Morgan Stanley | RESEARCH
tively adjust upward our multiple on future carried interest earnings by 2 turns. For Apollo, we see that nearly the entire the increase in value in the upside case is driven by the expansion of the FRE multiple from 15x to 22.5x.
2018 Impact: Upside case impact is +13% vs. current price on average and 3.8x multiple expansion to a fully taxed EPS. In our upside case scenario, we assume a 22.5x multiple on fee-related earn- ings in our SOTP. We see favorable risk/reward skew APO.
Exhibit 7: We see the greatest contribution of fee-related earnings at ARES and
APO as a percentage of pre-tax earnings 2018e Pre-Tax Earnings Contribution
ulnvestment Income = Performance Fees
100% 90% 80% 70% 60% 50% 40% 30% 20% 10%
0%
mCore Fee Related Earnings
29%
399
ARES APO
BX OAK KKR Source: Company Documents, Morgan Stanley Research estimates Note; Fee Related earnings are on MSe Core methodology, ARES Core FRE include BDC Part 1 Manage- ment fees that are typically excluded from MSe Core FRE definition
CG Avg.
NORTH AMERICA INSIGHT ~~
Downside case impact assumes no multiple expansion of any kind, and that the stocks trade at their same current P/E, however on lower, fully taxed EPS. This represents -18% average downside from current prices. While this is likely an unreasonable outcome this is the concern among some investors, given that the only certainty in the analysis is a higher tax drag and lower earnings. We see less favor- able upside/downside skew for BX and KKR.
Exhibit 8: On average we see potential for 3.7x turns of multiple expansion on in our upside case with fully taxed EPS at a 24% effective rate. This could drive +12% upside on average to current share prices P/E Multiples for Alts: Potential Expansion =Total Multiple Expansion in C-Corp Upside Scenario (on fuly taxed EPS @ 24%) = Current Multiple on 2018e EPS
22.0x ~49.0x 167 15.4x 1x
17.0x 14.7x Ate 12.5x 40x 14.6x
12.0x aa 9.8x
7K 11.3x
2.0x
-3.0x
% Upside ARES APO BX OAK KKR CG_ Avg
toStork 99% = 26.5% 9.3% 11.3% 10.7% 7.5% 12.4%
Source: Company Data, Morgan Stanley Research estimates
Exhibit 9: Summary Scenario Analysis: Potential upside/downside valuation and multiples impact if Alts convert to C-corp structure and pay a full 24% tax rate Upside Case Assumptions: 1) Fully taxed earnings and carry receivable Downside Case Assumptions: 1) Fully taxed earnings and carry receivable balance 2) 22.5x Multiple on core FRE 3) Multiple expansion on carry of two balance 2) 15.0x Multiple on Core FRE 3) No P/E multiple expansion on fully turns to an average of 9.5x 2018-20 avg. performance fee earnings taxed EPS 4) Back into implied multiple on future carry of 5.6x on avg. i si 9, i js . ba A 9, . < ; Current Valuation (C Valuation Price/Fully A Current P/E vs. % Upside Price Valuation (C ; Valuation AGurrent PIE vs. % Downside Price Ticker Price Corp Taxed EPS wi 24% Taxed Change From Corp Price/Fully Taxed wi 24% Taxed EPS Change From Conversion) EPS Current Conversion) EPS ° Current APO $36.42 $46.07 14.6x 4.7x 26.5% $31.20 9.9x 0.0x -14.3% ARES $24.70 $27.18 19.1x 4.8x 10.0% $17.95 12.6x -1.7x -27.3% BX $36.78 $40.18 15.4x 4.1x 9.3% $29.51 11.3% 0.0x -19.8% cG $25.60 $27.52 9.8x 1.4x 75% $23.62 8.5x 0.0x -7.7% KKR $24.40 $27.01 12. 5x 3.6x 10.7% $19.21 8.9x 0.0x -21.3% OAK $45.20 $50.31 16.7x 4.0x 11.3% $38.39 12. 7x 0.0x -15.1% Average 14.7x 3.8x 12.6% 10.7x -0.3x -17.6% Median 15.0x 4.0x 10.4% 10.6x 0.0x 17.4%
Source: Company Data, Thomson Reuters, Morgan Stanley Research estimates. Note: Price as of 1/26/2017
HOUSE_OVERSIGHT_025559