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The magnificent seven of PE
The publicly listed Private Equity space is highly interesting to keep an eye on the business of PE. As the latest earnings season rolled over, I looked at the top 7 publicly listed PE stocks by AUM.
While plenty gets written about the $12 trillion Private Equity asset class, deals and investment strategies, the publicly listed aspect of it gets relatively lesser attention. This is a highly interesting space for you to keep a close eye on market movements and trends, and learn about the business of PE including aspects of developing new products (funds/strategies), raising funds, scaling operations, fees and deployments, amongst others. Most interestingly, about creating value for their shareholders as a private markets asset manager.
While the first private markets investor to go public was American Capital in 1997 (which listed as a Business Development Company, and was acquired by Ares Capital (another BDC) 20 years later), the real trend of going public as a private markets asset manager was kickstarted by Blackstone in 2007, raising $4.1bn at a valuation of more than $30bn. Fortress Investment Group (which was acquired by Softbank in 2017 and is now close to becoming a part of Mubadala) and KKR followed in 2007 and 2010 respectively, led by others like Carlyle, Apollo, Oaktree, Ares, EQT, TPG etc in the following decade. Today there are more than 15 global publicly listed PE managers (probably a lot more if you include VC and other closed end investment funds) with trillions in combined AUM.
As the latest earnings season rolled over, I looked at the top 7 publicly listed PE stocks by AUM managing about $4 trillion and having a combined market cap over $300bn - Blackstone (BX), KKR, Brookfield Asset Management (BAM), Ares management (ARES), EQT AB, Apollo (APO) and Carlyle Group (CG).
These seven are now well and truly diversified asset managers, investing across asset classes like PE, credit, real estate and infrastructure and across the globe. Why only seven? So that I could borrow the big tech moniker and call them the magnificent seven of PE.
Post IPO performance
Stock performance of these listed PE names has been mixed since their IPOs. But returns alone do not always tell the whole story. Blackstone for example, went public right before the financial crisis of 2008 and reached a low of about $4bn during the market drawdown of 2008-10, whereas KKR was listed right after the crisis in 2010 in a bull market which clearly acted as a tailwind for the stock price.
Others like ARES and EQT have used their stock currency to expand globally via M&A into other regions and asset classes, allowing them to grow their AUM (and their revenue base) rapidly.
Additionally, these stocks are highly sensitive to the macro environment (rates impacting fundraising, deploying capital and exits) and the overall economic conditions, making them high-beta names.
Here’s a quick look into the performance in the table below.
Long-term trends for the asset class and these stocks have been positive over the last decade. The pace at which the asset class has gathered AUM has been outstanding. The largest PEs have diversified their capital base globally and responded extremely well to institutional investor demands, built investment solutions they needed and delivered the performance they wanted in a low interest rate environment, making it an important component in institutional portfolios.
PE stocks are still impacted by sector related and idiosyncratic factors, like any other publicly listed corporation. The fundamentals of the PE asset manager business give you a framework to assess these stocks.
The business of PE
Like every other asset manager, fee revenues are an integral part of a PE business. The 2 & 20 model (2% management fee and 20% carried interest from realised investments) is well known, but today things are quite different. Firms offer institutional investor discounts, co-investment opportunities, fee holidays and other attractive deals to get them to commit capital for their funds.
On a blended basis, fee revenues are around a 100 basis points given the competition that exists in the industry. However, large brand names still have some pricing power on specialist funds or strategies, backed by their scale to source deals and deploy capital on attractive opportunities.
To put it bluntly, no, I think scaled managers with strong performance, strong track record leadership positions. Those aren't the ones feeling the pressure. And I think we're quite fortunate to have leading platforms across all our core asset classes. I candidly, I expect where that narrative is coming from is smaller or less scaled managers who are doing what they need to, to break into the space.
- BAM on whether they are feeling a pressure to reduce fees, Q2 earnings call
The markets love growth in fee revenues and higher fee margins given the stability and predictability in earnings it provides. The large listed PEs have raised a huge amount of capital, expanded into different strategies and products, and some of them have bought other private market managers to grow their asset base, and in turn their fee revenues.
For instance, ARES has compounded AUM and fee revenues at a CAGR of 19% since 2011 via organic growth by building credit businesses and inorganically by buying up PE and Infrastructure managers.
Fee related earnings (FRE) is another important metric tracked by analysts which gives you a sense of the operating efficiency of the firm and how much of the value stable revenue base can actually be distributed to the shareholders, after deducting employee and other expenses. KKR and BX for example, have best in class FRE margins of 61% and whereas ARES’ is a bit lower at 40-45%.
Realised investment income is the investment gains on exits, the lumpy and pro-cyclical part of a PE business’ earnings. This segment was down YoY for the entire sector given the volatility in the markets over 2022 and this year, driven by rising rates and a tight credit environment impacting exits, M&A and deployments.
Finally, distributable earnings (DE) is the sum of fee earnings and income (after expenses) from realised investments. It is used as proxy for distributable cash flows, and most firms would target giving back more than 90% of it to their shareholders via dividends and share buybacks.
These fundamental metrics are also used to construct multiples - Price/FRE and Price/DE for these stocks. Managements (in earnings calls and presentations) try to communicate the visibility of their stable sources of revenues to the market as a signal for the stock to trade at a better multiple of earnings.
Analysts would use these to compare PE businesses with each other or the rest of financial services sector. The premium or discount on the multiple could be a reflection of the confidence the market has in the prospects of the business and in the ability of the management to execute.
Here’s another table comparing key metrics for the magnificent 7.
So how are PEs driving growth in their asset base and fee revenues, and operating in this new market environment?
Some noteworthy themes emerged from recent earnings calls.
Private credit continues to shine:
Private credit has had a stellar year and a half since the start of the rate hiking cycle. The banking crisis in the U.S accelerated demand for lending products as banks retreated from the syndicated loan market. According to Ares, 85% of buyout financing activity happened in the private credit market this year.
Blackstone’s direct lending platform is now as big as $100bn, and it called it a “golden moment” of private credit. Apollo weighed in too by stating,
This is a great time for private credit. This is not a quarter, that's a great time for private credit. This is secular change. Not only do we have higher base rates and regulatory change and change in market dynamics, we are in the beginning of a secular shift in how credit is provided to businesses and a shift that I believe will continue to gather speed. To be successful in this market, you need a recurring supply of unique origination.
It had $23bn of originations in this quarter alone, whereas ARES’s credit assets have grown by more than $200bn in the last 5 years (incl. M&A)
KKR put a neat slide in one of its investor presentations showcasing the case for direct lending for PE.
You could expect further growth in this segment for the largest players as they leverage this asset class’ growth and expand beyond buyout and direct lending into Asset based finance and investment-grade credit products.
New products for new channels:
PE had always been an institutional asset class that was closed to individual investors. Blackstone, back in 2011, was one of the first movers to launch new products (funds) for a new Private Wealth channel - the high net worth individuals who want to invest in private markets. The BREIT, the Blackstone real estate income trust now alone has more than $65bn in assets. It subsequently launched BCRED, a private credit fund for this channel which has now $48bn in assets.
The private wealth channel has grown at a staggering pace with the others following suit. PEs are expanding their reach by offering products to wealth management platforms, distributing to HNW individuals via investment advisors (RIAs) and partnering with banks and non-bank financial services firms to reach investors who previously had little access to PE. Ares expects Individual AUM into Alternatives to grow by $9 tn over the next 10 years.
Insurance has emerged as another channel for PE to diversify their AUM base away from cyclical institutional money. The largest PEs have either bought insurers and annuity providers (like Apollo-Athene, KKR-General Atlantic, Brookfield-AEL) or strategically partnered with large insurers or reinsurers (Blackstone, Ares) to manage their asset book for a fee, and invest this capital into their suite of private markets products.
These channels have unlocked hundreds of billions of assets for the largest PE managers. But most importantly, they are a source of “Permanent capital” - another metric that is closely tracked and disclosed in their results.
Individual and insurance assets are permanent for that they do not have a 10 year fund lifecycle like traditional PE funds. Private wealth funds are semi-liquid funds that can be redeemed by investors upto a certain % per quarter. This is another competitive advantage for managers who can, at scale, build these distribution channels and capabilities and lend more stability to their FRE, and therefore DE.
Last week, Blackstone combined its Credit and Insurance units with $295bn in assets and expects it to grow to $1tn by itself.
The following excerpt from Ares’ Q2 earnings call highlights what the largest PE managers are doing in the space:
We have ambitious global product expansion plans, and we've made the investments in personnel and infrastructure to launch certain credit products into the European and APAC wealth management markets later this year and into next year.
We also formally launched Access Ares, a comprehensive online platform that offers product agnostic and educational content and thought leadership for the wealth channel.
Within our affiliated insurance segment through Aspida, we saw $2 billion of new annuity premium inflows from both our retail and reinsurance platforms in the second quarter. In the first half of 2023, Aspida has issued $3.6 billion in annuity premiums and has grown to approximately $9.5 billion in AUM.
Operating and driving value creation in this new environment:
From EQT, but the idea has been echoed by almost all of the magnificent seven
While the last decade was about low rates, large fund raises, leveraged returns in a bid to get bigger, this period seems considerably different. It is underlined by a more normal rate environment, breadth of products, scale, innovation, consolidation and getting better at managing capital and driving value creation. Interesting times lie ahead for the magnificent seven of PE.
Until next time,
The Atomic Investor