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Analysis - Blackstone and peers have a bargain for you: themselves

By Greg Roumeliotis

NEW YORK (Reuters) - Alternative asset managers such as Blackstone Group LP and KKR & Co LP have for decades scoured the stock market for undervalued companies. Now they are trying to convince investors that shares in their own firms are a bargain.

As a group, their valuations tend to be weighed down by at least three factors. Because they have gone public relatively recently, their track record as public companies is relatively short. The presentation of their results is complicated and makes comparisons difficult. What is more, their founders and partners have retained significant stakes, which can be negative for their stock when investors fear a significant share sale.

Even so, shares of these firms - a list that also includes Carlyle Group LP and Apollo Global Management LLC - are unlikely to stay cheap for long, analysts say.

If these firms can keep generating strong results, turning profits from asset sales and paying out more in dividends, stock market investors are bound to pile in, they say.

"We believe the valuation gap with the traditional asset managers will converge, if not reverse, over time," Credit Suisse analyst Howard Chen said. "The alternative asset managers are still a very young sector for public market investors."

Even after a rally that boosted shares of the group by 40 to 110 percent in the last 12 months, alternative asset managers still trade at a big discount to traditional money managers.

Blackstone, the largest alternative asset manager, went public in 2007. It trades at close to nine times its 12-month projected earnings. That's a steep discount to a peer group that includes traditional asset managers, which trades at almost 15 times, according to data compiled by Thomson Reuters.

The valuation gap is particularly glaring because Blackstone has a dividend yield of 4.5 percent. By comparison, the peer group on average has a 2 percent dividend yield.

To underscore the point, Blackrock Inc , the largest traditional asset manager, has a dividend yield of 2.2 percent while trading at 16.8 times its forward 12-month earnings.

At Blackstone's annual investor day in New York earlier this month, Stephen Schwarzman, chief executive and co-founder, said: "One day you are gonna wake up as an investor ... You are gonna say 'nine?' (of the firm's price-to-earnings multiple) - "Who came up with nine?"

In Blackstone, he said, "You've got the best returns, basically, in the world. You've got growth that is hundreds of percent higher than companies that are valued at double the multiple."

Alternative asset managers focus on asset classes such as private equity, real estate, corporate credit and hedge funds, and some of them lock up client money for 10 years or more.

Traditional asset managers such as Blackrock invest mainly in stocks and bonds, and their clients can generally take their money out much more easily.

With interest rates at record lows, both traditional and alternative asset managers have benefited from the pursuit of higher yield by investors.

Firms such as Blackrock, which was founded with help from Blackstone in 1988 but severed ties in 1995, has seen a surge of fund investors moving into stocks.

By the same token, alternative asset managers have enjoyed a boost from large institutional investors such as pension funds and insurance firms looking to beat the stock market and make more than two times their money on investments.

UNORTHODOX METRICS

KKR, Apollo and Carlyle, which went public in 2009, 2011 and 2012 respectively, also trade at a significant discount to the traditional money managers.

Blackstone and its peers sponsor funds that buy or invest in assets such as companies, single-family homes, distressed loans, and hedge funds. They hold them, work to increase their value and then sell them, often at a big profit.

Because some of the funds have a lifespan of 10 years or more, their assets may have been on their books since the firms went public. Although investors have updated estimates of their values, the eventual sale price may differ.

"The investment community still has not seen a full cycle for these firms, and specifically, active harvesting and distribution payout," Credit Suisse's Chen said.

The complexity of the earnings is also an issue, Chen said. To show their earnings potential, alternative asset managers use metrics that are not recognized under standard U.S. accounting principles. Economic net income, for example, figures prominently in their quarterly reports and reflects the estimated market value of their assets.

A second unorthodox metric is fee-related earnings. It shows how much money is generated from fees other than the so-called carried interest, the fund manager's slice of the investment profits.

To make matters more complicated, there is no uniform calculation of these metrics. Unlike Blackstone and Carlyle, KKR includes discretionary compensation and incentive fees in its fee-related earnings. Apollo uses a different metric called management business ENI, instead of fee-related earnings.

These are just a few of the discrepancies that make it more difficult for investors to make apples-to-apples comparisons. As time goes by, however, investors are becoming increasingly educated about these differences.

Representatives of Blackstone, KKR, Apollo, Carlyle and Blackrock declined to comment for this story.

SUSTAINABLE DIVIDEND YIELD?

A third obstacle to higher valuations for alternative asset managers is the relatively small percentage of their shares that trades in the stock market. Founders and senior partners own large stakes, and that can be a drag on the stock when some of them decide to cash out, even partially.

Apollo shares, for instance, slumped more than 7 percent last week after two of its founders sold a fraction of their shares.

"The market for these names will increase over time. Lowering the insider ownership and having a bigger float and not having as many insiders over the long haul will make them more investable," Goldman Sachs analyst Marc Irizarry said.

Irizarry also cautioned that once these firms have exited from a lot of the lucrative assets that they hold, the sustainability of their dividend yield may come into question, at least until they have more profitable investments to harvest. This means that the value of their shares will not always be on the rise.

Said Irizarry, "If all the low-hanging fruit has been picked, then the value of the stocks might not be what it is today."

(Reporting by Greg Roumeliotis in New York; Editing by Soyoung Kim, Frank McGurty and Prudence Crowther)

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