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Shares in private equity firms soar on tax status change

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Via Financial Times

The shares of America’s biggest private equity firms have soared, swelling the fortunes of moguls such as Leon Black and providing them with firepower for deals after their decision to pay tens of millions of dollars a year in extra taxes by switching from partnership to corporation status.

Mr Black’s Apollo Global Management has notched up gains of more than 25 per cent since May, when it joined rivals Blackstone, KKR and Ares in renouncing a tax-advantaged partnership structure that made it difficult for mutual funds and index trackers to own the firms’ shares.

Vanguard, one of the world’s biggest mutual fund managers, now ranks among the biggest shareholders of all four firms, which are trading near record highs.

The higher share price could open the door to more deals in which private equity firms use their own equity as currency for acquiring strategic assets. Just last week Apollo paid $1.6bn, mostly in its own shares, to nearly double its stake in its affiliated life insurance company, Athene Holding.

“We think we’re only in the middle innings in terms of realising the benefits of our . . . conversion,” Joshua Harris, Apollo’s co-founder, said last week. He added that the firm’s inclusion in the so-called CRSP indices had prompted Vanguard to buy nearly 13m shares.

Rising valuations have also delivered a windfall to an ageing generation of financial tycoons who pioneered the alternative investment industry in the 1980s and 1990s. Most retain large stakes in the firms they founded, even in what some industry insiders speculate may be the final years of their careers. 

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Stephen Schwarzman, Blackstone’s founder, last year negotiated a suite of unusual retirement benefits, including the right to keep his office in the firm’s midtown headquarters and lifetime access to a car and driver — although the 72-year-old tycoon “has absolutely no intention of retiring”, the firm said at the time. 

Mr Schwarzman’s Blackstone shares are today worth about $12.5bn, having risen by roughly $3.5bn since the firm announced in April that it was abandoning its partnership status.

The dramatic share price appreciation vindicates what looked like a risky gamble as recently as last February, when Ares became the first listed private equity firm to announce plans to become a corporation. 

As partnerships, the firms were allowed to bypass corporate taxes on some of their earnings, instead passing the money directly to investors. But the tax-advantaged status came with heavy bureaucracy, forcing holders to file complex tax returns in multiple US states if they owned even a single share. 

After Congress approved tax cuts that slashed the levy on corporate earnings, executives concluded the tax relief was worth less than the share price appreciation they could expect if mutual funds began buying the stock.

The firms have been rewarded with “meaningful shifts in their shareholder bases,” said Devin Ryan, an analyst at JMP Securities. “And it’s still early days. Long-only and passive ownership is up significantly, they are being added to indices, with more to come, and investor interest more broadly is up.”

David Rubenstein’s Carlyle Group will become the last major listed private equity group to make the switch when it drops its partnership status in January. The firm’s shares have climbed by nearly one-fifth since it announced the move in July.

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