CPD: A deep dive into Listed Private Equity Investments

Listed Private Equity spans a range of assets, including alternative asset managers, buyouts, private equity-backed listed companies and private debt.

Private equity (PE) is ownership of, or interest in, a corporate entity that’s generally not publicly listed or traded, although PE is increasingly backing listed companies where there are opportunities for transformative growth and, in some cases, taking them from public to private.

PE managers typically raise capital from high-net-worth individuals or institutions into PE funds, then use that capital to purchase stakes in private companies or acquire control of public companies with plans to execute long-term value creation strategies.

Private equity investment vehicles can be listed or unlisted. Listed Private Equity (LPE) comprises entities listed on global stock exchanges whose main activity is investing in private companies, private equity funds or the investment managers of private equity funds.

LPE managers typically invest in a range of assets. These include:

• buyouts
• private equity backed listed companies
• alternative asset managers
• private debt.

Each of these asset types will now be explored in greater detail.

Buyouts

Many of us are familiar with private equity buyouts; such transactions have long been a feature of the Australian corporate landscape. In 2021, KKR acquired a 55 percent stake in Colonial First State Investments for $1.7 billion and, more recently, CFS was scouring the market to buy sub-scale superannuation providers in a bid to consolidate the sector^[1]. KKR also made headlines earlier this year with its $1.5 billion purchase of the Perpetual name, along with the firm’s corporate trust and wealth management businesses^[2].

A buyout refers to an investment transaction where one party acquires control of a company, either through an outright purchase or by obtaining a controlling equity interest. The buyout can be funded through debt or equity financing – usually a structured combination of both^[3].

The transaction typically occurs when the buyer views the firm as undervalued or underperforming, with potential for operational or financial improvement under new ownership. Like any investment, a buyout happens when the acquiring party sees an opportunity for a positive return on investment.

For some companies, a buyout may form part of its exit strategy, whether it be by a PE firm or a competitor. For others, a buyout may arise as the unintended consequences of poor management, unexpected circumstances or an unforeseen opportunity that arises.

While buyouts can take several forms, the two most common are:

1. Management Buyouts (MBOs) and Management Buy-ins (MBIs)

A management team, whether the current firm’s leadership or incoming, leads the acquisition of a company. Both provide an exit strategy for corporations that want to sell off divisions that are not part of the core business, or where owners may want to exit the business.

2. Leveraged Buyouts (LBOs)

A financial or corporate buyer leads the acquisition of a company. Significant amounts of borrowed money can be used to acquire the company, with the assets of the company being acquired often used as collateral for the loan.

For a PE-backed buyout to succeed, it is crucial that the acquired company also conducts thorough due diligence on its new owners or partners. This isn’t just another transaction – both sides are entering a long-term, symbiotic partnership. As a result, ensuring the right fit between the parties is essential.

What is a buyout fund?

The acquisition of a company, i.e. a buyout, requires substantial capital. Typically, the private equity (PE) firm raises funds from a range of investors, traditionally large institutional investors such as pension or superannuation funds or sovereign wealth funds, to establish a PE fund with pooled assets. The PE firm then seeks potential businesses as buyout opportunities and works to close these deals.

PE firms often specialise in specific industries or sectors, employing professionals with relevant skills and experience who can be leveraged once a company is acquired. Over the following years, the PE firm collaborates with the companies in its portfolio, the focus to drive operational and transformational improvements. Each phase of this process is funded through either the acquired company’s assets or the PE fund itself.

To return capital to investors, the PE firm will eventually seek to exit its investments. The exit may occur through various strategies, such as taking the company public or selling it to a trade buyer. Figure one illustrates the typical lifecycle of a PE fund, along with the typical cycle for each portfolio company.

PE managers charge 1.5-2.0% per annum management fee, and take a share of the profits from the PE fund of typically circa 20%.

The investors stand to make a multiple on their invested capital. Good PE firms that can affect significant transformational change on the underlying companies are capable of generating attractive multiples on invested capital. The attractive nature of the return potential from private equity has been a significant driver of growing investor demand and inflows into this alternative asset class.

As with all investments, investors need to be cognisant of the associated risks with the underlying assets in which they are investing. In the case of PE, the risks one should consider are that:

• Invested capital is locked up for a long time – PE funds have a lifecycle often nearing 10 years
• Many PE funds are concentrated on a small handful of companies (and potentially focused on a certain sector or industry)
• The returns for investors are significantly weighted to the back end of the PE fund’s lifecycle

Traditionally, PE funds have been in unlisted, closed-end structures where the investor’s capital is locked up for the duration of the lifecycle of the fund. However, access to PE and buyouts continues to evolve, as an increasing number of PE funds operate as listed vehicles. This creates an ecosystem where the PE firm has access to permanent capital to fund buyouts, and where the investors have the ability to exit more flexibly, because there is the liquidity that comes from a broader shareholder base behind the listed vehicle.

PE backed listed companies

A PE-backed listed company is one where a PE manager holds significant equity ownership, or a controlling stake, of that listed public company’s shares. Typically the PE manager would have representation on the company’s board.

Although the number of PE led IPOs had fallen in 2021-23, the resurgence of private equity or venture capital backed IPOs has been a notable trend in 2024. These offerings accounted for 41 percent of IPO proceeds in the first half of 2024, a significant increase from 9 percent in the same period of 2023. This trend was especially evident in the Americas, where PE/VC-backed companies contributed 74 percent of IPO proceeds^[4].

What is the relationship between a company and a private equity partner?

Whether a company is private or public, it’s possible that any business can come to a junction in its lifecycle where the current management team may lack the specific skills or knowledge to successfully navigate the company going forward or to tackle the next phase of growth. A PE-backer does not simply provide a funding source; it’s a symbiotic relationship that forms between a company and the PE manager.

There is substantial empirical evidence to suggest that more companies are welcoming of PE-backing, whether they be private or public; it can be argued that the governance model is more conducive for PE-backed companies to plan and operate effectively.

While the comparisons presented in figure two specifically reflect the differences between PE-backed private companies versus public companies, the same positive characteristics and governance strengths would also be present in PE-backed public companies as well^[5].

Increasingly, PE firms – whether looking for buyout opportunities or to back a public company – have become more specialised with managers often focusing on specific industries, sectors or aspects of the businesses lifecycle. Often the manager brings with them a broad range of skills and capabilities that management can draw upon, such as:

• Knowledge of specific industries
• Operational experience
• Financial modelling and analytical skill
• Customer, competition and market research

Each of these factors can be leveraged to benefit the strategy and shape the direction of the company the PE firm is backing.

What is the investor’s perspective of PE-backed listed companies?

As a growing universe, PE-backed listed companies can provide investors access to listed companies where the PE manager still has a significant equity ownership, board representation and ultimately the same transformational approach to affect positive change in the company. It is not dissimilar to a private equity ‘co-investment’, where other investors might sit alongside a PE manager in a traditional buyout of a private company.

While this universe is growing, it is not easy for an investor to identify a PE-backed public company as there is no global database or benchmark/index that consolidates and tracks these businesses. These companies are not well covered by the broader research community.

There are only a few specialist private equity firms and global equity fund managers that have identified this investment opportunity and spent the time and resources to (a) mine the market in an attempt to identify these companies and (b) undertake in depth coverage and research of these companies. Needless to say, investment management firms that pursue these investment opportunities tend to be active, research driven organisations.

Alternative asset managers

An alternative asset manager (AAM) is a fund manager that manages capital invested in alternative assets, i.e. assets that sit outside of the traditional asset classes of shares, bonds or cash. Alternative investments can include private equity, venture capital, hedge funds, real assets, commodities, derivatives and private debt.

AAMs specialise in these investments, which historically have been the domain of institutional investors or high-net-worth individuals because of their complex nature. Despite the complexity, they are attractive to investors due to the potential for superior returns. These investments typically have common characteristics and are generally:

• illiquid
• in need of large injections of capital
• long duration, in that it can take time to generate returns.

Historically AAMs haven’t typically been accessible on public markets. However, over the past 15 years there has been a trend that has seen an increasing number publicly list; as a result, a number of AAMs are now accessible to smaller, non-institutional investors. Examples of such companies include Blackstone Group (BX), Apollo Global Management Inc (APO), Carlyle Group (CG) and Kohlberg Kravis Roberts/KKR & Co. (KKR).

There are several factors at play when an AAM considers listing, with the primary drivers being succession planning and attracting an increased amount of permanent capital.

Unlike traditional fund managers, AAMs – particularly in private equity – manage the asset. These companies provide the resourcing and guidance to the private (or public) companies they buy, with the aim to transform them to be better and more profitable businesses.

AAMs tend to have well-resourced teams with specialists across a range of sectors and industries, providing skilled guidance to the private companies they source and financially back^[6].

AAMs provide diversification of returns

AAMs generate earnings from several sources, including management fees, performance fees, transaction fees and returns from balance sheet portfolio investments. Management fees are charged on assets under management (AUM) at a contractually set rate, typically ranging from 1-2 percent.

Unlike traditional asset managers who primarily charge a fixed fee on AUM, alternative managers also earn performance fees – usually around 20 percent – on profits that exceed a predetermined hurdle rate. This means the better a fund performs, the higher its potential earnings.

Some AAMs who have an in-house corporate finance team may also earn transaction fees from companies they acquire. These fees compensate the AAM for taking a company private, restructuring or recapitalising it, and preparing it for a return to public markets or a sale to another buyer. Such fees can be highly lucrative.

AAM shareholders will have claim on the return from the AAM’s participation in all deals, plus the management and performance fees, less the cost of running the business^[7].

Private debt

Private debt, specifically corporate direct lending, describes a transaction in which the lender provides a loan directly to the borrower without involving a bank or intermediary.  In most cases, the lender originates the loan by working directly with private equity sponsors or business owners, such as those in commercial real estate.

These loans are typically held until maturity, and the lender has the right to take control in the event of repayment issues, as specified in the loan agreement. Unlike traditional loans, private debt loans are not rated by credit agencies and are usually secured by the business’s cash flow or assets. However, they do not typically amortise over the loan’s duration.

How has the private debt market grown?

Institutional investors that invest in private equity programs have long included allocations to mezzanine debt and distressed debt funds. However, the hunt for yield in a lower interest rate environment has fuelled growth in other types of private debt funds, particularly private debt funds that make direct, hold-to-maturity loans to businesses. Australian investors have seen a plethora of private debt funds become available over the past two-three years.

Increased regulation imposed on the more traditional banking system has created opportunities for nonbank lenders such as private debt funds. As banks have dramatically scaled back their direct lending in response to a raft of regulatory reforms, private debt funds offering very attractive risk-adjusted returns have stepped in and are filling the void.

According to the IMF, global private credit assets under management have quadrupled over the past decade to US$2.1 trillion in 2023^[8].. Private debt and private credit are terms that are often used interchangeably. The growth of the broader private debt market is supporting the growth of listed private debt funds. Listed private debt provides a liquid way to access an otherwise illiquid institutional market.

What are the advantages of private debt?

• The illiquidity premium: a return premium earned for holding non-traded debt.
• Hold-to-maturity and step-in rights: non-syndicated, hold-to-maturity loans give lenders greater control in workouts and alignment with the borrower
• Tighter deal terms: tighter covenants and lower leverage
• Alignment with a private equity sponsor: advantage of access to “top-up” equity in times of stress
• Stronger credit performance: historically middle-market loans have experienced lower loss rates vs the broader institutional loan market.

Why choose listed private debt?

In a world of lower cash rates, listed private debt funds stand out as offering attractive yields (8-10 percent), floating-rate interest exposure and compelling risk-adjusted returns. The growth of the broader private debt market – driven by the lower interest environment and the vacuum created by the traditional lenders (i.e. banks) focusing elsewhere – supports the growth of listed private debt funds, particularly as broader set of investors seek more liquid ways to access an otherwise illiquid ‘institutional’ market.

Compared to traditional high yielding investments such as high yield bonds, REITs and utilities, which are trading at very low yields, many of the listed private debt funds currently represent very good value.

What are listed private debt funds?

Listed private debt funds are publicly traded on major exchanges and provide direct loans to businesses, infrastructure projects, commercial properties, or specialised sectors such as venture capital and resource-based investments.

Unlike many listed credit funds, which invest in highly traded credit securities such as corporate or government bonds, mortgage-backed securities, or syndicated debt, listed private debt funds primarily focus on non-traded, non-syndicated, self-originated loans held until maturity. This approach allows investors to benefit from an additional illiquidity premium.

What are business development companies (BDCs)?

Within listed private debt funds, the largest category of funds making direct, hold-to-maturity loans are the US-listed Business Development Companies (BDCs). The BDC model was created by US Congress in the 1980s to facilitate lending to small and middle-market companies. BDCs are regulated under the Investment Company Act of 1940.

BDCs are closed-end investment companies that typically focus on direct, hold-to-maturity loans to US middle-market private companies with EBITDA typically in the range of US$10-$150 million. A number of the BDCs focus on specialty finance niches such as asset backed finance, equipment leasing or venture lending and offer running yields of circa 10-12 percent per annum, which compare favourably to other fixed income investments. The underlying senior secured loans in most listed private debt funds are generally regarded as having a credit risk of BB (i.e. sub-investment grade).

What are the advantages of BDCs?

• Private equity backed borrowers: Middle-market lenders tend to invest mostly in private equity sponsored deals. The private equity companies’ ability to provide “top-up” equity in periods of market stress offers better risk adjusted returns. Private equity backed borrowers are also less likely to default.
• Lower default rate and stronger recovery rate: vs syndicated and leveraged loans. We believe the close interaction between borrower and lender, and the ability of lenders to assume control, have been major drivers of this stronger credit performance.
• Illiquidity premium: Given that direct loans to midsized businesses are less liquid than high yield bonds or leveraged loans to larger companies, investors can expect an extra return for the illiquidity.
• Tighter covenants and lower leverage: vs syndicated and leveraged loans.
• Stronger credit performance: vs syndicated and leveraged loans.

Access to private equity and the broader ecosystem of private market opportunities continues to expand, with listed PE funds now increasingly available to investors. This provides PE firms with permanent capital to support their investment activities while offering investors greater flexibility due to the liquidity that comes with a publicly traded vehicle. In essence, listed private equity has made PE more accessible to a broader range of investors.

Beyond liquidity, investors in listed PE funds gain immediate exposure to a diversified portfolio of companies at various stages of operational improvement, which helps smooth returns over time. Historically, private equity has delivered higher returns compared to public equities, with lower volatility due to its illiquid nature. Listed private equity offers the potential for capturing the private equity return premium while providing daily liquidity. However, LPE carries higher market-like volatility due to its daily pricing on public exchanges.

Many argue that the PE model, with its focus on skilled management, a balanced mix of equity and debt (leverage), as well as more favourable pricing in private markets, offers superior governance and ownership structures, which enable stronger returns. As a result, a growing number of investors are turning to PE and LPE as a way to diversify their portfolios and tap into meaningful returns, driven by a governance model designed for long-term success.

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References:
[1] https://www.afr.com/companies/financial-services/kkr-s-colonial-first-state-wants-to-buy-up-sub-scale-super-funds-20241015-p5kigx
[2] https://www.afr.com/companies/financial-services/perpetual-to-be-broken-up-name-sold-to-kkr-in-1-5b-deal-20240507-p5fqh0
[3] Corporate Finance Institute, What is a Buyout?, 2020
[4] https://www.forbes.com/sites/robertdaugherty/2024/09/16/ipo-market-rebounds-tech-unicorns-lead-charge-amid-global-uncertainties/
[5] Brown & Kraeussl, Risk and Return Characteristics of Listed Private Equity, 2010
[6] Investopedia, Alternative Assets, 2019
[7] Forbes, Alternative ways to tap into Alternative Investments, 2014
[8] https://www.rba.gov.au/publications/bulletin/2024/oct/growth-in-global-private-credit.html

Important information: While every care has been taken in the preparation of this document, neither Barwon Investment Partners Pty Limited ABN 19 116 012 009 AFSL 298445 nor PAN-Tribal Asset Management Pty Limited ABN 35 600 756 41 AFSL 462065 make any representation as to the accuracy or completeness of any statement in it, including without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document has been prepared for use by sophisticated investors and investment professionals only and is solely for the use of the party to whom it is provided.