The Blackstone Group (NYSE: BX) has fallen sharply from its peak of $38/share all the way down to its current level of around $15/share over the last year. Analysts are now saying that the $100 billion private equity fund could earn less than half of what was expected during the fourth quarter thanks to increasing credit market turmoil. In fact, leveraged buyout plunged more than two-things in the second half of 2007 compared to the first half of the year. Much of this is due to banks pulling financing out of existing deals and refusing to finance new deals. The result has been an earnings outlook cut over 50 percent from late last year. So, what does this mean for Blackstone shareholders?

Just last year, private equity funds were in a “golden era” with spectacular deal sizes and record profits. Things quickly changed when deal financing from traditional banks dried up, putting private equity firms in a tough position. These firms make big profits through leveraging themselves and then milking a businesses cash flow, selling off non-core assets, and/or turning the businesses around to re-IPO. However, without any cheap money to go around, the process becomes much more difficult.

The solution? Blackstone announced that it is now workong on deals to bypass this reliance on traditional banks and instead get M&A financing from hedge funds and mutual funds directly. This could end up altering its fee results since these parties would likely charge more than banks, but may end up enabling it to obtain more attractive non-financial terms. The private equity giant also continues to raise money from the all-popular sovereign wealth funds, like China’s foreign reserve agency that recently bought a 10% stake.

Blackstone still faces a variety of problems before it can turn around. The private equity fund was sued by Alliance Data Systems last month for not being able to finish its $6.6 billion acquisition of the company, but that was recently dropped in hopes a new deal could be cut. Meanwhile, regulators are also pushing through changes to the taxation of fees charged by hedge funds and private equity funds. Currently, these firms enjoy paying only capital gains tax on their fee income, but this may soon change to the full corporate tax rate. This could mean a jump from around 15% to closer to 40% of net income going towards taxes. Many firms like Blackstone were grandfathered in, but will likely face higher taxes in a few years.

In the end, Blackstone looks like it is in a little trouble right now. A tight credit market has limited its access to leveraged capital while it is still working out the details for alternative financing. If the firm is able to identify alternative sources of financing, this stock could quickly move up. However, many analysts don’t believe the pain will be over until the credit markets improve. In the meantime, this could be a great time to load up on some cheap stock!

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