By | Steven Zhou, Partner and Head of Global Business at FOF Weekly
On August 11, 2018, London-based private equity firm Bridgepoint sold a passive minority stake to Dyal Capital Partners as it seeks to expand in new markets and products.
As part of the transaction, Dyal will benefit from a percentage of dividends and carried interest, the share of investment profits that alternative managers are paid as an incentive to generate high returns.
Dyal Capital has been particularly active in scooping stakes of private equity firms. A niche strategy at Neuberger Berman, Dyal Capital has actively bought stakes in Silver Lake, Vista and others who either lack scale or the desire to get listed.
1. Defining GP Stake
Why Bridgepoint choose to sell part of the share to Dyal instead of going public?
First, Bridgepoint will face strict regulation if it chooses to go public, while selling minority stake to Dyal can avoid such regulation meanwhile fulfill the firms’ large amount of long-term capital necessary to expand outside Europe and to develop new product line.
Bridgepoint can also leverage Neuberger Berman’s diversified product lines to provide more services to its clients.
Dyal was attracted by Bridgepoint’s great track record for the past twenty years; the investment will not only allow Dyal to share Bridgepoint’s current fund’s management fee and carries, but also entitle Dyal for profits due to future AUM growth of Bridgepoint.
“LPs’ liquidity needs increase with investment horizon; LPs can leverage the GP stake model to diversify their investment into more high-performance GPs and good companies”
It is clear that GP stake is a new investment strategic in the private market. We will go through more details below.
GP stake strategy is that a LP or a GP Stake Fund to purchase a passive minority stake in a GP, becoming its strategic investors, and sharing its revenue as well as future long-term income due to the growth of AUM.
In another word, a GP Stake Fund is like a PE investor who invests in other PE firms. A GP stake deal is a direct equity investment in the GP’s underlying management company.
2. The Development And Trends Of GP Stake
Recently, GP stake deals are quickly gaining more attention in US PE/VC market, but the GP Stake strategy only has around ten years of history; it is still a relatively new strategy, which attracts more institution investors to explore and participate in this new business model.
From LPs’ perspectives, institution investors and Ultra High Net Worth Individuals are willing to invest more into private market asset class based on current market condition. Meanwhile, they are also continuously looking for new strategies.
Back in 2000, CalPERS acquired a 10% stake in the Carlyle Group after a long time partnership between two parties. This investment gave CalPERS many direct and indirect benefits that Carlyle Group’s other LPs do not have, including co-investment opportunities, detailed information about invested companies and the future profit from the increasing AUM of Carlyle Group. It seems like CalPERS just did a regular PE investment, and the invested company itself is Carlyle Group, which bought great financial return and value added services to CalPERS.
From GPs’ perspectives, mature GPs need long-term capital to pay increasing GP commitment, buyout retiring partners’ shares, develop new product line and expand into new market. GP stake model seems to be a great solution: it is quicker and more cost-effective to sell minority shares in private transaction than going public.
In the early explorations, which were executed by a single investor that typically had a longstanding relationship with the GP, paved the way for institutional capital. In 2007, Goldman Sachs’ Alternative Investments & Manager Selection (AIMS) Group raised $1 billion for its inaugural Petershill fund to specifically target these types of deals in hedge funds. Neuberger Berman started a new platform called Dyal Capital Partners and subsequently raised $1.3 billion in a debut fund to start its own GP stake strategy in 2011.
A total of 11 funds explicitly focused on GP stakes have been raised until September 2017, the major players include Blackstone, Goldman Sachs, and Neuberger Berman.
From Hedge Fund To Private Equity
In fact, many of GP Stake Fund’s early investment were made into hedge fund, such as Affiliated Managers Group (AMG) and Credit Suisse’s Asset Management Finance (AMF). AMG purchased minority share of AQR Capital in 2004; AMF purchased minority stake in Rigel Capital in 2007. During this period, many leading global alternative managers also tried to sell minority stake to sovereign funds and another LPs with huge amount of capital.
Some of the early GP Stake Funds took hits when invested hedge funds faced huge redemption during economic downturn and liquidity shortage. The failures came for a variety of reasons, from poor performance, investment team turn-over and compliance issues. Moreover, the AUM of hedge funds fluctuate quickly: it could be increasing drastically in booming era, but the redemption during economic downturn also bring huge risk to GP Stake Funds.
Therefore, GP Stake Funds started to shift their focus to more illiquid strategies — — private equity, in which investors would not be able to redeem their capital until the end of fund life.
PitchBook has data on 64 GP stake deals, including 27 deals completed since the beginning of 2016. Hedge funds were once the primary target of such investments, but private equity firms are now accounting for more than half of all GP stake deals; this trend is likely to continue as more capital is dedicated to strategies that explicitly target PE firms, many of which are using GP stake investments to facilitate succession plans.
Based on the graph above, hedge funds were once the primary targets of GP stake deals, they have comprised about 40% of such deals over the last two years, with the proportion of deals into PE firms growing to more than 50%.
3. Strategic Analysis On GP Stake Fund
3.1 Major Players In The Market
In recent years, selling minority stake is becoming normal for alternative managers in the US. The three major players in the market are Goldman Sachs’ Petershill, Neuberger Berman’s Dyal Capital Partners and Blackstone’s Blackstone Strategic Capital Holdings.
- Goldman Sachs initiated Petershill in 2007 to invest in minority stake in hedge fund. It has over $4.5 billion investment in alternative managers, including global macro manager Caxton Associates, credit manager Knighthead Capital Management and Private equity manager Pelham Capital; it also invested in British quant fund Winton Group.
- Dyal Capital Partners is dedicated to acquiring minority equity stakes in established alternative asset managers. With over a decade of stake transaction experiences, the team has completed 40 transactions across three permanent capital funds with approximately $14.5 billion in aggregate AUM. Dyal is the first GP Stake Fund to shift its focus from hedge fund to private equity and has become the market leading player in term of AUM and completed transactions.
- Blackstone’s Blackstone Strategic Capital Holdings raised $3.3 billion for its first GP stake strategy back in 2014 and have made the first private equity investment in 2017 to become a shareholder for Los Angles based Leonard Green Partners. In March 2018, it expanded its investment into real estate companies, purchasing minority stake in Rockpoint, a real estate investment firm. Recently, it partnered with Goldman’s Petershill to purchase minority stake in Francisco Partners, a tech focused private equity firm. It also acquired minority stakes in Marathon Asset Management, Magnetar capital partners, Solus Alternative Asset Management and Senator Investment Group.
Apart from these three major players, Wafra investment is also very active in this area; other large institutions such as Aberdeen Standard Investments, Magnetar Capital Partners, Hycroft Capital and GP Interest are also planning to enter this field. Meanwhile, Credit Suisse and AlpInvest Partners long time endeavor in GP stake strategy has been shut down.
These evidence shows that GP Stake Fund, especially in PE/VC market, is becoming more popular and have attracted many large institution investors’ attentions.
3.2 Pros And Cons
GP stake strategy creates value for both GPs and LPs. More details on pros and cons please see the chart below.
Chart 1: Pros and cons on GP Stake Fund for GPs and LPs Source: PitchBook
4. Fund, FOF And GP Stake Fund
For get a better understanding on GP Stake Fund, we analyze three different investment models: fund, FOF and GP Stake Fund.
4.1 Investment Patterns
4.2 Contrastive Analysis
5.GP Stake In China
GP Stake Fund starts from the U.S. and now most GP Stake deals are completed in North America. As more and more LPs pay attention to GP Stake, it’s just a matter of time for GP Stake Fund in Asia or China.
Dyal, Petershill, and Blackstone are already eyeing minority investment opportunities in top private equity funds in Asia and China, as fewer U.S. and European investment targets in the market. Blackstone completed the first GP stake deal in Asia among GP stake funds, taking a stake in Hong Kong-based alternative investment management group — — PAG.
Neuberger Berman begin to explore Chinese private equity market since it become the first WOFE institution with a QDLP license in 2018, and the GP stake strategy is Neuberger Berman’s fist strategy in private market in China. Besides, Petershill is seeking more investment opportunities in Asia after it closed most recent fund in 2018.
Once the GP Stake Funds mentioned above effetively expand their GP network in China, the number of GP Stake deals in the U.S. and Europe will in turn increase and the GPs will face more opportunities. So, GPs in China can make the GP Stake model work well, fundamentally.
GP Stake Model will bring lots of opportunities for GPs in China, such as:
- GP Stake Fund’s investment targets;
- Co-invest with GP Stake Fund into US/Europe GPs;
- Cross-border M&A opportunities through strategic cooperation with the invested GPs in the same sector;
- Potential exit channels for GPs.
On one hand, cooperation with the Chinese top GPs will promote the development of GP Stake business globally, improve the bargaining power in pre-investment period, enhance the value-added service in the post-investment period, and effectively improve the investment return.
On the other hand, GP Stake Funds like Goldman Sachs, Neuberger Berman and Blackstone are welcomed to be the strategic shareholders of GPs in China, especially the leading GPs. The high-quality overseas shareholders mean a lot for Chinese GPs. It can optimize their shareholding structure, enhance the global recognition, leverage the shareholders’ rich product line, get ready for the overseas listing, co-invest or cooperate with the overseas GPs, and accelerate the globalization of GPs in China.
In China, although there is no mature GP Stake Fund, and there is no systematic and rigorous pricing and valuation for GPs, the GP Stake Model is not a mysterious.
In the past, many Chinese GPs sold their minority shares to third-parties, most of which are listed companies. In August 2016, Gopher Assets acquired minority stakes in a Shenzhen-based fund — — Costone. Now, some GPs are planning to expand their footprint into the FOF business, and they are willing to build their localized GP Stake Funds in China.
Considering the investment environment in primary market and the development stage of leading GPs in China, we believe, in the near future, there will be more GP Stake deals in China, and the GP Stake Fund will be dual-currency and more localized.
About The Author:
Chenqi (Steven) Zhou is the Partner and Head of Global Business at FOF Weekly. Steven was an entrepreneur as Head of Business Development at LEAP, which committed to bridge the gap between Chinese GPs/LPs and global GPs/LPs. Prior to that, Steve served as Investment Analyst at Boson College Endowment. Steven used to be a top performing Investment Manager at Cinda Securities, where he optimized portfolios in different assets classes including internally developed arbitrage products, Private Equity, Hedge Fund, and Real Estate. He started his career at KPMG.