StepStone Group Appears Positioned For Private Fund Market Opportunities (NASDAQ:STEP)

Overview of StepStone Group

Step Stone Group Co., Ltd. (Nasdaq: Step) provides custom investment solutions to clients interested in private market asset exposure.

I previously wrote about Stepstone with a buying outlook ahead of the US Federal Reserve’s record rate hike In 2022 and 2023.

Leading economic data point to at least a mild recession in the next few quarters, and rate hikes may be coming to an end.

If so, STEP is a buy, but for now I’m neutral [Hold] I will stick with stocks until I see a change in fundamentals.

Overview of StepStone Group

Based in New York, NY, StepStone Group Inc. was formed to develop private market asset expertise and provide customized portfolio construction advisory services to clients worldwide.

The management team is led by co-founder and CEO Scott Hart, who has been with the company since 2007 and previously served as president and director. Associate at private equity firm TPG Capital and analyst at Morgan Stanley.

The company counts a variety of corporate and family offices as clients, as shown in the chart breakdown of 2020 IPO filings below.

The company’s main products include:

• StepStone Private Market Intelligence

• Omni database

• Multi-Asset Class Expertise – Private Equity, Infrastructure, Private Debt, Real Estate.

The company operates in nearly every major region of the world, with most of its AUM/AUA coming from the Americas region, as shown in the chart below.

The company seeks out new institutional and individual clients through its direct business development and marketing approach and through its fund distributors.

With the majority of the company’s AUM/AUA coming from outside the Americas, the management team has offices in Dublin, Hong Kong, Lima, London, Rome, São Paulo, Seoul, Tokyo, Toronto and Zurich.

market and competition

Based on 2022 market investigation report The global market for wealth management services is estimated at $255 billion in 2021 and is projected to reach $509 billion by 2030, according to Bain & Company.

This equates to a projected CAGR of 8% from 2023 to 2030.

The main drivers of this projected growth are the rising retiree population, the rising wealth of the HNWIs and the growing demand for alternative investments that offer decent yield opportunities.

Other aspects that could negatively impact the wealth management industry include the continued restraint effect of the COVID-19 pandemic, the rise of fintech companies looking to automate their services, and the increased use of passage investment techniques.

Rising global wealth will drive demand for services, with “an estimated 250 million Gen Y and Z customers (born between 1981 and 2012) earning more than $100,000 annually by 2030.”

The majority of these new customers will come from the Americas and Asia Pacific regions, with 110 million in the Americas and 90 million in Asia Pacific.

Younger customers will demand more sophistication from digital channels and prefer hybrid engagement models that combine digital and human interaction for greater decision making.

StepStone’s recent financial developments

• Quarterly total revenue bottomed out in 2022 and has recently rebounded significantly. Quarterly operating profit has also increased significantly recently.

• Quarterly gross profit margins are trending downward. Selling, general and administrative expenses are a low percentage of total quarterly revenue.

• Diluted earnings per share returned to positive results in the most recent quarter.

(All data in the chart above is GAAP.)

As the chart below shows, over the past 12 months, STEP’s share price has risen only 11.27%, while Apollo Global’s share price has risen 48.75%.

On the balance sheet, the company ended the quarter with cash and equivalents of $128.6 million and total debt of $98.4 million, neither of which were classified as part of the one-year portion that is due within 12 months.

Over the next 12 months, free cash flow was a staggering $145.6 million, during which capital expenditures were $5.6 million. The company paid out $24.9 million in stock-based compensation (“SBC”) in the last four quarters, the highest amount in 12 months in the last 11 quarters.

StepStone ratings and other metrics

Below is a table of the company’s relevant capital totals and valuations.

measurement [TTM]	amount
Enterprise value/Sales [FWD]	4.2
Enterprise value / EBITDA [FWD]	10.6
revenue growth rate [FWD]	10.6%
Net profit margin	new mexico
EBITDA%	new mexico
Net Debt vs Annual EBITDA	-0.5
market capitalization	$3.08 billion
Corporate value	$2.71 billion
operating cash flow	$151.18 million
Earnings per share (fully diluted)	-$0.33

click to enlarge

(Source – Seeking Alpha.)

Commentary on step stones

In its previous earnings call (source – Seeking Alpha), which covered its fourth quarter 2023 results, management emphasized the company’s challenging operating environment, but said fee-related assets under management increased. [AUM] It was up 14%, bringing total assets under management to $5 billion in the quarter.

Executives also noted that the company’s diverse platforms are “designed to grow throughout market cycles.”

The company faces short-term headwinds as the cost of capital continues to rise due to negative pressure on valuations, but management sees structural tailwinds for growth opportunities in the private markets “well into the future.”

In particular, the failure of Silicon Valley Bank had a limited impact on the company’s venture capital activities.

Total revenue decreased 52.7% year-over-year in Q4 2023, while gross margin increased 26.9% for the same period.

Selling, general and administrative expenses as a percentage of sales increased by 15.6 percentage points year-on-year, and operating income decreased by 35.5% year-on-year.

The company is in good financial standing, with ample liquidity, long-term debt, and significant free cash flow.

Looking ahead, management sees strong demand for VC secondary funds, which is not uncommon in times of stress.

Moreover, recent cautionary cuts in lending by banks have opened up opportunities for the company in the private bond market.

From management’s most recent earnings call, we have created a graph showing the frequency of key terms mentioned (or not mentioned) in that report, as shown below.

What interests me most is the frequency of potentially negative terms, so the question for management and analysts is “challenges.”[es][ing]”” 3 times, “macro” 2 times, “drop” 1 time, “volatility”[e][ity]” one time.

Potential upside for stocks could include less rate hikes as the macroeconomic environment calls for a more stable interest rate regime.

I’m in the camp of believing that interest rates will reach a terminal state in the near future as leading economic data continue to point to a mild recession ahead.

If so, companies like StepStone Group may stand to benefit from increased demand for non-bank funding.

I’m still neutral [Hold] For the stock of StepStone Group Inc. in the short term. Stocks could be ready to buy if interest rates pause.