Blackstone sees a possible “significant adverse effect” on its portfolio companies as a result of the US Tax Cuts and Jobs Act, among a number of risks to its operations and future profitability identified in its annual report.
The law has left a number of firms weighing up whether to convert to a C-corporation in the US and reap potential benefits such as a broadening of the eligible investor base and more straightforward tax reporting.
Blackstone’s take analyses the potential downsides, drawing out five changes it says “could have a material effect on our business operations and our funds’ investment activities”. It highlights the reduction to the federal corporate income tax rate; the partial limitation on the deductibility of business interest expense; limitations on the use, carry back and carry forward of net operating losses; changes relating to the scope and timing of US taxation on earnings from international business operations; and the longer three-year holding period requirement for carried interest to be treated as a capital gain.
The potential impact of higher tax on carry has been downplayed by some industry watchers, especially as research shows only a small percentage of private equity-held companies are sold after less than three years, but significant uncertainty remains regarding the treatment of profits from add-on acquisitions which are made later into a platform investment program and therefore often exited sooner.
While the investment giant says the “exact impact of the bill is still unclear and difficult to quantify”. the raft of changes “could have a material adverse effect on our business, results of operations and financial condition”.
Carried interest is also on the firm’s mind at a state level. A number of US states including New York, Illinois, New Jersey, and Maryland are considering increasing taxes on carried interest, and the proposal from New York Governor Andrew Cuomo – which would see carry taxed at 17 percent – is conditional on Connecticut, New Jersey, Massachusetts and Pennsylvania enacting the same shift.
Blackstone says if such changes are enacted they “could cause us to incur a material increase in our tax liability” and could subject unit-holders to higher tax rates than at present. The firm also said the carry tax changes in the tax reform bill, and any state-level changes, “may adversely affect our ability to recruit, retain and motivate our current and future professionals.”
The greater protectionist stance signalled by the Trump administration is also singled out as a risk, with the firm pointing to immigration reform, import tariffs and an expansion of the role of the Committee on Foreign Investment in the United States in blocking sales of US companies to non-US entities. Written before President Trump announced his plan to place steep import tariffs on steel and aluminium, the firm says tariffs “could increase costs, decrease margins… and adversely affect the revenues and profitability of companies whose businesses rely on goods imported from outside of the US.”
The firm also highlights recently introduced legislation which would dramatically increase the number of transactions subject to the jurisdiction of the CFIUS. It says that if the proposal becomes law it “may reduce the number of potential buyers and limit the ability of our funds to realise value from certain existing and future investments.”
Blackstone has exited a number of US businesses by selling to non-US companies in countries which appear to be the focus of the Trump administration’s aggressive posture, particularly China, including the $6.5 billion sale in 2016 of a 25 percent stake in Hilton Worldwide Holdings to China’s HNA Group and the $2 billion sale of the Waldorf Astoria hotel, sold to China’s Anbang Insurance Group in 2016. Anbang was last month seized by the Chinese state for alleged financial crimes.
This week CFIUS recommended Trump block the takeover of California-based telecommunications company Qualcomm by Singapore’s Broadcom on national security grounds. On immigration reform, Blackstone says the changes “may make it more difficult for current and future portfolio companies to recruit and retain skilled foreign workers and may increase labor and compliance cost”.
The firm also sets out its concerns for its credit business, saying proposals focused on deregulation, including changes to the Volcker Rule and aspects of the Dodd-Frank Act “could have the effect of increasing competition for our credit-focused businesses”. The firm says the potential move into this market by banks and other financial institutions “could have the effect of reducing credit spreads, which may adversely affect the revenues of our credit and other businesses whose strategies include the provision of credit to borrowers.”
Cybersecurity is also identified as a key threat. Blackstone revealed it had been attacked which it says involved “attempts intended to obtain unauthorized access to our proprietary information, destroy data or disable, degrade or sabotage our systems, including through the introduction of computer viruses”.
The firm says investors can’t be assured that measures it takes to ensure the integrity of systems will provide protection, “especially because cyberattack techniques used change frequently or are not recognized until successful”. Cybersecurity is a growing concern among GPs, and measures to combat it are rising up firms’ agendas. However a recent survey of firms by pfm and EisnerAmper found the majority of firms were only moderately prepared for cyber attacks.
On the fundraising side, the firm foresees potential risks relating to changes to the US Foreign Account Tax Compliance Act, which require foreign financial institutions to comply with what Blackstone says is a “complicated and expansive reporting regime.” It says this compliance “may discourage some foreign investors from investing in US funds, which could adversely affect our ability to raise funds from these investors”.