One of the Most Valued Private Equity Firms Isn't on Wall Street

(Bloomberg) -- Talk about the titans of private equity and you’ll probably think Blackstone Group LP, KKR & Co. or Carlyle Group LP.

But hidden in the small Swiss town of Baar, in a glass building opposite a McDonald’s and a couple of gas stations, resides a firm that by some measures is more highly valued than its big U.S. competitors. It has the third-highest market worth of publicly traded private equity firms worldwide, eclipsing much larger asset managers such as Carlyle. It went public a year before its first U.S. peers and surged more than 10-fold since, while Blackstone trades barely above its 2007 offer price.

Never heard of Partners Group Holding AG?

“The nature of their deals is under the radar,” said Michael Kunz, an analyst with Zuercher Kantonalbank. “They are unlikely to show up taking Burger King from the stock exchange.”

Founded in 1996 by three former Goldman Sachs Group Inc. bankers, the firm has kept a low profile for much of its history. Initially catering to clients in German-speaking Europe, it focused on mid-sized deals, investing in other managers and buying existing private equity stakes. Profitable investments made in the aftermath of the financial crisis helped increase assets under management in every year since its 2006 IPO, and the surge in the stock made billionaires of founders Alfred Gantner, Marcel Erni and Urs Wietlisbach.

But with about 58 billion euros ($69.46 billion) overseen for clients as of June 30, sustaining the pace of growth while preserving the firm’s DNA can be a challenge. A push to attract a greater share of assets in the U.S. has stalled, and an effort to break into the potentially huge area of defined contribution retirement plans has yet to gain traction. The firm, which is scheduled to publish year-end assets under management on Jan. 11, raised a record 6 billion euros for a new buyout fund last year, an amount that may require it to do more large deals.

"The growth of the firm has been remarkable, a small firm from Switzerland becoming one of the world’s largest asset managers," said Thomas Liaudet, a partner at advisory firm Campbell Lutyens. "The growth, however, can create problems. The buyout vehicle is now going to be a competitor to some of the firms it backs with its fund-of-funds vehicle."

Partners Group was started two decades after KKR, at a time when private equity had just recovered from the leveraged buyout bust in the early 1990s. U.S. firms had become household names with deals such as KKR’s $31 billion leveraged buyout of RJR Nabisco Inc. in 1988. While they were raising billion-dollar funds, the industry was in its infancy in Europe.

Gantner, Erni and Wietlisbach, who had all worked at Goldman Sachs in Zurich, scrambled together money from friends, families and a few institutions for a 150 million Swiss franc growth capital fund in 1998.

But their first defining transaction came when Royal Dutch Shell Plc was looking for a buyer to take over existing private equity investments in its U.S. pension trust. Together with Jeremy Coller, who had started London-based Coller Capital in 1990, a Partners Group joint venture bought the assets for $265 million in 1998, then the largest such transaction ever.

“At that time, the market for private equity secondary investments was very immature, it was basically Jeremy Coller and us looking at it,” said Steffen Meister, a partner at the firm and its chief executive officer from 2005 until 2013. “We said, wow, it’s hard to understand the value of these assets, but for this discount, we’d buy them.”

Biggest Buyer

It was the start of the firm’s secondaries operation, a business that took off when the dot-com crash and later the financial crisis forced endowments, banks, pensions and other institutions to shed illiquid holdings. Partners became one of the biggest buyers of secondaries in 2009, acquiring on the cheap $1 billion in illiquid assets from investors including banks and asset managers.

The direct investing business was slower to develop. After its initial growth fund in 1998, Partners didn’t raise a dedicated buyout fund until 2006, in part because the executives at that time were worried that pursuing deals could put it in competition with managers in which it invested through its secondaries and fund-of-funds businesses. The growth equity fund’s holdings, meanwhile, had run into trouble when the market for dot-coms crashed.

One investment in particular was giving the firm headaches: u-blox Holding AG, a maker of GPS receivers that had spun out in 1997 from the Swiss Federal Institute of Technology in Zurich. The market for GPS chips seemed promising when Partners Group first took a small stake in the company in 2000, but not long after sealing the deal, the tech bubble burst.

‘Dead Three Times’

“U-blox was dead three times,” Meister recalls. “Two or three times we weren’t sure if we should do more financing. But sometimes you need to be persistent, and you need to be lucky.” U-blox was finally listed on the Swiss exchange in 2007 and today has a stock market value of 1.5 billion francs. The growth fund made six times its money by the time it exited the company.

“There’s one thing we’re very proud of: we never give up on an asset until we’ve tried everything,” says Meister. "That’s how we brought back the growth capital fund."

The growth capital fund ultimately returned 1.6 times the money invested, before fees.

23% Return

The turnaround of the growth fund and the burgeoning secondaries business helped attract clients and increase assets more than 10-fold since 2005, to 57.8 billion euros at the end of June. Investors in direct investment funds pay a standard fee of 1.5 percent of assets and 20 percent of profits, once a minimum return of 8 percent is reached. The firm has no problem attracting clients. In July, it raised its forecast for expected new commitments in 2017 to as much as 12 billion euros.

Much of its success was driven by investments made in the years following the financial crisis. The Partners Group Direct Investments 2009 LP fund has produced a net internal rate of return of 18 percent, and Partners Group Direct Investments 2012 LP, the predecessor to the new 6 billion-euro vintage, has a net internal rate of return of about 23 percent. The firm has been telling shareholders and clients that those returns probably won’t be repeated with current asset valuations near records, though it still aims for returns in the mid-teens.

Beating Blackstone

Still more astonishing is the firm’s run on the stock market. Partners went public in 2006, a year before Fortress Investment Group LLC became the first U.S. private equity manager to take that step, at a price of 63 francs. Today it costs 685 francs. Fortress delisted in December after Japan’s SoftBank Group Corp. agreed to purchase the firm. The stock hadn’t traded above the IPO price for the past 10 years.

Stephen Schwarzman’s Blackstone, the biggest firm with $387 billion under management, closed at $33.28 on Monday, barely above the $31 at which it went public more than a decade ago. Schwarzman said in an interview last year that he didn’t understand how public investors could assign so little value to the stock when fund investors had committed so much.

In the past five years, Partners returned about 28 percent annually in dollar terms, including dividends, more than any of the large U.S. private equity firms. That run leaves the Swiss with a market value of about $19 billion, the third-biggest in the 60-member S&P Listed Private Equity Index, behind Blackstone, which manages about six times as much in assets, and Canada’s Brookfield Asset Management Inc., which oversees four times as much.

Peter Grauer, chairman of Bloomberg LP, is a non-executive director at Blackstone.

But taking on the U.S. firms on their home turf is proving harder than expected, at least on the fundraising side. While assets managed for North American clients have grown in absolute terms, they accounted for just 14 percent of total assets under management at the end of June, down from 17 percent in 2012. The U.K. contributed 23 percent, Switzerland 17 percent and Germany and Austria together 18 percent, with the rest spread among other regions.

“They are not a U.S. player and don’t have the same networks as KKR or Blackstone,” said Tomasz Grzelak, an analyst at Baader Helvea AG in Zurich. “They are still developing a track record there.”

Andre Frei, the firm’s co-CEO, acknowledges that Partners Group’s low profile and quiet investing style may make it harder to get the attention of U.S. investors.

“In America, to be successful on the fundraising side, you need to have deals, prominent deals with your name attached to them,” he says.

Biggest Deals

The company has since revived its private equity direct investing business. Recent deals include the purchase of United States Infrastructure Corp. from Leonard Green & Partners last year, and the 2016 acquisition of Foncia, a French provider of property management services.

Through its secondaries business, it invested in equity of Whole Foods Market Inc., the grocery store chain acquired last year by Amazon Inc. for about $13 billion, and in Alibaba Group Holding Ltd. Both deals are showcased in the “Hall of Fame” at the entrance to the firm’s Swiss headquarters.

Denver Hub

Today, direct deals account for about 60 percent of investments, compared with 20 percent when Partners Group went public. In July, Partners Group announced it had raised 6 billion euros for direct deals, the largest such pool in its history, split between a fund that it capped at 3 billion euros and additional commitments.

While the size of the fund may mean “a slightly higher average” investment amount than the firm traditionally spent on targets, the change won’t be dramatic because prior funds were able to draw on other capital within the firm and were already doing deals of $1 billion and more, says David Layton, who oversees the firm’s private equity business.

Like many of the firm’s executives, Layton joined at a young age and rose through the ranks. Recruited in 2005 out of Brigham Young University by BYU alum Gantner, he spent several months at the firm’s Swiss headquarters before moving to New York. Now he’s in charge of building up the firm’s new North American hub near Denver, where Partners Group currently has more than 100 employees.

Located in Broomfield, Colorado, between Denver and Boulder, the new campus is scheduled to open in early 2019. “We want to have a bit of distance to the big money centers, to Wall Street, to be around people who have a little longer-term mindset,” says Meister.

North America has long been a major focus for the firm’s investment, with roughly 40 percent of deals being done there, about as much as in Europe, according to Layton. Analysts including Andreas Venditti, at Vontobel in Zurich, say a hiring push in the U.S. and the building of the new Denver hub should help close the gap on the fundraising side.

“I think there they really punch below their weight” in the U.S., says Venditti, who has a buy recommendation on shares of Partners Group. “They are expanding there, they are hiring, they are building up their new hub in Colorado and this, I guess, will give them greater weight.”

‘Consistently Humble’

"Their approach has been consistently humble, unlike some of their public peers, which have a higher profile and more forthright way of dealmaking," said Campbell Lutyens’s Liaudet.

The firm is taking a similar attitude with regard to another strategic push -- its effort to break into the massive market of defined contribution retirement plans such as 401(k)s in the U.S., which are increasingly replacing the traditional pension plans that used to invest in private equity. In the U.S. alone, investors had $7.7 trillion in such plans at the end of the third quarter, compared with $8.9 trillion combined in government and private sector defined benefits plans, according to the Investment Company Institute.

Managers including Blackstone and Carlyle have been trying for years to break into that market, but funds sold on such platforms need to price daily and meet minimum liquidity levels. That’s a problem for an industry that often relies on 10-year lockups in its funds. Partners solved it by adding allocations to credit -- private debt and senior loans -- as well as to publicly traded private equity firms, whose shares should rise or fall with the performance of its investment funds, at least in theory.

"It’s clearly a market segment that everybody is looking at," said Nori Gerardo Lietz, a senior lecturer at Harvard Business School, who was a partner at the Swiss company until 2011. "Nobody is creating new defined benefit plans anymore, it’s all going to defined contribution."

In the U.S., Partners is among the few private equity firms offering funds in compliance with 401(k) requirements (another one is Pantheon Ventures, a London-based firm working with KKR). The Partners vehicle, started in 2015, so far has two investors, according to the company -- a corporate pension plan that provided an initial $50 million commitment and a public pension that is in the process of joining.

Ironically, both are defined benefit plans, which have more leeway to invest in non-traditional funds. Companies that offer defined contribution plans, by contrast, may be reluctant to add private equity to their 401(k) lineup because they can be sued by employees for offering complex products that charge higher fees.

Former CEO Meister, who helped drive the firm’s push into defined contributions globally, says despite such obstacles, the long-term trend toward defined contribution in retirement is clear. Partners Group also offers products for such plans in the U.K. and Australia, where adoption has been faster.

Should defined contribution plans open up to the private equity offerings more widely, Meister estimates it could account for 20 percent to 30 percent of the industry’s growth in the next 10 years. “I think this can be very significant,” he said. “It will happen. It’s just a question of time.”

To contact the reporters on this story: Lukanyo Mnyanda in Edinburgh at lmnyanda@bloomberg.net, Christian Baumgaertel in Munich at cbaumgaertel@bloomberg.net, Kiel Porter in New York at kporter17@bloomberg.net.

To contact the editors responsible for this story: Neil Callanan at ncallanan@bloomberg.net, Siobhan Wagner

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