returns for clients as well as performance fees for BX shareholders. If interest rates remain elevated, this will further increase cap rates and compress valuation multiples, making returns less attractive for clients (and potentially increasing fund redemptions/weakening fundraising) while also reducing performance fees earned for BX shareholders. Moreover, in some cases, interest rates on maturing debt may exceed the cap rates/earnings yields of the related property/business, forcing BX to choose between returning the keys to the lender or running a cash flow negative property/business. Interest rate headwinds have already been felt a bit in the real estate business in particular, with redemptions from BX’s real estate fund rising, and BX having to default on some of its maturing mortgages.
- The economy goes into a steep recession. While BX’s high quality and well-diversified portfolio should be able to weather a steep recession, there is no doubt that a steep recession would weigh on the performance of BX’s businesses, leading to lower performance fees in the short-term and potentially leading to an erosion of AUM through a combination of declining valuations, potentially a few portfolio holding bankruptcies, and a steep slowdown in fundraising.
With all of that said, given BX’s high-quality assets, enormous amount of dry powder, and treasure trove of industry and macroeconomic data, they are better positioned than just about anyone else in their sector and the economy at large to not only survive a period of economic stress, but to take advantage of the opportunities it will create and emerge out of it stronger than ever.
BX stock has been on a great run since going public, generating outstanding returns for shareholders over that period. Given its substantial competitive advantages, capital-light high return on invested capital business model, and attractive valuation, we believe that BX is likely going to outperform the broader market moving forward. As a result, even though it is not our top alternative asset management pick at the moment, we still rate it an attractive Buy.