StepStone Group Inc. — Fiscal 2020 Second Quarter
Reporting period: Quarterly and six-month periods ended September 30, 2020. The company completed its reorganization and IPO on September 18, 2020; pre-IPO results represent the predecessor partnership, while Class A earnings per share and net income attributable to StepStone Group Inc. cover only September 16–30, 2020.
Business context
StepStone is a global private-markets investment firm providing investment management, advisory, data and portfolio-reporting services across private equity, infrastructure, private debt and real estate. As of September 30, 2020, it reported approximately $313 billion of combined private-markets allocations, comprising $72 billion of AUM and $241 billion of AUA, with 553 employees in 19 offices across 13 countries.
Key financial metrics
| Metric | Three months ended September 30, 2020 | Year-over-year change | Six months ended September 30, 2020 | Year-over-year change |
|---|---|---|---|---|
| Total revenues | $242.9 million | Up 84% | $181.5 million | Down 22% |
| Management and advisory fees, net | $75.7 million | Up 41% | $139.2 million | Up 33% |
| Carried interest allocations | $166.1 million | Up 115% | $37.6 million | Down 70% |
| Total expenses | $132.9 million | Up 58% | $117.5 million | Down 22% |
| Income before tax | $109.3 million | Up 130% | $58.0 million | Down 27% |
| Net income | $108.4 million | Up 134% | $56.0 million | Down 28% |
| Net loss attributable to StepStone Group Inc. | $0.8 million | Not comparable | $0.8 million | Not comparable |
| Fee-related earnings | $28.2 million | Up 125% | $46.6 million | Up 89% |
| Adjusted net income | $18.3 million | Up 59% | $33.7 million | Up 43% |
GAAP income before tax margin was approximately 45% for the quarter and 32% for the six-month period. Net income margin was approximately 45% and 31%, respectively. These margins were materially affected by unrealized carried interest allocations and the unusual timing of the IPO and reorganization. Adjusted net income per share, assuming exchange of partnership units and other adjustments, was $0.19 for the quarter and $0.34 for the six months.
- Operating assets: AUM increased to $72 billion from $67 billion at March 31, 2020. AUA increased to $241 billion from $229 billion.
- Fee-earning AUM: Increased to $44.3 billion from $41.2 billion at March 31, 2020 and $36.2 billion at September 30, 2019. Undeployed fee-earning capital was $16.4 billion.
- Cash flow: Operating cash flow was $82.9 million versus $46.7 million in the prior-year six-month period. Investing cash flow used $5.7 million, and financing cash flow used $7.2 million.
- Liquidity: Cash, cash equivalents and restricted cash totaled $159.8 million at September 30, 2020, compared with $89.9 million at March 31, 2020.
- Debt: The company repaid its $146.6 million senior secured term loan in connection with the IPO and had no debt outstanding at quarter-end. The repayment generated a $3.5 million write-off of deferred financing costs and discount.
- Investments: Investments totaled $544.1 million, including $486.2 million of accrued carried interest allocations. Accrued carried interest-related compensation was $245.8 million.
Material changes versus the prior comparable periods
- Quarterly revenue growth was driven primarily by a $89.8 million increase in unrealized carried interest allocations, reflecting recovery in underlying fund valuations after the initial COVID-19-related market decline, as well as higher management and advisory fees.
- Six-month revenue declined because the first three months included substantial COVID-19-related unrealized depreciation. Management reported a $128.5 million decline in investments and accrued carried interest allocations in the first three months, followed by a $166.1 million increase in the next three months.
- Realized carried interest declined 23% in the quarter and 49% for the six months, reflecting lower private-equity realization activity.
- Quarterly performance fee-related compensation increased 107% with unrealized carried interest revenue, while six-month performance fee-related compensation decreased 73% because of the first-quarter decline in carried interest.
- The IPO generated $337.8 million of net proceeds before offering costs. The company used approximately $209.8 million to acquire newly issued Partnership units and approximately $128.0 million to purchase existing Class B units.
- StepStone granted 2.5 million restricted stock units in connection with the IPO, with aggregate grant-date fair value of approximately $45.2 million and generally four-year vesting.
Guidance, outlook, risks and unusual items
The filing does not provide formal quantitative revenue or earnings guidance. Management expects recurring liquidity needs to be met through operating cash flow, existing cash and future financing capacity, and states that it expects sufficient cash to meet obligations for the next 12 months.
- COVID-19: Further outbreaks, restrictions, slower fundraising, delayed capital deployment and delayed investment exits could reduce management fees and performance fees. Private-market valuations are recorded on a three-month lag.
- Carried interest volatility: Unrealized carried interest is based on hypothetical fund liquidation at current fair values and may reverse with future investment losses. The estimated maximum contingent repayment exposure was $79.9 million net of tax, although management viewed a total-loss scenario as remote; no clawback liability was accrued.
- Liquidity commitments: Unfunded capital commitments to StepStone Funds were $61.4 million. Contractual obligations included $81.1 million of operating lease payments and $474,000 of contingent earnout payments.
- Tax receivable agreements: StepStone generally owes 85% of realized or deemed net cash tax savings arising from specified tax basis increases. A $50.7 million payable to affiliates was recorded at September 30, 2020, and future payments could require additional borrowing if cash is insufficient.
- Ownership and attribution: StepStone Group Inc. held approximately 30.8% of the Partnership’s economic interest at quarter-end. Most consolidated income was allocated to non-controlling interests, which explains the $0.8 million GAAP loss attributable to the public company despite $108.4 million of consolidated net income.
- Market sensitivity: Management estimated that a 10% decline in fund investment values would reduce annual management fees by approximately $0.5 million and investment income by approximately $5.8 million, with carried interest effects varying by fund.
- Legal and controls: The company reported no material current litigation exposure, effective disclosure controls and no material changes in internal control over financial reporting.
Important facts for investors to verify
- Separate recurring fee-related earnings and adjusted net income from highly volatile unrealized carried interest allocations.
- Whether post-IPO public-company earnings attributable to Class A shareholders increase as Partnership units are exchanged.
- The sustainability of the recovery in underlying fund valuations and its effect on carried interest, investment income and potential clawbacks.
- Future obligations under the tax receivable agreements, including timing and cash funding requirements.
- Progress in deploying the $16.4 billion of undeployed fee-earning capital and converting AUM and AUA growth into recurring fee revenue.
- The impact of COVID-19 on fundraising, capital deployment, realizations, client activity and private-market valuations.