Private equity groups under pressure to buy own stock

The world’s largest private equity companies are coming under increasing pressure to buy back their own listed shares after the downturn in both the credit and stock markets hit the value of their portfolios.

A sharp drop in profits, including the unrealised value of investments, at Blackstone and Apollo in the fourth quarter has cast buyout groups in an unforgiving light, with Carlyle, KKR and Oaktree still to announce earnings this week.

Since peaking in early 2014, shares in Apollo and Carlyle have fallen by two-thirds, while KKR’s stock has halved and Oaktree’s has declined 30 per cent. Blackstone — the largest group by assets, with $336bn — has dropped nearly 40 per cent since hitting a record $42.92 a share last May.

The fall in their stock has left executives venting frustration that share-sellers are not recognising that the market drop will leave rich pickings for buyout funds to pluck in the long term, supporting their earnings.

In an investor call last week, Blackstone chairman Stephen Schwarzman said conservative assumptions on asset growth and the fees investors pay its funds to do deals over the next decade implied a share price of at least $100.

“It doesn’t seem like a tough decision to me but it apparently is to many of you, so I’m in the minority,” Mr Schwarzman said. “If an investor can do better than four to five times their money in 10 years, then they ought to go ahead and find something to do it with.”

Leon Black, chairman of Apollo, who called his own company’s valuation “an absurdity”, last week went beyond trying to reason with numbers. For the first time since listing in 2011, Apollo said it would buy back up to $250m of its shares, including future equity grants to employees.

Though buybacks have become a normal practice for other listed companies, buyout executives have usually preferred to focus capital on their own deals.

However, the share price falls of the five buyout groups mean that investors are effectively entirely discounting their future performance fees, or the share of profit the groups take alongside investors in their funds when they exit successful deals, underlining extreme scepticism about the companies’ value.

Performance fees are a big source of earnings, nearly all of which is paid out by these companies in dividends. Because the fees depend on exits, investors find them harder to predict than steadier, but less lucrative, income from managing fund assets.

The buyout industry has reaped record amounts of cash from selling or listing investments as the equity and credit markets surged in recent years. It returned $475bn to investors in funds in 2014 and $189bn in the six months to June last year, according to the data provider Preqin.

Shareholders fear the boom has largely ended alongside the hangover in the stock market, with investments being made now years away from generating fees, and possibly facing a tougher environment for financing acquisitions in the debt markets.

Management fees dominate the income of traditional asset managers, such as BlackRock, whose earnings are generally valued more than their private equity cousins.

“There is very little investor interest in owning the alternative managers, despite the compressed multiples and high dividend yields,” Kenneth Hill, an analyst at Barclays, said in response to Blackstone’s results.

Blackstone has so far decided against buying back its stock, unlike Apollo, or KKR, which changed its payout policy last year to permit repurchases, arguing that it could better use the capital in deals.

It has more technical reasons to eschew a buyback using cash on its balance sheet, which it reserves for acquisitions — such as that of the credit manager GSO, which it closed in 2008 — and to maintain a buffer when the sales of assets might slow.

That means Blackstone may simply have to wait for investors to believe Mr Schwarzman’s message.

Mr Hill added: “We still see Blackstone as the best positioned of the ‘alts’, with a highly diversified asset base and industry leading teams in each of their segments, but we struggle identifying a catalyst other than a materially more promising macro environment.”