HPS Investment Partners Confidentially Files for IPO

Originally published in the December 3rd edition of Transacted.

HPS submitted its registration to the SEC more than a year ago, but had postponed its listing in response to equity capital markets softness. The firm is now revisiting those plans, hiring Goldman Sachs and JP Morgan to advise on a potential listing that could value HPS at more than $8 billion.

With assets under management of more than $100 billion, HPS is set to join publicly traded peers Ares Management Corp. and Blue Owl Capital Inc., both of which have enjoyed strong market performance this year.

Ares is up 64 percent year-to-date, and, with a longer public track record, boasts an industry-leading valuation. Blue Owl’s year has been somewhat choppier, though the firm is still up around 35 percent despite well-publicized recent management turmoil. Both report continued growth in both direct lending origination and fundraising.

HPS, however, thinks it has a competitive edge over Ares, Blue Owl, and the broader private credit competitive set. Its marketing materials point to deeper expertise in distressed situations, a willingness to enter into more esoteric deals, the capital to take down the largest opportunities, and the non-sponsor capability to open up exposure to a much less competitive corner of the market.

It’s an edge that even the competition acknowledges, at least according to HPS Managing Director Scot French: “Our competitors refer to us as the nerds of private credit, and we take no offense.”

The Founding Story

In 2007, a year before Lehman Brothers’ collapse, founder Scott Kapnick decamped from his former role as co-head of global investment banking at Goldman Sachs to build out a new strategy at JP Morgan: HPS (the acronym stands for Highbridge Principal Strategies) was launched as a division of Highbridge, JP Morgan Asset Management’s hedge fund business.

At Goldman, Kapnick had held a front-row seat to the rapid growth of the firm’s mezzanine strategy. One of private credit’s earliest iterations, the group invested outside capital, rather than invest off the firm’s own balance sheet.

Sensing a broader trend, Kapnick sought to replicate Goldman’s success elsewhere. At the time, JP Morgan had no presence in the space and reached an agreement with Kapnick that allowed him to build out a competing franchise under the Highbridge umbrella.

Moving Out

In the aftermath of the financial crisis, banks’ in-house investment units found themselves squarely in regulators’ crosshairs. While HPS’ approach was never expressly outlawed under the Volcker rule, which primarily concerned proprietary balance sheet trading, the activities nevertheless drew unwanted scrutiny.

Along with broader uncertainty for traditional financial institutions, HPS’ position within JP Morgan had become more precarious than expected. In an interview with Bloomberg, Kapnick recalls the changing relationship:

By 2016, Kapnick and his senior team reached an agreement to spin out their business from JP Morgan and its Highbridge unit. Putting up $100 million of their own cash, along with $300 million of debt financing from Bank of America, the management group bought out HPS in a deal that valued the firm at around $1 billion. JP Morgan retained a minority stake, which it’s since sold down to Dyal Capital and Guardian Life.

Checking In on the Golden Age

Near-daily golden age proclamations give the impression that we may be nearing peak private credit. But, rather than try to temper sentiment, Kapnick is in full agreement. “You’re seeing the rebuilding of Western capital markets beyond the banking system,” the HPS CEO told Bloomberg.

HPS points to a set of market conditions that, along with a general maturation of the asset class, provide a unique set of potential tailwinds:

• Reduced bank lending hands direct lenders an opening to continue to take share. At the same time, private credit’s speed and certainty of execution can often be more important in deals than even pricing.

• Wider credit spreads and higher base rates should offer relatively greater returns over the near term, particularly attractive to limited partners accustomed to a decade of bottomed-out interest rates.

• An upcoming 2024 maturity wall with today’s higher rate environment means refinancings will be more complex than they have been historically. That’s a benefit to direct lenders who can offer borrowers the flexibility to structure more unique financings. “[Borrowers] need to find some solution to get their capital structures amended and extended. They’ll possibly need common equity or a more bespoke piece that a firm such as HPS can offer,” says French.

Private credit’s ascendancy may not continue unchecked, however. Attempting to offset the loss of meaningful leveraged loan fees, banks have begun launching their own private credit strategies.

Earlier this month, Nomura announced a $1 billion direct lending fund, which was followed up by news that Citigroup is planning to launch its own offering by January 2024, potentially in partnership with another firm to provide outside capital for Citi-originated deals. Wells Fargo, Barclays, and Société Générale have all made similar moves this year.

A flurry of bank activity, but still a drop in the bucket compared to what Preqin pegs at a $1.6 trillion private credit market, led by established lenders like the aforementioned HPS, Ares, and Blue Owl trio, along with the private credit arms of firms like Blackstone, Apollo, and KKR.

However, banks aren’t the only group trying to barge their way into the market. Traditional asset managers have completed a number of recent deals in the space as they try to secure a foothold of their own — at least 26 asset managers have bought or launched new private credit units in the past two years.

Highlights include T. Rowe Price’s $4.2 billion deal for Oak Hill, Man Group’s purchase of a majority stake in Varagon Capital, and BlackRock’s acquisition of Kreos Capital.

The jump in activity and fundraising has led to increasing concern over just how much dry powder is stacking up within private credit. The growing volume of lenders, including traditional bank-led leveraged loan offerings, could simply compete away the excess risk-adjusted returns HPS and its peers are counting on.

In a downside scenario, managers who must put capital to work within a defined fund lifecycle will chase lower-quality deals with lighter documentation, leaving them exposed should borrower defaults tick up.

There’s also likely more capital on the way — more than 63 percent of allocators indicate they intend to increase their private credit exposure from current levels, per a Wolfe Research survey.

But, absent a major credit event, the party may just continue for a while longer, particularly with what many hope is a meaningful uptick in M&A activity heading into 2024. At the very least, HPS should receive a warm welcome from prospective shareholders.