U.S. buyout group TPG’s initial public offering on Thursday will bring about a tectonic change in the private equity industry, as a spate of companies listing shares by offering shareholders a smaller claim on their lucrative, but irregular, performance fees.
TPG is to restructure its finances as part of its IPO to offer shareholders only 20 percent of its future performance-based profits, the firm said in its prospectus, down from 50 percent if the change was not made.
Operations managers called TPG’s structure a “next-generation” private equity IPO – one that gives public shareholders less of a share of performance fees, but more of more stable management fees.
“This is the new standard,” said Saul Goodman, head of alternative asset management banking services at Evercore. “Nearly every banker in the space who advises private equity firms on IPOs currently advises not to contribute a large percentage of performance fees to the public company.”
TPG, founded in 1992, will be the youngest private equity group exploit public markets when it listed on the Nasdaq at a price of $ 29.50 per share, which the firm values at about $ 9 billion. TPG declined to comment.
The IPO fee policy remains in place in contrast until Blackstone became the first major private equity firm to go public in 2007. Blackstone sold more than half of its overall management and performance fee-based earnings to shareholders, a model followed by KKR, Carlyle Group and Apollo Global Management.
Private equity groups typically charge a 2 percent management fee to their investors, in addition to a 20 percent share of investment profits. Investors buying into TPG’s shares will own an entity that generates most of its earnings from base management fees, not performance-based fees.
Analysts and investors are attracted to private equity management fee income because it is consistent and easy to model, according to bankers and private equity executives. Meanwhile, they discount performance-based profit because it can vary with market conditions and is more difficult to predict.
“The public appreciates management fee earnings much more than the transaction makers within firms, which are largely driven by interest bearing,” says Joseph Lombardo, head of private equity general partnership advisory practice at investment bank Houlihan Lokey.
Recent private equity IPOs have outweighed shareholder exposure versus management fees. Stockholm-based private equity firm EQT Partners offered public shareholders one-third of performance fees in its 2019 listing, but all of its management fees. New York-based asset manager Blue Owl offered public shareholders about 15 percent of its performance-based profit in its May 2021 listing.
Publicly traded firms have seen their valuations rise to 25 to 30 times their management fee-based earnings, insiders said, but the groups still receive valuations of just five to 10 times their investment profit. Old-line listed private equity firms adjust their economies to look more like new entrants.
In February 2021, KKR revealed that it would change the way it rewards employees, from paying more than 40 percent of overall management and performance-based fee earnings to insiders. Now it pays up to 25 percent of management fee-based earnings to employees, but up to 70 percent of performance fee-based earnings, a move that has increased public shareholders ‘claim on management fees and insiders’ claim on performance profits.
Apollo said in November it would limit insider pay to 25 percent of management fee-based earnings, but payout performance fees would increase from 50 percent to as much as 70 percent. Revelations Blackstone made in the second quarter show he is making similar changes.
Under its new structure, TPG generated $ 505 million in profits that were available to distribute to public shareholders over the past 12 months, compared to $ 1.2 billion if it did not change its fee ratios. Of TPG’s earnings, 62 percent, or $ 311 million, would have come from base management fees, up from less than 20 percent before the restructuring.
“What TPG is doing is properly and even shareholder-oriented,” said CT Fitzpatrick, founder of Vulcan Value Partners, who declined to comment on whether he had invested in the firm’s IPO, but one of the largest shareholders in KKR and Carlyle Group is. “We do not have a problem weighing more of the performance fees to the management team.”
However, because private equity firms are sending public market investors to management fee earnings that will be valued higher, Fitzpatrick called the change a “mixed blessing.”
“It can make it more challenging for us to find undervalued companies in this area,” Fitzpatrick said. “We are not in a hurry to sell, but if they reach our fair value estimate, we will do so.”
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