By Margarida Veloso
Over the last eleven years we’ve seen many private equity firms go public, among them major names in the industry such as Blackstone in 2007 and KKR in 2010. However, stocks of many PE firms that were listed are still trading below their IPO price. Why are PE firms still going public if their stocks don’t seem to outperform? And what are the possible reasons for such a below expectations stock performance after the IPO?
Incentives to become publicly traded
Regardless of the issue’s performance, the most evident advantage of going public is the availability of funds that, otherwise, wouldn’t be so easily raised. Going public allows firms to raise money without spending time and resources on fund raising. It is sometimes seen as an evergreen source of capital, although not agreed upon by all industry specialists.
Another important aspect of being publicly traded is the diffusion and enhancement of the company’s brand image alongside with increased ease of hiring and retaining staff. Publicity surrounding public issues can be a low-cost marketing device, and the ability to pay staff in stock with liquidity becomes an important perk with regards to compensation and incentives.
Additionally, going public means that stock can be used as acquisition currency in expansions, like with Blackstone’s acquisition of GSO Capital Partners. Going public also usually results in your company getting a credit rating, which can be a very valuable testimonial of financial soundness to ease any investors’ concerns.
Access to public funding also allows PE firms to pursue deals in an increased number of geographies and in more types of assets, since the limitations placed on traditional LPs regarding geographies and asset classes can be bypassed. It is also important to mention that IPOs can represent a quite profitable exit strategy for founders that wish to leave the company, and may also provide tax benefits to the GPs in some jurisdictions.
Ways of going public
One way is that the PE firm can IPO the management company, entitling shareholders to a portion of the profits of the firm arising from management fees and carried interest. Another possible strategy to become publicly traded is to launch an investment trust in which the management company co-invests with the public, like a SPAC or a vehicle resembling a mutual fund. When in need of raising more capital, the fund will simply issue more shares if it’s open-ended. These two strategies are very different both in the way the money is raised as in the implications it has on the management of the firm. Nevertheless, applying both methods are also possible if firms want to retain some independence from public disclosure requirements for the majority of its operations.
Main concerns about going public
One of PE investors’ main concerns arising from going public is the fact that the management team might become more focused on quarterly earnings and in increasing the company’s stock price rather than new opportunities available for the PE firm to invest in, leading to a breakdown in the incentive schemes for the GP. PE firms invest with a time frame of three to seven years, therefore their focus should be on the performance at the end of the period and on the exit multiple, not on quarterly or yearly performance levels. This mismatch between the investment horizons in public versus private markets gives rise to the main risk of going public – the possible shift in the mindset and overall strategy of the PE firm.
Another constraint arising when becoming public is the need for more transparency and disclosure. The PE firm might be obliged to act in accordance with regulations, and reporting requirements will increase as the public stake becomes more and more significant. Additionally, other limitations on what a firm can invest in may be instituted in the interest of retail investor protection. All of this will constrain the PE firms’ actions, making them slower and possibly even restraining them from profitable investment opportunities.
Possible reasons for underperforming stocks after IPOs
One of the main reasons pointed at when trying to explain why the PE stocks are underperforming lies in the business model of PE firms, namely in the unpredictability of performance fees. The economics of the GP business may just not be attractive to investors. Also the fact that PE stocks are relatively recent in the stock market, are not included in indices such as the S&P 500, and are severely taxed are some other reasons why these stocks are laggarts.
Market trend and historical data
Looking at the share price of some of the most prominent PE firms that have gone public in the last years show that they have been underperforming. In 1997, American Capital had an IPO, becoming the first PE firm to go public. However, it was only after the IPOs of Blackstone and Fortress in 2007 that this new trend in the industry started with many others following – KKR in 2010, Apollo in 2011, Oaktree and Carlyle in 2012, Ares Management in 2014. This trend can be seen as the natural evolution of an industry that keeps on growing. While most of the PE firms just mentioned have expanded rapidly, their market valuations don’t reflect that – e.g. Blackstone went public in 2007 with a share price of $36.45 and after eleven years, the share price is still below the IPO price of $32.71, despite the increase in the size and revenues of the firm.
However, it is important to notice that, from 2016 onwards, more publicly traded PE stocks experienced an increase in prices and are now performing more in line with the market, and of course, there have been some PE firms who have outperformed the market entirely for decades like Canada’s Clairvest Group.
The share price should not be the only indicator of the success of an IPO decision. Blackstone benefited substantially from enhanced brand image (especially abroad) as well as being able to use their shares for stock-based compensation and acquisition currency, like in their acquisition of GSO Capital Partners. The PE industry is estimated to be worth 1-1.5€ trillion, however, the listed companies amount only to 10% of the total estimated market. Perhaps in the future these public issues will start growing into that valuation, and going public may become a natural and increasingly orthodox step forward for PE firms.
Editor: Stefan Larsen
Authors: Margarida Veloso