Kevin Dowd May 20, 2016
The "private" in private equity refers to the fact that the companies owned by PE firms are not publicly traded, and for the majority of the industry’s existence, it also applied to the firms doing the buying and selling. Buyout shops are traditionally private partnerships with decision-making power concentrated in relatively few hands. They are reliant on LPs for capital and carried interest/fees to make profits. They are also free from the cumbersome reporting required of companies in the public markets.
Increasingly, though, that definition is changing. In the past two decades, nine firms that frequently engage in PE activity have IPO'd on the NYSE or NASDAQ, with rumors arising every year of more big firms considering the leap. For the most part, those firms are chasing the same things—such as liquidity for shareholders and the large influxes of cash that accompany a public offering—yet the markets have largely been unkind. Of the nine that have gone public, six are trading below the share price when they opened trading.
Has going public paid off? It’s of course a many-layered question, one with different answers for different firms with different motivations. The arcane accounting practices such firms often employ cloud the picture further, making it difficult to compare and parse balance sheets with much certainty. But there’s at least one founder of a public PE firm already expressing seller’s remorse.
“I can’t imagine why any private equity firm would ever want to go public,” The Carlyle Group’s David Rubenstein said earlier this year, quoted in The Wall Street Journal from SuperReturn International 2016 in Berlin. “Private equity firms that are public have underperformed virtually every other publicly traded stock.”
The first firm to take the public plunge was American Capital, headquartered in Bethesda, MD. American Capital—like Ares Management and Main Street Capital—operates a bit differently from the other firms featured in this post, being perhaps better known for its middle-market credit activities. But all are still active enough in PE to qualify here. (American Capital and Main Street are also both business development companies and are thus regulated differently from other PE firms. So is Ares Capital, the middle-market-centric arm of Ares Management which trades on the NASDAQ under the symbol ARCC.) American Capital debuted on the NASDAQ under the ticker symbol ACAS on September 2, 1997, opening at $19.50 per share; it remained the only publicly traded PE firm for the next 10 years.
It wasn’t until 2007 that a trend began to develop. First, in February, Fortress Investment Group held an IPO on the NYSE. In June, it was Blackstone's turn, joining the NYSE. And in October, Main Street IPO'd on the NASDAQ. All three hit the market just before the financial crisis began—a fact that allowed them to raise much more capital than would have been possible just months later.
Blackstone offers an interesting case study of why some PE firms choose to go public. At the time of its public offering, one of Blackstone’s two co-founders, Peter G. Peterson, was 81 years old and on the verge of retirement, looking for a way to cash out from the firm he’d spent two decades building. He sold the majority of his shares in the IPO, pocketing a stunning $1.8 billion in the process. Peterson’s co-founder, Stephen Schwarzman, earned $700 million on the initial sale and retained a further $8.8 billion in stock. For aging partners typically atop the masthead of firms mammoth enough to even consider going public, that sort of windfall has a certain appeal.
Nonetheless, by November 20, 2008, Blackstone’s stock had plummeted to $4.15 from an opening share price of $36.45 just 18 months earlier. By Christmas 2008, Fortress stock was trading at less than a dollar per share, a precipitous decline from its $35 open price. American Capital fell victim to the recession, too, dropping below a dollar during 2009. In general, the decay in PE share prices outpaced the decay in the market as a whole. The sagging economy was priced into portfolio companies, diminishing the ability to generate fees and hit hurdle rates. The stocks of American Capital and Fortress have never truly recovered; to this day, each firm’s share prices were at their highest during the heady pre-crisis days of 2007.
Still, there were other PE firms ready to follow their lead. KKR was next in July 2010, employing some serious financial gymnastics to line up its offering amid the untoward market conditions post-crisis. In the couple years prior to 2010, the firm executed a complicated reverse merger involving an exchange of stock with an Amsterdam-listed affiliate. The arrangement limited its founders’ ability to immediately exit and didn't raise new capital, but it did allow KKR to set its own valuation, rather than relying on the book-building process. Perhaps just as importantly, it allowed KKR to establish itself as a publicly traded financial institution, positioned to live on well after its founding partners depart.
Three months later, Main Street followed KKR to the NYSE, switching exchanges under the same MAIN ticker symbol. In the next two years Apollo Global Management, Oaktree Capital Management and The Carlyle Group joined the fun. The share prices of all five crept mostly upward until 1Q 2014, when a market correction caused stocks across the public markets to plunge. This proved to be the collective high-water mark for this second crop of publicly traded firms. None of the five’s share prices have yet returned to the peaks reached two years ago. In the wake of that bearish spring, Ares Management debuted on the NYSE, opening at $18.15 per share on May 2.
The past year has brought a third round of tumbling share prices for PE firms. Carlyle, Fortress, Blackstone and KKR are all trading at more than a 35% decline from last spring, with Apollo and Ares also declining as part of a larger market regression. While indices have since somewhat recovered, the stock of these firms continues to lag. If the only variable that mattered was share price, it would be fair to call the experiment of going public a failure for most firms.
Fortunately for the firms, there’s much more to the issue than numbers on a stock ticker. There are other reasons firms choose to go public, such as the chance to transform from an entity focused purely on private equity into a public asset manager, or the high dividends that PE stocks often return. Conversely, there are plentiful reasons to avoid going public, including the regulatory constrictions levied by Sarbanes-Oxley and the effort required to execute an IPO. From the outside, it’s difficult to judge a firm’s competing motivations. With the massive quantities of capital that accompanied their IPOs, perhaps major shareholders are no longer as concerned about day-to-day fluctuations in stock. And the siren song of liquidity attracts all.
Still, low share prices are obviously a cause for concern. In recent months, Carlyle, Apollo and KKR all announced plans to buy back hundreds of millions worth of their own stock. The goal of such a move is to help boost share price by lowering the number of outstanding shares on the market, in the process returning capital to shareholders and retaining talent with stock options. Buybacks would make particular sense if a firm feels the market is undervaluing its stock and that a bounce-back is in the offing. That’s certainly a possibility considering the opacity of public PE firms, which can make it difficult for investors to properly gauge their worth.
One thing’s for sure: limited partners haven’t been cowed by underperforming stocks. Carlyle, KKR, Blackstone and the rest continue to raise larger and larger vehicles for PE activity, in the process catalyzing billions and billions worth of investment.
So, is it a good move for private equity firms to go public? It’s a question only the firms themselves can answer. And two very different responses were given at SuperReturn in February.
First, from Joseph Landy, a co-CEO of Warburg Pincus, one of the private firms rumored to be considering an IPO.
“We have no interest in going public,” Landy said. “If you actually went back to some of those owners and founders of private equity firms and asked them if they were happy about going public, I think it would be very interesting in terms of what you might hear, you know, in fits of honesty.”
And finally, from Apollo co-founder Leon Black, on what he heard from advisors when the firm was considering going public.
“Half of them said, ‘Of course, this is an unbelievable opportunity. You can grow this to be a global alternative asset company,’” Black said. “And the other half said, ‘Are you crazy, you must be out of your mind.’ I’m glad we made it, despite my whining about the stock price, because it has helped us build into a global, integrated alternative firm."
(Update 5/23: Ares Capital, the middle-market-lending subsidiary of Ares Management, has reached an agreement to acquire American Capital for about $3.43 billion.)