Description

P10 – PX

Executive Summary

P10 is an alternative asset manager that provides its clients access to the private markets. P10 charges a fee on clients’ committed capital over a 10-to-15-year period. As P10’s assets under management grows so does P10’s earnings power.

P10’s cash margins shrunk considerably over the last three years. As a result, P10 is trading at the cheapest multiple of its AUM and revenue since it uplisted in October 2021. The decline in cash margins resulted from a mix shift in the composition of its strategies, the transition to a new CEO, growing working capital, and investments for further AUM growth.

P10’s valuation today reflects the ambiguity around long term margins and the disappointing 2024 FPAUM growth forecast. Throw in some factor exposure to duration, a CEO transition, and a short report from left field and you arrive at a severely discounted equity with massive potential.

P10’s new CEO received an incentive stock grant based off five different VWAP hurdles over a five-year period. To hit these hurdles, P10 will need to grow FPAUM and expand margins. With a few years of patience, P10 is likely to return to double digit FPAUM growth, expanding margins, and a multiple re-rating. In the meantime, P10 will buy back stock and pursue M&A to grow its suite of private market strategies.

What I Expect

• A return to double-digit organic FPAUM growth
  • Fee Paying Assets Under Management (FPAUM) is the primary growth driver for P10. P10 grew pro-forma FPAUM at a 16% CAGR since 12/31/2020. 
  • P10 disappointed the market guiding to 4% net growth in FPAUM for 2024. Peers are expecting to grow double digits.
  • P10’s new CEO is Luke Sarsfield the former Global Co-head of Goldman Sachs Asset Management (GSAM).
• Margins improve
  • 2023 was a transition year, and 2024 will be an investment year.
    • Stock-based compensation, non-recurring expenses, and earn-out-related compensation represented ~59% of FY 2023 Adjusted EBITDA.
    • P10 guided 2024 Adjusted EBITDA margins to mid-40’s excluding effects of acquisitions. Previous long-term guidance indicated >55% Adjusted EBITDA margins in an investment year.
  • Margin deleveraging is the result of rising compensation costs and a mix shift in AUM from fund of funds to direct strategies which operate at a lower EBITDA margin.
  • The multiple today doesn’t consider margin upside as P10 trades in line with peers on a multiple of GAAP operating cash flow.
• Wise capital allocation
  • P10 will pursue M&A to add to its suite of offerings for its clients.
  • P10 increased the share repurchase authorization by $40 million bringing the total authorization to $50 million.
  • $48 million of capital is tied up in fees owed to P10 subsidiary, Enhanced Capital Group (ECG), from related party Enhanced Permanent Capital (EPC). This receivable consumes ~9% of P10’s revenue per year.
• Incentives
  • Mr. Sarsfield was awarded an incentive package that will pay him $40 million in equity if the stock trades above certain price hurdles within his first five years with the firm. His personal incentive is to invest upfront and build a foundation to grow AUM. Then as P10 returns to growth allow margins to expand driving cash flow per share and the possibility of a multiple re-rating enabling him to hit his VWAP hurdles.

Risks

• Regime change in interest rates
  • There is a risk that higher interest rates hamper the private equity business model. Higher rates could reduce returns for the asset class and likely lead to a lower volume of transactions. This scenario could negatively impact client demand for PE allocations thereby hurting FPAUM growth.  
  • Ares wrote up a summary of what PE GP’s and LP’s are navigating. It can be found here: https://www.aresmgmt.com/news-views/perspectives/flexible-capital
• Private equity allocations decline
  • After a decade of wallet share gains with allocators, private equity is experiencing slowing growth in new AUM.
• Margins never improve
  • Competition for talent is prevalent throughout the industry. P10’s peers note the compensation is rising.
• P10’s PE investment performance falters
  • As a base assumption, I am assuming P10’s investments perform well and generate underwritten returns. Investment professionals retain incentive fees from the underlying investment performance ensuring a proper alignment of interests.
• Assets originated via ECG do not find a permanent capital vehicle.
  • ECG, a subsidiary of P10, underwrites credit and equity impact investments. At year end, $48 million of these assets reside on P10’s balance sheet in “due from related party.” This figure has grown over time and represents a significant use of capital for P10 shareholders.
• Fee Rate Compression
  • A decline in fees would pressure margins and hurt P10’s profitability.

Valuation

I rarely start with valuation for any investment, but P10’s valuation today provides a significant margin of safety and highlights the general pessimism associated with the Company. I utilize EV as a % of AUM. Not all AUM is equal due to different fee structures on client capital. Multiplying EV/AUM by the fee rate yields a sales multiple.

EV/AUM

EV/TTM Revenue excluding Incentive Revenue

EV/TTM OCF

Shrinking Margins

The table below is constructed by breaking down P10’s cash flow from operations. It highlights the primary issue with P10 – converting revenue into cash flow.

P10 Cash Flow

Hamilton Lane Cash Flow

Enhanced Capital Group (ECG)

Part of the issue is ~9% of revenue goes to the balance sheet each year in a growing receivable from Enhanced Permanent Capital (EPC), a related party. At 12/31/2023 $48 million of the $55 million of the “due from related parties” is due to P10 from EPC.

In the Q3 2023 10-Q, PX added the following language to the ECG disclosures: “Payment is expected to be collected as the permanent capital subsidiaries complete and liquidate projects covered under this agreement.”

The wording was slightly changed in the 2023 10-K: “Payment is expected to be collected as the permanent capital subsidiaries complete and liquidate multi-year projects covered under this agreement.”

I claim no insight into the timing of this receivable, but its size is ~4% of P10’s current enterprise value. It would be immediately accretive to shareholders either in paying down debt, funding P10’s share repurchase, or funding M&A.

Margins and Compensation

Compensation costs are the primary use of capital. Costs continue to rise as a percentage of revenue. Adjusting for discrete items, the compensation costs were in line with FY 2022 as a percentage of revenue.

Given the 2024 mid-40’s Adjusted EBITDA guidance, management is likely to run a higher compensation budget to expand their workforce as well as hire a General Counsel/Chief Compliance Officer, Head of Distribution, and the recently announced Head of Strategy and M&A - Arjay Jensen.

Despite the above, P10 continues to be in line with peers from a FPAUM per employee and exceeds peers in a margin per employee. Unless there is a material change in the figures below then I would expect an eventual return to margin expansion as P10 grows its FPAUM.

*Note Hamilton Lane and StepStone operate a March 31st fiscal year end.

Incentives/Alignment

Incentives matter, and the alignment between management and P10 shareholders is outstanding. P10 hired Luke Sarsfield, the former Global Co-Head of Goldmans Sach Asset Management, in October 2023. Included in his pay package is a stock grant program based off five different VWAP thresholds over a five-year period from his start date (10/23/2023). Mr. Sarsfield will only achieve the top half of VWAP awards if he successfully drives FPAUM growth and expands margins.

M&A

P10 was built through M&A, and Sarsfield has an M&A background. P10 will likely buy a strategy this year based on this comment from the Q4 call: “We also hope that in 2024, we will announce at least one strategic transaction”.

P10’s current equity valuation isn’t conducive for M&A, but there are multiple financing options available to conduct a deal (e.g., earnouts and debt).

Friendly Bear Short Thesis

Here is a link to the report. I’d point interested parties to Crossroads 2023 audited financial statements specifically footnote 19. “On August 28, 2023, the SBA notified Capital Plus that it had concluded its investigation and review of Capital Plus with no material adverse findings.” It’s a non-issue, but worth mentioning.

Other

• P10 will host an Investor Day in 2H 2024
• Leverage Profile
  • Term Loan Balance ~$201.9 million with a weighted average interest rate of 7.39%
  • Revolver Balance ~$90.7 million with a weighted average interest rate of 7.56%
  • Financial Covenants
    • (a) Total Net Leverage Ratio. As of the last day of the most recently ended four fiscal quarter period of the Borrower with respect to which financial statements have been, or were required to have been, delivered pursuant to Section 5.2(a) or (b) (commencing with the four fiscal quarter period ending December 31, 2021), permit the Total Net Leverage Ratio, to be greater than 3.50:1.00.
    • (b) Fee Paying Assets Under Management. Permit Fee Paying Assets Under Management as of the end of any fiscal quarter of the Borrower (beginning with the fiscal quarter ending December 31, 2021) to be less than the sum of (i) $11,381,300,000 plus (ii) 70% of the aggregate amount of (A) any Fee Paying Assets Under Management acquired pursuant to any acquisitions or other investments not constituting organic growth minus (B) Fee Paying Assets Under Management acquired pursuant to the foregoing clause (ii)(A) that are Disposed of in a secondary transaction, in each case, consummated after the Closing Date and on or prior to the last day of such fiscal quarter, in the case of this clause (ii), calculated as of the date of such acquisition or other investment or Disposition, as applicable, after giving pro forma effect thereto.

P10 AUM Bridge

P10 AUM

Peer AUM

Margin Commentary Timeline

• 11/12/2021 – Earnings Call – “Our Target adjusted EBITDA margin is between 55% and 60%”
• 3/1/2022 – Earnings Call – “In aggregate we’re still expecting about 55% as we continue to invest in the business”
• 5/12/22 – Earnings Call – “then on the out years, it really is a balance for us reinvesting into our business, expanding our sales force. We mentioned opening an office in the Middle East versus generating a higher margin and paying that cash flow out. We feel like 55% to 60% is the right range. And in investment years, it's probably 55% and more of a harvest year, maybe it has upward pressure. But we do feel like the guidance we set out a couple of quarters ago should hold.”
• 8/11/22 – Earnings Call – “we plan to continue to reinvest in the business while targeting an overall 55% annual margin”
• 11/10/22 – Earnings Call “over the course of the full year, we continue to target an overall 55% adjusted EBITDA margin, with excess margin reinvested into the business to accelerate organic growth.”
• 11/10/22 – Earnings Call “WTI does come in at a lower margin than our core 55%. So in the near term, before they start growing we’ll have some incremental pressure on the margin. But obviously, our raw dollars are going up.”
• 3/6/2023 – Earnings Call “For 2023, when you take into consideration our implied WTI guidance that we provided last August, with Fund VII rolling off, we expect the combined P10 and WTI adjusted EBITDA margins to equate between 51% and 52%. This margin guidance reflects the full integration of WTI into the pre-existing P10 business model and the continued strong growth of our direct strategies which can carry a lower margin as they scale.”
• 3/6/2023 – Earnings Call “it is absolutely related to the fact that we added a lower-margin business in WTI and the fact that our direct strategies are significantly outgrowing the business as a whole. And those do require more boots on the ground. We think that that's wonderful. These are high-fee paying, great strategies, and we think there's a lot of runway. But they are lower margin businesses. Do we think long term those margins can structurally increase? We certainly hope so. We think so. But as these businesses right now are growing faster than the enterprise as a whole, we think the 51% to 52% is the right way to look at it. And remember, WTI we don't expect to necessarily be in the market in '23. So we haven't talked about the incremental margins on a potential Fund XI as presumably that would hit 2024.”
• 3/6/2023 – Earnings Call “We have better fee revenue on those products with lower margin, but the dollars continue to increase, and that's what we really care about.”
• 5/15/2023 – Earnings Call “As we have discussed on prior calls, the acquisition of WTI brought a higher average fee rate and a lower operating margin. Moreover, we continue to generate strong growth in our direct strategies, which share a similar financial profile. Ultimately, this should lead to more revenue and adjusted EBITDA dollars with margins in the low 50% range on an annual basis. 
• 8/10/2023 – Earnings Call “For the full year, we continue to expect margin to be in the range of 51% to 52%”
• 11/9/2023 – Earnings Call “there is a balance between investing for growth and maintaining margin. Both have been historically an important part of the P10 story.”
• 2/29/2024 – Earnings Call “[where margin will begin to inflect higher] depends on a few things. One is, obviously, it would depend on M&A. This all presumes that we're running the platform as it is for the foreseeable future. As we've talked about, we imagine that will probably not be the case. And so anything we did from an M&A perspective would obviously have some impact and largely likely to be at least initially a margin-dilutive impact. I would say it also then depends on this question of relative growth rates, right? And so the question then becomes, how is that relative growth rate? On the one hand, you want your fast-growing businesses to grow faster and growth is valuable, even if that comes at a relatively lower but still high margin versus the wider world and the wider opportunity set, we do think I want to be clear that some of the foundational investments we're making, obviously, they will be most impactful in the first year that you make them. And then over time, you will see the accretive benefit of those investments bearing fruit. The question then will be that accretive benefit relative to the ongoing mix shift that will still be happening on the forward -- how does that trade off? I don't know, frankly, today that we have perfect visibility on that. Some of it will depend on the relative growth rates, and we're investing to grow everywhere. And so in some places, we're looking to reaccelerate growth. And so look, I would tell you, I think the foundational investments we're making are going to be highly accretive to the franchise, highly ROI generated to the franchise and will help us drive accelerating growth and margin on the forward with some of the offsets I just noted.”

DISCLAIMER: This does not constitute a recommendation to buy or sell this stock. We have a position in this company, and we may buy shares or sell shares at any time.

Catalyst

Investing at an all time low valution when uncertainty is high and management is financially aligned with shareholders.