Price of alternative investment companies hotly debated

19 March 2017

 The acquisition of Fortress, the US asset manager, for $3.3bn by SoftBank, the Japanese technology giant, has sparked fresh debate over the pricetags attached to alternative investment companies.

SoftBank, which was founded by Masayoshi Son, the billionaire businessman, paid $8.08 a share in cash to buy Fortress. This represented a 39 per cent premium to the investment company's closing price on the day before the deal was announced.

The chief executive of a rival asset manager, who did not wish to be named, says the price paid for Fortress has raised eyebrows across the industry. "Fund industry executives and investment bankers experienced in takeovers are shaking their heads in disbelief. The price is just crazy," he says.

But the deal is a boost for executives at listed alternative investment managers and private equity companies, their closest competitors, who have long complained that shareholders fail to recognise the growth potential of their businesses.

Valuations for these companies remain hotly debated due to the complexity of their business models and the uncertainty surrounding their future earnings, which can be volatile.

Last month Tony James, president of Blackstone, said his company's stock traded on a valuation that was around 25 per cent lower than the comparable share price-to-earnings ratio of the average company in the S&P 500 index.

Blackstone's shares were "quite a bargain for an industry leader", Mr James said during a call with analysts.

Will Riley, a fund manager at Guinness Asset Management in London, believes Mr James may have made a valid point.

Investors tend to attach lower valuations to alternative fund companies specialising in niche areas such as private debt or hedge funds than they do to traditional active managers, such as Franklin Templeton or T Rowe Price, according to Mr Riley.

But he believes alternative fund companies are more protected from the inexorable rise of passively managed funds than their counterparts in the traditional investment universe.

He adds that alternative managers in the US "look particularly well placed" to prosper following the election of Donald Trump as president, as the new administration is likely to cut both personal and corporate taxes.

"Favourable tax reforms will raise the level of assets available for investment, which in combination with looser business regulations should translate into higher returns for alternative asset managers," he says.

But other investors believe alternative investment companies are understandably cheap.

Jon Little, founder of Northill Capital, a London-based multi-boutique asset manager, sees the SoftBank-Fortress tie-up as "a one-off", adding that the valuation discounts attached to alternative asset managers "exist for a reason".

Mr Little is a serial buyer of asset management businesses, acquiring five since Northill was founded in 2010. He also participated in the acquisition of the fund companies Insight Investment, Walter Scott, ARX and Pareto in his previous role as vice-chairman of BNY Mellon Asset Management.

He says: "Northill would not consider taking a stake in a private equity manager. They tend to be incredibly complex structures that are not always transparent to their investors.

"The shares of listed private equity groups trade on low valuations because of their opaque nature.

"Investors often have a healthy scepticism over whether the economics of private equity groups are distributed fairly between the managers and the shareholders."

Sean Healey, chief executive of Affiliated Managers Group, the $727bn US-listed multi-boutique asset manager, goes one step further. He believes a pricing bubble has developed as a result of increased competition among buyers for private equity firms, or for stakes in buyout groups.

Petershill, part of Goldman Sachs Asset Management, is in the process of raising up to $2bn to acquire stakes in smaller private equity firms, which it hopes will develop into companies that can rival Blackstone.

Dyal Capital, a division of Neuberger Berman, the US investment manager, last year raised $5.3bn to buy ownership stakes in private equity companies, more than double its original target. Over the past 12 months, Dyal has acquired minority stakes in a number of well-known private equity managers, including KPS Capital, Starwood, HIG and Silver Lake.

Mr Healey says: "In a number of recent transactions, the buyers are making truly heroic assumptions about future returns for private equity funds that are growing ever larger in size, so there is a considerable risk of disappointment.

"Investors in these vehicles may suffer losses when senior partners who have driven the growth of the private equity firms wish to retire or leave, making subsequent fundraisings challenging, especially if recent performance has been poor."

His caution is shared by Andrew Brown, senior consultant at Willis Towers Watson, the world's largest adviser to pension schemes. Mr Brown says that a willingness to sell an ownership stake should be a "troubling sign" for potential buyers, as it may signal a lack of confidence by the private equity group in its future growth prospects.

He is also concerned by the lack of clarity over an eventual exit for investors who have bought a stake in a buyout firm, noting that private equity companies may not want to disclose sensitive information to future buyers. This could then derail a sale process.

He says: "If a private equity manager is willing to sell a stake, the question investors must ask is: 'Am I buying a lemon?'"

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