Feb 9, 2018

Private equity giants consider a major structural change

KKR co-CEO Henry Kravis. Photo by Drew Angerer/Getty Images.

Listed private equity firms are frustrated by what they view as artificially-low share prices, and are actively considering a structural fix: Converting from publicly-traded partnerships to C-corporations.

Why do it? Publicly-traded partnerships are off-limits for many institutional investors, and also aren't eligible for most equity indexes (like the S&P 500) or exchange-traded funds.

Why do it now? The corporate tax rate has moved closer to parity with capital gains, via the recent tax cuts. At 35%, conversion was a nonstarter.

Why not do it? There are still negative tax implications, and firms are trying to determine if they'd get enough stock price boost to offset. For example, KKR estimates that its 2017 after-tax economic net income would have been around 17% lower, calculated with the new tax rate. That means it would need to "see approximately two turns of multiple expansion, all else being equal, for a break-even stock price."

The conversion option was raised during several earnings calls in the past week — including for Apollo, Blackstone and Carlyle — but was brought into sharpest focus yesterday morning by KKR, which said it is "analyzing the potential impact of a conversion" and would likely have a final answer during its next earnings release.

Carlyle's Glenn Younkin added that converting is a "is a no-going-back kind of decision."

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