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How do You Value a Private Equity Asset Manager?

Question asked of @skrisiloff by @scheplick

May 22, 2013 by S from Santa Monica, CA in  |  Flag
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Scott provided a great summary of these Alternative Asset Managers business model and sources of revenue, but did not give a specific valuation metric. Coming up with a So I am going to give my 2 cents.

Any business is valued based on its present and future cash flows discounted at a certain rate of interest. So the question is, are these Alternative Asset Managers going to grow at a rate faster than the Traditional Asset Managers and do they deserve a higher multiple or lower discount rate, etc.

The first Alternative Asset Manager that went public a couple of years ago was Fortress Investment Group (FIG). Per Yahoo Finance it is currently valued as follows (caveat: these have not been independently verified):

Forward PE=10.5 PEG Ratio=0.77 Price/Sales=2.0 Price/Book=2.59 EV/EBITDA=9.80 ROE=26% Forward Dividend Yield=3.2%

One can compare FIG to Traditional Asset Managers like Legg Mason (LM) and/or Blackrock (BLK). What I found in a quick and dirty back of the envelope comparison was that there was not a clear cut valuation parameter that stood out for one group (Traditional) vs. the other (Alternative). For example, on a PEG basis FIG at 0.77 was lower than 1.33 for BLK. The market obviously feels that BLK deserves a premium based on its size, longevity, etc.

Ultimately, the valuation will depend on the following parameters:

1) Your forecast of the future growth of the business cash flows 2) Confidence in your forecast 3) Management's ability to execute and deliver on those forecasts 4) Whether the management is shareholder friendly 5) Demand for the shares etc. etc.

I have copied links of various articles and reports that will shed more light on various valuation related issued when looking at Private Equity Managers.:





Hope this helps.

Comment   |  Flag   |  May 22, 2013 from Appleton, WI

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Without getting too specific on any of the individual names that are public today (e.g. Oaktree, Blackstone), here are some of my general thoughts on the business model:

1) The main thing to remember is that these are asset management companies at their core. The primary difference between a private equity company and a more plain vanilla asset manager (think Blackrock or PIMCO) is the fee structure, which is much more favorable to the private equity model.

2) The difference in the fee structure is that when a private equity company raises a fund, they raise committed capital, which means that they are literally raising the right to receive capital at a future date from a client (for example a pension fund). The PE company begins taking fees on this pool of committed capital before it is even deployed. The PE company then typically has a certain amount of time to invest the committed capital, and if it doesn't deploy all the capital it loses the right to invest those commitments. On top of the fees on committed capital, there are then a series of other fees that the PE company takes. The main ones are the management fee, which the company charges to oversee owned assets once the capital is deployed and then of course the incentive fee, which is the ~20% fee that the company can earn on a profitable investment.

3) So to answer the question more directly, the value of a PE company is tied to its AUM like any other asset manager, and for a PE company you would have to include committed capital in that calculation. I haven't run a specific comp table comparing the value of the PE companies to other public asset managers (Blacrock, Legg Mason, etc.) but I would assume that the PE companies trade at premiums to the vanilla asset managers, although I'm not sure that's justified (I'm not sure it isn't justified either though). As to whether or not they should trade at a premium, I can see the argument going either way based on my level of understanding. On the one hand, PE companies have the potential to earn much, much higher fees than traditional managers. On the other hand I would argue that there are disadvantages to the PE model in that you are only as valuable as your last fund because the funds have defined lifespans. By contrast PIMCO can and probably will be managing its mutual funds for the foreseeable future.

4) Two other items to note:

a) Remember that if the market has enough confidence in a company, it will not be valued based on its present operating fundamentals but on its prospects for future growth. Asset managers are operating in extremely deep capital markets, and so the potential for growth can be astronomical even if the growth wont necessarily materialize.

b) Growing an asset management business isn't about who is the best manager, it's about who has the best sales and marketing. A good sales force will beat a good investor every day of the week in building a successful business.

5) Remember who you're partnering with. As a shareholder in any company it is imperative that you evaluate the trustworthiness of management. This means not just going with the smartest team, because if the smartest team happens to be a greedy one, they will spend their day thinking about how they can enrich themselves at the expense of the shareholder. For PE companies you should take extra care for the following reasons:

a) Asset management businesses are people businesses. They are not capital intensive and so arguably there is very little reason why they should be public companies. The primary operating reason that most asset managers come public is for succession and retention purposes, meaning that it gives them a tool to give equity to their employees. PE companies are generally not coming public to enrich their public shareholders and in fact it is likely that behind closed doors they view retail investors as "dumb money."

b) Wall Street is teeming with smart, selfish and short term thinkers. That's one of the most dangerous combinations I can think of. In my mind the excessive fee structure that PE companies charge should be an instant red flag highlighting management's propensity for greed. PE firms are hired by their clients to advise on investment opportunities. Part of being a good advisor is protecting your client from excessive fees even if that comes at your own expense. IMPORTANT: That is not to say that everyone who works in PE or manages a PE firm is greedy and lacks integrity, but it is a warning to potential shareholders to tread with extra caution.

Comment   |  Flag   |  May 22, 2013 from Santa Monica, CA

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