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GP Stakes Investing: Beware of Valuations

There’s an old adage in the private equity market: “Nobody ever got fired for investing in Blackstone.” Although one might be tempted to suggest that’s because of returns, in the fundraising market it’s commonly used when discussing the risks associated with private equity investing.

Because Blackstone has such a strong brand and large investor base, if you invested with them and lost money, well, so did everyone else – so perhaps you won’t be blamed (or fired). No doubt the Park Hill team had something to do with promoting this concept a few years ago….

Blackstone’s purchase of private equity general partner stakes through its Strategic Capital Holdings, and similar investments being made by Neuberger Berman’s Dyal Capital Partners and Goldman’s Petershill funds perhaps make sense to its investors seeking very long-term, multi-generational returns.  However, most of us probably won’t live long enough to enjoy the upside.  The valuations of these types of investments are driven by discounted cash flows – largely projected management fees and carried interest – from several successor funds and often from funds investing in an ever-expanding number of strategies.

Here we are, nine years into a global public equity bull market.  As most private equity insiders know, fundraising is highly correlated with public market returns.  Asset allocators continually increase their absolute commitments to private equity as public equity valuations rise.  Ever increasing fund sizes appear possible, and today’s mega funds selling general partner stakes are taking advantage of the market’s new highs.  But when the public market turns, or if the supply of leverage required by large buyout funds dries up, fundraising will slow down as well – particularly for the large buyout firms.  Management fee streams forecast for the next several generations of funds will be seriously impacted – not to mention carried interest returns.

Moreover, the leadership of the largest, brand-name general partners who are selling shares in their management companies are aggressive and smart negotiators.  Having known the leadership of these firms for over 20 years, the Meteor5 team can attest as to their acumen in buying and selling businesses.  It’s not a coincidence that they are now selling in the late stages of a bull market.  It makes sense for general partners to seek full value for interests in their businesses, in part for intergenerational transfers.  But make no mistake: these savvy general partners would not be selling if they weren’t getting top-of-the-market valuations.

Buyer beware.