Ares Management Corporation (ARES) Earnings Call Transcript & Summary

Good afternoon, everyone. Let's get started. This is Craig Siegenthaler from Crédit Suisse, and it's my pleasure to introduce Michael Arougheti from Ares Management. Michael is a co-founder of Ares and also the firm's CEO, President and a Director. We also have Ares' CFO, Michael McFerran, joining us too. Guys, thank you so much for joining us.

Thanks for having us. Excited to be here.

Great.

So just a quick background before we start. Ares is one of the largest alt managers in the world with $180 billion of AUM and over a 1,400 employees. They're best known for their industry-leading global private credit business and their leading public traded BDC Ares Capital. The firm is headquartered in L.A., but has offices that span the globe, including in Europe and Asia. Okay. Let's begin the fireside.

And let's start with your U.S. direct origination business, which is the largest in North America. What do you view as your competitive strengths? And what is your plan to keep growing this business?

Sure. So I'm going to take a step back and maybe give a global perspective before I drill down on the U.S. And I think you're hitting on something very important in alternatives, which is the real key to value creation, over time, and sustainable growth starts with building deep origination networks in local markets. And the reason for that is a couple fold. One, when you build deep relationships in the local market, you see more deal flow. And as a result, you can be more selective. So what we've noticed over time, the broader we build our origination teams and engines, the more selective we can be in combing through our pipeline. And through that selectivity, we think that we drive better investment performance. Two, what it allows you to do is, in building those relationships, control more of those assets and company relationships for longer. And as I'll get to in a minute, what that does is it extends the life of those relationships and you monetize them over a long period of time, and it allows you to grade investment product off of that relationship and meet the needs of the investors. So it's a great place to jump off because so much of the value proposition to the client, whether they are investors or investees starts with that origination. And I think we were early in the understanding of that. A lot of folks in the alternative asset management business started in private equity and really weren't about building these broad-based local networks or were coming at it from the leverage finance side, and were probably more used to thinking about towards -- from desks and banks. The folks that started our private credit businesses were really coming out of banks and knew just how valuable it was to develop that relationship network. So going back to the start of our U.S. direct lending business in 2004, started off with a very large commitment to building offices around the country to drive that origination advantage. And so where the business stands today, we have about 150 investment professionals just in that core direct lending origination effort and probably another 50 in our alternative credit and asset-based lending business. And what that allowed us to do is build a very deep track record of investments. So we've put out well over $75 billion in 1,000 transactions, since we founded the business. We probably transacted with over 500 private equity firms, many of them multiple times. And we actively cover probably 650 of them. So through that origination, you build scale, and then you get into this really, really virtuous cycle of scale, creating the ability to invest in origination, creating outperformance, creating your ability to raise more capital and so on and so forth. And so what we have seen is, as we've invested in origination and we surround that origination with a broader product set, we're capturing more share, and we're capturing it in unique ways. And in our more mature businesses like U.S. direct lending now, the value of that incumbency is significant. 50% plus of the deployment that comes in that business today is from existing relationship. So I'm glad you started here, because I do think, and I'm very proud of what the team has built in the U.S., but we've taken that playbook and we've exported it, not just into other parts of the world like Europe and Asia, where we've built pan-European and pan-Asian office and origination footprint, but we've done it in other product sets as well. So what we learned in the early days on the corporate side, we've been able to export into our real estate lending business. We've been able to export into alternative credit business. And then you start to get synergies across the different product types in the local markets as well, and there's an amplification effect. So it's -- there's a really big competitive advantage there on the origination front, and I think that's been one of the big value drivers here for us.

Michael, I'm glad you brought up Europe there because you do have a very large business in Europe. Your -- I mean, how do you look at the European business environment? And how is it different than the U.S. in terms of competition, maturity, how you interact with clients?

Yes. So Europe, I mean, maybe stating the IMS. Europe is a collection of countries with different cultures and different bank regimes, different regulatory framework. So if you really want to succeed in Europe in the private markets, you have to be pan-European. Also in order to attach to the local market and the cultural nuances, but also to understand the structural requirements of those markets. So similar to what I just described in how we thought about building the U.S., as we built out our European capability, we focused on building out that pan-European footprint. So now we've got people in London, Stockholm, Frankfurt, Paris, Madrid, Amsterdam, and that allows us again to source locally, whereas I think a lot of folks focus on London or at least historically focused on London and expected the flow to come to them. I think that's fundamentally a different approach. Because Europe is so dispersed, obviously, the different countries are experiencing different pace of recovery and there's different competitive dynamics in each of those markets. So without coming into that, I'll make a general statement, which is the European private markets are less evolved than the U.S. markets, for sure. That's a combination of historical bank positioning. It's also a function that there are still a lot of SMEs, middle market companies, in each of these jurisdictions. So the size of the opportunity is probably more fragmented, and it's just taken a while for the capital formation and the investment infrastructure to catch up with that, but it's accelerated. So to put that in perspective, when we started our private credit business in Europe in 2006, 2007, the idea of a scaled non-bank or institutional lender taking share from the bank was unfamiliar. Culturally, sponsors and companies were not accustomed to borrowing outside of the banking system. Post the GFC, everything changed. And the combination of banks derisking, banks pulling back into their local markets, banks pulling back on liquidity really opened up those markets in a way that allowed us to accelerate. And I think a lot of our peers felt that post-GFC, the bank derisking would create a massive asset transfer in the secondary market and form capital around big NPL opportunities. We did that as well, but what we experienced was what really did was create a gaping hole in the primary market for self-originated credit as the banks were effectively frozen. So if you look at what we've been able to accomplish there, similarly, we've built out a 65 person front-facing origination and investment capability across the region. And we have scaled that to be a very sizable business, culminating in -- I think you saw, Craig, our fundraise for our fifth flagship fund in Europe that is approaching an EUR 11 billion fluid capital, which I think is indicative of how significant the opportunity set there is. So Europe, less evolved, less mature. I think that means that we probably have more opportunity to exploit country-specific and market-specific opportunities there. And our expectation is it will continue to evolve along the lines that the U.S. market has, but we're not quite there yet.

So we know direct lending is your biggest business in Europe. But if you look at the other businesses that you have, remind us what you're doing, the growth trajectory? And then what are the major product gaps today in Europe? Maybe you could look to fill?

Yes, I'm glad you asked it. So our European private credit business is, by far, our largest, but all of our capabilities reside in Europe now for the most part. And one of the ways that we think about growth is we extend into new geographies and product adjacencies off of some of our big core competencies. So if you take direct lending, build a big capability and strategic road map on how to run these businesses at scale, export it to Europe, build a big playbook around commercial real estate lending in the U.S., export it to Europe. And so a lot of what we're doing in Europe now that we have such significant presence across the region and assets under management is we're slotting in product that we're quite good at in other parts of the world into the European market. So we're scaling our private equity teams. We are scaling our opportunistic credit teams. We're scaling our alternative credit teams. But we're doing it from a position of strength and deep relationship in the local market. Our second biggest business in Europe, and people probably don't appreciate this, is real estate, real estate equity. And Ares is probably one of the longest tenured, I think, one of the better performing European private equity businesses. And we have the full spectrum of capability there and a 20-year track record of investment. That's positioned us again, pan-European, to start to feed other product into those teams and continue to grow. So we're bullish on the opportunity for Europe, given what we've accomplished there so far.

So let's move on to Asia. We all know you made an acquisition in Asia recently. I wanted to see if you could provide us an update on what exactly are you doing in Asia? And what are the product holes and the geographic holes? And how could you look to fill that?

Sure. I like that where you're taking me because what you're going to see is a picture emerge of this geographic expansion Eastward from L.A. to New York to London to now into Asia. And the reason for that is we're following the development and maturation of these markets. And really in order for us to build the businesses that we're used to building, we need to see a lot of things line up, right? We need supportive capital markets, supportive regulatory regimes. We need supportive investors. We need to be able to find the talent to execute, et cetera, et cetera. Asia, for us, is a big focus of growth. Number one, because of its current, but expected contribution to global GDP and two, to its current and future contribution to alternative asset allocation. So we've been in Asia for over 10 years, largely on the growth equity side. We had a view that as these markets are developing, that we needed to be bigger and we needed to be more diversified, both by geography and by product in Asia. And that's what led us to make the acquisition of SSG in July. And it is going as well as we could have expected, if not better, in terms of the cultural fit, the quality of the integration, the deployment and the performance there. So while it's still early into that partnership, it's going about as well as we could have hoped. Similar to Europe, we talk about Asia as a thing, but it's really a collection of countries each in different phases of development. And what attracted us to SSG and what we're leveraging there is we have on-the-ground capabilities in China, India, Hong Kong, Indonesia, Australia so on and so forth. That footprint, going back to the earlier comments, sets us up in those local markets to build relationships and feed product and create investment product for our investors. So we are leading right now with private credit with an emphasis on distress. Sometimes it's better to be lucky than good, but to buy a distressed credit platform going into a global pandemic, that served us well. And so the returns in 2020 will set us up, I think, for some pretty healthy fundraising in that strategy later this year. But we're now helping to take that private credit capability, move it into some of the more developed markets like Australia and New Zealand, but then also unpack some of the historical capability in places like real estate lending and infrastructure lending and broaden out the product set. So the core business is performing exactly as we hoped it would, and our opportunity to broaden the set is already accelerating. But you have to take a long-term view there, obviously. That's a developing market. The private markets are not nearly as evolved there as they are in the U.S. and Europe, but we feel that our timing is right to try to develop a leadership position there, the same way that we have in the U.S. and Europe.

Great. Let's move on to investment. So maybe remind us how much dry powder you hold today. And then I know you get this a lot, and I'm pretty sure I know the answer, but are you worried about deployment with that dry powder and with existing funds that are raising, just given where valuations are today across -- especially public markets?

So we have about a $56 billion of dry powder, which may seem like a lot to you. But if you look at the evolution of the company, you'll generally see that we run with roughly 25% to 30% of our total AUM uninvested. And that's, both, by design in terms of trying to capture multiple vintages and pace our deployment, but it's also a structural based on when we start raising new capital in a fund series or a strategy relative to the prior fund. So regardless of when you took the snapshot, you would see that. And I think that's important because it's not as though the growth of the dry powder is outpacing the growth of the platform. Two, what we've historically said is we would expect to execute on that dry powder, usually in a 2-ish year time frame. And sitting on the $56 billion, last year, we put out an excess of $20 billion and so the prior year. And being able to deploy as well as we did last year gives us confidence that, that's the right amount of dry powder, and we have the right balance and tension between uninvested and the available market opportunity. Look, the valuation environment is high. Obviously, you have to separate, as you mentioned, the public markets from the private markets. The public markets, both debt and equity, are not the real economy. And so while we are seeing the impact of low rates and lots of liquidity, impacting both valuations and returns in the private market not nearly to the same extent as we see in the public markets. But one of the ways that we participate in that type of an environment where the public markets are signaling something different than the privates is we lean into the public markets to monetize portfolios. And we lean into the debt markets to better finance and create ROE and arbitrage in our debt books. So not surprisingly, you've seen us accelerate monetization of our PE portfolio into the public market with a lot of success over the last 18 months. You've seen us accessing the CLO market in our commercial real estate business that had an incredibly well-structured terms and pricing. You're seeing us active in the capital markets on the BDC that you referenced earlier. So there is a put and a take in terms of what it means when you see high valuations, but what it also means, you can do to structure performance returns for your investors. I think it's also just a basic reflection of the fact that the risk-free rate is low, it's 0. So you, through that lens, even if it's detached from what we all were used to thinking about forward earnings, it makes sense. And so we have to keep that in mind when we're thinking about it and when we're thinking about the excess return that we're able to generate, it have to be viewed through the lens of the rate environment that we're in. One other thing I would mention because I think it's important, is as the platform grows and diversifies, we obviously have the opportunity to deploy in liquid markets and -- in liquid markets. And that's really been a hallmark of the firm is the ability to pivot and identify where the best relevant value is. But we're also now diversified by stressed and distressed strategies and regular way flow lending businesses, high-grade fixed income alternatives, sub investment-grade fixed income alternatives. So with that broad product set, we're able to deploy really in any market environment, and you're seeing that come through in both the breadth and consistency of the deployment. What's unique about the market we're in now because of the nature of the crisis and the nature of the recovery, we're actually balanced in a way that we haven't been before, executing in what I would call the non-COVID regular way part of the market, but also the COVID impact, the distress side. So it's actually a rare deployment environment for us. Typically, this floats to the depths of the crisis. We're going to be much more disproportionately exposed on the distress side, where it's now we're finding a pretty unique opportunity to put capital to work, both distressed and regular way, which I think bode well for the deployment picture for the foreseeable future.

Interesting. So Michael, let's stick with investing for a moment. And don't give us any of your secrets, but when you look across all your businesses and as you just said, there's sort of the COVID distress side is the normal sort of regular way side. Where are you seeing the most attractive opportunities, global, to invest? And I think about it, where the potential IR is the highest versus sort of what your target range is?

Yes. It's a hard question because investors come to us for different solutions, right? So we may have an insurance company client who wants investment-grade rated private ABS, that we can deliver that to them at an excess return relative to the liquid market equivalent that's attractive to them. And we can invest deep into the private equity market and the distressed market and generate really high rates of return. So one of the value propositions to the investor dealing with Ares is you can access different geographies, different markets, different products and different risk return. So it's not as simple as saying flashing green light in one part of the business. I think we've been fortunate that back to the origination, we're seeing quality flow in all of our businesses right now. Maybe as a general response to your question, the places where we are able to exploit some kind of a capital inefficiency or some kind of a capital markets uncertainty is clearly where we're seeing the highest return. So those replaces like our special opportunities business, our distressed for controlled private equity business, our alternative credit business, where we're taking advantage of some of the lingering stress, distress or structural challenges in the capital markets. That's where you're going to see the highest absolute rate of return and probably the highest risk-adjusted rate of return. But again, the appetite that the global investor community has for the core 8% to 10% private market is to get opportunities we put in front of them is pretty strong as well. And so it's hard to say that they're comparable.