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Morgan Stanley | RESEARCH
NORTH AMERICA INSIGHT

What Is the Appropriate Multiple for
Performance Fees?

Investors have a wide dispersion of responses on what is the
appropriate multiple for performance fees. We believe that at cur-
rent share prices, the market is valuing fee-related earnings 15.0x.
This represents an 1.8x turn premium or +13% premium to current
traditional multiples on 2018e EPS of 13.2x. Using this as a starting
point, we see the market valuing performance fees at 7.5x on
average using a sum of the parts framework. If we assume C-corp
conversion with a higher 24% tax rate, and believe alts fee related
earnings can re-rate from 15x to 22.5x, then we see the market valuing
performance fees at just 6.1x on average today.

Where should performance fee-related earnings trade? Given
that carry earnings (performance fees) are cyclical and historically
volatile, we look to Goldman Sachs as a comp for this earnings
stream. On average since 2010 (post crisis) the FY2 price to earnings
multiple at GS has been 9.5x, with a standard deviation of 1.4x.
We see a range of multiples of +6.7x to +12.3x using two standard
deviations above and below the average. We see this as reasonable
starting point for valuing performance fees. The group average
implied future carry multiple of 7.5x is 1.4 standard deviations away
from GS FY2 P/E multiple. If alts convert, we believe this multiple
should be able to move upward but will likely remain at a steep dis-
count to the FRE multiple given the volatile nature of the perform-
ance fees. In our upside case scenario, we bake in two turns of
multiple expansion from current implied rate for each company. This
results in median performance fee multiple across the group of 8.5x,
about slightly less than one standard deviation from GS FY2 multiple
since dating back to 2010.

On a cash basis, the volatility of performance fee earnings (net
cash carry) for the alts on a TTM basis has been fairly similar to
the volatility of Goldman Sachs operating earnings. For
Goldman, we look at operating earnings both with and without
investment management revenues to isolate the more volatile busi-
nesses. The following bar graph looks at the standard deviation of
the year over year % change of the trailing twelve months earnings.
The alts average is 1.2 about double the volatility of GS (ex invest-
ment management) of 0.6. This suggests even further upside and
greater conviction in our multiples for performance fee multiples,
especially for those companies with less volatility (Carlyle and KKR).

Exhibit 24:
With a 24% tax rate on all earnings and a 22.5x FRE multiple, we
see future performance fees valued at and implied 6.1x multiple
on average.

[Table Header]
Implied Future Carry Multiple using a 15.0x FRE multiple
Implied Future Carry Multiple using a 22.5x FRE multiple

[Table Data]
APO 5.1x 2.0x
ARES 11.6x 8.4x
BX 9.5x 9.3x
CG 6.0x 7.1x
KKR 7.0x 5.4x
OAK 5.5x 4.5x
Avg. 7.5x 6.1x
Med. 6.5x 6.2x

Source: Company Data, Morgan Stanley Research
Note: We use a 18.4x multiple for ARES as the stock has already priced in much of the potential
value of C-corp conversion Note 2: Scenario using 15x FRE does not use fully taxed net accrued
carry and future carry while the scenario using a 22.5x FRE multiple assumes C-corp conversion
and full 24% effective tax rate on both net accrued carry and future carry earnings.

Exhibit 25:
Goldman sachs has historically traded at an average FY2 P/E of 9.5x
and a standard deviation of 1.4x
GS FY2 P/E Multiple
[Chart showing volatility from Jan-10 to Jan-18]
Source: Thomson Reuters, Company Data, Morgan Stanley research
Note: Data includes daily FY2 P/E ratios to calculate standard deviation of P/E ratios using data begin-
ning January 2010

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