Publicly Traded Private Equity Firms — A Good Buy?

January 20, 2022

Source: Bloomberg Source: Bloomberg

The private equity industry has grown in size and maturation since the wave of the early leveraged buyouts (LBOs) in the 1980s, including one of the most infamous deals of all time, KKR & Co.’s $25 billion LBO of RJR Nabisco in 1988. The growth in the industry has been particularly evident since the great financial crisis of 2007-08, as large alternative asset managers including Ares Management, Apollo Global Management and The Blackstone Group have continued to grow assets under management (AUM) in a world where institutional investors are looking to deploy large amounts of money in hopes of high returns on invested capital.

As shown in this week’s chart, the large publicly traded alternative asset managers have seen material share appreciation since 2016 amid an environment of low interest rates and Federal Reserve intervention during the COVID-19 pandemic. In addition to the primary asset classes in which these firms invest, which consist of private equity, real estate and credit, a push toward environmental, social and governance mandates among institutional investors has helped these alternative asset managers grow in size. Many alternative asset managers in the market today offer investment funds focused on climate change, clean energy, energy transition and social causes.

As the AUM of these firms continue to grow, the deal and exit environment has expanded as well. According to a Preqin study, deal and exit values soared throughout 2021 as managers looked to deploy record amounts of dry powder, as well as use the public markets as an effective exit strategy for their portfolio companies. Overall, total private equity deal value reached $804 billion in 2021, a 70% increase over 2019. In addition, total private equity exit value reached $767 billion, a 92% rise over 2019.

In terms of AUM growth, Preqin forecasts that global private equity and venture capital firms will manage roughly $11.1 trillion by 2026, compared to just $4.1 trillion in 2015 for all private market asset classes. As a whole, Preqin is forecasting that the AUM total for all major alternative asset classes (private equity, venture capital, private debt, hedge funds, real estate, infrastructure and natural resources) will reach $23.2 trillion by 2027, with private debt seeing the largest growth in terms of AUM.

Private equity firms earn money through various fees and services, including management and advisory fees, incentive fees, investment income, interest and dividend revenue. These alternative asset managers generally charge “2 and 20,” which consists of a flat 2% fee on committed capital of the fund as well as 20% carried interest, or a 20% share of the profits. As these alternative investment managers continue to raise larger funds and expand into other asset classes, the management fees grow accordingly.

Ultimately, growth in management fees translates into “recurring” revenue that analysts can model out into the future, although performance fees are more difficult to forecast. Given where interest rates are and the need for institutional investors to continue deploying large amounts of capital, these alternative asset managers will likely continue to steadily grow their capital base, thereby simultaneously increasing revenue.

Key Takeaway

Due to low interest rates and the vast capital that institutional limited partners need to deploy, large publicly traded alternative asset managers like Apollo, Ares, Blackstone, Carlyle and KKR have continued to grow their AUM over the past decade. As these alternative asset managers are compensated on the size of their capital base, growth in AUM can also be interpreted as growth in their revenue.

Given the environment today, it is reasonable to think that AUM growth will likely continue, and the share prices of these alternative asset managers should continue to appreciate as management and incentive fees are generated across a broader suite of investment products under the umbrella of each individual asset manager.

Tags: Private equity | leveraged buyouts | alternative asset managers | limited partners

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