Perhaps the golden era of U.S. private equity is over. Interest rates finally seem that they will rise, crimping the cheap debt that fuelled so many leveraged buyouts. At the same time, the mature yet choppy equity markets can make it more difficult for the firms to exit past investments, realize profits, and pull in new fee-generating client money.
Many investors seem to have embraced the theory. The big publicly traded private-equity firms – Blackstone Group LP, KKR & Co. LP, Apollo Global Management LLC and Carlyle Group LP – are trading well below their 52-week highs, despite a nice run-up this year. They're still trading at levels that are producing eye-popping dividend yields of 8 per cent to 12 per cent. Three of the four have reported earnings in the last 10 days, and all posted results sufficiently mixed to keep their shares in check.
Indeed, they may muddle through the remainder of 2016 as the macro situation becomes clearer. This, however, may create an opportunity for investors with a longer-term focus and a belief that the firms are actually doing what it takes to build franchises that can deliver consistent earnings and dividends to their shareholders.
First, let's start with the descriptive term for these firms: They are known these days as "alternative asset managers," or some variation thereof. KKR (formerly known as Kohlberg Kravis Roberts) and Blackstone Group, to name two, have historically made headlines for their leveraged buyouts, in which they issue debt to finance their purchases of public companies, then flip them back out to public investors a few years later at a huge profit.
But these LBOs are just a part of the wide range of investing the firms are doing. Blackstone, for example, has a large real estate portfolio, a significant collection of hedge funds, and a sizable lending operation in addition to what most people consider private equity.
Before we look at each firm, a word about the above dividend yields, which are based on the last four quarters of payouts. The firms pay irregularly, declaring dividends that vary period to period. Blackstone's upcoming dividend, to be paid late this month, is 28 cents, well below the prior year's 89 cents. Carlyle's upcoming 26-cent dividend is just slightly below the 33 cents of May 2015, however.
Do the most-current declarations represent the best case, going forward? That pessimistic view would result in dividend yields in the 4 per cent to 6 per cent range. If, instead, the future payouts are a mix of the highs and lows we've seen in recent quarters, the yields could continue to push double digits.
Blackstone is the biggest of the four as measured by market capitalization, and it also happens to be analysts' current favourite, with 17 of the 21 who follow the firm placing a buy rating on the shares, according to Bloomberg. The average target price of $34.71 (U.S.) represents 26 per cent upside from Friday's close of $27.44.
Blackstone is also the most diversified asset manager of the four firms, says Morningstar analyst Stephen Ellis, and has "the strongest track record of strategy innovation and fund raising," he writes in a recent report. It's brought in more than $200-billion in assets to manage since 2011, which he believes is greater than the next four largest firms combined. It's added several new investment strategies in the last decade since its IPO, such as distressed real estate and "tactical opportunities" fund that mixes asset styles, and has attracted $130 billion to them, Mr. Ellis believes.
Blackstone "is nearly always a contender for new assets," Mr. Ellis says, as he estimates 20 per cent of the firm's limited partners (the firms that invest in Blackstone funds) are investing in all four of the firm's major divisions, "a sign of a very strong cross-selling platform" that is "increasingly serving as a one-stop shop for limited partners." Mr. Ellis' fair-value estimate of $41 for Blackstone shares results in a four-star (out of five) Morningstar rating.
KKR is another analyst favourite, with 13 of 17 buys and an average target price of $18.50 that represents 36 per cent upside from Friday's close of $13.60. KKR, more so than most of the firms, uses its own money to buy equity in its buyout deals. The good news is that when the deals work, it has more profit potential than firms who invest less.
The bad news, as shown the firm's first-quarter results this week, is that when investments underperform, it takes a bigger hit. KKR took credit-card processor First Data Corp. private before the global recession and could only take it public last year. First Data's dismal share performance in the first quarter led to a loss of more than $300-million.
Analyst William Katz of Citigroup Global Markets Inc., who has a buy rating and $20 target price on KKR, describes the First Data situation as the proverbial "baby and the bathwater" situation, and suggests it's distracting investors from a number of positive events such as a quality balance sheet and robust fundraising from clients. More buybacks of KKR units (technically, investors aren't buying "shares") would improve investor sentiment, Mr. Katz argues.
Analysts are less enthused about Apollo (eight buys, 10 holds) and Carlyle (five and 10), with average target prices implying returns in the teens.
Morningstar's Mr. Ellis is intrigued by Apollo's strategy of acquiring Athene Holding Ltd., a provider of fixed-income annuities, which now provides nearly 40 per cent of Apollo's assets under management. Unlike private equity funds, which have a life cycle of 10 to 11 years, Mr. Ellis says, "Athene's assets do not need to be returned to investors, meaning that Apollo can earn steadily greater fees as the asset bases increase over time and as it invests more of Athene's [assets] in Apollo funds." In addition, he says, Athene should help Apollo benefit from rising interest rates, as its costs are fixed but its investments are in assets whose yields rise, he says. (He has a fair value estimate of $25 on Apollo shares, versus Friday's close of $16.91, is good for a four-star rating.)
Carlyle, Mr. Ellis says "is clearly struggling," and while it's facing the same challenges as the rest of the industry, "some of its wounds are self-inflicted": a high cost structure and poor performance in some of its investment vehicles, including some recently acquired hedge funds. His fair value estimate of $19, versus Friday's close of $16.74, results in three stars in Morningstar's system.
Ken Leon of S&P Capital IQ, however, sees Carlyle's strength in real estate and traditional private equity, combined with nearly $60-billion in funds ready to deploy in new investments, as ultimately proving shareholder value. "We believe this opportunity will drive higher returns over the longer term," says Mr. Leon, who has a $20 target price.
Higher returns over the longer term. The current share prices of all of these firms suggest there's some doubt that can be achieved. If they follow through, however, shareholder gains are sure to follow.