How Have Private Equity Firms Fared in the Public Market?
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Ever since Blackstone (NYSE: BX), one of the largest and most prominent private equity firms, went public in June 2007, other well-known private equity firms have also followed suit, including KKR (NYSE: KKR) in July 2010 and Appollo (NYSE: APO) in March 2011. Now five years after Blackstone's IPO, Carlyle is the latest private equity heavyweight to finally see its shares' public debut.
Having shown keen interest in taking their private equity firms public, companies nonetheless have all offered a rather limited number of shares to the public. Outstanding shares of private equity firms mostly remain in the hands of company founders, their partners, and other executives. Raising capital from an IPO usually is not an overwhelming concern for private equity firms and thus outside investors, institutional and individual, represent only a small percentage of a private equity firm's ownership. This often translates to low liquidity in trading volumes and can potentially hurt stock performance.
Carlyle plans to sell about only 10 percent of its total shares to the public, as Blackstone did the same with its IPO. KKR sold the most of its shares by offering the public around 30 percent of all shares outstanding, followed by Appollo selling approximate 20 percent of its available shares at the time. Capital raising is only one purpose in private equity firms' IPOs, and seeking compensation for existing owners is another reason why a private equity firm would decide to go public. The amount of capital raised from IPOs by private equity firms are mainly used to cover ongoing operating expenses. Private equity firms as asset managers do not put up their own capital in investments, which are financed by capital contributions from investors of individual private equity funds. IPOs largely provide a liquid public marketplace for founders of private equity firms to cash in by selling part of their holdings. But even after selling their shares, original owners often remain as the largest shareholders and thus can keep private equity firms mostly in their own hands even as public companies.
There often is a disconnect between the amount of capital obtained from new share issuance and the amount of additional earnings expected to be generated by the capital, because the fresh capital is not meant to be directly used for investment purchases. The amount of investment assets under management, or AUM, has more relevance to earnings and is directly tied to the amount of money raised from investors of each private equity fund that a private equity firm creates. These investors are not company shareholders but referred to as limited partners of individual private equity funds within a private equity firm. Therefore, without also expanding a private equity firm's fund raising capability and making more private equity investment deals, the increase in shareholders' capital actually brings down the average return from investment management fees and any carried interests earned under currently managed investments.
For shareholders of private equity firms, AUM is a more important measure when evaluating company earnings, not the asset or equity value reported in a firm's balance sheet. Assets under management are off-balance-sheet investments, and the firm and its shareholders do not own them but each fund's investors do. However, the level of assets under management can be indirectly assessed based on the reported revenue in the income statement. Private equity firms charge management fees as revenue usually at one or two percent of the amount of assets under management.
Because of the nature of the private equity business, the stock of private equity firms may not be the ideal candidates for achieving long-term price appreciation. To continually increase revenue and profit, private equity firms have to sponsor new private equity funds to raise more money, and find additional investment deals over time. Meanwhile, the money raising and deal making must offset the effects of fund closing when investments are sold for a profit and money returned to fund investors. Thus, the financial performance of private equity firms can be hardly expected to be in a linear fashion. Many private equity firms have lost money for shareholders in terms of their stock prices. Blackstone has declined from its post-IPO's high of $35 level all the way to today's $13 range, and so has Appollo with its stock price coming down from initially about $18 to now around $12. However, with their stocks trading at 2 to 3 times book value, private equity firms are reasonably valued and may be good targets for dividend-income investments.
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