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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.Ox. 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@ee 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 14x. 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 acash 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. Implied Future Carry Multiple Implied Future Carry Multiple using a 22.5x FRE multiple using a 15.0x FRE multiple 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 14.0x 13.0x ON NS 11.0% eee ae Ee 10.0x 9.0x 8.0x ee a 7.0x 6.0x 5.0x_ ; 1 ; 1 Jan-10 Jan-12 Jan-14 Jan-16 Source: Thomson Reuters, Company Data , Morgan Stanley research +2 St. Dev 12.3x j----| -1 St. Dev 10.9x wenn Avg 9.5x ann nen ne en nnn nnn -1 St. Dev 8.1x SSS ea ae nue nee eee I eEeeeeeee -2 St. Dev 6.7x Jan-18 Note.: Data includes daily FY2 P/E ratios to calculate standard deviation of P/E ratios using data begin- ning January 2010 HOUSE_OVERSIGHT_025566