Why Are Public Private Equity Stocks Struggling?
Author — George Trager, Financial Markets Enthusiast, Editor of investbrain.net
The largest public private equity firms have overall had a rough time in the public markets over the past 3 years. As shown in the below chart, with the exception of Steve Schwarzman’s Blackstone Group, the stock prices of the four other major private equity firms are in the negative territory over a three year period – for comparison sake, the S&P 500 index is up 32% over this same period.
The significant under performance really begs the question of why public investors have chosen to allocate their capital away from public private equity firms who themselves are professional capital allocators (by definition). The fact that we’ve been through several years of accessible credit markets, cheap financing options, record mergers and acquisitions and a multitude of initial public offerings serves to compound the confusion. We see two explanations for the under performance:
Private Equity Firms Are Relatively Opaque
Though most of the large private equity companies have now diversified into other businesses outside of traditional private equity, it continues to represent the majority of their business. The issue with this however is that by its very nature, private equity investments are private. Public investors have to trust management’s assessment of what their holdings are worth in a given quarter. Going through the process of assessing the various investment holdings is a task few, if any, public investors can do with any accuracy given the lack of information available on these private companies. Investors are left with having to trust that managements estimates are close to market value.
Public Private Equity Stocks – Portfolio Company Indebtedness
The traditional private equity deal structure involves acquiring companies with a significant amount of leverage. The benefits of such structures are obvious – the equity investment required to gain ownership of the company is relatively small meaning that if they can sell the company in the future for a higher amount than they purchased it, and also lower the debt load, they can earn multiples of their initial investment. However, in a risk-off market environment with rising rates, leverage flips from being a great thing to being a scary source of risk. Public private equity companies hold portfolios of these highly levered companies. The above chart depicts the Bank of America/Merrill Lynch U.S. High Yield Index which has declined precipitously since the middle of 2015, roughly when the declines in the stocks of these private equity firms began.
The performance of these companies’ stocks has led to management voicing their frustrations publicly and some of the firms, such as Leon Black’s Apollo Global Management, launching share repurchase programs. There’s no question these companies have significant value, so the ability to purchase shares of Blackstone, Apollo Global Management, The Carlyle Group at roughly 10x forward earnings (or in some cases even less), could prove to be a great buying opportunity. The flipside however could be that we are on the other end of the cycle and going through a period where credit will no longer be cheap and private equity exits via the public markets will be tougher to come by.