Shares in private equity firm The Blackstone Group (BX) are severely undervalued, according to a new analyst report from BoA Merrill Lynch.

The private equity giant has been among the financial stocks getting hammered this month, down nearly 20% to open trading today at just $12.84 per share. That’s down 34.59% from its 52-week high, and a whopping 58.58% from its June 2007 IPO price.

A lot of the stock’s slide seems attributable to expected valuation decreases in Blackstone’s investment portfolio, which have not yet been updated to reflect July and August’s rocky public equities market. Not only Blackstone’s public equities positions, but also its private equity positions which must eventually be marked-to-market.

BoA analyst Guy Moszkowski, however, believes these worries have been overemphasized. He writes that Blackstone’s fund management and advisory fees alone should be worth $14 per share, which means that any upside on the investment portfolio would be gravy for those buying at today’s prices:

Based on this valuation, investors implicitly receive a free call option on the future carry opportunity, which should be significant once the environment recovers, potentially yielding billions in distributions to unit holders.

If we were talking about another private equity firm, I might question the management fee assumptions. After all, falling private equity portfolio valuations can make it difficult to raise new funds, thus reducing future management fee prospects. But Blackstone is flush with dry powder, having only recently begun investing its $14.3 billion BCP VI fund earlier this year. Moreover, that fund has not yet held a final close, and is expected to do so on a total of more than $16 billion by year-end.

The only real question I have about Moszkowski’s analysis is his focus on Blackstone’s publicly-traded portfolio companies. He writes:

BX benefits from having fewer portfolio companies that are publicly traded, allowing marks to be applied based on underlying fundamentals (Revenue/ EBITDA growth), and is thus more immune to market volatility swings.

What this ignores, of course, is that prolonged market volatility could make it difficult for Blackstone to exit some of its larger private positions. Sure it may be able to do some optimistic accounting on paper — even though Blackstone, like like PE firms, prefers to remain conservative on private valuations — but that won’t help it push out IPOs if the public markets are broadly rejecting new issues. Remember, just two of this past week’s 12 anticipated IPOs managed to price.

But, again, this is part of the reason why I think the public markets still don’t quite understand the long-term nature of private equity. Buying Blackstone is a lot like buying an option on future economic growth. So long as private equity firms have adequate capital reserves, then it has the luxury of selling assets when markets are on the rise. They don’t face redemptions — save for in their hedge funds, of which Blackstone has several — nor are there serious default concerns based on portfolio company credit agreements (thanks to the persistence of covenant-light terms).

So if Blackstone is a buy, it’s a buy-and-hold. Short-term, all bets should be off.