For Blackstone, a Pot of Gold Remains Out of Reach

Eight years after its inception, the biggest private equity fund in history has yet to meet its own minimum expectations.

The investment performance of the fund, a $21.7 billion war chest raised by the Blackstone Group, remains below a threshold that it must clear in order for Blackstone to start collecting profit from it, according to a disclosure on Thursday.

The fund is getting closer to that goal, but it was still about $1.3 billion short as of Dec. 31, Blackstone said. The fund, known as Blackstone Capital Partners V, represents a potentially lucrative source of profit for Blackstone â€" but one that remains locked up for the immediate future.

The predicament underscores how the financial crisis continues to haunt Blackstone, the biggest alternative investment firm on Wall Street.

As a result of the crisis and the economic recession, the fifth buyout fund was forced to stay invested in deals longer than it otherwise would have, raising its target for minimum performance. The deteriorating economy also put a strain on some of the fund’s big deals, like Hilton Worldwide Holdings.

Private equity firms like Blackstone get their income in the form of performance fees, also called carried interest, which represent 20 percent of an investment’s profit. The firms get paid when a company they own is sold or taken public, realizing a gain. But Blackstone, like many other firms, sets a hurdle that the fund must meet before “carry” can be paid.

The BCP V fund, raised at a time when private equity was booming, was hailed as a milestone in the buyout business. It got to work in December 2005, investing in companies and achieving gains. In that context, the fund paid out cash to its investors.

Even more investors wanted in, and Blackstone raised a separate vehicle tied to BCP V, calling it BCP V-AC, for “additional capital.”

But in 2007, the crisis struck, putting pressure on Blackstone. The cash that BCP V had paid to investors now translated into a shortfall for the fund, because of its particular accounting rules. The legal arrangement was such that the subsidiary fund, BCP V-AC, could not pay carried interest until it had made up the shortfall for BCP V.

The situation seemed worrisome for Blackstone. But the private equity firm managed to avoid disaster.

Hilton did much better than many thought it would. Blackstone, which bought the company with its big private equity fund along with a group of real estate funds, took Hilton public last December, having increased the value of its investment by nearly $10 billion.

Another major investment for the private equity fund, SeaWorld Entertainment, more than doubled Blackstone’s capital when it went public last April.

Over all, the value of BCP V has increased to $29.7 billion as of Dec. 31, Blackstone said on Thursday. Last year, BCP V fund grew 34.5 percent.

But that’s not enough for Blackstone to start making serious money. Blackstone doubled its profit in the fourth quarter of 2013, but an additional trove of potential profit remains locked up in BCP V, just out of reach.

The threshold for the fund is 8 percent of invested capital, compounded annually. That means that the longer the fund holds its investments, the higher the bar climbs.

When the fund reaches its threshold, it will create a sort of bonanza.

Blackstone will be entitled to all of the profit that it would have earned on those gains. It will start taking 80 cents on every dollar earned until it catches up. Then, it will transition to collecting the standard 20 percent of profits.

This goal is growing closer. As of the fourth quarter, the BCP V-AC subsidiary has paid what it owed to BCP V and become eligible to pay carried interest to Blackstone. The larger BCP V fund, however, is still 4 percent short of its threshold.

At this rate, the big private equity fund could reach its carry threshold in late 2014 or early 2015, said William R. Katz, an analyst at Citigroup. Blackstone’s shares rose 4.2 percent on Thursday, possibly in anticipation of that future profit.

“The market has underestimated the earnings power once that shifts back into carry,” Mr. Katz said. “Today’s results provide a line of sight to that probability.”