Why 2017 to 2018 Could Be Boom Time for Private Equity
By Jon C. Ogg
With the bull market nearing eight years old, it has been impossible to ignore the stock market rally since the election in November. Investors are cheering that the Dow Jones Industrial Average has been challenging 20,000. They are also cheering pro-business and pro-growth initiatives coming down the pipe in 2017. Private equity shops have seen their shares (units) perform rather well since the end of the election, but 2017 might end up being a perfect pro-growth climate needed to let private equity shops thrive.
Oppenheimer has raised its expectations on major private firms. The call from January 9 is really an underlying forecast for solid growth ahead in 2017 and perhaps beyond. Chris Kotowski of Oppenheimer previously said that the private equity–based asset managers have the best business model in the financial services sector. He expects that the climate fostering the mega-rally in banks and financial services will be great for private equity.
One word of warning should be expected before these companies get into earnings season. The fourth-quarter earnings results from 2016 are not expected to be meaningfully affected by the election, even if they show another fairly steady quarter of good cash earnings. Kotowski’s view is that the companies leading private equity are misunderstood and undervalued.
Kotowski noted that the private equity group is valued, even after a strong start to the year, at only 10 times Oppenheimer’s 2017 cash earnings estimates, and that they are valued at nine times the 2018 cash earnings estimates. He spent most of the report talking up earnings and opportunities ahead, but Monday’s report also noted some defensive characteristics, depending on the business cycle:
No one really knows whether the next recession will be in 2017 or 2019 or 2021 in any case, and even if one did, we don’t think it would matter much to the cumulative three- to five-year return. These companies create value at all points in the cycle—by buying low, selling high and managing to increase the cash flow of the portfolio companies in between.
24/7 Wall St. generally likes to take a “both sides of the coin” review on analyst calls. After all, no single analyst is always right, and sometimes there can be assumptions that are far loftier than peer analysts may have. Other recent analyst calls in the private equity sector have been noted, if available.
Apollo Global Management LLC (NYSE: APO) had assets under management of roughly $189 billion as of September 30, 2016 spanning private equity, credit and real estate funds invested across a core group of nine industries.
Apollo saw its price target raised to $27 from $20 at Oppenheimer. On January 4, Goldman Sachs raised its rating to Buy from Neutral with a $24 price target.
Apollo has seen fewer analyst calls of late, aside from Oppenheimer and Goldman Sachs. At the start of January, S&P Capital IQ remained at a Hold rating and with an $18 price target. JMP Securities reiterated its Market Outperform rating and $27 price target late in November, ahead of the Athene IPO.
Apollo Global was last trading relatively flat at $21.43, with a 52-week trading range of $12.35 to $21.49.
The Blackstone Group L.P. (NYSE: BX) is one of the top private equity forms in the world by size and by reputation. It counts over $360 billion in assets under management via global investments in private equity, real estate, public debt and equity, credit, real assets and secondary funds. Oppenheimer raised its Blackstone price target to $34 from $32 on Monday. Blackstone’s yield is over 5%.
Blackstone units were last seen up 0.7% at $30.73, versus a 52-week range of $22.31 to $30.91.
As of September 30, 2016, KKR & Co. L.P. (NYSE: KKR) had a book value of $9.6 billion, or $11.95 per outstanding unit. That would compare to a share/unit price of $16.90 and a market cap of $13.7 billion today. KKR is a top global investment firm that manages investments across multiple asset classes, including private equity, energy, infrastructure, real estate, credit and hedge funds.
KKR saw its Outperform rating reiterated and its price target raised to $24 from $23 by Oppenheimer on Monday. S&P Capital IQ recently reiterated a Buy rating with an $18 price target.
Barron’s reported over the weekend of January 7, 2017, that KKR could offer 25% or for deep-pocketed investors. Their view was that a 4% dividend yield and its value of 8.1 times its economic net income being under peers make it valuable. They also talked up the recent acquisitions.
While these two calls were far less ambitious on KKR, Deutsche Bank raised its price target to $16 from $15 on January 6. In early December, Wells Fargo raised its valuation range to $16 to $18 from $15 to $17, based upon a sum of the parts evaluation, and from an 8.5-time multiple on its 2017 economic net income per share estimate of $2.00.
KKR units were trading up 2.6% at $17.17, in a 52-week trading range of $10.89 to $17.57
Two more quotes from Chris Kotowski should stand out to private equity investors:
That said, we would expect more than the usual lumpiness in 2017 because a number of the companies’ large public equity positions have been sold down, and more of 2017 earnings are likely to come from M&A transactions. Thus, expect more volatility in distributable earnings (DE) on a quarterly basis, but when all is said and done, we think 2017 will be close to where we previously had it.
While there are a great many doubters about the sustainability of the earnings of the PE-based asset managers (generally misplaced, in our view), we think that 4Q16 results will provide another set of data points to support the simple notion that the PE managers are successfully deploying capital, generating good returns and raising more funds. We believe that maintaining this pattern will drive success for the stocks through the cycles in the long run …