Bridgepoint shares are too hot

But for those UK stock-pickers hungry for a stake in the future cash flows of this apparently unstoppable asset class, the brightest opportunity landed on 21 July. This was the day when mid-market outfit Bridgepoint Group (BPT) Bridgepoint Advisers listed itself on the London Stock Exchange. In typical private equity fund style, it picked its moment wisely.

The initial public offering was priced at 350p and involved the issue of around £300m of new equity and the sale of £489m in existing shares by insiders. By the time ordinary investors could get in on the action, the price had risen to 420p. Within two weeks, the stock had climbed to a high of 565p, a 61 per cent ‘pop’ which a limited free float and the relative scarcity of listed private equity firms in Europe is likely to have contributed to.

Evidently, investors are also buying into a growth story. The recent spate of public market takeover activity has only served to shine a spotlight on three factors powering private equity right now: much-improved deal-making sentiment, low interest rates and record amounts of capital in fund managers’ hands. Ever-growing appetite for private equity assets from pension funds and sovereign wealth funds looks all but assured, along with bumper management fees for the buyout funds.

Bridgepoint is well placed to benefit from this. But its shares are not without risks and look expensive on 30 times the already bullish adjusted earnings forecast for 2024 by broker Numis. Against net operating profit after tax (also known in the trade as NOPAT) – a closer measure of post-tax fee-related earnings, which is more likely to be reflected in statutory income statement – the company trades on a far loftier multiple of 47 on the same time horizon.

As such, we struggle to see how much further the shares can rise over the medium term. Although Bridgepoint’s life as a public company is in its infancy, we think investors who got in early should consider cashing in.

What’s the Bridgepoint?

Headquartered in London, Bridgepoint began life as a part of NatWest Equity Partners before it was spun out of the bank in 2000. Historically, it has specialised in so-called mid-market private equity deals in Europe, meaning it uses pools of client funds to make equity investments of up to €1bn (£852m) in publicly and privately listed companies in the industrials, business services, consumer, financial services, healthcare and technology sectors. Today it counts Burger King master franchises in the UK and France, and MotoGP-owner Dorna among its portfolio investments. Bridgepoint also owned Pret A Manger before selling the coffee chain in 2018.

Typically, its mid-market targets have enterprise values of between €200m and €1.5bn, which it views as the sweet spot for achieving a three times gross return on invested capital. Unsurprisingly, this has made it popular with investors; its last fund focused on this strategy, BE VI, pulled in €5.8bn when it launched in 2019, and has since generated a 12 per cent internal rate of return, according to disclosures made at the IPO.

Other strategies include funds focused on smaller growth companies, distressed companies, direct lending and a private debt business, the latter of which has expanded significantly following last year’s €3.9bn purchase of the credit arm of Stockholm-based peer EQT (SWE:EQT).

In its prospectus, Bridgepoint counted €27.4bn in total assets under management (AUM) across these strategies as of 31 March, which includes the value of unrealised gains, and is therefore 54 per cent higher than the €17.8bn AUM figure against which fees are charged. Elsewhere in its admission document, the group said it had €19.2bn total AUM in private equity and €7.4bn in private credit funds, leaving a gap of about €0.8bn.

Regardless of the exact measure, the asset pile is growing, leading to higher management fees (see charts). The latter rose 36 per cent in the first quarter of 2021 and helped push up pro-forma earnings to 4.59p per share. The real kicker is what comes next. Management anticipates “a step change and meaningful increase in AUM, with a corresponding impact on Bridgepoint’s revenue” in 2021 and 2022, as the group closes its Europe VII, Growth II, Credit Opportunities and Direct Lending funds.

Beyond that, the outlook remains strong: industry analyst group Preqin estimates private equity funds will grow at 15.6 per cent a year between 2020 and 2025, with allocations to private credit rising 11.4 per cent a year over the same period.

Big prospects, big rating

Against this bullish backdrop, our issue with Bridgepoint is less to do with its capacity to grow earnings than how highly its future profits have been valued by the stock market. And we think there are three reasons why the current multiple looks too hot.

The first is how it stacks up against peers. For UK investors, the closest comparison is FTSE 100 firm Intermediate Capital (ICP), which has a greater bias toward private credit but has been growing at a clip in recent years thanks to excellent fundraising activity and strong corporate demand for non-bank debt. Its shares trade at 18 times forecast earnings for the 12 months to March 2022. As Numis points out, US peers including Apollo, Blackstone and KKR – which have been on public markets for a lot longer – trade on around 20 times fee-related earnings.

Another reason to approach Bridgepoint’s medium-term earnings with caution is the possibility of higher interest rates. Although this might be a fillip to the private credit business, pricier and scarcer debt financing poses a challenge for private equity funds, which typically add leverage to their investments. The history of the sector shows that higher interest rates threaten fund net income, along with portfolio company liquidity and solvency.

Calling such shifts in monetary policy is a mug’s game, but rates are extremely low and any sustained rise would likely dampen the blistering expectations for fundraising, as bonds would regain some lustre (see chart).

The political environment is probably even harder to predict, but neither should it be discounted entirely. Although private equity managers like to be known for their ability to improve companies and dance in and out of markets, much of their historical profitability has involved an accounting wheeze which treats profits as capital gains rather than income.

This helps to explain the industry’s single-digit effective tax rates, and the enduring calls for this structure to be reformed. In the UK, a government with a former hedge fund manager for chancellor might not seem a likely threat, and despite a promise to simplify of capital gains tax no changes appear imminent. But the current multiple suggests investors expect acquiescence in perpetuity.