What is it that alternative asset managers KKR (KKR) and Ares Management (ARES) have changed and why? More importantly, how can investors profit from this?
There’s a profound and interesting change unfolding in the stock market. One by one, alternative asset managers are changing their business structures from limited partnerships to corporations. A wide variety of investors have been capitalizing on these situations, and it’s not too late for you to find ways to also join this investment party. Let’s examine the major players and where they stand in the corporate conversion process.
The alternative asset management industry is made up of investment companies that invest in private equity, real estate, businesses, lower-rated credit, hedge funds and other ventures outside of the typical public stock and bond realm. The industry has traditionally consisted of limited partnership business entities.
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In February 2018, Ares Management (ARES) announced that they would change their business structure to a corporation, quickly followed by a similar decision coming from KKR (KKR) in May 2018. At that point, it seemed to me that a tidal wave would take place within the industry, and that more corporate conversions would follow.
In May 2018, I promptly added Blackstone Group (BX) to the Growth & Income Portfolio within Cabot Undervalued Stocks Advisor. Blackstone is the world’s largest and most diversified alternative asset manager with $512 billion in client assets. At that time, I also notified investors that Apollo Global Management (APO) could come to an identical decision, later adding Apollo to my Growth & Income Portfolio in January 2019.
Blackstone ultimately announced their future corporate conversion in April 2019, followed by a similar announcement from Apollo in May 2019.
The effects of an alternative asset manager’s conversion from a limited partnership to a corporation include these outcomes:
- Institutional investors will be free to consider buying their stocks
Blackstone estimates that up to 60% of institutional investors (e.g. mutual funds, trust accounts, insurance companies’ investments and pension funds) and most stock market indexes have investment policy statements and prospectuses that prohibit them from investing in limited partnership shares. Once alternative asset managers complete their corporate conversions, institutional investors will be free to consider buying their stocks, thus potentially pushing their share prices upward.
- Higher tax rate
The company will gradually pay a higher income tax rate.
- Reporting earnings per share (EPS) instead of economic net income (ENI)
The company’s post-conversion quarterly reports will stop reporting economic net income (ENI) and begin reporting earnings per share (EPS). The EPS numbers are expected to be slightly lower than ENI.
- No K-1 reporting
Shareholders will eventually cease having to deal with K-1 reporting on their income tax returns.
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KKR quickly completed their corporate conversion in July 2018, followed by Ares Management’s conversion in November 2018. Blackstone completed their conversion in July 2019, and Apollo plans to complete their conversion in the third quarter of 2019.
How have KKR (KKR) Stock and Ares Management (ARES) Stock performed?
If you look back at the share prices of ARES and KKR during 2018, you can see that they whipsawed all over the place throughout the year. You might then assume that the act of converting from a limited partnership to a corporation does not resonate well with investors. I just want you to keep in mind that we had three stock market corrections in 2018—THREE!—in February, October and December. Therefore, despite any potentially bullish results from a corporate conversion over the medium- and long-terms, literally any company’s stock is still subject to short-term stock market volatility.
A more recent review of these companies’ price charts tells a different story. Investors are embracing shares of alternative asset managers, getting excited about the corporate conversions, and profiting handsomely from capital gains and dividends.
For most of these stocks, it’s not realistic to expect additional short-term capital gains after such outsized performance during the first half of 2019. Watch for opportunities to buy shares during market corrections, because alternative asset managers can be excellent long-term growth & income investments.
Are there any remaining alternative asset manager conversion announcements that investors might profit from?
There is one more major player within the alternative asset management peer group, and that’s Carlyle Group LP (CG). The company’s May 1 earnings conference call transcript brought this message from Co-CEO Kewsong Lee:
“I think it’s important to address our current thinking about Carlyle’s corporate structure. Over the past year, we’ve seen several firms in our peer group either announce or complete a conversion to a C corporation from their prior publicly-traded partnership status. At this point, we can say the following; we continue to seriously explore a conversion to a C corporation for Carlyle. The benefits we’ve seen from the conversions have not gone unnoticed. There are many complex operational moving parts in connection with the conversion and we intend to conclude our thinking with a decision in the not too distant future.”
When a CEO runs a publicly-traded company, it’s not enough for them to excel at running their business. They also have a tremendous obligation to their shareholders, which largely plays out by making decisions that can support and grow the stock price. All of Carlyle Group’s major competitors have made a corporate conversion decision that will likely continue to significantly and positively affect their stock prices. Despite the tremendously complicated task of corporate conversion, Carlyle’s CEO must now follow suit, if at all possible. That’s because lacking a corporate conversion, very few institutional investors will be motivated to buy CG shares in the future when they can more easily buy shares in its corporate peers, without tax complications or portfolio restrictions.
Carlyle Group manages $221 billion, divided among real assets, corporate private equity, investment solutions and global credit. Investors can visit the company’s website to access the webcast of Carlyle Group’s June 11 presentation at the Morgan Stanley Financials Conference 2019, their May 2019 Investor Presentation and their first-quarter 2019 earnings release.
As stated in the earnings release, Co-CEO Kewsong Lee plans to make “a decision [about corporate conversion] in the not-too-distant future.” It’s time for opportunistic investors to buy CG in anticipation of a potential near-term announcement that could boost the share price, both immediately and over a multi-year period.