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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 per- formance 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 asa 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 dif- ferent 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 tradi- tional asset manager business model earns management fees with a significantly smaller portion of revenues from performance fees rela- tive to alternative asset managers. We believe the AltsGmanagement fee earnings, however, com- mand a premium multiple given several factors: A) faster organic growth, B) stickier Long-term committed assets, C) fees paid on com- mitted 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 35.0x 28.9x 30.0x 26.0x 25.0x 23.4x 20.0% 45 4x 15.0x 10.0x 5.0x 0.0x Traditionals C-Corp Alts Bond Yield Average | MSe Upside Method Cap Rate Case Average 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 mmm Covered Trad. FY2 Avg. P/E Historical Multiple 05'-17' ~~=Median Ann. - Quarterly LT Net Flows/BoP LT AuM (%) 25.0X 7 Tralting 10Y:~2.3% Avg. Annualized 15.0% Organic Net Flows/BoP LT AuM 2Q15: Average FY2 PIE 13.8x below historical avg of 15.8x 10.0% 20.0x 4 ~ | . f \ ih. 5.0% a Vf | AAT LARAA 15.4x 15.0x 4 i 7 = “VJ ? OOF—=EL Oa pros j * A f{™ Al | Tied ; 5.0% 10.0x ERE / .0% i} | 10.0% 5.0x 15.0% 0.0x 4 -20.0% 2a 8s SSSSCODGDGGGDGGGGGGGGGDGGGGGGGGGGGGGCGGr eer AOTHADTHASTHAATHASTHABTHANHTHABTANBGIGGG Q Source: Thomson Reuters, Company Data, Morgan Stanley Research A) Faster net organic growth in fee-paying assets under manage- ment for Alts vs. slower growth rates at traditional asset man- agers. 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 fun- draising strength and fees turning on for existing funds that have already been raised. HOUSE_OVERSIGHT_025561