Private equity’s public market problems

October has seen the battle between listed private equity fund-of-funds managers SVG Capital and HarbourVest play out in full view of the public eye, with SVG eventually succumbing to an unsolicited takeover bid which sees HarbourVest acquire 100% of its assets and SVG wound down.

In late 2015 and early 2016, listed British LP Electra Private Equity saw activist investor Edward Bramson elected to the board after a long-running feud over the fund manager’s strategy, which saw Bramson’s Sherborne vehicle build up a corner position in Electra.

Electra and SVG’s experiences in many ways exemplify some of the main challenges faced by private equity firms traded on the public markets: pricing and control.

Pricing has long been a frustration for listed firms, with sluggish share price growth and several firms trading at a discount to their Net Asset Value (NAV). Since 2010, Electra and ICG are the only prominent private equity houses in Europe to have consistently outperformed the FTSE 250 – though British large-cap outfit 3i has performed strongly against the index more recently.

Swedish listed player Ratos has seen its share price drop around 40% since 2010, Gimv has underperformed the FTSE 250 by around 75% and Hg Capital Trust has also seen less growth than the London Stock Exchange index.

I can’t imagine why any private equity firm would ever want to go public. Private equity firms that are public have underperformed virtually every other publicly traded stock" – David Rubenstein, Carlyle

The picture is similar among the publicly traded asset managers and buyout giants in the US, where only Blackstone has performed better than the S&P 500 and Dow Jones Industrial Average in recent years. KKR dropped below the indices in late 2015, having regularly outperformed them since the financial crisis. Apollo Global Management managed only briefly to outpace the S&P since the firm listed in 2011, as has been the case for The Carlyle Group since it listed in 2012.

In the fund-of-funds space, SVG Capital and Pantheon have seen better share price performance than the FTSE 250, while Scandinavian Private Equity and HarbourVest have traded substantially below both the FTSE 250 and local market indices.

Most of the listed buyout houses have been reaping good returns for its LPs at a fund level, and generated solid revenues in the listed management companies as a result, yet their shares remain somewhat unloved by public market investors.

According to research by the UK’s Association of Investment Companies released early in 2016, private equity suffers the second widest discount to NAV in the investment company sector, averaging a 23% discount compared to the overall average of 6%. Only Asia-Pacific real estate traded at a larger discount. The only aforementioned European firm to trade at a premium to NAV is 3i, which had a 22.9% premium in the 12 months to May 2016.

"I can’t imagine why any private equity firm would ever want to go public," Carlyle co-founder David Rubenstein said at the Super Return conference in February, despite his firm having listed on the New York Stock Exchange in 2012. "Private equity firms that are public have underperformed virtually every other publicly traded stock."

Terminal differences?
One of the issues at the core of listed private equity’s troubles is the difference in timeframe taken by the public and private markets. While private equity is often accused of being short-termist, public markets are far more focused on short-term performance than private equity.

The typical time horizon for a private equity investment is around three to six years, whereas public companies might take a year-to-year view of performance – or quarterly view at worst. Co-founder of listed buyout house KKR, Henry Kravis, once said he believed quarterly earnings are the worst thing to have happened to corporate America.

"If you look at earnings and quarterly reporting, and the implied short-termism of that, it isn’t compatible with the private equity model," says Douwe Cosijn, former 3i head of corporate affairs and current CEO of listed private equity industry organisation LPEQ. "Even the scrutiny and reporting that is required from the public markets, relevant to being private, isn’t necessarily compatible with the private equity model. Public markets may not be pricing the private equity model accurately irrespective of the near term reporting cycle – this may also be a function of where markets are presently."

Cosijn says quarterly earnings do not necessarily accomplish a great deal from a company or GP perspective, because they give no forward-looking view on valuations and their direction, which he sees as an issue listed private equity is confronted with. "There are a variety of private equity, asset-management-type businesses, that have become diversified financials, and they must find it a bit frustrating to suddenly be under the scrutiny of public market investors.”

He says the equity model is not well-understood in the public market and investors looking at listed private equity without an understanding of how it works may not apply an appropriate liquidity discount, which Cosijn says is clearly reflected in share prices. While the underlying assets of a GP are less liquid than their public market equivalents, there is more control of liquidity in private equity than it is given credit for, Cosijn says, adding that GPs can typically initiate a sales process at their leisure, even if the timeline until liquidity is triggered is not instant.

"If investors fully understood the private equity model, I think they would put a premium on the model relative to the immediate liquidity of the underlying assets. That is what needs to be bridged,” says Cosijn.

His comments also illustrate an aspect of battles for control such as Electra and SVG. If the public market prices private equity shares at a discount, investors with an intricate understanding of the private equity industry can better price the underlying assets and act opportunistically to acquire at a discount.

Public life positives
Though listing would appear to have few upsides for a GP – given the issues with share pricing, risk of takeovers and overall unloved nature of private equity in the public markets – there are positives to going public. "Given the scale of money in the public market, there must be an opportunity for private equity to access that liquidity, which would be of benefit to the industry," says Cosijn.

He says that while the best-performing GPs do not need to raise capital from public markets, the sheer scale of capital available should cause some firms to give more consideration to raising capital from that source. "It also gives GPs a window on the public market and the opportunity to build relationships with a different set of investors." The listed space allows buyout firms to participate in an asset class that is otherwise inaccessible to them.

If investors fully understood the private equity model, I think they would put a premium on the model relative to the immediate liquidity of the underlying assets. That is what needs to be bridged” – Douwe Cosijn, LPEQ

"If you’re buying the model and are prepared to really invest in it, you should be benefiting from the returns," Cosijn says. "That has been reflected in the historical returns, even in listed private equity, despite the liquidity discounts." He believes the listed model is an alternative that is attractive in its own right if the market is attributing the correct value to it, with a caveat: “In the current environment, there is more competition across different alternatives spaces and it is probably less in favour of listed private equity.”

However, being listed adds a degree of recognisability to a business as well institutionalising it to some degree, as has been noted by Apollo founder Leon Black. Becoming a publicly traded company has raised the profile of many buyout firms that made the transition to asset manager institutions in recent years, aligning them more closely with established institutional investors.

Says Cosijn: "As the asset class has become more mainstream, it has also been sensible for some private equity firms to access the public market and have a blended public/private model."

However, scepticism remains with some of the asset-manager-type private equity firms. “We have no interest in going public,” Warburg Pincus co-CEO Joseph Landy said at Super Return. “If you actually went back to some of those owners and founders of private equity firms and asked them if they were happy about going public, I think it would be very interesting in terms of what you might hear – you know, in fits of honesty from them.”

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• Topics
• GPs
• LPs
• Listed private equity
• Top story
• SVG Capital
• HarbourVest
• 3i
• Ratos Holding
• Gimv
• Apollo Management
• KKR
• Pantheon
• Carlyle Group