A $1 Billion Pop? Hot LBO Stocks Come With Strings Attached

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Public-market investors have done a lot of moaning about buyout shops raiding listed firms, but it turns out they’re infatuated with the industry too.

Buying shares in the publicly traded private equity firms is a wager that their fee income is only going to increase as pension funds and endowments throw more money at them, hoping that their portfolios will gain a few extra percentage points of investment performance. What’s more, in a low-return world, buyout firms may not even have to perform that well for the trend to continue. However that thesis has some weak spots.

In a stellar London initial public offering this week, Bridgepoint Group Ltd. raised 789 million pounds ($1.1 billion), mostly from partners selling existing shares. The IPO valued the U.K. buyout firm at 2.9 billion pounds. After a pop in the share price, it’s now valued at some 3.7 billion pounds.

That’s about 50 times the firm’s annualized first-quarter earnings, immediately putting its valuation on a par with Swedish competitor EQT AB, a more proven firm which offers more scale and diversification. The attraction is the stable management fees levied on the sizeable, long-term funds that these firms are looking to raise. Assume that Bridgepoint’s earnings achieve a step-change by 2023 thanks to successful fund launches and the multiple falls to the mid-20s.

You can see why investors are willing to pay for that today. EQT’s half-year results, released on Thursday, showed both management and performance fees doing better than expected. Its shares rose as much as 16% and are now trading at six times their issue price. The reality is that analysts have repeatedly underestimated EQT’s ability to deliver, and the company has consistently grown into its high valuation relative to expected earnings.

There is a virtuous circle for these listed firms. Bridgepoint’s strong debut is a vote of confidence that can only help when it comes to raising its next buyout fund, and if that goes well, it would support the share price too.

Where will it all stop? Those who put money into private equity doubtless realize that the 20%-plus annualized returns of yesteryear are getting harder to achieve. Yet even low double-digit returns should be good enough today. The long-run return on U.S. stocks is around 7%, and that might be hard to achieve in the coming years given where markets are now. The returns from bonds are negligible or negative. All told, that could fuel ever-larger allocations by institutional investors to private assets, even before considering a potential second wave of growth from retail investors.

Bigger funds will force private equity firms into areas where they’ve not invested before, and to attempt larger, potentially riskier deals. Competition for buyout targets will intensify. The industry isn’t crisis-proof either: A market correction would hamper the ability to exit investments and damage performance fee income. In turn, a blip in the track record would slow fundraising, with the knock-on effect that investors would then be likely to ascribe lower valuation multiples to these firms.

True, the broader trends and the locked-up nature of buyout funds provide a cushion against such a downturn, which would hit conventional asset managers harder. But investors shouldn’t let the secular growth story blind them entirely to the cyclical risks this industry faces.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Chris Hughes is a Bloomberg Opinion columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

©2021 Bloomberg L.P.

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