PRESSURE ON PRIVATE EQUITY TO SPEND CASH / THE FINANCIAL TIMES

Smart Money

June 22, 2015 9:07 am

Pressure on private equity to spend cash

Henny Sender

Industry feels pain of investor activism and regulatory scrutiny

©Bloomberg

 

 

Blackstone celebrated its eighth anniversary as a public company over the weekend. That it has just raised yet another private equity fund, this one at $17bn in seven months, bringing its total funds under management to more than $300bn, is another indication of both its clout and how far ahead of its rivals it is.

 

Moreover, it has no succession issues in contrast to some of its peers, such as Apollo or Carlyle, and many banks including Goldman Sachs and JPMorgan. When Blackstone went public, it instituted a lock-up for eight years before the shares fully vested for some of its partners, but now that the shares have fully vested there have been few departures. There is little doubt that Blackstone’s founder Steve Schwarzman and its president Tony James have built a best-in-class firm.

 

Blackstone’s market cap is more than $50bn — more than all the key rivals combined (KKR at about $19bn, Carlyle at $9.2bn, Oaktree Capital Management at $8.2bn and Apollo Global Management at $3.7bn). The shares trade at about $42, comfortably beyond the $31 listing price and well above the financial crisis low of $3.55 plumbed in 2009. Blackstone is also generous to shareholders, paying big dividends, though admittedly the main beneficiaries are Blackstone executives with 51 per cent of the shares.

 

In other words, the past few years have been kind to Blackstone and every other private equity firm. The Federal Reserve’s quantitative easing and zero interest rate policies have been especially kind to users of other people’s money, such as the big alternative investment firms.

And yet the outlook for Blackstone and its competitors may not be as terrific — especially for their core private equity business.

The fortunes of these firms have also been buoyed by record distributions as Blackstone and everyone else sold companies to take advantage of the rally in the stock market. Blackstone alone returned $50bn to investors in its funds in the past 12 months. But it is not apparent that their stock of portfolio companies can be replenished as attractively as they once could or as attractively as their corporate rivals.

That is because companies are under pressure to spend their idle cash whether through share buybacks (and never mind the record level of their stock price) or through mergers and acquisitions, at a time when their revenues are not growing and any cash they have is earning next to nothing thanks to zero rates. Many executives feel the pressure, or potential pressure, of activist hedge funds that dislike seeing masses of cash sitting idle, as a recent report from Citigroup notes.

Meanwhile, purchase price multiples (enterprise value over ebitda) are at an all-time high of about 10 times, Citi says, deriving the figure by combining price earnings multiples and the public-to-private premium. While both financial and non-financial firms have to pay about the same price for debt, the equity of private equity firms is more expensive, which makes it difficult for them to outbid non-financial companies, even before considering the synergies that the latter can price in to their deals.

Moreover, most of Blackstone’s competitors do not have anything like its diversified businesses.

In addition, in a speech in mid-May, Marc Wyatt, a Securities and Exchange Commission official, said the regulator might bring additional enforcement actions against these firms involving undisclosed and misallocated fees and expenses and conflicts of interest. The SEC has also widened its focus beyond private equity to look at real estate, credit and infrastructure funds. Investors are scrutinising their investment terms more closely than ever before.

 

 

 

What then is the ultimate fate of these curious creatures? There has been speculation that traditional asset management firms could buy them. BlackRock, which has a market cap of almost $60bn, for example, has been trying to build up its alternative business for a while without notable success. One former Carlyle executive, for example, speculated that the firm could easily be sold to the likes of BlackRock, given where the market values stand today. But investors who would consider these firms as candidates for takeovers should be cautious. Senior Carlyle executives say the structure of the agreements with the limited partners in their funds makes such takeovers virtually impossible.

 

Blackstone will probably do far better than its rivals, especially given its diversification. This is not a case of the higher they rise, the further they fall. But it does suggest even the best are not immune.