Despite Increased Volatility, Private Equity Weathers the StormVW Staff
Despite some increased volatility in equity markets, benchmark interest rates and credit prices, Credit Suisse expects ‘to see fairly resilient underlying business performance and cash earnings generation for the alternative asset managers during the June quarter highlighted by a modestly improving fundraising backdrop’. However, Howard Chen of Credit Suisse notes in the new report that still positive portfolio company fundamentals/investment performance (though they trim 2Q return expectations by 100-300 bps), more in the way of harvesting activity across private equity, real estate and credit (timing of exits was not surprisingly weighted towards April/May) and quieter deployment levels. More details on Private Equity 2Q expectations below.
Private Equity: Equity Sectors’ Further Earnings Expansion
We believe there’s still meaningful upside for further earnings expansion in Private Equity , distribution generation and long-term sector re-rating on the back of a sustained opening in the capital markets and progression of the realization cycle—we believe the recent pullback in the stocks provides an attractive entry point. We favor those alternative asset management firms and private equitythat we believe are best positioned to benefit from a combination of superior investment returns, long-term fund raising and a visible pipeline of accelerating cash distributions. At current share prices, we still estimate a solid 8% distribution yield for 2013, on average for private equity firms, with further running room into 2014-2015. While we see upside to the entire sector, we currently see the most total return upside in shares of Private Equity firms, Carlyle Group LP (NASDAQ:CG), Apollo Global Management LLC (NYSE:APO) and The Blackstone Group L.P. (NYSE:BX); we are currently Neutral rated on KKR & Co. L.P. (NYSE:KKR) and Oaktree Capital Group LLC (NYSE:OAK) given relative risk/reward prospects at current valuations
Private Equity Company Summaries: 2Q Earnings Outlook
Incorporating our final view of 2Q private equity fundraising, deployment, fund performance and realization activity, we revise our estimates—we raise our cash earnings and distribution estimates for each of Apollo, The Blackstone Group L.P. (NYSE:BX) and Carlyle, maintain our estimate for KKR & Co. L.P. (NYSE:KKR) and modestly trim our expectations for Oaktree Capital Group LLC (NYSE:OAK). Our economic net income (ENI) estimates are generally stable-to-lower given June’s pullback in equity and credit markets with the exception of Blackstone where we raise our ENI expectations to factor in a more active quarter for BX’s financial advisory, real estate and credit businesses. Company specific, user friendly tear-sheets can be found on pages 17-21.
Apollo Global (Outperform). We raise our 2Q cash earnings and dividend distribution estimates by more than 20% for private equity firm Apollo, as we expect the firm remained quite active on the monetization front this quarter—the primary driver of our higher estimate is related to the gains related from a Lyondell secondary offering completed during June (we expect that deal to contribute at least $0.12 per unit of net carry; recall that management spoke to $0.75 net carry as of early May). We trim our 2Q ENI estimate to $0.55 from $0.61 given less fulsome marks/lower than expected returns in Apollo’s private equity and credit portfolios (APO’s five largest public holdings were flat during the quarter, on average).
Blackstone (Outperform). We expect the second quarter to look fairly similar to the March quarter for BX with modest puts and takes (seasonally better advisory revenues, more RE/credit related harvesting activity, more modest private equity gains). We increase our 2Q cash earnings estimate to $0.33 (old: $0.27) and distribution estimate to $0.27 (old: $0.24), as BX was more active on the realization front in Real Estate and Credit than we previously anticipated; markets willing, we expect monetizations to pick up even further from here. We bump up our ENI estimate to $0.55 (we estimate +6% appreciation in Private Equity and +4% in Real Estate).
Carlyle Group (Outperform). We increase our 2Q cash earnings estimate to $0.34 (old: $0.28) given healthier 2Q harvesting activity as evidenced by numerous follow-on transactions (Cobalt, Hertz and SS&C) as well as our expectations for more creditoriented sales. Similar to Apollo, while we raise our cash earnings forecast (our primary focus), we trim our 2Q ENI estimate to $0.55 (old: $0.70) reflecting still strong appreciation within Carlyle’s Private Equity business (+5% qtr/qtr) partially offset by negative returns in Real Assets (-2% qtr/qtr).
KKR (Neutral). We maintain our 2Q cash earnings and dividend distribution estimates given the firm’s healthy monetization activity during the quarter—recall management spoke to $0.18 per unit of net carry as of May, and there have been a few notable deal announcements since then (Nielsen and Seven West follow-on offerings and a China Modern Dairy exit). We trim our 2Q ENI estimate to $0.29 (old: $0.82) due to our forecast now for 0-2% portfolio returns during the quarter (KKR’s 5 largest publicly traded portfolio companies were down 2%, on average).
Oaktree Capital (Neutral). Oaktree reports “adjusted net income” rather than economic net income—we view this as more consistent with our estimate for underlying cash earnings. We trim our ANI estimate to $1.91 (old: $2.22) and distribution estimate to $1.45 (old: $1.52) on the back of weaker equity and credit markets in the back half of the quarter—we view this level of performance as reflective of the firm’s still healthy cash flow generation prospects and active harvesting mindset.
Important to note, while quarter-to-quarter changes in asset prices create a high degree of economic net income volatility, we expect the alternative asset managers to remain healthy generators of free cash flow. We view underlying cash earnings as the most meaningful and consistent metric for valuing the alternative asset managers—this is most visible in the cash distributions these firms pay to unitholders as all pay the majority of their realized cash earnings to investors. Differences in portfolio composition (e.g., public vs. privately held companies) can skew ENI results for similar companies despite similar cash flows and underlying business dynamics given the MTM dynamics of carried interest accruals. A focus on cash flow normalizes for these differences.
Private Equity Fundraising
The private equity fundraising environment remains mostly favorable and has shown recent signs of improvement for the best performing alternative asset managers, supported by recent fund closings and a healthy pipeline. We expect to hear important updates on the state of fundraising for several flagship PE funds during earnings season. And despite the recent interest rate shock, we continue to see healthy fundraising trends for private equity across alternative credit—longer-term, we believe a sustained higher base rate environment could actually bode well for alternative credit fundraising particularly relative to more traditional fixed income investment products. In addition, we believe the trend towards more specialized private equity funds focused on particular sectors (real estate and energy) and regions (Asia) continues unabated.
Apollo Global. Apollo commenced fundraising efforts for its flagship Fund VIII last November with a $12 Bn target. After the first eight months of fundraising, we believe Apollo raised $7.0 Bn in its first closing and expect the fund will reach the hard cap of an impressive $15 Bn by the first half of 2014. We believe strategic credit and CLO products remain other notable focuses for the firm. Looking forward, we expect Athene expansion and the consummation of the Aviva U.S transaction will be the largest contributor of growth for Apollo—if completed, we believe the pro-forma company will represent one of the largest fixed life reinsurance carriers. As of the last earnings call, Athene managed $16 Bn of AUM related to the life reinsurance platform, of which 40% was managed directly by Apollo.
Blackstone Group. We estimate Blackstone will have several 2Q fund closings including BREP Asia’s first close of $1.5 Bn ($4 Bn target) and BRED II’s first close of $2 Bn ($3 Bn target). We forecast BAAM enjoyed $2 Bn of net flows (BX reported $1.7 Bn of hedge fund inflows in April alone) but also experienced a seasonally higher amount of outflows this quarter given the June redemption period (we estimate -$750 million). We also forecast an additional $1.7 Bn from the second Rescue Lending fund as we expect the fund reached its $5 Bn hard cap during the quarter. Looking forward, we expect Blackstone to be active in Real Estate and Credit (actively-managed ETF and retail BDC continue to attract healthy inflows) as well as Tactical Opps (special situations platform with a broad investment mandate; expect $1 Bn of inflows in 2Q).
Carlyle Group. During the 2Q, we expect CP VI to announce its first closing representing a very robust $9 Bn. Buoyed by the latest fund’s strong results, we believe Carlyle will exceed its initial target of $10 Bn—we estimate total size of $12 Bn. We also expect additional inflows to CAP IV (~$1.5 Bn raised as of March, target is at $3.5 Bn) as the fund begins its investment period. Looking forward, we believe CEP IV will hold its first closing during the second half of 2013 ($4 Bn target) and complete fundraising in 2014. We also expect the recent NGP acquisition will provide a modest increase in annualized fee-related earnings (an incremental ~$15 million of fee-related earnings in 2Q).
KKR & Company. We anticipate the second Asia fund (“Asia II”) to begin investing from its $6 Bn fund in the second quarter, providing a modest $15 million boost to feerelated earnings for 2Q. For NAXI, we forecast another $500 million in commitments in the second quarter as the fund approaches its final closing. Looking forward, we believe KKR will launch a dedicated energy fund ($1.5 Bn target) and a real estate fund (initial commitment of $500 million; we assume another $500 million was raised during the second quarter).
Oaktree Capital. We expect Oaktree’s Opportunities Fund IX ($5 Bn fund raised as of 1Q) to turn fees for additional $250 million during the second quarter. We also expect to see continued inflows to Real Estate Opportunities Fund VI, Enhanced Income Fund and Emerging Markets Fund. We also expect Oaktree to begin the investment period for Global Principal VI Fund (target size of $3 Bn) in 2014.