It's just shy of five years since Blackstone Group LP took in $4.1 billion in an initial public offering staged at the market's ecstatic peak. With Carlyle Group's less-than-electric listing May 3, every major U.S. private equity house that has evinced interest in going public has now done so.
So it's a good time to look back and take stock. Have the listings functioned as advertised? Do IPOs of private equity firms make sense? If so, for whom?
First, let's dispense with the contention that publicly listing a private equity firm, as the Financial Times has put it, violates a "business model predicated on the superiority of being private." Rubbish. The model doesn't call for PE-owned companies to remain private in perpetuity. Indeed, buyout firms, after fixing up or turning around the companies they buy away from the public spotlight, routinely take gains by taking them public. As to the PE franchises themselves, 20 or 30 years of private ownership is surely enough prep time for prime time.
Or is it? Most have performed abysmally in the public glare. Blackstone's shares have fallen 62% since its IPO. Och-Ziff Capital Management Group LLC and Fortress Investment Group LLC, which, like Blackstone, both went public in 2007, have nose-dived 77% and 84%, respectively. Oaktree Capital Group LLC is down nearly 17% since it began trading in April. Carlyle's shares limped out of the gate at $22 -- a lowball value meant to whet demand -- and have closed below the offering price nearly every day since. Only Kohlberg Kravis Roberts & Co. LP's shares have edged up, but that's because it listed in 2010 during a market trough.
The reasons for the weak showing go beyond the private equity industry's post-crisis woes. A key point against them is that, unlike most publicly traded companies, PE firms' earnings aren't entirely in hard cash. Instead, a chunk of them are latent -- reflecting performance fees the firms stand to collect down the road on unsold PE investments.
Moreover, those "fees" are based on the firms' own estimates of worth, and by the time the firms actually unload the holdings, the market climate and the investments' value are apt to have changed. Making these stocks yet harder to draw a bead on, the buyout houses withhold detailed performance data that would enable public shareholders to size up the portfolios themselves.
In addition to their opaque financials, the firms all have a limited partnership structure that deprives minority shareholders of having a real say.
Which begs the question: If these businesses are patently ill suited to public understanding and acceptance, why take them public at all -- especially since they draw a wealth of fees from their institutional fund investors and don't need to tap the stock market to expand and thrive?
The answer is found in the money trail. During the opening wave of IPOs in 2007, the argument went that listing would give the firms an "acquisition currency" -- stock they could use to buy other businesses. There's been a bit of that: Months after listing, Blackstone paid $930 million in stock and cash to absorb debt fund manager GSO Capital Partners LP. And KKR used stock in 2010 to merge with a publicly traded buyout fund it managed. The deal enabled KKR to go public and simultaneously take direct ownership of $3.5 billion in leveraged buyout assets, a war chest whose value has since jumped. But such stock-driven expansion has been the exception, not the rule.
More visible has been an orgy of profit taking the IPOs have enabled. Directly or indirectly, the firms' partners have garnered most of the loot -- often without selling a single share. Blackstone set aside about $1.2 billion of the more than $7 billion it raised in its IPO and an accompanying sale of a stake to the Chinese government; the rest went to its partners. Fortress used its offering proceeds to retire some of the debt it took on to finance a $1.3 billion cash dividend to its owners. Similarly, most of the Carlyle proceeds went to repay debt the firm raised in 2010 to award a $400 million distribution to partners.
The IPOs, too, have paved the way for the founding partners, most of whom are in their mid- to late 60s, to convert their holdings into billions in cash when they exit the stage.
That agenda, plainly, has been the chief motivator for private equity firms to list. While there is nothing wrong with maneuvering to monetize -- PE firms couldn't make a living without it -- public investors to date have paid a steep price for playing along.
David Carey writes about private equity for The Deal magazine.