Busted IPO, long-term diversifier or short-term value play?
A longer than usual deep dive, with dozens of charts, so be prepared. Also, some readers might be disappointed by the contradictory conclusions.
Petershill Partners plc (PHLL LN) is a UK-listed permanent capital vehicle managed by Goldman Sachs Asset Management (GSAM) which invests in independent alternative asset managers.
In Wall Street lingo, Petershill is a GP (General Partner) solutions investment group: it only acquires minority stakes thus providing asset managers with capital to drive their growth, in addition to offering strategic advice by leveraging the experience and network of Goldman Sachs. [Note: going forward “Petershill” will refer to the whole group within GSAM, while the listed vehicle Petershill Partners plc will be referred to as “PHP”].
Through a portfolio of 23 partner-firms, PHP has exposure to four areas: private equity, private credit, private real assets and absolute return.
These firms control $266 billion of total assets under management, comprising a diverse set of more than 200 primarily long-term funds across 76 different strategies: the underlying funds generate recurring management fees and the opportunity for meaningful profit participation over their lifecycles.
On an ownership-weighted basis, PHP “controls” around $34 billion in AUMs, with 84% allocated to private capital and the rest to absolute return strategies.
This is the full list of current holdings with details on their strategies.
PHP went public in September 2021, with GSAM retaining a 75% stake, at a price of £3.5 and a valuation of £4 billion, equivalent to $5.5bn at the time: however, the relative illiquidity and low initial interest in the stock saw it fall almost 50% within just one year. [Note: the stock is traded in GBp on the London Stock Exchange but all financials are reported in USD: the vast majority of revenues is also dollar-denominated.]
History and operational structure
PHP (the listed vehicle) is part of the larger Petershill ecosystem that originated inside GSAM in 2007 to provide private equity capital to the alternative asset management industry: it has therefore one of the longest track records in the GP solutions industry.
Since its inception, Petershill has deployed more than $8.5 billion of capital (including seed proprietary funds) through 42 investments over four funds (Petershill I to IV, which are at different stages of their lifecycle), delivered an average 24.4% gross IRR (and 2.4x gross MOIC) and realised more than $2 billion in gross proceeds.
PHP was officially incorporated in March 2021 in preparation to the IPO by transferring certain assets held by Petershill II, Petershill III and Goldman Sachs’s Vintage VII (another 2017 $7bn fund with a broader mandate): as such, LPs in Petershill II and Petershill III are today the majority shareholders in PHP. The $5 billion Petershill IV fund, which will be invested along the same strategy and will be a potential co-investor with PHP in some deals, was closed in January 2022.
The following chart illustrates a simplified version of the operating structure at the time of the IPO (today the number of partner-firms has increased to 23).
Market trends: growing interest in private markets and increasing demand for capital and partnerships in the GP solutions industry
In the low interest rate environment (until last year) where actively managed public market funds have, as a group, generated low/negative levels of alpha (after fees), institutional investors (particularly those with long-duration liabilities) have increased their allocations to private market assets. In sharp contrast to traditional asset managers, which have experienced persistent pressure on management fees from cheaper passive offerings, the strong demand has protected the fee rates of private market asset managers, especially those with top quartile performance track records.
You can’t open an article or report on the asset management industry without finding several charts and statistics on the secular growth trends in alternative/private market strategies. Institutional investors are indeed in love with the asset class:
“The California Public Employees’ Retirement System rolled out an upsized 15% exposure target to so-called real assets for the fiscal year beginning July 1 from 13%, including a 13% allocation to private equity from a previous 8% bogey.”
“We have more room to do more with private equity since we were late to the game,” Nicole Musicco, CIO of the $440 billion fund, declared at an investment committee meeting on Monday. The executive reckons that insufficient PE exposure from 2009 to 2018 cost Calpers as much as $18 billion in profits. Overall, PE holdings among state and local pension funds reached $480 billion as of this summer according to Preqin, up 60% from 2018.” (Source: “Second nature”, Almost Daily Grant’s, 21 September 2022)
Here are some charts to support this assertion:
Morgan Stanley/Oliver Wyman expect private market AUMs to further grow 12% a year through 2025, with the new push driven by a large increase in allocation from HNW/UHNW investors: people with between $1m and $50m to invest would in total commit an extra $1.5 trillion by 2025.
“Apollo plans to raise more than $6 billion this year from individual investors, Kleinmann relayed yesterday, up from $1 billion across 2021. The executive added that $15 billion in such fundraising represents his firm’s targeted annual run-rate.” (Scott Kleinman, Co-President of Apollo Asset Management at Bank of America’s 27th Annual Financials CEO Conference in London on 21 September)
“When the markets stabilise, it will be a tremendous time for private equity” and an influx of retail money is “a matter of when”, not if, Verdun Perry, global head of Blackstone Strategic Partners, said on the conference’s main stage this week. (“Private equity parties on French Riviera and targets retail investors”)
And few days ago, fellow PE giant KKR announced a partnership with Securitize Capital to make pieces of its $4 billion healthcare fund available on the blockchain to facilitate investments from the public.
“We’re talking real democratisation,” Virginie Morgon, chief executive of the buyouts group Eurazeo, said at the conference. The industry would raise money from “not, like, high net worth individuals” who can invest €1m or more, but people with €5,000 or €10,000, she said.” (“Private equity parties on French Riviera and targets retail investors”)
Historically, alternative asset managers have largely been able to self-finance their growth through reinvestment and compounding of their fees with limited alternative sources of financing available given their typically private status, relative small scale, and counterparty and governance preferences.
Prior to 2008, GP minority stake investing was sporadic: activity was primarily carried out by financial institutions seeking participation in absolute return firms to realise revenue synergies (e.g. brokerage, sales and trading) and/or institutional investors looking to acquire stakes in private equity firms to reserve access/capacity in future fund vintages. GPs typically sold primarily to obtain financial diversification and tax benefits.
For example, in the mid-2000s investment banks used their own balance sheets to buy minority stakes in hedge funds: in 2007 Lehman Brothers acquired a 20% stake in both D.E. Shaw and London-based emerging markets specialist Spinnaker Capital Group; Citi bough 100% of Old Lane; and Morgan Staley acquired 19% of Lansdowne Partners and 20% of Traxis Partners (founded by its former chief strategist Barton Biggs). Earlier in the decade, CalPERS had acquired a 5.5% stake in Carlyle Group in 2001 for $175 million, but then sold out in 2013 when the PE manager was publicly listed.
However, in the wake of the global financial crisis, the big banks moved away from this strategy due to regulatory considerations and the performance of their portfolios. As a result of Lehman's 2008 bankruptcy and the significant change in bulge brackets' leverage, funding and risk appetite, the balance sheet-driven players withdrew from GP investing.
At the same time, post-2008 GPs increasingly appreciated the broader advantages of having a minority partner. Similar to how many private equity firms support portfolio companies, GPs recognised the potential benefits of having partners with the ability to provide permanent capital and add strategic value, while still allowing them to retain control and autonomy over their businesses.
With buyers more regulatorily constrained in their ability to continue to pursue minority investments, there was an unmet need for access to capital resulting in the establishment of funds dedicated to GP minority investing, where balance sheet limitations did not interfere with the viability and desirability of the strategy. In addition to Petershill/Goldman Sachs, two other large institutions entered the space in the early 2010s: Dyal Capital Partners (started as a division of Neuberger Berman, today part of Blue Owl following the merger with Owl Rock Capital Group) and Blackstone (through the firm's Blackstone Strategic Capital unit). Other players include Wafra and AlpInvest Partners. [Please refer to the Appendix at the end for a brief introduction to Dyal/Blue Owl and Blackstone Strategic Capital].
Their initial focus was mainly on hedge fund managers, but with the industry growing rapidly GP staking evolved and expanded into multi-asset class strategies, especially private equity, private credit and real estate, including underserved market segments (e.g. middle-market). The attractiveness of GP solutions has gradually increased over the last decade and accelerated over the last few years, evidenced by the pace of acquisitions by both dedicated funds and traditional asset managers.
When looking to fund their growth plans, GPs have different strategic options:
Retained earnings: while this allows the existing partners to maintain 100% ownership in the GP, it often means delaying/slowing growth until the earnings materialise
Debt: cheaper than equity, but often tax inefficient for partnerships, notably in the US
Listing / IPO: the solution chosen by some of the biggest private equity managers, it allows access to capital but will subject the firm to public reporting and increased regulatory oversight
Control sale: existing partners may receive a price premium as a result of the sale, but they will have to cede control and give away the potential upside
GP solutions / minority stakes act as a sort of growth equity: GPs can partner with strong backers while generally maintaining control over the firm’s operations. On the other hand, majority sales can be disruptive given these firms are people businesses driven by intellectual and human capital: many GPs recognise that maintaining their firm’s culture, compensation flexibility and economic upside are crucial to driving sustainable and multi-generational longevity.
In addition to allowing founders to monetise (part of) their stakes, GP solutions can help with both financial and strategic goals:
Meet GP commitments: a slowdown in realisations on prior funds can create an increasing need for capital
Seed new strategies: geographic and adjacent strategies expansion require initial seed capital from the balance sheet in order to build track record and demonstrate "skin in the game"
Build institutional balance sheet in order to move funding from individuals (partners, employees) to firm liability and simplify capital structure by retiring debt or other complex securities
Optimise the ownership structure and create long-term employee incentive mechanisms: to buy-out passive and/or legacy shareholders (seeders, banks, transitioned founders) and to facilitate equity redistribution among the leadership team; it also provides a credible third-party valuation to support hiring and retention mechanisms for key employees
PHP offers not just “capital”, but also consultant-like services and capital-market solutions to fund managers:
Access to market intelligence
Advice on new strategies and hands-on support for geographic expansion
Feedback on how to further improve the firm and its running
Endorsement vis-à-vis potential clients
Support for fundraising, e.g. through introductions to other Goldman clients
PHP compared to other publicly listed alternative asset managers
Given the compelling industry economics, and despite barriers to entry present challenges to new entrants (capital raising requires patience, persistence and a long-term commitment of working capital), more competitors have entered the arena in the last few years.
Even though there are only three/four real dedicated institutions, the larger end of the market (in terms of firms with AuM typically above $10bn) appears rather crowded, with more than 45% of top-end firms having sold a GP stake (source: Pitchbook). Competition in this space is relatively high (with Dyal/Blue Owl being the leading player), to the point that sometimes two firms jointly invest at the same time: example of co-operations are Blackstone/Petershill in Francisco Partners and Petershill/Dyal in Clearlake.
Petershill typically targets the lower end of the large-sized and the entire middle-market segments: competition in the latter is relatively lower at the moment, with less than 10% of the middle market having sold a GP stake. With LPs (asset owners and allocators) set to increase their allocations to private markets, the growth of successful middle-market and smaller-sized GPs may provide the strongest pipeline of opportunities for GP stake investors.
However, there is fierce competition also at the lower end of the AuM spectrum (typically up to $2bn AuM). Examples include Investcorp's Strategic Capital unit, Bonaccord (a subsidiary of abrdn), RidgeLake, Stonyrock (founded by ex-Blackstone and Carlyle executives), Azimut Alternative Capital Partners (using Azimut’s own balance sheet and offering retail distribution to partner firms), SP Capital (a seeding platform sponsored by the principals of Sixpoint Partners), Meteor5 Capital, and Capital Constellation (owned by Wafra).
In the listing prospectus, PHP presents several charts to compare its fundamentals to those of its competitors (i.e., the largest asset managers within the global alternative investments industry, but for some reason Blue Owl is not included…). Obviously, these companies are not exactly the same even if they all compete in the same arenas: Sweden’s EQT, for example, has a preference for long-term (as in decades) holdings, as opposed to the more typical five to seven-year cycle of private equity funds.
PHP’s partner-firms' AUMs are well diversified across the four main strategies, an asset class mix which is broadly similar to those of Blackstone, KKR and Partners Group.
In line with selected listed peers, the majority of revenues is derived from management fees, while fee-related earnings (FRE) margin compares favourably.
This is how PHP summarises the uniqueness of its business model:
The higher “diversification”, coupled with margin protections clauses, provide a higher quality of earnings, reducing the volatility and increasing the profitability of the business.
Some financial numbers
PHP’s earning models consist of three income streams generated by the partner-firms’ underlying funds:
Management & advisory fees (which accounted for 68% of distributable earnings from 2018 to H1 2022)
Realised performance fees (24%)
Realised investment income from balance sheet investments (8%)
These revenues are earned across a host of funds and strategies, giving PHP diversification and resilience to not rely on any one brand, one fund or one strategy: the largest underlying fund is less than 5% of AUMs and less than 7% of fee-related earnings. The majority of the revenues are recurring and stable, coming from funds with a weighted average duration of more than 8 years (and close to 90% of AUM are in long-term lock-up funds).
Given its unique structure (a minority holder in a large number of asset management businesses), PHP can’t consolidate any of the holdings. Instead, it reports the Partner Distributable Earnings, the share of the underlying earnings it is contractually obligated to receive through its ownership positions. There are then a number of expenses for the listed vehicle (e.g., the payment to GSAM for managing the portfolio, interest charges on PHP's debt, taxes, etc) that are deducted in order to determine PHP's distributable group earnings.
To assess its financial performance, PHP uses a plethora of key operating metrics derived from financial and other information reported by the partner-firms.
Aggregate AUM: the total of partner-firms’ underlying funds plus uncalled commitments (so it includes partner-firms’ AUM outside of PHP’s ownership interest)
Aggregate FP (fee-paying) AUM: the portion of Aggregate AUM which is entitled to receive management fees (i.e. excludes co-investments on which partner-firms generally do not charge fees and fund commitments where capital has been raised but fees have not yet been activated)
Partner blended net management fee rate: net management and advisory fees divided by the average FP AUM weighted for PHP’s ownership interests in each partner-firm
Implied blended partner-firm FRE/PRE ownership: the weighted average of PHP’s ownership stake in, respectively, the partner-firms’ management fee-related earnings (FRE) and performance fee-related earnings (PRE). PHP owns a greater proportion of Partner FRE (~14%) than Partner PRE (~9%) by design, as contracts are structured to ensure that partner-firm management's incentives remain closely aligned with generating strong performance at the underlying funds
At the income statement level, the most important metrics are:
Partner net management and advisory fees: PHP’s share of net management fees payable for the provision of investment management and advisory services
Partner FRE: the most important stream of earnings, calculated by deducting from the above the partner-firms’ core operating expenses (staff compensation and overheads but not performance related expenses)
Partner realised performance revenues: the second most important stream of earnings, it represents the carried interest allocations and incentive fees, less any realised performance fee-related expenses
Partner realised investment income: the third (and smallest) stream of earnings, resulting from the realised gains (losses) or any distributed income from the investments held on partner-firms’ balance sheets; it’s the returns associated with GP commitments invested in the funds (typically ~2%, of which PHP contributes its minority share), and represents “working capital” and self-funding
Partner distributable earnings: the sum of Partner FRE, Partner realised performance revenues and Partner realised investment income
Partner revenues: the sum of Partner net management and advisory Fees, Partner realised performance revenues and Partner realised investment income. So similar to distributable earnings but including gross management fees (i.e. pre-operating expenses)
Due to the wide diversification over several different performance fee-eligible funds at different stages of their lifecycle, PHP anticipates that realised performance revenues will be earned regularly going forward, making them a “quasi-recurring” source of income within a range of 20%–30% of total revenues over the medium term.
“We believe first quarter AUM growth and partner [inaudible] earnings reflect the resilience of our business model in what are clearly more volatile markets against the background of great economic uncertainty. We built Petershill Partners to be an all-weather company, differentiated through the triple strength of the quality of our partner firms, the diversification of our footprint, and the cash-based earnings nature of our earnings. We're particularly proud of the strong asset raising shown by our partner firms, which is set to continue driving the growth in our recurring fee base, but also continued generation of performance related earnings.” (PHP Q1 Analysts Call)
As a permanent capital vehicle, PHP has no employees or physical operations, and minimal overhead costs. The most significant recurring cost is the “operator charge”: as consideration for its services (GSAM has the discretion to acquire, dispose and manage the assets, initially for a term of seven years), PHP pays GSAM a 7.5% recurring operating fee, calculated on distributable earnings and paid quarterly. (*) As it’s common in the alternative space, PHP will also pay GSAM a profit-sharing charge of 20% of total income from investments in management companies from new investments made post-IPO, chargeable only after a two-year ownership period from the date on which the investment closed and subject to the relevant investment achieving a return of at least 6%.1
Considering this charge and the other overhead costs (board, administrator, audit and other related expenses), PHP should be able to generate a 85%-90% normalised EBIT margin. From a pure accounting point of view, the elephant in the room in the income statement is the mark-to-market adjustment for the value of the equity stakes (“Movement in financial assets and liabilities held at fair value”), which are impossible to forecasts in advance.
Including the proceedings from the IPO, as at 30 June 2022 PHP has a net cash position of c.$305 million, or $230 million pro-forma for deferred acquisition costs.
Coupled with the recurring cash flow generation, the capital allocation priorities are:
GP capital commitments: small and typically expected to be funded from realised investment income
Capex-like M&A: 3 to 6 new acquisitions for $100m-300m are to be expected per annum and includes follow-on, direct equity and secondary opportunities
Dividends: a progressive dividend policy (+10% p.a.)
On the back of the 2021 results, the company proposed a $30 million final dividend in line with guidance (pro-rated for the roughly three months since IPO: pro-forma full dividends would be $120 million as indicated during the IPO roadshow), as well as a $50 million 2022 buyback program.
Leverage is expected to remain below 1.5x the net leverage ratio (defined as net debt divided by adjusted EBITDA), although there is ample gross debt capacity (>$1 billion relative to the self-imposed upper bound of 3x) should it be required to fund additional acquisitions. In August 2022 PHP completed the issuance of $500 million US private placement senior unsecured notes with a group of institutional investors: they comprise of five tranches (with maturities from 7 to 20 years, weighted average is ~11 years) and carry an average coupon of 5.65%. The new notes will be used to retire the outstanding $350m senior secured notes (which have a weighted average tenor of less than 7 years) and other liabilities due to the Petershill funds.
In addition to the growth in the underlying markets, M&A is also a significant driver of future value.
“We have multiple drivers of sustainable growth. The industry growth, our partner firms' growth and value creation and inorganic growth driven by the operator. Even if we were to never make another acquisition, our industry is growing robustly, expected at double digits long-term CAGR, and our partner firms have demonstrated outperformance and growing faster than this industry average. We add value to these businesses, working actively with our management teams on capital formation, business development and using our capital and follow-on investments to develop their businesses. We also have a long track record of targeted, repeat, accretive acquisitions. And we also look to operate in a capital efficient form, making acquisitions, but also returning capital when appropriate, as demonstrated by the board's proposal this year.” (PHP Q1 Analysts Call)
Since the IPO, PHP has already spent $560 million across five transactions, plus one follow-on investment.
With the growth in the entire industry, the universe of scaled alternative firms continues to expand: there are likely more than 1,200 potential targets with AUMs greater than $5 billion, and thousands more with AUMs sub $5bn.
As such, the deal sourcing and screening process is a key element of the operating model, if not the most important. Over its 15-years existence, Petershill has examined more than 1,400 firms, of which around 300 underwent detailed due diligence: on average, over the last 3 years it had ~120 sourcing meetings and evaluated ~50 deals, with only 14 brought for review at the investment committee and 6 approved and closed (so c.5% conversion rate).
The criteria for selection are:
$5-15bn+ in AUM
a minimum 10-year track record
consistent top or upper quartile performance (across multiple vintages)
and at least a $100m annual run-rate in management fees
The acquired stakes typically range between 5% and 35% of the equity of each partner-firm (no single stake currently exceeds 25%). Over time PHP has held on average a 13%-14% weighted stake in the fee-related earnings of the underlying partner-firms: for the latest acquisitions, Petershill overall took a ~20% stake, but PHP only took 5%, with the rest owned by the other Petershill funds.2
Usually, when fund managers seek a buyer for a minority stake, they speak to multiple potential investors and run an auction-style process. PHP/GS can sidestep the usual auction process and maintain a high degree of exclusivity on transactions: according to Petershill, it bought over 70% of its stakes based on exclusive negotiations and paid an average entry multiple that is 20% below comparative transactions completed by peers. Fund management entrepreneurs are willing to give relatively cheap shares to Petershill because of the additional business they are likely to gain with their help.
Btw, Blue Owl also claims to have the same “exclusivity”…
Every investment is made with critical governance and economic protections which give significant benefits irrespective of the level of ownership and provide for at least annual profit distributions:
Margin protection: either through revenue-sharing agreements (gross fees, no exposure to partner-firm's underlying expense base) or through structured equity positions (restricted compensation for equity owners, equitable pay-out rights, and general limitations on non-essential business expenses)
Negative consent rights: usually include M&A transactions, issuance of preferred equity, change of nature of business, or any other transaction that has a material adverse effect on acquired stakes. Pre-defined negative covenants include issuance of debt, non-pro-rata distributions, and similar actions.
Ownership dilution protection: to ensures that Petershill's interests is not diluted by future capital-raising exercises or liquidity events
Information rights: include management meetings, regular audited fund reports, quarterly management reporting, and audits of management company entities
This means that, unlike ordinary equity where shareholders receive dividends after management, PHP participate alongside or ahead of management: this results in better returns than ordinary equity would achieve.
Management and corporate governance
PHP is run by a triumvirate of Managing Directors who are global co-heads of the GSAM/Petershill Group:
Ali Raissi (EMEA region): 22 years of industry experience of which 18 years at GS
Christian von Schimmelmann (Americas region): 24 years of industry experience of which 22 years at GS
Robert Hamilton Kelly (Americas region): 17 years of industry experience of which 12 years at GS
In addition, it has a Board of Directors composed of 5 Non-Executive Directors who are NOT affiliated or working for GS.
There isn’t much transparency on how much PHP’s management owns directly in the company: at the time of the roadshow the company said it was “significant and reflected their ownership of the private Petershill funds” but it was not detailed as it was below the 3% disclosure threshold. Only when presenting Q2 results (at least to my knowledge of public sources, so I might be wrong), PHP revealed that the direct and indirect Petershill team ownership is around 7 million shares (0.6%), worth today a mere $14 million.
PHP went public last year at a valuation of roughly $5.5bn: new shares issued by the company accounted for $720m (net proceeds), while existing investors (i.e. the Petershill funds) sold shares for $625m.
Since the IPO, PHP has lost c.50%, more than the other listed private equity managers, already down more than the S&P 500 (mostly due to the terrible start immediately after the IPO: YTD the performance is in line with the other private equity managers, but still worse than the S&P500). Also because of the depreciation in GBP, today the company is only worth around $2.3 billion. At the IPO prices, PHP was listed at a P/E of 22x on 2021 actual earnings: today, the stock is much cheaper.
Alternative asset managers are typically valued using hybrid models:
Annuitised cash flows relating to management fees are afforded a higher multiple due to their persistence, stability and growth potential
Variable cash flows relating to performance fees are assigned a lower multiple, sometimes a mix of P/E and P/BV depending on capital structure
Suitable valuation metrics for private-market managers:
Price to (adjusted) cash earnings: while imperfect, over the long-term these follow distributable earnings and ultimately drives distributions to shareholders
EV/EBITDA: compared to P/E, it takes the net cash or debt positions on the balance sheet into account; but enterprise value calculations are more complicated and open to interpretation, and EBITDA fails to capture the differences among tax rates in various jurisdictions
Bad valuation metrics for private-market managers:
Price/AUM: while common (and sometimes useful, in particular in M&A transactions) for public-market asset managers, this is a crude valuation metric in private markets: it does not really capture the underlying revenues and earnings, which are dependent on product mix, management fee rates, carried interest and the level of co-investment
EV/sales: never really used as it fails to capture the cost efficiency, operating margin and any scale benefits of the company
The chart(s) below show the current valuation multiples of several European and US private-market asset managers (as well as one broadly diversified absolute-return manager, Man Group: there are very few other listed absolute-return managers of size). It’s not easy to make direct comparisons as some private-market asset managers use their balance sheet more aggressively than others, and not all of them report a metric comparable to distributable earnings. To simplify, I used the more “crude” forward P/E ratio.
Legend: light blue = US private equity; green = European private equity; red = hedge funds; dark blue = GP solutions providers
Assuming the estimated earnings CAGR (from BofA) are correct, not surprisingly there is a direct, almost linear, relationship between growth and the multiple the market is willing to assign to a company. It’s also not a surprise that Man Group is one of the cheapest stocks in this universe at less than 7x 2022e net earnings (PHP is not too far behind): with most private-market funds having lock-ups ranging from 5 to 12 years, their AUMs (and thus the revenue/earnings streams) are more recurring and easier to forecast than for absolute-return funds, which generally have lock-ups ranging from three to 12 months.
Two points must be considered when valuing PHP on an earnings-basis (premium/discount v. peers). On one hand, PHP is a minority investor: it does not sit on investment committees, hold board-level seats or have voting rights in its partner-firms. As a result, it does not exercise control over the business decisions the way listed asset managers can. It’s the GP that owns the brand, the intellectual property, the client relationships and the distribution system. PHP's lack of control over these aspects of the business could result in the market applying a discount to its shares. On the other hand, PHP benefits from wider diversification than single private capital managers: the minority stakes in 23 partner-firms provide portfolio diversification benefits in the form of lower idiosyncratic risk as well as less volatile revenue/earnings growth. The market could apply a premium to PHP as a result of this difficult-to-replicate diversification.
So, here is my very simple, back-of-the-envelope valuation for the company.
According to Blue Owl, its average entry valuation multiple has been 6.3x distributable earnings (see slide above), a 50% discount to comparable listed companies. Considering the discount Petershill claims to achieve during negotiations (multiples 20% below similar transactions) and the implicit discount to listed companies for PHP’s operating model, I assume the “fair” multiple for these private companies is something around 8x distributable earnings. As a reference, PHP is currently trading at 6x trailing twelve-months distributable earnings, while Blue Owl trades at 20x (but the latter is much more than just GP solutions: please see Appendix).3
As a check, PHP provides its detailed methodology used to value the stakes internally: using these multiples/discount rates, the blended internal multiple of distributable earnings is 6.7x, so in line with the assumptions above.
Currently, PHP controls $24.5bn of fee-paying AUM (and an additional $9bn where fees have not yet been activated): at the 1.58% weighted management fee, this translates into $386 million in partner management fees; assuming a 70% FRE margin we get $270 million in fee-related earnings. Even if we don’t include any additional earnings from performance-related fees and realised investment income, at current exchange rate we already have a value in line with current price.
Performance fees and realised investment income over the last 12 months were $171 million as at June 2022: they were highly influenced by the bonanza in H2 2021, but are unlikely to be zero in the near future as some of the carried interest is already in the bag but not yet paid out. Depending on the estimates and the fair multiple applied, PHP can easily be worth £2.50 to £2.80, a 40%-50% upside from current price.
Alternatively, we can check how much we are currently paying at different levels of performance fees: in the base case scenario, we are only paying 8x-9x net earnings for a stream of recurring income.
In addition, returns are juiced by dividends: with the expected full-year dividend ($120m, with $40m as interim dividend already deliberated), the current dividend yield is 5.2%. With expected dividends just 30% of distributable earnings, PHP should not have problems maintaining its progressive policy (in addition to the just commenced $50 million buyback program).
Regulatory, tax and legal changes: given their growing importance, it is possible that regulators could increase oversight of private asset managers, for example limiting the allocations for banks, insurance companies or pension funds (“Citi to slash lending to buyout funds as new capital rules bite”). Two other risks: 1) carried interest income is typically tax-exempt under local rules: changes to this tax treatment might adversely impact profitability and fundraising abilities; 2) most firms currently use limited liability structures to shield themselves from bankruptcies in their portfolio companies: any adverse change to such structures could negatively affect the industry's ability to deploy funds at the current pace
Fundraising in a downturn: during the global financial crisis, private-market fundraising declined by more than 50% from the previous peak: a similar slowdown could result in significantly lower growth for the industry
Inflation and interest rates: if central banks keep raising interest rates in rapid fashion to fight inflationary pressures, this could increase the cost of leverage, lower exit valuation multiples (borrowing costs are rising with earnings falling) and negatively impact future fundraising
Investment performance: the success of the underlying funds/GPs is largely driven by their investment performance: an extended period of underperformance, compared to peers or applicable benchmarks, may cause investors not to reinvest (or withdraw from open-ended structures), resulting in lower management and performance fees
Increasing competition in GP services: as the private-market sector continues to grow, market pricing for GP stakes could become more efficient and transaction multiples could increase, resulting in lower potential returns
My personal two cents
First of all, what’s the long thesis?
Strong long-term secular growth trends in the alternatives industry
Global asset manager partnering with high-quality firms: given its unique track record, Petershill/PHP will continue to be presented some of the best deals
Business built on diversified and recurring earnings
Low capital employed, with a current net cash position, selling at depressed multiples of earnings
Value-add strategic affiliation with Goldman Sachs
But there are – at least in my opinion - several unanswered questions.
1. Petershill are GP/LP fund structures run by GS with no clear exit strategy
It is true that PHP has contractual rights to receive distributions from GPs whose estimated payback period for investments is approximately seven to eight years. But there are no predefined paths to fully monetise the minority stakes as it happens in a “normal” private assets fund.
The only alternatives are an IPO by the GPs, a control sale of the entire GP or the sale of the minority stake by PHP to another similar fund. They first two options are obvious, but if that was the game plan why haven’t the GPs already pursued it? The third option is definitely a possibility, but also carries additional problems (discussed below).
2. Lack of transparency and conflicts of interest
Not much is disclosed about the ownership details of the minority stakes: fund performance, revenues or profits of the partner-firms. PHP only reports its aggregate AUMs and aggregate fee-paying AUMs with a three-month lag: this is due to the timing of the financial information received from partner-firms, which generally require at least 90 days following each period end to present their final financial information.
Also, PHP does not disclose the “carried interest” (the share of profits from successful funds) received by management, and was very slow in disclosing how much directly and indirectly the Petershill team owned in the listed vehicle.
There is a very real, potential conflict of interest with the operator: PHP's contractual operator for the next seven years is the Petershill unit within GSAM, which is also the GP for the new Petershill IV fund and any future successor funds. The risk is that GSAM focuses on growing PHP's size at any cost, as most of the incentives (e.g., the recurring operating charge, the profit-sharing charge, the divestment incentive fee) focus on maximising PHP's fee income. While maximising partner-firm fees should lead to a higher share price, consideration must be given to the quality of those earnings.
Finally, PHP could become an exit vehicle for the Petershill funds (as the IPO indeed was for some of the older investments): there is the potential risk that investors react negatively to PHP being the main/sole acquirer of portfolio investments within Petershill IV and successor funds (or even for other investments still held by Petershill II and III).
This is a well-known problem with private equity funds: as they approach the end of their lifecycle, they need to dismiss their holding at a satisfactory price, and when that is not possible with an arms-length sale there is an incentive to “pass” the assets to another of the sponsor’s funds (so-called continuation fund deals). Mikkel Svenstrup, chief investment officer at Danish pension fund ATP, was very clear on this issue recently (“Private equity may become a ‘pyramid scheme’, warns Danish pension fund”):
“A top executive at Denmark’s largest pension fund has compared the private equity industry to a pyramid scheme, warning buyout groups are increasingly selling companies to themselves and to peers on a scale that “is not good business”.
“[…] last year more than 80 per cent of the sales of portfolio companies by the private equity funds that ATP has invested in were either to another buyout group or were “continuation fund” deals, where a private equity group passes it between two different funds that it controls.”
“This is not good business, right? This is the start of, potentially, I’m saying ‘potentially’, a pyramid scheme. Everybody’s selling to each other… Banks are lending against it. These are the concerns I’ve been sharing.”
Undervalued Shares has a post on the company from last November with a lengthy discussion of why Goldman Sachs wants PHP to succeed (the short answers: PHP must pay off for its new shareholders or otherwise it would suffer on multiple levels, mostly reputationally). I might not agree with all its points but it’s an excellent read.
3. Expiration of lock-ups
It’s normal for the founders / first investors in a company to take come chips off the table at the IPO, but investors are also aware that they might sell additional shares.
The first tranche (6 months after IPO, so March 2022) has expired with no “original” shareholders selling. The GSAM stake (75%) continues to be held by the long-dated private funds that incubated PHP: the GP of those funds (GSAM, again), would ultimately decide on their realisation.
Petershill II, the older of the two funds, was launched in 2013 and is already after its investment period, so there is a natural step-down in activity and a final full divestment phase that should occur around 2026 (after 12-ish years). Petershill III is younger (launched in 2017), so it’s still within its investment period.
The next expiration of the lock-up is March 2023: GSAM expects to reduce its ownership to less than 25% over the medium term, with September 2026 (the fifth anniversary of the IPO) the latest possible date according to US banking regulations. Sooner or later those shares will be sold to return capital to the LPs of these funds, and after next March any day can be picked. GSAM will be incentivised to sell the PHP shares in an orderly manner to minimise the price impact, but for the moment expect this to act as an overhang on the share price.
4. Increasing competition and expected returns
Despite the growth in private assets, the larger end of the market for GP solutions appears quite crowded: it is unlikely that the recent high share of proprietary transactions will be sustained in the medium and long term, as the number of GPs is limited and competition is intensifying. As highlighted in the Blue Owl slide, the latest transaction post-2020 have been made at multiples closer to 10x than 6x.
According to Pitchbook, the cumulative dry powder (= uncommitted capital) that private equity alone has available is today $750 billion, a testament to their excellent skills in fund-raising over the last few years. But the risk is that a huge portion of that dry powder will be used by undisciplined investors for “insider rounds” amidst weakened syndicates and to prop-up “zombie companies that should rather go bust” in effort to avoid big write-downs (and lose the juicy management fees).
5. Unique structure and share overhang to drive discount
While it has some benefits, the closed-end structure managed by a third-party asset manager attracts less interest from institutional investors. Add the other issues discussed aboce, and PHP will likely keep trading at a discount to pure listed private market firms (KKR, Blackstone, Apollo), even if revenue/earnings growth will be similar in magnitude.
6. “If it walks like a duck, looks like a duck, and quacks like a duck, it's a duck”
At the end of the day, it's (levered) equity: it doesn’t matter how you call it or report it on you balance sheet. As Cliff Asnees correctly pointed out:
How much of a factor has been the desire "to pretend they don't own equities"? Or the allure to report lower volatility just because private assets are not subject to mark-to-market? Are private equity funds really not designed for alpha but for asset accumulation, driven by that pretension?
Dan Rasmussen of Verdad has another excellent piece (“Private Equity: Still Overrated and Overvalued?") where he shows that “future returns look materially worse and future risks materially higher", because the circumstances today are substantially different from the ones that led to the good returns of the past years.
“The average US buyout transaction looks quantitatively like a highly leveraged micro-cap public equity. In 2000, the average buyout was completed at a 50% discount to the S&P 500; in 2021, the average buyout was completed at a 10% premium to the S&P 500, during a period when S&P 500 valuations soared to near record levels. To justify these prices, PE firms have shifted to growth sectors like tech and healthcare. Leverage levels have increased. Credit stats look significantly worse than B-rated corporate bonds. In sum, PE LPs are paying higher-than-S&P 500 prices for near-distressed credit quality micro-caps with a heavy sector bias toward tech and healthcare. With cracks showing in public markets for these sectors, and for growth in general, I fear that the reckoning might be finally arriving for private equity.”
Just wrap it up, please!
So, to conclude, the key question is: do you trust Goldman Sachs to be making its best effort to turn this listed vehicle into a success after all?
It IPOed PHP just as the market was at its most bubbly ever and almost called the peak to the day. Anyone remember Blackstone’s IPO in July 2007? With perfect hindsight it turned out to be a good investment (an investor who bought at the IPO would be up 150% today), but after the GFC it took it almost 7 years (till March 2014) for the stock to re-touch the IPO price.
I’m probably too cynic, but I stand by: “Never buy what a Goldman banker is selling!” (and I say this with the utmost respect for GS's ability to make money in everything, not in a derogatory way).
Finally, there is the valuation component of the equation: all the weaknesses pointed out above are currently weighing on the stock, but assessing them is part of the opportunity. And also due to the recent weakness in the sterling pound and UK equities in general, the price has become very, very attractive. It won’t take much (a combination of growth and multiple expansion) to earn a decent if not excellent return.
Dyal Capital Partners was founded in 2010 as part of Neuberger Berman. The first dedicated GP stakes fund was launched in 2012 and so far Dyal has raised four funds: the initial investments included minority stakes in hedge funds, and net IRRs of Dyal I and II were negative. After the company shifted strategy to investing primarily in private equity stakes, net IRRs for Dyal III and IV improved substantially.
In December 2020 it agreed to merge with Owl Rock Capital Group to form Blue Owl, which subsequently went public by merging with a SPAC (Altimar Acquisition Corporation) in May 2021. The “new” Blue Owl has four key strategies:
Alternative manager GP stakes
Private equity GP financing
Co-investments and structured equity
Professional sports (NBA franchise) minority stakes
As of 30 June 2022, the combined entity manages over $100 billion and has a broader strategy than Petershill: GP Capital solutions is c.40% of the business ($41bn), with the rest being direct lending ($45bn) and real estate ($16bn). Relative to Petershill, Blue Owl/Dyal has also historically targeted larger GPs: for example, it has minority investments in Silver Lake ($88bn in AUM), Vista Equity Partners ($94bn), Bridgepoint ($37bn), Clearlake ($70bn), Cerberus ($55bn) and HIG Capital ($43bn).
Blackstone Strategic Capital (part of Blackstone Alternative Asset Management – BAAM)
BAAM is the world's largest discretionary investor in hedge funds and is responsible for the group's GP stakes deals – in addition to special situations, seeding, registered products, and customised and commingled portfolios. Blackstone's first fund for GP stakes closed at $3.3bn and then the company raised another $3.5bn for its second GP stakes fund in 2020.
Blackstone has exposures to somewhat larger private market firms, but generally targets middle-market GPs. It acquired minority interests in New Mountain Capital ($37bn in AUM), Francisco Partners ($31bn), Kohlberg & Company ($11bn aggregate commitments), and BC Partners (more than $40bn).
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However, this 7.5% cost is lower than the typical salary and overhead costs in comparable alternative asset management firms: as a percentage of revenues, it also gives more visibility and stability around costs. And, importantly, there is no “double layer” of fees, as PHP is the beneficiary, not the payer, of fees generated by the underlying partner-firms.
As the new acquisitions are completed alongside with the Petershill IV (and successor) funds, this will result in a lower blended ownership for the new transactions relative to the 19 partner firms that the company started with at the time of the IPO. This is why attributable AUM (i.e., the underlying AUM in which PHP owns an economic interest in the FRE) is a more helpful metric: PHP's attributable AUM should grow at a slower pace than the aggregate partner-firms AUM. Attributable AUM is reported quarterly but typically not within Key Operating Metrics.
Note: this is different from the previously reported 9x for PHP, as that refers to forward adjusted net earnings, not current distributable earnings.