Buying Stakes in Big PE Firms Has Never Been More Popular — Or Expensive

As one GP told PitchBook, “You’d have to be an idiot not to sell at these prices.”

Krisztian Bocsi/Bloomberg Creative Photos

Krisztian Bocsi/Bloomberg Creative Photos

Allocators may balk at the exorbitant fees they pay for private equity — but they’re also trying to get a piece of the action.

Investors are plowing money into funds that buy stakes in the general partners behind private equity funds. The GP stakes funds that invest in the largest private equity firms now have so much cash on hand that the number of available deals is dwindling — and prices for these stakes are skyrocketing, according to a new report from PitchBook.

“GPs selling a stake at the top end have some pricing power and often sell stakes at auctions to further bid up prices,” said PitchBook senior analyst Wylie Fernyhough, who did the research for the report.

PitchBook estimates that at the current rate of investment there’s only enough supply of the largest PE firms to last a few more years. Almost 42 percent of eligible firms have already sold a stake to a fund, according to the private markets data firm. But asset owners are still increasing their allocations to private equity, and smaller GPs will grow to fill the vacuum, according to PitchBook.

[II Deep Dive: The ‘Inconvenient Fact’ Behind Private Equity Outperformance]

Firms that have been buying stakes in large private equity managers include Blackstone Strategic Capital Partners, Neuberger Berman’s Dyal Capital Partners, and Goldman Sachs’ Petershill unit. As a result of the strong demand for stakes, Petershill and Blackstone recently jointly invested in Francisco Partners, while Petershill and Dyal teamed up to buy a piece of Clearlake.

It’s easy to see why these funds have raised so much money. Blackstone, Dyal, and Petershill underwrite deals at multiples of invested capital that range between 1.8 and 2.3, with a 15 to 20 percent net IRR. According to PitchBook, however, some financial engineering has been going on underneath, particularly as competition has heated up. The data firm reported that GPs are using tactics such as delaying capital calls using subscription credit lines and delaying payments to their underlying portfolio companies in order to boost IRRs.

The result has been healthy yields for GP stakes funds — at least for now.

“The question is whether this can continue as capital pours into the strategy, especially into deals with firms at the top end,” PitchBook said in the report. “There already appears to be a valuation gap between how GP staking firms and target GPs value themselves. One GP told our analyst, ‘You’d have to be an idiot not to sell at these prices.’”

Sellers have the upper hand for the most part, but there are some potential new sources of deals. Some institutional investors are shopping the stakes they took years ago.

“For example, China Life Insurance owns a stake in TPG Capital and Kuwait Investment Authority, and GIC owns one in CVC Capital (not to say these specific investments are on the market),” PitchBook’s analysts wrote.

For GP stakes funds, purchasing stakes from sovereign wealth funds or other institutions won’t be a departure from their current strategies, according to PitchBook. “The acquisition of secondary equity is already common at auction deals, so the only change would be buying this equity from other investors rather than from a retiring founder,” the analysts wrote. “These potential (and for the moment, theoretical) deal-sourcing supplies could augment present sources and allow the big three GPs to continue investing at their current rate for years to come.”

Plus, even though the largest GP deals may be losing their allure, asset managers are already looking at other targets, including emerging managers and spinouts. In these areas, there are more targets than potential buyers, which include firms like Investcorp. PitchBook estimates that only 8.5 percent of middle market firms have sold stakes so far, and only 2.9 percent of emerging managers have done so.