HOUSE_OVERSIGHT_025561.jpg

Morgan Stanley | RESEARCH
NORTH AMERICA INSIGHT

Why Should Fee-Related Earnings Re-Rate Higher?

We point to three approaches to thinking about how to value fee-related earnings and what the right multiple should be on this earnings stream. We believe that under a C-corporation structure with a broader potential investor base and ownership, this portion of the Alts earnings are most likely to re-rate significantly higher while there could be more variability in the multiple investors ascribe to performance fees. We currently believe the market is pricing in fee related earnings around 15x times, a discount to where these earnings could trade up to. As we explain in greater detail in the Appendix, we see ARES as a stock that is likely to convert, and as we take a look at the SOTP, we believe FRE for ARES has already seen significant expansion. We estimate the multiple on ARES FRE has already gone up from 15.0x to 18.4x.

Below we look at where multiples could trade for the broader group as a whole, but acknowledge that investors likely use different FRE multiples for companies to account for duration of assets, growth in AUM, franchise value etc. On average, our three approaches suggest a 23.4x multiple for fee related earnings. In our upside case we use a 22.5x multiple. These multiples are on 2018e fee related earnings as we are trying to evaluate where the stocks trade today, and where they could potentially trade to in the near term.

1) Premium to Traditionals Asset Managers

We see the historical average P/E multiple for traditional asset managers of 15.4x as a starting point for FRE multiples. The traditional asset manager business model earns management fees with a significantly smaller portion of revenues from performance fees relative to alternative asset managers.

We believe the Alts management fee earnings, however, command a premium multiple given several factors: A) faster organic growth, B) stickier long-term committed assets, C) fees paid on committed capital which limits downside risk to revenues, and D) more insulation from fee pressure.

Exhibit 11:
The average of our three approaches to FRE multiples suggests and FRE multiple of 23.4x
FRE Multiples Across Three Approaches
[Chart: Bar graph showing multiples]
Traditionals Method: 15.4x
C-Corp Alts: 26.0x
Bond Yield Cap Rate Average: 28.9x
Average: 23.4x
MSe Upside Case: 22.5x
Source: Company Data, Morgan Stanley Research estimates

Exhibit 12:
Traditional managers trade at a 15.4x FY2 P/E multiple with average net flows of just +1% during that time period
Covered Trad. AMs' FY2 P/E, and Annualized Flows
[Chart: Line and bar graph showing trends from 1Q08 to 4Q18E]
Note: 2Q15: Average FY2 P/E 13.8x below historical avg of 15.8x
Trailing 10Y: ~2.3% Avg. Annualized Organic Net Flows/BoP LT AuM
Source: Thomson Reuters, Company Data, Morgan Stanley Research

A) Faster net organic growth in fee-paying assets under management for Alts vs. slower growth rates at traditional asset managers. The Alts have outpaced organic growth rate of traditional asset mgrs over the past 4 years by nearly 700 bps, and we estimate 900bps of continued outperformance on average from 2018 through 2019. Organic growth has averaged 5% for the alts from the period 2014-17e, while the traditionals have seen net outflows and organic decay of -2%. Looking two years out, we see traditionals net inflows of 1% vs. alts on average at 10% driven by continued fundraising strength and fees turning on for existing funds that have already been raised.

MORGAN STANLEY RESEARCH
11
HOUSE_OVERSIGHT_025561