Morgan Stanley | RESEARCH

Morgan Stanley | RESEARCH For Ares, we believe conversion makes sense, given the company is largely a play on fee related earnings from draw down funds, separately managed accounts, and their relationship with ARCC, the publicly traded business development company. Earnings from per- formance fees at ARES are a smaller portion of overall profitability, which is furthered by relatively higher compensation payout on per- formance fee revenues, which in turn approach 80% in strategies such as private equity vs. peers typically in the 45-55% range. The company could benefit as a first mover and if the stock price reacts favorably, we could see other alternative peers follow suit. Apollo in our view may stand to benefit the most from conver- sion with the best risk reward skew in our analysis using a SOTP framework. Why? Similar to ARES, the company has meaningful fee-related earnings as a percentage of overall operating income. This is largely driven by their advisory relationship with Athene, where APO earns a fee on ~$74b of assets and should benefit from additional management fees from the company©most recent $24b flagship private equity fund. Our deep dive suggests Apollo has relatively longer-duration stickier assets under management vs. peers, which gives us greater confidence in APO® fee-related earnings stability, growth, and potential for a re-rating. ApolloOAUM has a 12-year duration on average (measured as outflows and realizations as a per- centage of beginning of period AUM). This is noticeably better than HLNE@at 9.1 years, which trades at 23.4x P/E, and below Partners Group of 16.7 years, which trades at 28x P/E. We see Blackstone as potentially less likely to convert, but see amore nuanced story at KKR given their token dividend policy; for both we do not see as much valuation upside from are-rating of FRE multiples. BX and KKR have larger concentration to perform- ance fees and as a result we see less of an impact to potential upside should fee related earnings multiples re-rate. Our estimated tax rates for KKR and BX are also significantly Lower than the group given the earnings mix and other offsets. We see a greater downside to current share prices if there was a conversion that had a higher tax drag and multiples did not expand. That said, KKR has a history of making major changes, such as its payout policy change in 2015 that sharply reduced the dividend with a shift in strategy to grow book value. At the time we thought such a change by KKR was a prelude NORTH AMERICA INSIGHT ~~ i. od to converting to a C-corp, as we wrote here. However, the stock has lagged and KKR@limited/token dividend means investors do not receive the full benefit of a flow through partnership structure with single-layer taxation. So we again raise the question, Why not convert to a C-corp with a token dividend that is effectively single layer taxation? C-corp Conversion Could Be the Catalyst to Unlock Value and Drive Multiple Expansion The alternative asset managers trade at a steep discount to broader financial peers. We believe this is largely due to 4 factors: 1) volatility of the earnings (particulary performance fees) and ques- tions as to alpha persistency going forward by public market inves- tors, 2) complicated business models, 3) corporate governance concerns, and 4) corporate structure as a partnership. We do not expect to see the first three factors change, but conversion could make a meaningful difference by: 1) Expanding the universe of eligible investors in the Alts, 2) Alleviating the tax complexities of current K-1 tax reporting, 3) Unlocking value via multiple re-rating, particularly for manage- ment fee-related earnings in the widely used sum-of-the-parts valua- tion for Alts. We could also see incremental upside to current valuations if multiples on performance fee earnings adjust upward (more details below). Exhibit 3: Alts trade on average FY2 of 10.5x, a 28% discount on average to other financials subsectors Alts vs. Financial Subsectors P/E m2018P/E Alts % Discount/Premium (RHS) 30.0x x ; 10% 25.0x 7% ee , 0% 22.1x : | tii ‘Oxi an 7 + : | 0% = I Thr ee -30% : LULU anes 5.0x -50% 0.0x -60% A Pee, Mon, ie, A usin ‘ay, Pho aa Fas par. com Mio, Sung, "ati, Cony a0, One, Se dng, 0 ps “ss Sen ans — ng Pani ong era 4, 8, wang eo “range Meg hy Source: Company Documents, Rowen Stanley Data Note: P/E multiples for other financials subsectors aside from brokers and asset managers are based on Morgan Stanley Estimates as of 1/18/2017 HOUSE_OVERSIGHT_025556