Blackstone Mortgage Trust (BXMT) is an externally-managed Real Estate Investment Trust (*REIT), managed by Blackstone. The firm originates senior loans collateralized by commercial Real Estate in the US, Europe, and Australia. Loans are primarily floating rate loans benchmarked to LIBOR plus a premium. The loans are funded with floating rate LIBOR loans plus a premium and some equity. The firm is levered about 4 to 1, e.g., a $100 loan is typically funded with $80 of debt and $20 of equity.
External Management Structure
Blackstone Mortgage Trust (BXMT) is externally managed by BXMT Advisors L.L.C. – a subsidiary of Blackstone (BX). Blackstone is massive with about $554B of assets under management including $157B allocated to Real Estate. Blackstone Mortgage Trust (BXMT) is roughly 10% of the real estate asset allocation.
Blackstone’s Superior Economics
Blackstone earns a base management fee of 1.5% of common equity. In addition to the base management fee, Blackstone is entitled to an incentive fee. The incentive fee is essentially 20% of incremental ROE above a 7% threshold. The incentive fee is not calculated using GAAP earnings, instead it is calculated using “core earnings”, a figure that adds back some non-cash expenses. Over the trailing twelve-month period Blackstone earned approximately $76.9M of Management and Incentive Fees.
Importantly, Blackstone is invested alongside shareholders through its ownership of 6.9M shares. At the current dividend run-rate of $0.62 per quarter Blackstone will earn about $17.2M in dividends annually.
External management structures are infamous for potential conflicts of interest. Typically, management fees increase with firm size, not necessarily firm value.
In this case we see that Blackstone (BX) earns a base fee linked to common equity (‘size based), but the incentive fee is based on high ROE (‘value based), somewhat mitigating the incentive to grow for the sake of growth. Additionally, Blackstone has a substantial equity ownership and collects dividends at an equivalent rate to common investors. Nevertheless, we can see that current management fees $76.9M is much higher than the dividend run-rate of $17.2M.
Since March 2015 we can see that Common Equity and Management Fees have increased at an annualized rate of 23% and 24% per-year, respectively:
Book Value and Dividends Per-Share have grown about 2.5% and 4% per-year, respectively, trailing the growth in Common Equity and Management Fees by a wide-margin:
Geographically, approximately 76% of asset (net book value) exposure is to the US. Office properties account for approximately 50% of loan exposure. Hotel and multifamily account for about 16% and 15%, respectively. The remaining loan exposure is diversified into various property types. As of November 2019 (3Q earnings release) 100% of loans are performing.
Net Interest Margin
Blackstone Mortgage Trust (BXMT) generates net revenue by earning more on its loans than the cost to fund them. Twelve-month trailing Net Interest Margin has mostly been above 3% since March of 2015:
Net interest Margin is a metric commonly used in the banking and financing sectors, but it does have some flaws, including not accounting for differences in capital structure. We are most interested in returns to equity holders, and will focus on Return On Equity (‘ROE) going forward.
Return On Equity
BXMT has generated consistent returns on equity (‘ROE) over the past five years. The last quarters annualized ROE was 8.5%, and the median ROE since March of 2015 is 9%:
Importantly, the analysis of ROE includes the impact of total Management Fees (base and incentive). ROE is an estimate of the return to equity owners after all expenses.
Dupont Analysis of ROE
A simple Dupont Analysis can help us determine the sources of ROE. We can break ROE down into two components, Return On Assets (‘ROA) and (multiplied by) Leverage. We estimated ROE for the last six years, 2013-2018. Median ROE for the period is 9%. Notably, ROA has decreased slightly since 2015 and has been offset by a slight increase in leverage:
(Source: Author Estimates)
Expanded Dupont Analysis of ROE
We have expanded the Dupont Analysis by breaking ROA down further. Of course, calculated ROE remains the same as above. Leverage remains the same as above, but ROA is broken down into the following variables:
- Tax Burden
- Adjustment Factor
- Management Burden
- Net Revenue Margin
- Asset Turnover
We are focusing on the ‘Management Burden’ component. Below we explain the calculation of each component and what it measures:
- Tax Burden = Income from Cont. Ops. Pretax Income. Measures tax efficiency and a ratio of 1 tells you that the REIT pays (almost) no taxes.
- Adjustment Factor = Pretax Income Operating Income. Cleanup factor that captures extraordinary losses. One tells you the accounting is clean.
- Management Burden = Operating Income Net Revenue after Provisions. This item contains General & Administrative costs as well as Management Fees. It attempts to estimate the cost of managing the REIT
- Net Revenue Margin = Net Revenue after Provisions Total Revenue. Similar to gross profit margin.
- Asset Turnover = Total Revenue Avg. Assets. Measures asset efficiency. This is low as expected for this type of business.
The median Management Burden for the time period is .72. Subtract this number from 1 and the interpretation is that the cost of managing the REIT consumes about 28% of Net Revenue.
Is this reasonable?
We can compare this to some public market comps. Blackstone Mortgage Trust is similar to banking and financial service companies. We also bring in data on REITS and the entire US market. I’m using margin data put together by Aswath Damodaran in January of 2020. The Management Burden of BXMT is similar to the SG&A to Sales relationship of financial service companies. The cost of BXMT is far less than Banks but far more than REITS. Relative to the entire market it is more expensive to operate Blackstone Mortgage Trust (BXMT) than your average company. We think financial services are the best comp here so it appears that the Management Burden is at least in-line to slightly better.
This is a difficult question without considering the value provided. For this cost you get access to Blackstone’s deal pipeline and Blackstone as manager.
Justified Price to Book Ratio
The last reported book value was $27.87 at Q3 2019. Currently, at $38.42 the stock has a price-to-book ratio of 1.38.
Three variables should determine the P/B ratio:
- Discount Rate (Equity)
P/B = ROE -g / r-g
We will estimate all three to arrive at a justified P/B ratio.
Informed by our Dupont Analysis we see that Blackstone Mortgage Trust (BXMT) has consistently generated returns on equity in excess of 8%, with a median of 9%. As of last quarter ROA was close to 2.2%, and leverage was 3.9. Using these numbers gives an ROE of 8.6%, which we are comfortable using instead of the historic median.
We are assuming a 0% growth rate. The firm pays out 100% of net income leaving no cash to be reinvested in the business for organic growth. However, with equity now priced at a premium to book value it is possible that BXMT can generate external growth.
To estimate the discount rate we need:
- Beta (relative measure of risk)
- Equity Risk Premium
- Risk-free rate
The risk-free rate (10 Yr. Treasury) is currently 1.6%. I’m using an Equity Risk Premium of 5.25%. We are using an unlevered beta of 0.31 for Mortgage Finance companies. Using the firm’s debt to equity ratio of 2.1 our levered beta estimate is 0.93.
The estimated discount rate is 6.5%. (1.6% + .93 * 5.25%).
Our estimated justified P/B ratio of 1.32. This ratio implies intrinsic value per-share of $36.79 and the current price per-share is $38.32. This is about 4% below the current stock price.
We think BXMT is about fairly valued trading about 4% higher than intrinsic value implied by our justified P/B ratio. We estimated a justified P/B ratio of 1.32 and the current ratio is 1.38. The current yield of 6.47% is certainly attractive to investors seeking income. However, keep in mind that we think that the current yield is equal to total return as the dividend is unlikely to grow given the 100% payout ratio. There are potential conflicts with the external management structure and they are somewhat mitigated with the incentive fee linked to ROE and Blackstone’s common share investment. The cost of managing BXMT (management burden) seems to be reasonable and in-line with financial service companies. Blackstone Mortgage Trust has been able to generate ROE of around 9% inclusive of the cost of the external management structure.
Disclosure: I am/we are long BXMT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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