Private equity pay gawkers have had quite a spectacle of late. Leon Black personally pocketed over $100 million from his firm, Apollo Global Management, last year. Combine Black’s earnings with the paychecks of Stephen Schwarzman at Blackstone and five others at KKR and Carlyle — and the haul tots up to some $900 million. Their enviable lucre is mostly derived from investment profits. Paradoxically, when it comes to valuing the firms they run, investors focus instead on management fees.
As a relatively new and complex asset class, private equity isn’t for the weak-kneed in public markets. The companies use odd metrics to measure their success. Moreover, their returns tend to be lumpy. Public shareholders generally have fewer rights than at other companies. But buying private equity shares ultimately should amount to a simple bet: that the firms can make money investing over the long run. That’s not the way it’s working, though. Apollo earned $81 million of profit last year from management fees paid by investors in its funds. Investment firms like BlackRock and T Rowe Price command an average trading multiple of around 18 times for such fees. At that rate, Apollo’s are worth $1.5 billion.
On the incentive side, Apollo lost money last year, proving the point that private equity returns are choppy. But over the long run, the firm and its big-name peers have minted fortunes on investing profits, or carried interest. And Apollo ’s $5.5 billion market value implies that investors consider the carry, using the 2010 figure in place of the negative number from 2011, worth a multiple of only about three. But consider Apollo’s earnings another way.
Assume its $67 billion of deployed assets fetch a blended management fee rate of about one percent, subtract half for expenses and that’s about $330 million a year.
Next, figure Apollo can earn a 15 per cent internal rate of return and keep a commingled 17 per cent of the profit from the capital markets and private equity arms. Strip out 40 per cent for profit allocated to partners and that’s about another $1 billion annually for shareholders. Tax the combined $1.3 billion of earnings at 10 per cent, put it all on a multiple of eight — and Apollo would be worth a little over $9 billion. Of course, that requires a willingness to value private equity the same way partners at the firms do — and a belief that Black and his cohorts can do for public investors over the next decade what they have done for themselves over the last two.