StepStone Group - Q4 2023

Transcript

Operator (participant)

Greetings. Welcome to StepStone's fiscal fourth quarter 2023 earnings call. At this time, all participants are on a listen only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note this conference is being recorded. I will now turn the conference over to your host, Seth Weiss. You may begin.

Seth Weiss (Head of Investor Relations)

Thank you. Joining me on today's call are Scott Hart, Chief Executive Officer, Jason Ment, President and Co-Chief Operating Officer, Mike McCabe, Head of Strategy, and Johnny Randel, Chief Financial Officer. During our prepared remarks, we will be referring to a presentation which is available on our investor relations website at shareholders.stepstonegroup.com. Before we begin, I'd like to remind everyone that this conference call, as well as this presentation, contains certain forward looking statements regarding the company's expected operating and financial performance for future periods and our plans for future dividends. Forward looking statements reflect management's current plans, estimates, and expectations and are inherently uncertain and subject to various risks, uncertainties, and assumptions.

Actual results for future periods and actual dividends declared may differ materially from those expressed or implied by these forward looking statements due to changes in circumstances or a number of risks or other factors that are described in the Risk Factors section of StepStone's most recent 10-K, and which will be updated in our upcoming 10-K. These forward-looking statements are made only as of today, except as required, we undertake no obligation to update or revise any of them. In addition, today's presentation contains references to non-GAAP financial measures. Reconciliations to the most directly comparable GAAP financial measures are included in our earnings release, our presentation, and our filings with the SEC. Turning to our financial results for the fourth quarter of our fiscal 2023. We reported GAAP net income of $56.8 million.

GAAP net income attributable to StepStone Group Incorporated was $28.8 million. We generated Fee Related Earnings of $37.8 million, Adjusted Net Income of $27.1 million, and Adjusted Net Income per share of $0.24. The quarter reflected retroactive fees resulting from an interim closing of StepStone's multi strategy global venture capital fund that contributed $0.5 million to revenue, Fee Related Earnings, and pre-tax Adjusted Net Income. This compares to retroactive fees in the fourth quarter of fiscal 2022 that contributed $3.4 million to revenue and $3.0 million to Fee Related Earnings and pre-tax Adjusted Net Income. Before turning to Scott, I would like to remind everyone that we are holding an Investor Day on Tuesday, June sixth in New York. Registration and additional details are available at investorday.stepstonegroup.com.

In-person capacity is limited. Please register as soon as possible to request on-site attendance. A live webcast will also be available on that same Investor Day website or through our shareholder site. I'll now hand the call over to StepStone's Chief Executive Officer, Scott Hart.

Scott Hart (CEO)

Thank you, Seth, and good afternoon, everyone. Turning to slide five, we delivered strong results in our fiscal 2023 amid a difficult operating environment as we grew fee-related assets under management by 14% and full year Fee Related Earnings per share by 19%. Focusing on our most recent quarter, we generated Gross AUM additions of over $5 billion. This strong fundraising reflects balanced growth across asset class, commercial structure, and geography. We have deliberately built a diversified platform that is designed to thrive across market cycles, and this quarter's result exemplifies StepStone's ability to prosper even in difficult environments. Turning to our financial performance, we generated Fee Related Earnings of $38 million for the quarter, up 5% from the prior year.

Excluding the impact of retrocession fees in both this quarter and the prior year's period, we would have grown Fee Related Earnings by 13%. We produced an FRE margin of 28% for the quarter and 31% for the full fiscal 2023, which is in line with the expectations we set heading into the year. We believe a full year view of margins is most appropriate given the seasonality of expenses and the timing of revenue, as growth can be uneven and dependent on timing of deployment and activations. We earned $27 million in Adjusted Net Income for the quarter for $0.24 per share. This is down from $44 million or $0.38 per share in the fourth quarter of last year, driven primarily by lower performance fees and lower contribution from retroactive fees.

Looking forward, we believe there are structural tailwinds for the private markets that will present growth opportunities well into the future. In addition, there are StepStone specific growth drivers given the continued runway within each of our asset classes in our private wealth business. While there are clearly near-term macro headwinds, StepStone is built to grow through all cycles. It is during volatile markets when our clients need the most assistance and our offerings are especially valued. We look forward to articulating our strategy and outlook in more detail at our Investor Day on June sixth. For today, I'd like to re-emphasize a number of key messages for our stakeholders as they try to better understand how StepStone is navigating recent events in the banking industry and across the broader macro backdrop.

The failure of Silicon Valley Bank was a loss for the entire industry, but it had limited impact on our venture capital activities, which make up 15% of our fee-earning AUM. Like others, we had to make some operational adjustments, but beyond that, the collapse of Silicon Valley Bank has not materially or directly affected the performance of our business or our portfolio. Venture and growth equity are an important part of our platform, and we remain bullish on the long term prospects of these sectors. Great companies are created across all market cycles. Technology and software are more pervasive than ever, and there are many exciting innovations in different stages of development. Themes such as cloud computing, energy transition, and generative AI are just a few examples of transformative technologies that are propelling the global economy and are areas that we believe are going to drive superior returns.

The keys to reaping those returns are consistent investment, an experienced team, and a platform with differentiated access and insights. We acknowledge there are challenges in the venture capital market, with valuations and fundraising down across the market in 2022. With these challenges come opportunities, and given our market-leading platform and diversified offering across strategy and company life cycle, StepStone Group is well-positioned to capitalize on these opportunities. Two of our approaches that are particularly well-suited for today's market are venture secondaries and growth equity. First, on secondaries, there's a growing demand for liquidity within the venture ecosystem, from GPs looking to support their portfolio companies and LPs who have more than $1 trillion of net asset value looking for liquidity. The regional banking turmoil magnified the risk off mentality, which is catalyzing an increase in secondary sales and an acceptance of a new valuation reality.

As many of you are aware, shortly after the closing of the Greenspring Associates acquisition, StepStone closed on the largest venture secondaries fund in the market. We believe the current backdrop offers a unique opportunity in which to deploy this strategy. Demand for a future VC secondaries fund offering is already strong, and we anticipate this strategy will be a source of growth as we raise successive vintages. Shifting to growth equity, this is a unique corner of the private equity market that is well positioned in the current environment. Growth equity strategies are distinct from venture and buyout, having characteristics that mitigate many of the risks facing cash-burning VC companies or highly leveraged buyout companies. Growth equity companies are typically cash flow positive.

They tend to have limited leverage that are not greatly impacted by rising interest rates in terms of financing costs, and they are attractive from an acquisition standpoint, providing for exit optionality that is not reliant on the IPO markets. Another important message we would like to reinforce is our approach toward real estate. Commercial real estate, office in particular, has come under recent pressure. However, our global office exposure makes up only 10% of our total real estate assets under management and under 1% of our total firm AUM. Driven by our top down house views, the office exposure in our flagship real estate fund is even lower, as instead weighted towards the living sector, industrial, logistics, and data centers.

While there is likely to be continued pressure on private real estate valuations driven by the rise in rates, our real estate exposure is high quality and well underwritten, and the gross exposure is modest. Importantly, corrections in the real estate market create opportunities for our flagship manager led real estate secondaries fund. This strategy was developed coming out of the financial crisis and specializes in providing capital to liquidity constrained investment vehicles and investors through recapitalizations and secondaries, for which there is typically high demand in periods of market dislocation. This real estate commingled fund is currently in market and off to a very strong start to fundraising. The fund had its first closing in our fiscal fourth quarter and has now closed on over $900 million.

Lastly, the recent instability of certain regional banks is accelerating a general retrenchment in bank lending and opening the door for private debt to further capture market share. We have a versatile private debt platform that sources deals across asset class and can invest in an array of debt classifications, from senior secured to more opportunistic non-performing assets. Private debt has proven to be a very valuable asset class for StepStone's clients, and we believe we are poised to benefit further from tailwinds in the market. Before turning the call over to Mike, I'm thrilled to announce the hiring of Joe Linhares as our Global Head of Business Development. Joe has 30 years of experience leading sales and distribution for several large financial service providers.

Joe's addition is reflective of the growth and maturation of StepStone's platform and is representative of the investments we continue to make to further scale our business. I'm excited to partner with Joe as we continue to expand. I'd now like to turn the call over to Mike McCabe to speak about the fundraising and fee earning asset development in more detail.

Mike McCabe (Head of Strategy)

Thanks, Scott. Turning to slide seven, we generated $16 billion of gross AUM inflows during the last 12 months, with $6 billion coming from our commingled funds and $10 billion coming from our managed accounts. Slide eight, shows our fee-earning AUM by structure and asset class. For the quarter, we grew fee-earning assets by roughly $2.5 billion, driven by contributions from managed accounts across asset classes and additional closes of our debut commingled infrastructure co-investment fund and our multi-strategy global venture capital fund. We also generated notable growth in our undeployed fee-earning capital, which increased from $14 billion to nearly $16 billion, driven by several new client wins, managed account re-ups, and closings related to our commingled real estate fund that Scott just mentioned. We anticipate activating fees on the fund near the end of this calendar year.

We continue to generate steady growth in our private wealth platform, which brought our aggregate fee earning AUM to over one and a half billion dollars at the end of the quarter. Our investment performance continues to be very strong, with SPRIM, our evergreen private markets fund for accredited investors, generating a 29% annualized return since inception. SPRING, our evergreen venture and growth equity fund, off to a very strong 21% return since its launch in November of 2022. We continue to generate steady monthly subscriptions of over $60 million in our private wealth platform, with contributions spread across distribution channels and products. Slide nine, shows the evolution of our management and advisory fees.

We generated a blended management fee rate of 54 basis points, which is higher than prior years due to a mix shift toward commingled funds from the contribution of our expanded venture capital platform. We produced over $4.30 per share in management and advisory fees over the last 12 months, representing an annual growth rate of 25% since 2018. Before turning the call over to Johnny, I am pleased to announce the declaration of our first supplemental dividend of $0.25 per share, which will be distributed in addition to the $0.20 per share normal quarterly dividend. This approach enables us to take advantage of our capital efficient business model by maximizing distributions to our shareholders in a transparent manner.

As a reminder, we plan to generally grow our base dividend in line with fee-related earnings, while our supplemental dividend will be driven by net realized performance related earnings, subject to any discretionary capital uses. Future dividends are, of course, subject to board approval. We are thrilled to be able to deploy a healthy total payout even during periods when the realizations environment is soft, and we expect our approach will allow shareholders to tangibly reap the benefits of more substantial carry monetization when the realization environment is stronger. Importantly, our net accrued performance fees currently stand at nearly $600 million, which serves as a backlog for future distributions. With that, I'll turn the call over to our CFO, Johnny Randel.

Johnny Randel (CFO)

Thank you, Mike. I'd like to turn your attention to slide 11 to speak to our financial highlights. For the quarter, we earned management and advisory fees of $133 million, up 18% from the prior year. The revenue increase is driven by growth in fee-earning AUM from commingled funds that were activated earlier in the year, as well as continued deployment and fundraising. We generated an FRE margin of 28% for the quarter, below last quarter's 33% margin and below the fiscal 2022 fourth quarter margin of 32%. As a reminder, the prior quarter's margin benefited from retroactive fees. The March 31st period tends to be our seasonally weakest margin quarter, driven primarily by annual salary adjustments and the associated payroll tax resets for U.S. staff, which go into effect on January 1 of each year.

For the full year, our FRE margin was 31%. This is a strong base upon which we anticipate we will expand over time. Continue to expect margins to migrate into the mid-30s over the long term as we balance profitability with sustainable growth. As we've commented in the past, the path may not be linear. Shifting to expenses, compensation was up sequentially, driven primarily by annual salary raises and modest increases in headcount. G&A also increased sequentially, driven by occupancy and professional fees. Gross realized performance and incentive fees were $20 million for the quarter, generally consistent with last quarter and reflective of a continued lower transaction and realization environment. We anticipate realized performance fees to remain muted in the near term.

Income attributable to non-controlling interests was $10 million, generally in line with the level of the last two quarters and is a fair baseline for your models moving forward. We expect NCI to generally grow in line with Fee Related Earnings. Our tax rate reflected in ANI was 22.3% for the quarter and for the full fiscal year. We anticipate reflecting that same 22.3% tax rate in fiscal 2024 based on the blended statutory tax rate derived from our expected state apportionment of income. Moving to Slide 12, adjusted revenue per share was up 1% relative to the prior fiscal year, which is the result of a 22% growth in management and advisory fees per share, offset by a 37% decrease in gross realized performance fees per share.

Speaking to the long term, we have grown adjusted revenue per share by 26% compounded annual rate since fiscal 2018. Shifting to our profitability on slide 13, we grew full year Fee Related Earnings per share by 19%. The increase was driven by growth in management and advisory fees. Looking over the longer term, we have generated an annual growth rate in Fee Related Earnings per share of 41% since fiscal 2018. Our year to date ANI per share is down relative to last year, driven by lower performance in incentive fees, but has increased at an annual rate to 28% over the long term period, driven by robust growth in both Fee Related Earnings and realized net performance fees.

Moving to the balance sheet on slide 14, gross accrued carry finished the quarter at approximately $1.2 billion, up 9% from the previous quarter, driven by underlying valuation increases for the period ended December 31st. As a reminder, our accrued carry balance is reported on a one quarter lag. Our own investment portfolio ended the quarter at $147 million. Unfunded commitment to our investment programs were $89 million as of quarter end. Our pool of performance fee eligible capital has grown to $63 billion. This capital is widely diversified across multiple vintage years and 180 programs. 60% of our unrealized carry is tied to programs with vintages of 2017 or earlier, which means that these programs are largely out of their investment periods and are in harvest mode.

59% of this unrealized carry is sourced from vehicles with deal-by-deal waterfalls, meaning realized carry may be payable at the time of investment exit. This concludes our prepared remarks. I'll now turn it back over to the operator to open the line for any questions.

Operator (participant)

Thank you. At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two, if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question comes from the line of Ken Worthington with JPMorgan. Please proceed with your question.

Ken Worthington (Senior Equity Research Analyst)

Hi, good afternoon. Thanks for taking the questions. I'd say two for me. Maybe first, retail continues to build at a pretty consistent dollar level from quarter to quarter. You know, $700 million went to $1 billion to $1.3 billion to $1.6 billion. Can you talk about the build out of distribution, including the more recent additions of Europe and Australia? While things probably appear to be quite, you know, stable on the surface, I'm sure there's puts and takes beneath the surface. How is distribution sort of seasoning and growing inside the U.S. versus these newer platforms internationally?

Jason Ment (President and Co-COO)

Thanks, Ken. Jason here. You know, totally fair characterization. There are puts and takes. Remember now we've got not only SPRIM, but also SPRING, and it's actually four different funds, U.S. and Lux for each of those. The flows have been, you know, broadly consistent quarter to quarter in aggregate. The distribution syndicate continues to grow. We're approved on over 150 platforms now globally. The team build out within the private wealth team has historically been almost entirely U.S. We are building out dedicated European coverage now with a few people on the ground. Outside of those two geographies, distribution has largely been driven by our institutional BD team that does have relationships in the local markets. In terms of the flows, I would say the U.S. continues to be stronger than rest of world.

I think that that's consistent across both SPRIM and SPRING, and that's really just driven by seasoning. The distribution efforts on both of the Lux platforms is just much more nascent, therefore we're continuing to build out that syndicate, and it just takes a bit once you're approved, to start seeing flows. The other thing to remember outside the U.S. relative to the U.S. market is that the number of super large players like you've got in the U.S., it's a bit more limited globally as a percentage of the platforms that are out there. Think of it more akin to the RIA and IBD-type flows rather than wire-type flows in the main.

Ken Worthington (Senior Equity Research Analyst)

Okay, perfect. That was wonderful. Then just on the... I guess continuing on the flow side. I believe you had seven or so funds in market this past quarter. Which of these funds actually did have closes in the March quarter, and what are the expectations in terms of closes, for June?

Scott Hart (CEO)

Sure. Thanks, thanks, Ken, for the question. This is Scott. We do continue to have a number of funds in market, that will continue to be the case. Maybe I'll just give you an update on all of those funds that are currently marketing, starting with the ones that had interim closings. Our multi strategy global venture capital fund held interim closings and currently stands, you know, around the $750 million mark today. We did mention during the prepared remarks that our real estate secondaries fund held a first close during the quarter and currently stands at just over $900 million of commitments. We held interim closings on our inaugural infrastructure co-investment fund, which now stands a bit shy of $500 million today.

There are others that continue to be in market, like our private equity secondaries fund, which stands at roughly $1.6 billion. We also, subsequent to quarter end, had a closing on our multi-strategy growth equity fund as well.

Ken Worthington (Senior Equity Research Analyst)

Perfect. Thank you so much.

Operator (participant)

Our next question comes from the line of Ben Budish with Barclays. Please proceed with your question.

Ben Budish (Senior Equity Analyst)

Hi there. Thanks for taking the question. you know, you mentioned that the margin tends to be lumpy and doesn't necessarily go up, you know, immediately over time. I'm just curious, any thoughts you can share on fiscal 2024 and what your top investment priorities for the year, if you can kind of share in advance of your investor day coming up?

Mike McCabe (Head of Strategy)

Sure. Thanks, Ben. This is Mike here. Our 31% FRE margin for the year was a very strong result and largely in line with the guidance we had provided throughout the year. You know, and when we look back at the trend, you know, since we took the company public in 2020, we've expanded margins by nearly 500 basis points. You know, specifically for the quarter, you know, as you mentioned, and as Scott and Johnny mentioned, you know, we saw some fluctuations. We did see a step up in compensation, as we've seen in the fourth quarter of prior years. G&A expenses were also up, particularly travel, as our teams are out there supporting existing clients and developing new relationships.

You know, lastly, you know, as Scott touched on this, the timing of fund closings, activations, you know, and capital deployment are a little bit tricky to predict. So, you know, we describe our margins as nonlinear in the past and currently on today's conversation. Which is why we don't really either look at or manage our business from a quarter-to-quarter basis. We look at margins, you know, really over the medium to long term.

Scott Hart (CEO)

In the past, you know, our guidance for margins has been, you know, in the mid-thirties over the medium to long term, and we don't see any reason to change that guidance. The priorities that we have as an organization really are to support, you know, the growth and profitability of the firm. Just to name a few, you know, as Jason mentioned, we're continuing to expand our retail franchise, you can expect us to continue to invest there. Developing products like SPRING, as well as developing new products for our institutional investors, like our infrastructure co-investment fund. You know, providing seed capital for these new launches and continuing to build out the team globally are really the priorities, you know, we're focusing on this year.

Ben Budish (Senior Equity Analyst)

All right. Great. That was really helpful. Just maybe following up on Ken's question before. I know, Scott, you gave a great overview of all the commingled funds in the market. Just any color you can share on what you're seeing on the SMA side. It looks like the last several quarters you kind of had, you know, increasing levels of contributions and maybe what does that look like over the next, say, 12 months?

Scott Hart (CEO)

Sure. Look, on the SMA side, I think we're seeing similar trends to what we're seeing in the commingled space. If I had to characterize it, I would say that the re-up conversations continue as planned and those re-ups have continued to take place at a high rate. I would say that new investor conversations. Look, they're taking time. And even if that is the period between initial approval and the ultimate signing of an account or getting to that initial approval, some of those new separate accounts are taking time, but they are happening. We're pleased to say that in the current quarter did have a combination of both re-ups and sizable new separate accounts that help drive that $5 billion of inflows, AUM inflows during the quarter.

As we look ahead, we continue to have a number of potential re-up conversations and very active conversations with new clients as well. Some of these are multi asset class in nature. Some are created by the combination with Greenspring Associates, where we're finding that our new and strength and venture capabilities, combined with our historic focus at StepStone on providing separate accounts, is proving to be quite valuable in this, in this environment. I think we'll see continued activity on the SMA front in the year ahead.

Ben Budish (Senior Equity Analyst)

Great. Thanks so much for taking the questions.

Operator (participant)

Our next question comes from the line of Mike Cyprys with Morgan Stanley. Please proceed with your question.

Speaker 8

Hey, good afternoon. This is Truman here standing in for Mike. Thanks for taking the question. I just wanted to circle back to the discussion about venture. When you talk to your LP, just curious what their attitude right now at this point in the cycle is towards VC. Is it something that they're looking to avoid or are they looking to stay invested? You know, any color you can share on that?

Scott Hart (CEO)

Yeah. I mean, and appreciate the question. It's one of the areas where it's probably a bit difficult to generalize because if you separate between the impact on existing portfolios and then look at the go forward investment opportunity, those are two very different questions. I think for those investors that were heavily allocated to the asset class over the last several years, there clearly have been, you know, markdowns and challenges in the portfolio. Those markdowns look very different if you compare late stage versus which has been most heavily impacted with early stage or growth equity. As you think about the go forward investment opportunity, I'd say there is growing excitement, for example, about the secondaries opportunity. Obviously we highlighted during the prepared remarks, the growth equity opportunity as well.

Now, in some cases, those are different categories of investors that we're now seeing look at the venture space. In some cases, they historically had trouble accessing venture, but in this case, are not heavily exposed to the asset class today. I think a lot of the conversations, and I know we've said this on prior quarter calls as well, you know, with investors, you hear the comment that, "Look, we've been thinking about starting an allocation or starting a venture program. We're more excited about doing that today in this valuation environment than we were a couple of years ago." Again, I often find myself having to distinguish between the impact on the existing portfolio versus the excitement around the go forward investment opportunity.

Speaker 8

Great. Thank you. If I could just follow up quickly. In terms of the opportunities on the secondary side, I wonder if you could help frame what that opportunity looks like. You know, any numbers you can put around that in terms of the, I guess, any step up in deal flow that you're seeing or step up in completions. I think you talked about the sort of rationalization of pricing, where folks are starting to look at this and say, "Well, hey, in this environment, maybe it's not such a bad deal as maybe it looked maybe six months ago.

Scott Hart (CEO)

Sure. I might expand. I'm assuming the question is specific to venture. I might also expand, just talk about the secondaries opportunity more broadly. In venture, look, what you have is over $1 trillion of unrealized net asset value across venture portfolios today. In many cases, there are embedded gains in those portfolios. Even if there's a need to sell at a discount, those investors can still lock in an overall gain on their original investment. I think that is one of the things that is leading to a greater willingness to sell today. That's largely in the LP secondary market, but you can imagine much like the trends we've talked about in the broader secondaries market around GP-led secondaries, around strip sale, et cetera, there are a number of different factors and types of transactions driving deal flow.

I do wanna make sure to highlight that, you know, and I know we have done on prior calls as well, our excitement around the secondaries opportunity, not only in venture but in the broader private equity space. Increasingly in real estate, where you heard us mention the first closing on our real estate secondaries fund, which we think is really tailor made for this type of environment with a strategy developed coming out of the financial crisis and led by a senior and experienced team that's getting great traction on that fundraise. In other parts of the market, including private credit and increasingly infrastructure as well, where you saw a significant amount of primary fundraising coming out of the financial crisis.

Now, you know, 10, 15 years on, you know, I think that is leading to an increase in potential secondary sales there as well. I think there's a number of factors driving the overall opportunity today.

Speaker 8

Excellent. Thank you so much for taking the questions.

Operator (participant)

We have reached the end of the question and answer session. I now turn the call back over to Scott Hart for closing remarks.

Scott Hart (CEO)

Well, great. Well, thanks everyone for joining the call today. Just as a reminder, we look forward to speaking with many of you during our investor day on June sixth. In the meantime, appreciate your interest in the StepStone story. Thanks, everyone.

Operator (participant)

This concludes today's conference, and you may disconnect your lines at this time. Thank you for your patience.