Equity markets went on a tear in 2016, but alternative asset managers and private equity firms settled into a more moderate pace when it came to asset sales and capital deployment fronts after setting new records in the past couple of years.
Asset disposals totaled $330 billion in 2016, a far cry from 2014 and 2015 when private equity-backed exits touched $465 billion and $431 billion, respectively, according to Preqin. The research firm pegged investments in private equity-backed buyouts at $319 billion in 2016, compared to more than $400 billion in 2015.
Fourth-quarter 2016 earnings reports from some publicly listed alternative asset managers could illustrate the impact of a falloff in exit activity, with several analysts projecting another quarter of muted distributable earnings, a measure of cash earnings available for distribution to unitholders.
Blackstone Group LP, the largest in the group of alternative asset managers in terms of market capitalization, already saw distributable earnings decline significantly for much of 2016. That metric totaled $1.48 billion for the nine months ended Sept. 30, 2016, versus $2.97 billion for the comparable period in 2015. Blackstone was quite active in selling investments in its private equity and real estate holdings during the final quarter of 2016, but Keefe Bruyette & Woods analyst Robert Lee said in a note that he does not expect the company to record a significant amount of cash carry from those sales.
Quarterly results at Apollo Global Management LLC, Carlyle Group LP and Oaktree Capital Group LLC are also expected to be dampened by weak realization activity, according to Credit Suisse analyst Craig Siegenthaler. KKR & Co. LP, on the other hand, is expected to register another strong quarter of asset sales, thanks to the disposal of its stake in Walgreen Boots Alliance Inc., Siegenthaler wrote in a Jan. 11 note to clients.
The group's quarterly performance as measured by economic net income, another earnings metric that includes both realized and unrealized gains, may be more favorable thanks to a sharp rally in stock prices following the election of Donald Trump as president in November 2016. According to an analysis of S&P Capital IQ, seven of eight alternative asset managers are expected to report higher earnings on a year-over-year basis. Five companies are projected to grow revenues year over year.
Still, higher stock market valuations may not necessarily lead to a significant bump to earnings results for Apollo and Carlyle in the future, Oppenheimer & Co analyst Chris Kotowski said in a note to clients, as the two companies in recent years have liquidated most of their public holdings. Changes in market values of private investments are beginning to weigh more heavily on economic net income of the two companies.KBW's Lee also pointed out that inventory at private-equity firms is now comprised of fewer public investments that are ripe for sales. A pickup in realization activity now hinges on an improved M&A environment for companies to cash out private investments.
Apollo-backed Athene Holding Ltd.'s strong stock performance since becoming public on Dec. 9, 2016, is expected to boost the company's earnings results. Athene's stock price was up nearly 20% as of Dec. 31, 2016, prompting Jefferies analyst Gerald O'Hara to raise his fourth-quarter 2016 economic net income estimate for Apollo to 69 cents from 48 cents. Apollo did not sell its stake in the IPO of the insurer.
"For most managers, the proportions of existing, mature investments that remain in publicly traded securities has declined [during] the past few years, so realizations over the next year or so will increasingly rely on strategic sales, dividend recaps, and other non-public transactions that can be difficult to monitor," Lee wrote.
Soaring valuations and intense competition for deals have made it increasingly difficult for asset managers to deploy their growing mountain of uncalled capital. Dry powder at private equity firms climbed to a record $839 billion at the end of the third quarter of 2016, according to Preqin. In the private capital industry, undeployed money awaiting suitably priced deals in all asset classes stood at $1.47 trillion at the end of 2016.
Alternative asset managers' ability to generate lucrative returns could come under further scrutiny as a potential tax reform looms large, Barclays analyst Kenneth Hill wrote in a Jan. 20 note.
Alternative asset managers could see lower returns from their portfolio companies due to a tax proposal by Trump to eliminate the ability of companies to deduct interest expense. Trump also called for the elimination of a tax break that allows private-equity managers to pay lower tax rates on carried interest. That said, a cut in overall taxes and full expensing of capital business capital expenditures may blunt such negative impacts.
It is premature to gauge the overall impact of the reforms until the new administration offers details on these proposals, according to Hill. When Blackstone holds its conference call to discuss its fourth-quarter 2016 earnings, executives may not be forthcoming with their views on tax reforms, Hill said.
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