Banking & Finance

Should Alternative Asset Managers Be Buying Back Their Own Shares?

Jon C. Ogg

When investors hear about stock buybacks and share repurchases, the aim is generally considered to be one of the two top methods of returning cash to shareholders. The other method is of course dividends. Some companies and sectors see a lot more buyback activity than others. One which rarely sees share buybacks is the alternative investment management sector.

Some investors might think that private equity firms and alternative asset managers might find better bargains via opportunities for outside acquisitions after a sell-off. So why does an alternative asset manager need to even bother buying back stock?

Apparently, 24/7 Wall St. is not entirely alone in this question. Fitch Ratings has issued a report which highlights some risks if and when the alternative investment management sector repurchases shares/interests. Fitch even warns that these buybacks could have modest impacts on liquidity and leverage.

Three alternative asset management firms have recently implemented share repurchase programs. KKR & Co. LP (NYSE: KKR) authorized a $500 million share repurchase plan back in October of 2015. KKR’s $500 million is versus a market cap of $5.8 billion. KKR has also reduced a dividend.

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In 2016 we have now seen Apollo Global Management, L.P. (NYSE: APO) say that they plan to buy back up to $250 million in shares and Fortress Investment Group LLC (NYSE: FIG) say that they would buy back $100 million in shares.  Apollo’s market cap is over $2.3 billion and Fortress has a market cap of $900 million.

Fitch’s brief report indicates that these buybacks are an effort by each group to improve their public stock valuations. Again, private equity managers and alternative asset managers just are not that active when it comes to buying back their own shares and interests. Some pay great dividends, but buybacks not so much.

Each buyback program is supposed to be coming from cash already on the balance sheets. While the use of cash reduces balance sheet liquidity without providing incremental earnings for the firm, Fitch said it believes that  the repurchase programs are relatively modest within each firm’s overall liquidity profile and earnings capacity.

Fitch also points out that if there are big share price gains on the heels or going into the buybacks, other alternative asset management firms may follow suit. Fitch also noted that some other firms may be more constrained by their amount of float. The report said:

Fortress is also expected to use balance sheet cash to fund at least a portion of its program. However, should Fortress use borrowings to fund its entire tender offer, which is not considered, its leverage would increase to 2.4 times on a pro forma basis, using Fitch’s methodology for calculating leverage, which uses fee-related EBITDA in the denominator. This calculation is based on its Sept. 30, 2015 borrowings outstanding and the addition of the $155.7 million promissory note issued in the fourth quarter. This leverage level is well within what Fitch views as appropriate for an alternative asset manager in the ‘BBB’ rating category.

Alternative IMs have historically traded at a discount to their traditional IM peers, based on price-to-earnings multiples. Fitch believes the discount is driven, in part, by limited float and the complexity of an alternative IM’s organizational structure and financial reporting. Traditional managers’ earnings are derived largely from management fees, while alternative IMs also have the potential to earn incentive income on managed funds and investment income on fund co-investments (in addition to management fees), both of which must be marked-to-market on a quarterly basis and are very difficult to predict. As a result, earnings in the alternative IM sector can be relatively volatile, depending on market conditions.

Incentive income and investment income have been significant in recent years, as alternative IMs have actively sold fund investments into a strong valuation market, but many believe this cycle is coming to an end, which would hurt economic net income and cash earnings over the near term. Still, when market volatility increases, alternative IMs are generally able to find greater opportunities to invest. At present, un-invested capital, or dry powder, in the sector is at record levels, which could fuel earnings in the next realization cycle.

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KKR said that its assets under management were $98.7 billion and fee paying assets under management were $82.9 billion at the end of September 2015. Its book value was $10.2 billion on a total reportable segment basis or $12.01 per adjusted unit. Its share price was last seen at $12.64, versus a 52-week range of $8.00 to $24.79.

Fortress Investment Group had $74.3 billion in assets under management as of September 30, 2015. Its share price was last seen at $4.16, versus a 52-week range of $3.88 to $8.65.

Apollo had assets under management of approximately $170 billion as of the end of 2015 in private equity, credit and real estate funds. Its share price was last seen at $13.05 and its 52-week range is $12.40 to $24.19.