“If you missed your chance to buy the IPOs of Blackstone Group or Fortress Investment Group in 2007 you're in luck,” says an article from an online investing site. “The private equity bigwigs at the Carlyle Group are looking to go public.”
The author is — I hope — facetious, as the luckiest investors are the ones who’ve skipped the initial public offerings of private-equity firms south of the border.
Blackstone is down 40 per cent from its offering price, while Fortress has lost almost 80 per cent. OakTree Capital has declined more than 7 per cent since its offering two weeks ago. KKR Inc. is the industry’s sole post-IPO gainer, but is also the rare financial stock that is down 25 per cent from a year ago.
Of course, that’s all history. The management of Carlyle Group says investors should forget the industry’s lacklustre record of shareholder returns. They say their IPO, when it prices later this week, will be at a moderate valuation compared to its private-equity peers. The implication is that it will not suffer the same post-IPO woes as others in the industry.
It still seems, however, to be a case of buyer beware.
For starters, there are several reasons to be skeptical about the private-equity industry in general. “Alternative asset managers,” as they like to be called, invest in private companies or public companies that they take private. The private-equity wizards revamp these firms and realize much of their profits when they exit their investments by taking them public. That makes their success highly dependent on market conditions.
When private-equity firms do score a big win, the top executives have a tendency to take much of those profits for themselves: The top three Carlyle executives received $402-million (U.S.) in distributions in 2011, the IPO prospectus reveals.
These Wall Street sharpies obviously have a keen sense of when to buy low and sell high. Why, then, should you be buying what they’re selling?
Carlyle Group mitigates this concern, to some degree, because the principals of the firm aren’t selling their shares in the offering, which aims to raise around $700-million to pay off debt and would value Carlyle Group at over $7-billion.
Unfortunately, Carlyle Group’s offering is structured as a sale of limited-partnership units, not shares, which allows the company to flout all sorts of corporate governance rules. The board “representing” public shareholders will be limited in its independence and the company acknowledges that the general partner — representing the firm’s founders and early investors — has interests that may conflict with the public unitholders.
This is not uncommon for the public private-equity industry, but Carlyle’s early proposals for its offering suggest that the firm intends to lead its peers in shareholder contempt. The company inserted language in the offering document that said buyers of the units would have no ability to sue under existing class-action securities law and instead would have to take the company to private, binding arbitration. (The Securities and Exchange Commission told Carlyle that was a no-go, so the language has been excised.)
The problems don’t stop there. If you believe complexity is a negative, private equity is not for you. Carlyle’s flow chart for its post-offering corporate structure shows three types of owners and 13 related entities.
Okay, fine, you say: Enough of this granola-governance stuff — will this stock make me some serious money?
Well, if things go as well as Carlyle says they will, there’s some dividend yield to be had — the firm says it plans a 16 cent (U.S.) quarterly distribution, good for a yield of about 2.7 per cent, plus an additional annual payment that could push the yield into the high single digits.
That, of course, is if Carlyle can generate the “distributable earnings” it plans, no small feat in a business where profits are lumpy and irregular. It’s nearly impossible to value Carlyle’s peers on an earnings basis, because most of them have reported negative earnings before taxes and unusual items over the last three years.
Carlyle, for its part, claims about $864-million in distributable earnings for 2011, which is the core of its contention that a $7.3-billion market capitalization — less than 10 times earnings — is reasonable.
If you buy into the idea that you’re investing “alongside” the masters of the universe that run these funds, and are willing to overlook the inscrutable business model that defies conventional equity valuation, there may be a little piece of the action awaiting you.
But if you miss your chance to buy the IPO of Carlyle Group — well, you may be in luck again.