Business Breakdowns
· Sean Barrett
[00:00:00] S1: And it is a big piece of the story. I mean, what we've seen historically is that the stock prices tend to be very well correlated to asset growth for the alts. So it's an important part of the thesis. It starts with generating great returns, like you said, and having LPs who are willing to entrust you with more and more capital. I think for the upcoming fundraising cycle, there is a lot of skepticism in the market from investors and research analysts as to whether EQT can raise the 100 billion euros. It's a lot of capital. They manage 140 billion euros today, so adding 100 billion euros to that is no small feat. And if you look at the market, rates are a lot higher than they were during the last fundraising cycle. And a lot of investors are increasingly full up on private equity. At the same time, large LPs need to generate good returns to cover their future liabilities, which are also growing very rapidly with higher inflation and higher social inflation. So those investors are looking to best-in-class private equity firms to help them accomplish those goals. I think smaller PE firms will struggle in this environment, especially those that haven't generated great returns for their investors. But the large, best-in-class PE firms with great returns are frankly benefiting and gaining a ton of share. We just saw a couple weeks ago, Thoma Bravo announced they'd raised $34 billion, $24 in the flagship private equity vehicle and $10 billion in sleeves around that vehicle. That tells me that the market's healthy enough for great investment firms to continue raising money. But I think the mediocre ones will have a lot of trouble. And then while the market's tougher today than it was in 2021, EQT also has some growth drivers today that it didn't have back then. So we talked about the retail business, continuation vehicles, the sovereign wealth channel. That's becoming a bigger part of their business. And then lastly, EQT is innovating and launching these carve-out strategies like the transition strategy, regional strategies, future strategy. So even if the fundraising environment is tougher, going back to the building blocks again, we build up and predict this business based on each fund.
· Sean Barrett, Matt Reustle
And when I look at each flagship fund they're trying to raise across private equity across Asia, infrastructure and real estate, the returns and the DPI have been so good in the last five or 10 years that you build those up and you realize that those franchises are likely to continue growing pretty substantially. And the last thing I'll say about it, the first data point we have on this fundraise is BPEA Baring Private Equity Asia, which is raising its flagship fund right now. The last fund was 10 billion. It looks like this next fund will either hit the hard cap at 14 billion or maybe end up at 12 and a half to 13. But it's a 30% step up and that's consistent with what you want to see. For them to go from 75 billion in the last fundraise to something more like 100 in this fundraise. [00:00:00] S0: Yeah, it's interesting how power law shows up. Feels like what you're describing in the private equity space is another example of that being the case. One thing you mentioned there, which is admittedly how I thought about this, the asset growth and what assets they have under management. The fee-based model is very easy to understand and run through in Excel versus the investment results, which most people just aren't going through the individual funds to model that out. Do you see large gaps or opportunities just from your own perspective as looking at these as stocks where there's a disconnect between the AUM and what they're generating within the funds themselves that create opportunities?
· Sean Barrett
[00:00:00] S1: Oh, definitely. If you go back, gosh, 10 or 15 years, the best time to invest in these alts was always when people were not expecting much in the form of carry. So that's a lesson that I got to see for many of the other alts and it's something that we've applied to EQT. If you look back to 2015 and 16, investing in firms like Apollo and Blackstone, at the time, macro was shaky and public market investors were very reluctant to ascribe value to the future carry that could be generated by those great firms. And it turns out that was a great time to invest because those were growing innovative firms. And if you fast forward, of course they did generate a ton of carry, and on top of that they innovated and they grew substantially in the years ahead. So we're using that pattern recognition here to our advantage. At the moment, analysts are expecting very little for EQT in the form of carry over the next few years. Meanwhile, EQT has generated carry on every fund it's ever had since the early 1990s. And management has said that just on the existing funds, they think they'll generate over 8 billion euros of carry. That doesn't include the funds from the next fundraise. So it's pretty likely that you end up getting back almost a third of your market cap in the form of carry just in the next five years. And then of course, the firm can continue generating a lot more carry after that.
· Matt Reustle
[00:00:00] S0: It's a very interesting observation that that then leads into a feedback loop with the fundraising. So it's fun to get into the weeds on this. I think we've covered the financial model in some high level, but can you just describe how you would frame the business maybe from an income statement standpoint through margins, which you described a little bit, into free cash flow? Just whatever description you might have, and the easiest way to frame it for EQT?
· Sean Barrett
[00:00:00] S1: Yeah, absolutely. And as we talked about earlier, the reported accounting, either GAAP or IFRS for these businesses is very complicated because it often requires that these companies consolidate their underlying funds. So you really got to parse through it and understand that there are effectively two earnings streams that matter a lot to EQT. The first is the management fee business and the second is the carry stream. Starting with the management fee business, EQT earns roughly 1.5% management fees on committed capital. That's important because market swings don't move revenue around like they would for a traditional asset manager. In 2024, management fees were about 2 billion euros. So that's 1.5% on the 140 billion of fee-paying AUM. And EBITDA on that revenue stream was about a billion euros or roughly 50% margin. And that margin is going up over time. So we think about EQT raising another 100 billion more or less. They can do that with the same team. So the incremental margins are tremendously high and we'd expect those margins to continue going up. Again, in the industry, that earning stream is known as fee-related earnings or FRE. And based on fundraising cycles, EQT has historically experienced a really big step up in FRE every few years. And those step-ups can be 50 to 80% and we're about to get one of those. And then the second earnings stream is carry. So EQT earns 20% of the profits on its funds. That's the carry portion. And from the carry revenue it generates, it pays about 70% to its deal teams. That's higher than a lot of the other alts globally, but it results in attracting really great investors and it results in really long-term employee retention. And then the GP or the public shareholders keep about 30%. From an accounting perspective, the carry to the GP—that's us, the public shareholders—rolls through as net revenue at almost 100% margin. So again, the firm's generating very little carry right now. And historically that's a great time to invest in the alts. We think that carry will step up to a billion-plus euros of annual net revenue in the next few years. One important side note on the carry: EQT funds have a structure known as a European waterfall, meaning EQT only generates carry at the tail end of a fund after its investors have received their full preferred return of about 8% annualized.
· Sean Barrett, Matt Reustle
And then after that, EQT gets 100% catch-up and they generate a lot of carry all at once. This is different from many of the US players who benefit from American waterfalls, meaning they get carry after each deal is exited and then their investors can claw that back later if the fund ends up performing below the pref. So based on the European waterfall, EQT again is generating very little cash carry right now. But that's an opportunity because we think that they will generate a lot of carry in the next five years. [00:00:00] S0: It's interesting to hear some of the nuance and I know to your point the accounting conventions can be a struggle, but even that higher portion that goes to the deal team, you can make a very strong case that is the best alignment that you can have as a shareholder in terms of what they're being rewarded for. [00:00:00] S1: Totally agree. [00:00:00] S0: When you compare alts against one another, can you compare the financials you mentioned, the percentage that would go to the GP? Is there anything like in the margin profiles of the business that are comps to one another? I'm just curious if there's anything else that stands out. It might just be that GP carry, but given the nature of the operating leverage that exists within these, I'm curious.