Summary
- StepStone Group is an emerging private markets investment firm.
- The company has seen solid growth in assets under management and advisory, as results see volatility due to a large and a volatile carried interest revenue contribution.
- While a market multiple does not look very steep despite long-term growth prospects, I fear the longevity of the business model in the long run.
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StepStone Group (STEP) has gone public in an offering which was well-received by the market as modest earnings multiples (based on fiscal 2020 results) are combined with a solid long-term outlook for the company.
Unfortunately, the carried interest composition is very volatile, and even negative at times, as I have some long-term concerns about the business model preventing me from jumping onboard at a market multiple.
Investment Solutions
StepStone is a global private markets investment firm which focuses on customized investment solutions, advisory and data services to clients, which includes large pension funds, sovereign wealth funds, insurance companies and other wealth organizations, including high net worth individuals.
StepStone works together with clients to develop and build private market portfolios across asset classes such as private equity, infrastructure, debt and real estate. The company teams up with third-party fund managers in primaries, secondaries and direct investments (co-investments), and as of June 2020, it oversaw nearly $300 billion in private markets allocation. A minority of these are assets under management, while the majority of assets are under advisement, resulting in lower fees. This nearly $300 billion in total assets under management and advisory marks a steep increase from just a billion in 2007, demonstrating the long-term growth of the business.
In terms of asset classes, half of total assets under management are invested in private equity, with roughly a fifth allocated to private debt, infrastructure and the remaining into real estate.
Valuation Thoughts
StepStone and its underwriters initially aimed to sell 17.5 million shares in a range between $15 and $17 per share. Demand for the offering has been solid, as pricing has been set at $18 per share, resulting in gross proceeds of $315 million.
Upon the offering, there are nearly 95 million shares outstanding, which values equity of the company at $1.71 billion at the offer price. As none of the proceeds will benefit the company (as the money will be used to buy out previous interests), I peg net debt on a pro forma basis around $50 million, pushing up the enterprise valuation to $1.76 billion.
Amidst the increase in assets under management and under advisory, revenues have been trending higher in recent years. In the fiscal year 2018 (ending in March 2018), StepStone generated $264 million in revenues, comprised out of $141 million in management and advisory fees, and $122 million in carried interest allocation. The company reported very fat operating profits of $86 million and net earnings of $81 million.
2019 revenues fell slightly to $256 million, and this is only the result of carried interest falling to $64 million while the steadier management and advisory fees rose to $191 million. This modest and unexpected fall in carried interest meant that operating profits fell back to $62 million, as net earnings came in at $54 million.
The fiscal year of 2020 has been a very strange year, of course. With the fiscal year ending on March 31, the drawdown from COVID-19 was not yet reflected in the valuations. Management and advisory revenues rose to $235 million, as carried interest tripled to $208 million, resulting in operating profits of $149 million and net earnings of $132 million. Based on this profit number, earnings came in at $1.40 per share, valuing the operations at essentially 13 times earnings, that is at the offer price. With shares having risen to $25 at the first days of trading, the valuation has jumped to $2.4 billion, as this results in an earnings multiple of 17-18 times. It should be said that 2020 earnings have been very strong in relation to 2018 and 2019.
The first-quarter results for the fiscal year 2021 (ending June 2020) is dismal, as the impact of COVID-19 is now seen in the results. Management fees for the quarter came in at $63 million, for a run rate of $250 million. The issue is a $129 million reversal of carried interest allocation, in part offset by lower performance fee allocation to staff, as the company reported an operating loss of $51 million. While these are dismal results, we have, of course, seen a big recovery in the markets in recent months (with general market indices setting new records) which means that second-quarter results are likely very strong.
