Ares Management Corporation (NYSE:ARES) Q1 2024 Earnings Call Transcript May 2, 2024

Ares Management Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Welcome to the Ares Management Corporation's First Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded on Thursday, May 02, 2024. I would now like to turn the call over to Greg Mason, Co-Head of Public Markets Investor Relations for Ares Management. Please go ahead, sir.

Greg Mason: Good morning, and thank you for joining us today for our first quarter conference call. I'm joined today by Michael Arougheti, our Chief Executive Officer; and Jarrod Phillips, our Chief Financial Officer. We also have a number of executives with us today who will be available during the Q&A session. Before we begin, I want to remind you that comments made during this call contain forward-looking statements and are subject to risks and uncertainties, including those identified in our risk factors in our SEC filings. Our actual results could differ materially, and we undertake no obligation to update any such forward-looking statements. Please also note that past performance is not a guarantee of future results, and nothing on this call constitutes an offer to sell or a solicitation of an offer to purchase an interest in any Ares fund.

During this call, we will refer to certain non-GAAP financial measures, which should not be considered in isolation from or as a substitute for measures prepared in accordance with generally accepted accounting principles. Please refer to our first quarter earnings presentation available on the Investor Resources section of our website for reconciliations of the measures to the most directly comparable GAAP measures. Note that we plan to file our Form 10-Q later this month. This morning, we announced that we declared our second quarter common dividend of $0.93 per share on the company's Class A and non-voting common stock, representing an increase of 21% over our dividend for the same quarter a year ago. The dividend will be paid on June 28, 2024, to holders of record on June 14.

Now I'll turn the call over to Michael Arougheti, who will start with some quarterly financial and business highlights.

Michael Arougheti: Thanks, Greg, and good morning, everyone. We hope everybody is doing well. We generated strong first quarter results with double-digit year-over-year growth across our key financial metrics, including 19% growth in AUM, 18% growth in fee-related earnings, over $17 billion in gross capital raised, a 21% increase in our deployment from drawdown funds and strong investment performance across our investment strategies. Our AUM increased to $428 billion, which is well ahead of the growth trajectory that we outlined for our year-end 2025 goal of $500 billion and our available capital and AUM not yet paying fees, both reached new records up more than 27% year-over-year. In our opinion, we're very well positioned for strong future growth as the transaction environment improves.

As we had expected, our first quarter realizations were seasonally light, leading our realized income to be comprised entirely of higher quality, more stable fee-related earnings. Yet, our future performance income potential continues to build as our incentive-generating AUM increased by 26% year-over-year, and our net accrued performance income balance increased by more than $55 million year-over-year despite realizing $136 million in net performance income over the past 12 months. As we stated previously, we expect most of the realizations from our European-style funds this year to occur in the second and fourth quarters, with the largest quarterly amount anticipated in the fourth quarter. The economy is proving to be remarkably resilient in the face of higher interest rates and companies in our portfolios are, on the whole, consistently generating strong cash flow and earnings growth.

Aggregate default levels in our credit portfolios continue to be well below historical levels, while key fundamental credit indicators remain healthy. In the first quarter and continuing into Q2, we are seeing a significant number of upsizing opportunities with our existing borrowers. With over 800 corporate borrowers in our global direct lending portfolio, the benefits of incumbency enable us to efficiently retain and invest more capital to support the growth of our portfolio companies. In real estate, operating fundamentals continue to be sound in our highest allocated sectors, particularly within industrial, multi-family and our adjacent sectors like student housing and single-family rental. The strength that we're witnessing is not exclusive to the U.S. European markets are experiencing a moderate rebound in activity across the continent and the economies of the Asia Pacific region are showing signs of growth.

While we continue to invest in strategic growth initiatives across our firm, such as secondaries, infrastructure and insurance, we believe that we have built one of the top global platforms in private credit, which is one of the fastest-growing sectors and alternatives. We now have over $280 billion in AUM, in what we define as private credit, and it spans direct lending in the U.S., Europe and Asia as well as asset-based credit, opportunistic credit, real estate debt and infrastructure debt. We believe that we are early in the transformation of many of these large and fragmented addressable markets, particularly within asset-based credit, opportunistic credit, global infrastructure debt, European real estate debt and Asia private credit. For years, we've been investing in the future growth in these areas.

And today, we believe that we have leading platforms in many of these segments. For example, our alternative credit team, which now has approximately 70 investment professionals and $36.5 billion in AUM manages what we believe is one of the largest pools of noninsurance capital focused on non-rated asset-based credit. As an example, this flexible capital makes our team an ideal partner for the banking sector's long-term transition away from noncore assets. Similarly, we believe that we've been making the necessary investments to benefit from the significant demand for private infrastructure capital solutions over the next several decades, as global players modernize digital infrastructure and transition to sources of clean energy. Infrastructure debt is a multitrillion dollar market that has historically been primarily financed by banks and other traditional providers, where we're seeing a growing need for private capital solutions.

Our team, which we believe is one of the leading providers of private infrastructure credit, is well positioned for these trends. We continue to see strong fundraising momentum across our platform as both institutional and retail investors remain meaningfully under allocated to alternative investments. We believe that we're continuing to capture an increasing percentage of our investors' capital as existing investors are re-upping into new funds and investing across our strategies at a high rate. Our fundraising success has come in different rate cycles and economic environments over the past decades, which supports our view that assets follow performance. We believe that we also set ourselves apart with our differentiated deployment capability and market insights as well as a high-quality investor service.

During the first quarter, we were active with our various private credit strategies and our two largest commingled funds in the market have now each exceeded the sizes of their previous vintages. Our third U.S. Senior Direct Lending Fund raised an additional $2.8 billion in the first quarter and subsequent to quarter end, raised another $500 million in equity commitments. The fund now has $9.7 billion in equity commitments and over $17 billion in potential investment capacity at quarter end with current and anticipated future leverage. This compares to the previous vintages $8 billion in equity commitments and approximately $14 billion in total investment capacity. We anticipate the fund's final close will occur sometime this summer. Our sixth European Direct Lending Fund raised an additional €1 billion in equity commitments in the first quarter, bringing total equity commitments to €11.5 billion, exceeding the previous vintage of €11 billion.

The fund has over €17 billion of potential investment capacity at quarter end with current and anticipated future leverage. We're continuing to raise additional capital, and we anticipate a final close towards year-end. Both of these funds are already investing with over 1/3 of the respective current equity commitments deployed for each fund. Alternative credit had another strong fundraising quarter despite the absence of a significant campaign fund in the market. We raised $1.5 billion in three separate SMAs for large third-party insurance clients in our rated strategies, of which one has already added an incremental $250 million upsize following quarter end. Our open-end Core Alternative Credit Fund, which accepts new subscriptions up to twice a year, raised nearly $330 million during the quarter.

Since its inception less than three years ago, this fund has grown to more than $5 billion in AUM. In the first quarter, with the CLO markets recovering, we raised $1.7 billion in liquid credit mandates, including two CLOs. We also priced three additional CLOs in April and through the first four months of the year have already exceeded the amount of capital that we raised in CLOs for all of 2023. Our wealth solutions platform is beginning to reach an inflection point, where several of our perpetual funds are experiencing accelerating inflows from our efforts to expand our distribution, both domestically and internationally. In fact, our first quarter equity inflows in the wealth channel, which totaled $2 billion, were more than 50% higher than our fourth quarter last year.

30% of the inflows this quarter came from outside the U.S., and we're seeing a material increase in interest from Europe and Asia. Our quarter's strong equity inflows were driven by our nontraded BDC, ASIF, which raised nearly $600 million and our direct lending fund in Europe, ASIF, which raised nearly $500 million in its inaugural quarter. Our private equity secondaries fund, APMF, is also gaining significant momentum nearing $1 billion in AUM and our diversified credit fund, CABC, surpassed $5 billion in AUM and is seeing a ramp in new international flows. So including leverage in our credit vehicles, we raised nearly $3.2 billion in total AUM in the wealth channel for the quarter. This momentum continued into April with another $800 million in equity inflows.

Across our six nontraded wealth management products, we've reached approximately $25 billion in AUM, nearly 4x the amount that we had following the launch of our Ares Wealth Management Solutions platform less than three years ago. Looking ahead, we're excited about further growth in the wealth management channel as our broadening product suite is enabling us to further penetrate within our existing distribution and to attract a growing number of new distribution partners. Finally, Aspida continues to experience strong quarterly growth with assets under management increasing by an additional $1.5 billion, reaching $14 billion in total AUM. We continue to pursue an asset-light balance sheet approach to our affiliated insurance platform and are seeing increased third-party interest in funding Aspida.

We believe the third-party capital we raised in the first quarter and expect to raise in the coming months will provide us with sufficient runway for Aspida to maintain its strong growth trajectory for the foreseeable future. On the Ares balance sheet at quarter end, we had less than $900 million directly invested in either credit assets or in our affiliated insurance vehicle. This represents approximately 0.2% of our total AUM and stands in stark contrast to the amount of on-balance sheet credit assets held by banks and insurance firms across the country. Our entire investment portfolio represents less than 0.5% of our total AUM, which highlights our commitment to an asset-light approach across our businesses. Overall, we expect over 35 different funds in the market this year across our investment strategies, including the two private credit funds we discussed, our third special opportunities fund, our sixth infrastructure debt fund, our seventh corporate private equity fund, our fourth European value-add real estate fund, our 11th U.S. value-add fund, our second climate infrastructure fund and secondaries funds in infrastructure and credit, to name several.

As the traditional credit markets have increasingly become more active, this is drawing out more investment activity across the U.S. markets. CLO formation is robust and banks are becoming more competitive in the syndicated loan market driving increasing transaction volumes. Of note, a significant portion of the transaction activity to date has been refinancing related with less coming from new M&A. Although activity levels in our European and Asia Pacific markets are comparatively slower, we expect to see some pickup in transactions in those regions. In the quarter, our gross deployment activity increased to $18.6 billion, a 52% increase over the first quarter of last year, including nearly $15 billion in private credit. Since refinancing activity also increased, our net deployment was a little more muted, which slowed our growth in fee-paying AUM.

However, we continue to have conviction that the pent-up demand for M&A, the significant amount of private equity dry powder and the demand from LPs to return capital will be conducive to an improved transaction environment this year. Across U.S. and European Direct Lending, we deployed more than $11 billion in the quarter, which is more than double our deployment from a year ago period, as we gained significant market share in a relatively slower market environment. We were active with both incumbent borrowers and new companies, finding opportunities to invest in more traditional middle market companies as well as larger businesses that opted for a direct lending solution. Alternative credit experienced robust deployment in the quarter with nearly $2.9 billion invested across various asset-based submarkets.

Notable transactions include forming an equipment leasing platform, Ansley Park, acquiring a portfolio of newly originated consumer loans from upstart and investing in digital infrastructure in partnership with the infrastructure equity team. Additionally, the team remained active in fund finance, particularly in NAV lending and structured GP solutions. Subsequent to quarter end, we announced a joint venture within the non-QM residential space. supporting over $2.5 billion in new originations. In real estate, transaction activity is improving and our pipeline is growing, driven by our substantial dry powder, more economic certainty and compelling market values. We're seeing low double-digit return opportunities in senior debt, mid-teens return opportunities and funding the gaps within capital structures and intriguing equity opportunities, primarily in our core sectors of industrial, multifamily and student housing.

And within secondaries, transaction volumes are expanding with GP-led transactions continuing to outpace LP-led opportunities. We anticipate LP-led opportunities to gain further momentum as portfolios reprice and liquidity needs increase. As an example, in April, we completed the largest LP-led private equity secondaries transaction in our firm's history. And now, I'd like to turn the call over to Jarrod for more detailed comments on our quarterly financial highlights and outlook. Jarrod?

Jarrod Phillips: Thanks, Mike. Hello, everyone. Thank you for joining us today. We continue to deliver strong results in the first quarter with mid- to high-teens growth in AUM, management fees, fee-related earnings and realized income along with stronger growth of 28% in our AUM not yet paying fees, which we view as a leading indicator of our capacity for future growth. With the current geopolitical risks, sustained inflationary data and high interest rates, our high-quality FRE-based earnings stream provides strong visibility because it's less dependent on the uncertainty arising from the timing of realization activity. As Mike stated, we're off to a solid start in fundraising, raising over $17 billion in the first quarter, and our available capital has reached a new high, positioning us well for future growth and taking advantage of a return to higher levels of M&A activity.

Starting with revenues. Our management fees totaled over $693 million in the quarter, an increase of 15% compared to the same period last year, primarily driven by the deployment of our available capital. As expected, fee-related performance revenues were also modest in the quarter as the vast majority of FRPR is crystallized in the fourth quarter. In our credit segment, our credit FRPR should benefit from the higher for longer interest rate environment, assuming no significant changes to spreads or asset valuations. FRE totaled $302 million, up 18% from the first quarter of 2023, driven by higher management fees and a margin improvement of roughly 150 basis points to 42.1%. We expect continued FRE growth during the rest of 2024 as deployment activity gains momentum throughout the year.

As Mike mentioned, seasonality, continued rate uncertainty and bid-ask spread differentials on values constrained our realization activity in the first quarter. As a result, we generated $10 million of realized net performance income in the first quarter, up from $7 million a year ago. As we've mentioned on previous earnings calls, our European waterfall realizations are currently more seasonal in nature and meaningfully concentrated in the fourth and second quarters. The current seasonality of our European-style waterfall realizations is primarily due to the early stage of our larger eligible credit funds that make distributions to investors to cover tax payments compared to older, smaller European-style funds that are at the end of their life cycles.

This seasonality will persist until several of our larger European funds start regularly realizing performance income toward the end of their fund lives. For 2024 and 2025, it's best to assume 60% in the fourth quarter, 30% in the second quarter and 10% spread across the other quarters. For the full years 2024 and 2025, we continue to believe that the net realized performance income from European-style waterfall funds will generate $420 million in 2024 and 2025 with over 2/3 of that amount realized in 2025. Realized income in the first quarter was $289 million, a 14% increase over the previous year. Importantly, our realized income was entirely comprised of our fee-related earnings due to our limited realized performance income for the quarter.

After-tax realized income per share of Class A common stock was $0.80, up 13% from the first quarter of 2023. As of March 31, our AUM stood at $428 billion, up from $360 billion in the previous year, representing a 19% increase. Our fee-paying AUM reached $267 billion at the end of the quarter, up 14% from the previous year. Strong deployment across our U.S. and European direct lending, alternative credit and opportunistic credit strategies, all of which pay management fees on invested capital, primarily drove our year-over-year growth in fee-paying AUM. Following sustained fundraising momentum, we're building our shadow AUM, setting the stage for higher deployment and future management fee growth. Our AUM not yet paying fees available for future deployment totaled nearly $65 billion at quarter end, representing over $621 million in potential future management fees.

Our incentive eligible AUM increased by 17% in the first quarter of 2024 to $247 billion. Of this amount, $82 billion is uninvested, representing significant performance fee earning potential. In the first quarter, our net accrued performance income increased to $938 million as we continued to compound interest income above the hurdle rates in our credit strategies. Of the $938 million of net accrued performance income at quarter end, $772 million or just over 80% was in European-style waterfall funds, with $506 million coming from funds that are out of their reinvestment period. Finally, in terms of fund performance, we believe our fundraising success is driven by our consistent investment performance throughout market cycles. Our first quarter's performance continues to reinforce that view.

Across our credit group, we had another excellent quarter with gross composite returns ranging from approximately 3% to 7% for the quarter, and gross composite returns ranging from 10% to nearly 40% over the last 12 months across our six primary credit strategies. Across real assets, we generated gross returns and infrastructure debt at approximately 3% for the quarter and 7% for the last 12 months. And in U.S. real estate equity, the quarter composite returns turned positive. As Mike stated, we continue to see positive fundamentals in our real estate portfolios, and we're beginning to see signs of a market recovery. Our private equity composite was flat in the quarter but has returned approximately 7% over the last 12 months. Our portfolio fundamentals are sound with low teens year-over-year EBITDA growth.

And our latest corporate private equity fund, ACOF VI has generated a 24% gross IRR since inception. Overall, we remain on track for our 20% growth objectives for fee-related earnings and dividends per common share for the year, and we look forward to providing new long-term guidance at our Investor Day on May 21. I'll send it back to Mike for closing comments.

Michael Arougheti: Great. Thanks, Jarrod. We believe our first quarter highlights not only our significant momentum, but also the future growth potential across our business lines. Over the past several years, we've made investments in building out new investment platforms and distribution in significant new growth segments that are now coming online and contributing to our growth profile. These areas include alternative credit, infrastructure, real estate debt, APAC credit, secondaries, wealth management and insurance. We hope to capitalize on these segments secular drivers in the years ahead. We've also continued to heavily invest in our more scaled investing strategies, which positions us to outperform when markets get more competitive.

As you can see from our first quarter's results, our fundraising momentum remains robust, and we're positioned for growth with a record amount of dry powder and 28% growth in our AUM not yet paying fees. We believe our asset-light business model provides consistent and substantial earnings growth, while limiting our exposure to the volatility of the financial markets. And as Jarrod stated, we have great visibility into the future earnings streams from our European waterfall style funds in the years to come. We look forward to providing a deep dive into our business and discussing our promising long-term outlook with you at our Investor Day in a few weeks. And as always, I'm grateful for our team's hard work and dedication, and I appreciate our investors' ongoing support of our company.

And operator, with that, I think we can now open up the line for questions.

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