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Edited Transcript of ARES earnings conference call or presentation 24-Feb-17 5:00pm GMT

Thomson Reuters StreetEvents

Q4 2016 Ares Management LP Earnings Call

Los Angeles Feb 25, 2017 (Thomson StreetEvents) -- Edited Transcript of Ares Management LP earnings conference call or presentation Friday, February 24, 2017 at 5:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Carl Drake

Ares Management L.P. - Head of Public IR

* Michael Arougheti

Ares Management L.P. - President

* Mike McFerran

Ares Management L.P. - CFO

* Bennett Rosenthal

Ares Management L.P. - Co-Head of Private Equity Group

* Kipp DeVeer

Ares Management L.P. - Head of Credit Group

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Conference Call Participants

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* Chris Harris

Wells Fargo Securities, LLC - Analyst

* Patrick Davitt

Autonomous Research LLP - Analyst

* Jordan Freelander

Credit Suisse - Analyst

* Michael Cyprys

Morgan Stanley - Analyst

* MIke Carrier

BofA Merrill Lynch - Analyst

* Robert Lee

Keefe, Bruyette & Woods - Analyst

* Grayson Barnard

Goldman Sachs - Analyst

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Presentation

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Operator [1]

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Welcome to Ares Management LP fourth quarter 2016 earnings conference call. At this time all participants are in a listen-only mode. As a reminder this conference call is being recorded today, Friday, February 24th, 2017. I would now like to turn the call over to Carl Drake, head of Ares Management Public Investor Relations.

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Carl Drake, Ares Management L.P. - Head of Public IR [2]

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Thank you William. Good afternoon and thank you for joining us today for our fourth-quarter 2016 conference call. I'm joined today by Mike Arougheti, our President; and Mike McFerran, our Chief Financial Officer. In addition, Bennett Rosenthal, co-head of our private equity group, and Kipp DeVeer, head of our credit group will also be available for questions.

Before we begin I want to remind you that comments made during the course of this conference call and webcast contain forward-looking statements and are subject to risks and uncertainties. Our actual results could differ materially from those expressed in such forward-looking statements for any reason including those listed in our SEC filings. We assume no obligation to update any such forward-looking statements. Please also note that past performance is not a guarantee of future results. Moreover, note that performance of and investment in our funds is discrete from performance of and invest in Ares Management LP.

During this conference call we will refer to certain non-GAAP financial measures such as economic net income, fee related earnings, performance related earnings and distributable earnings. We use these as measures of operating performance not as measures of liquidity.

These measures should not be considered in isolation from or as a substitute for measures prepared in accordance with Generally Accepted Accounting Principles. These measures may not be comparable to like titled measures used by other companies.

In addition, note that our management fees include ARCC Part 1 fees. Please refer to our fourth-quarter and full-year 2016 earnings presentation that we filed this morning for definitions and reconciliations of the measures to the most directly comparable GAAP measures.

This presentation is also available under the investor resources section of our website at www.aresmgmt.com, and can be used as a reference for today's call. Note that we plan to file our Form 10-K early next week. I would like to remind you that nothing on this call constitutes an offer to sell or a solicitation of an offer to purchase an interest in any securities of Ares or any other person including any interest in any fund.

Now before I turn the call over to Michael Arougheti, let me provide a brief summary of our fourth-quarter and full-year earnings. We reported significantly improved GAAP diluted earnings per common unit of $0.34 for the fourth quarter and $1.20 for the full year.

We also reported aftertax economic net income per unit of $0.44 and $1.42 for the fourth-quarter and full-year respectively, compared to $0.20 and $0.87 for those periods in 2015. Our aftertax DE per common unit totaled $0.31 for the fourth quarter and $1 for the full year, amounts that were up 35% and 10% respectively over 2015 levels.

Keep if mind that our third- and fourth-quarter earnings metrics have been reduced by approximately $0.03 in each quarter from the distributions from our recently shipped Series A preferred units. We also declared a distribution of $0.28 per common unit payable on March 24th to unit holders of record on March 10th, bringing full year distributions to $0.91 per common unit for a growth rate of 8% over 2015. Now I'd like to turn the call over to Michael.

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Michael Arougheti, Ares Management L.P. - President [3]

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Great. Thanks, Carl. Good afternoon everyone.

As Carl mentioned, the fourth-quarter of 2016 concluded a very strong year for Ares, as we generated our highest quarterly levels of fee related earnings and distributable earnings, and our third quarter in a row of economic net income of over $100 million. As we look back on our important accomplishments in 2016, let me start by highlighting our strong investment performance, which partly drove our significant growth in fourth-quarter and full-year earnings.

Despite a year that started with collapsing commodity prices, recession fears and retreating markets, the equity and capital markets recovered quickly and then strengthened throughout the second half as investors regained confidence in economic growth and an extended business cycle. Against this backdrop, our investment returns were quite strong in our core strategies across all three of our investment groups.

For example, during 2016 we experienced gross returns of more than 30% in our corporate private equity fund composite of ACOF Funds 1 through 4. And approximately 20% gross returns in our largest US and European real estate private equity funds.

Within credit, we generated solid performance in a wide range of strategies including full-year gross returns ranging from 9% to 13% across our credit strategies in US and European direct lending, and our liquid strategies in syndicated loans and high yield. In addition, our externally managed BDC, Ares Capital Corporation, generated a total net return of approximately 10%.

On the back of this strong performance, we continued to see strong demand from existing and new investors across the platform. We followed our record 2015 fundraising with another great year in 2016 raising gross commitments of approximately $14 billion, supported by 127 direct institutional investors, approximately 50 of which were new to our platform.

Our differentiated and leading global credit platform continues to see great momentum as investors hunt for yield and non-correlated returns from established and large scale asset managers like Ares. These factors help us to raise more than $10 billion across over 40 funds, CLOs and SMAs in our credit business last year and the future pipeline is very promising.

We also hit our hard caps on two of our most important successor funds. Our latest private equitiy fund, ACOF 5, which has $7.85 billion in aggregate commitments and our latest European direct lending fund ACE III, which has 2.5 billion Euros in aggregate commitments.

Approximately 63% of the capital raised was from North American investors with 37% from abroad. Our largest investors continue to be pension funds, insurance companies and sovereign wealth funds, but we're also seeing good demand and momentum from high net worth investors, endowments, and foundations.

Our trend of receiving larger capital commitments from our existing investor base continued in 2016, as existing clients made up more than 80% of new commitments. At year end more than 40% of our investors or approximately 285 were invested in more than one fund with us, up from only 23% or approximately 45 just five years ago.

On the investment side, we were increasingly selective investors on the whole as the market environment for quality assets became more competitive in certain segments, particularly after the volatility in the first part of the year quickly subsided during the second half. Overall, we invested a little over $10 billion for the year compared to more than $13 billion in 2015, of which about $6.7 billion related to our drawdown funds, compared to $9 billion for the prior year.

More than half of our deployment was in US and European direct lending, where we're able to use the breadth of our direct origination platforms, superior scale, incumbent relationships, and asset flexibility to see a broad view of available transactions. We also continued to be active investors in structured credit including investing in third party CLOs for relative value and in the self originated private asset backed sector, where we continue to see banks retrench from providing asset based financing to other specialty finance companies.

With approximately $1.2 billion in drawdown deployment last year, we continued to invest in a variety of real estate private equity assets across our value add and opportunistic strategies in both the US and Europe. In the US we focused on acquiring undermanaged, cash flowing assets and investing in select derisked development opportunities. We also continued to expand our modern bulk industrial portfolio, where we have distinct sourcing advantages and insights and we remained active investors in multi-family and attractive in liquid markets.

In Europe, we leveraged our local knowledge and experience with complex multi-jurisdictional transactions to acquire and execute asset management plans for large Pan-European portfolios of both retail and office assets. We also built critical mass within our multifamily portfolio across select markets in the UK, Denmark, and Germany. And within real estate debt, we continue to be very active lenders to value added private equity sponsors in the middle market, completing transactions across 15 states.

While our corporate and power and infrastructure private equity deployment was lower year over year, we still made a sizable impact with the dollars that we did invest. In keeping with our opportunistic and flexible strategy, we were active investors in the energy sector, amidst the volatility in early 2016, where ACOF IV, along with a co-investor made a $350 million term loan with warrants and invested approximately $165 million in common equity in publicly traded Clayton Williams.

Our investment thesis was to unlock value and reaccelerate Clayton William's growth, through further drilling of their assets in the Permian Basin. As some of you may have seen, Clayton Williams has agreed to be acquired by Noble Energy, which based on current equity values would result in a substantial multiple of investment capital for our PE fund investors, and meaningful distributable earnings for our unit holders, assuming the transaction closes.

Within our power and energy infrastructure strategy, market fundamentals for new investment, driven largely by the ongoing shift in electricity production from coal to natural gas and renewables, remain vibrant. During the year we invested over $200 million into the development and construction of you new energy infrastructure assets, including completion of a natural gas fired plant in Southern California. We're also building two additional natural gas power plants in the midwest to replace retiring coal generation while constructing a gas pipeline to bring inexpensive Marcellus Shale gas to the eastern seaboard, among other projects.

Maybe now turning to monetizations. We took advantage of firmer market conditions last year to exit certain assets across our strategies, resulting in an increase in our distributions to approximately $1.7 billion for the fourth quarter and $5.2 billion for the year, compared to $857 million for the fourth quarter and $3.9 billion in 2015. Our stronger distributions were primarily driven by increased exit activity in ACOF III, our 2008 vintage corporate private equity fund.

Our realizations were tied to sales and recaps of private equity portfolio companies, monetizations within a variety of credit funds, and various real estate property sales primarily in our US equity funds. As a result, our aftertax E&I for the fourth quarter and full year increased 123% and 64% respectively.

Our distributable earnings also experienced meaningful growth, increasing 57% for the fourth quarter and 15% for the full year compared to the same periods a year ago. Highlighting the balance and diversity of our platform, all three of our investment groups achieved increased E&I and DE for the full year versus the prior year.

So as we progress into 2017, we're excited and optimistic about the trajectory of our business, which we expect will be fueled from existing capital and new capital raising initiatives and should drive growth in fee related earnings and see margin expansion. First, as we've discussed on past calls, management fees in our latest corporate private equity fund ACOF V will be activated upon the closing of that fund's first investment. As a reminder, there will with an associated step-down in fees on ACOF IV upon ACOF V's activation.

ACOF V has already identified its first investment in Gastar Exploration, a publicly traded E&P Company with assets in the STACK play in Oklahoma and this transaction was announced last week and is expected to close in the near term this quarter. The initiation of the management fees for a ACOF V positions us for a meaningful improvement in the run rate for management fees and FRE going forward.

Second, our externally managed BDC, Ares Capital Corporation, closed on its strategic acquisition of American capital on January 3. In addition to the increased competitive advantages that we obtained from greater scale, Ares Management's fee paying AUM increased by an amount that as of September 30th would have been approximately $3 billion on a pro forma basis.

I'd note that the exact amount of closing is not yet available and it will likely be lower initially due to asset sales. In the near term, we expect that the ACAS transaction will be modestly accretive to our FRE in the first quarter and become increasingly accretive to our FRE throughout the year and beyond as ARCC rationalizes the acquired portfolio. Mike McFerran will also discuss some related potential tax deductions related to the ACAS transaction that if available, may meaningfully benefit our DE.

While we have significant momentum fueled by our fund raising in PE and credit, the breadth of our diverse and differentiated platform has us well positioned for continued growth. Looking forward, let me provide a few thoughts on current areas of focus for us in our fund raising.

In keeping with our history of launching new adjacent asset classes within our core competencies, we're pleased to announce that this week we held a first closing of over $1 billion for our first junior capital private direct lending fund. We had very good participation from a variety of direct institutional investors with a little more than half new to the Ares platform. This is a complementary strategy to our existing senior loan focused direct lending funds. As it will provide junior capital to upper middle market companies in the form of private high yield, mezzanine debt and second lien loans.

Our credit group also continues to see significant demand from pension funds and other institutional investors seeking US and European direct lending where we have a significant pipeline of potential SMAs and funds. I think as folks may know, direct lending has become more established as a standalone investable asset class and the appetite is very strong as investors are gravitating towards their non-correlated, higher yielding assets that benefit in a rising rate environment.

We continue to raise significant capital in our liquid credit strategies both in high yield within SMAs and open ended funds. And also in syndicated bank loans, principally through new CLO issuance in both the US and Europe. Coming off a significant year in structured credit, we continue to raise SMAs and a co-mingled fund in this strategy, where we now manage a growing $4 billion plus in AUM.

We recently launched fund raising for our ninth US value add real estate private equity strategy and we're also nearing the next fund raising phase for another important successor real estate PE strategy in Europe. And within our private equity group, we continue to fund raise in our fifth power and energy infrastructure fund, with a final close targeted for the second quarter.

Lastly, I'd like to highlight that we recently made a significant hire to bolster our special situation strategy by naming Scott Graves the head of distressed debt investing within Ares. Scott's an industry veteran with more than 15 years of distressed experience, and in the intermediate term, we envision raising incremental distress capital, so please join me in welcoming Scott to the team. I'd now like to turn the call over to Mike McFerran to give his perspective on our financial results and future prospects.

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Mike McFerran, Ares Management L.P. - CFO [4]

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Thanks, Mike. Let me start by highlighting key themes about our financial results. Then I will walk you through our results in detail, provide an outlook for 2017. In general, we are encouraged with how our business is performing which is reflected in the growth in our key earnings and AUM metrics, and we believe we are well positioned for future growth.

As Mike stated earlier, our fourth-quarter and entire 2016 was a strong year of fund performance across the platform, which led to significant growth in our performance related earnings and also contributed to our ability to monetize assets and increase our distributable earnings across all three investment groups. We believe the strong performance and client satisfaction is setting us up for additional success in our fund raising including in new, adjacent strategies.

Also, we continue to focus on expense control and efficiencies while still investing in our platform for growth. The combination of our management fee growth and expense discipline should result in margin improvement over the coming year and beyond. Finally, we want to emphasize the importance of our growth in incentive eligible AUM to be invested, which stands at more than $19 billion, which we believe will be an engine of future performance income growth.

Now, let's turn to our results. We are pleased to have generated significant fourth quarter and year-over-year growth in economic net income or E&I and distributable earnings, reflecting stable fee related earnings and strong portfolio appreciation and realizations.

For the fourth quarter and full year, we reported E&I of $113.8 million and $357 million respectively, which translated into $0.44 and $1.42 on an aftertax per unit basis after preferred distributions. This was the third consecutive quarter where we have generated E&I greater than $100 million, as fund performance continues to be a strong driver of our performance related earnings.

The fourth quarter also represented our strongest quarter of fee related earnings to date with more than $48 million. As a result, our fourth-quarter FRE margins improved, reaching 28% from 27% in the third quarter, and 24% for the fourth quarter a year ago.

Turning to our AUM. It's important to look at all of our AUM metrics in order to understand the full picture. At the end of the fourth quarter, our AUM was $95.3 billion versus $97.3 billion at the end of the third quarter, primarily due to the runoff of SSLP, while our fee paying AUM increased from $60 billion to $60.6 billion over the same period.

During the year our AUM grew modestly at approximately 2%. Growth would have been more than 5% to approximately $99 billion when including ARCC's acquisition of American Capital on January 3rd of this year.

Our AUM not yet earning fees, or shadow AUM, increased materially, up 16% year over year, reaching $18 billion. Of this $18 billion, approximately $15.6 billion was available for future deployment with corresponding management fees totaling over $188 million and a blended expected management fee rate of 1.21%. Note that the $15.6 billion includes $7.6 billion related to ACOF V. However, does not include AUM or expected management fees related to ARCC's acquisition of ACAS, as this transaction closed in January.

Our incentive eligible AUM increased 11% from the prior year to $50.7 billion of which $17.7 billion is incentive generating and $19.2 billion remains to be invested. Interestingly, of the $19.2 billion to be invested, approximately 43% or $8.3 billion is to be invested in funds already above their hurdles and another $7.6 billion is in ACOF V.

For the fourth quarter, we generated year-over-year FRE growth of 22% and full year FRE of $172 million compared to $177 million a year ago. Our fourth quarter FRE was positively impacted by transaction based fees of approximately $8.5 million for a fund in our US direct lending strategy.

While we expect recurring transaction based fees from this fund and possibly other funds going forward, we do not expect to earn the same -- extent as we did this past quarter. A more normalized run rate would be closer to $2 million per quarter.

Fourth quarter FRE was also modestly impacted by a quarterly increase in G&A expenses primarily related to the timing of certain activities. However, full year G&A expenses of $114.7 million actually declined year-over-year by 3%, reflecting our focus on expense discipline and efficiencies.

Our compensation costs increased in the mid single digits for the year, primarily driven by headcount growth as we continue to invest in the growth of our platform. We saw a significant rebound in our performance related earnings for the fourth quarter and the full year with $65.4 million and $184.6 million respectively, versus $11.6 million and $39.4 million in 2015.

All three groups contributed to the full year increase, with higher performance related earnings versus the prior year. The increases were primarily driven by appreciation in our ACOF III and IV funds and our private equity strategy, and broad based, stronger credit fund performance, particularly in our credit opportunities and syndicated loan strategies.

Our balance sheet of approximately $622 million of diversified investments generated more normalized levels of income in 2016 of $51 million, driven by appreciation in our holdings in our corporate private equity, US direct lending and syndicated loan strategies. Our fourth-quarter distributable earnings were $79.5 million compared to $50.7 million a year ago. Our distributable earnings net of taxes were $0.31 per common unit versus $0.23 per common unit a year ago, including the impact of $5.4 million of preferred equity distributions.

Our fourth-quarter distributable earnings were driven by the increase in FRE, another strong quarter for realizations in our corporate private equity funds and credit funds, including CLOs and structured credits as well as two real estate private equity funds. These same general areas contributed to our higher distributable earnings for the full year, which increased 15% from $230.6 million in 2015 to $264.3 million in 2016. Our aftertax distributable earnings per common unit, net of preferred distributions, was $1 in 2016 versus $0.91 in 2015.

Taking into consideration our strong fund performance and monetizations, our net accrued performance fees increased 21% or about $29.2 million for the year to $169.4 million compared to year-end 2015. As Carl stated, we declared a fourth-quarter distribution of $0.28 per common unit. This brings full year distributions per common unit to $0.91, representing a payout ratio of just over 90% for the full year.

Looking ahead, we believe there are important growth drivers for our fee related earnings and distributable earnings. As Mike stated, there are two events that are expected to drive growth in the near term. The activation of management fees for ACOF V, which is expected to occur soon, with the closing of the fund's first investment, as Mike described, we'll begin to generate approximately $65 million of additional run rate management fees net of the simultaneous stepdown of management fees from ACOF IV, which will occur simultaneously.

Second, we began earning management fees on the assets that were acquired from ACAS on January 3 of this year. Since the 1.5% management fee is paid on average assets and the transaction occurred after quarter end, we are only earning half a quarter's worth of management fees while incurring virtually all of the quarter's expenses.

Also, keep in mind that we will begin waiving up to $10 million in ARCC's Part 1 income based fees with 10 calendar quarters beginning in the second quarter. Assuming we generate more incremental profits from the portfolio rotation, we expect the net FRE contribution from the ACAS assets to gradually improve from modest levels in the first quarter, becoming more accretive gradually throughout the year.

Let me update you on the potential tax treatment of the $275 million of financial support we provided at closing for ARCC's acquisition of ACAS. The tax treatment is subject to final determination and we believe could range from treating the $275 million as an immediate deduction or amortizing it over set periods of time, typically 15 years under tax guidance.

Determination of the final tax treatment may have a material positive impact on our aftertax distributable earnings. In particular, an immediate deduction would have a significant positive impact on our near term aftertax distributable earnings. But as I said, no assurances can be provided as to the treatment, which remain subject to final determination.

Our business is well positioned with a high degree of management fees, which represented more than 80% of our total fees for 2016 and our fee related earnings continue to make up the majority of our distributable earnings, representing 65% in 2016. We also believe the expected growth in fee paying AUM, fee related earnings from ACOF V and ACAS along with potential additional fees from new capital and deployment, provides an even higher base level distributable earnings going forward.

Regarding the realization component, we currently have less visibility on material realizations for the first quarter, but we have a good view on the pending realization from the Clayton Williams transaction, which may occur over multiple quarters beginning in the second quarter.

Lastly, today we took advantage of favorable financing market conditions and extended the maturity of our $1 billion revolving credit facility to February 2022 and reduced the pricing of borrowings from LIBOR plus 1.75% to LIBOR plus 1.5%. Now I'll turn the call pack to Mike for his closing remarks.

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Michael Arougheti, Ares Management L.P. - President [5]

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Thanks, Mike. In closing, 2016 was a great year for Ares. We feel very good about our business line performance and we believe that we're well positioned for growth going forward. We have significant dry powder, flexible fund mandates, and long dated capital poised to take advantage of opportunities as the market presents as we navigate through changing markets.

So before we take your questions, just let me leave you with a few summary thoughts. Macroeconomic and industry tailwinds for alternative managers like Ares continue to be positive, particularly with respect to the growing demand for yield and ill liquid credit which means fund raising prospects remain very strong.

We had an excellent year of fund performance and our existing clients and new investors are validating that performance by committing new capital to us in both existing and new strategies and across multiple products on the platform. We continue to expand our platform by introducing new or adjacent products like our new junior capital direct lending fund, where we can leverage our existing core competencies and track records.

As Mike highlighted, we believe that the combination of deploying our shadow AUM, activating ACOF V and the expected earnings accretion from ARCC's acquisition of ACAS will all catalyze earnings growth for this year and provide a higher base level for our DE in subsequent periods. And lastly, we sowed the seeds for further DE from the buildup in our incentive eligible AUM, which provides significant upside potential in the coming years.

I want to thank the entire Ares team for all of their hard work in what turned out to be an exceptional year for us despite changing markets and I want to thank everyone for their time today. And with that, William, I think we'll open the line for questions.

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Questions and Answers

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Operator [1]

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Thank you.

(Operator Instructions)

The first questioner today is Chris Harris with Wells Fargo. Please go ahead.

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Chris Harris, Wells Fargo Securities, LLC - Analyst [2]

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Thanks. Hey, guys. So you highlighted investment performance being pretty extraordinary this year. Wondering if you could delve into that a little bit deeper? Why is it that you -- how are you guys able to achieve such strong returns, I guess is the question. The 30% gross IRR in PE has got to be among the best around. So maybe talk a little bit about what drove that.

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Michael Arougheti, Ares Management L.P. - President [3]

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Sure. I'll let Bennett give you his perspective from the private equity standpoint and then we can chime in on the credit side as well.

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Bennett Rosenthal, Ares Management L.P. - Co-Head of Private Equity Group [4]

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Well, on the private equity side it's just a continuation of our strategy of targeting opportunities with extraordinary growth. And if you were to just look at our portfolio, we've been able to do what we've been able to do in the past, which is drive EBITDA growth.

While there was some multiple expansion in the valuation improvements, for the most part it was driven by strong EBITDA growth across the portfolio. As well as the success which was mentioned in the energy sector where we did deploy capital at a very attractive time in the energy space and benefited from that. But overall, I think the portfolio's performing really well and if you look across, there's EBITDA growth across the portfolio.

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Michael Arougheti, Ares Management L.P. - President [5]

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And Chris, I'd just make a general comment on credit. I think in the liquid credit strategy as we talked about, the technicals in the loan and high yield market were very strong. We got through the end of the year where were seeing not just good fundamental credit performance but spread tightening and pretty sharp increase in asset prices.

So I think there's a l combination in our liquid strategies of good fundamental credit selection coupled with just a he very strong technical backdrop. And as you've heard us talk about before and Kipp talked a lot about on the ARCC call, in the private debt and ill liquid credit spaces we do believe that we've created some meaningful competitive advantages in the market based on our scale and origination capabilities that allowed us just to continue to do what we always do, which is self originate what we think are high quality assets at premium to what we're able to get in liquid markets.

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Chris Harris, Wells Fargo Securities, LLC - Analyst [6]

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Great. And then one follow-up if I could regarding expenses. You guys have given some color in and around the management fees, but just wondering if you could talk a little bit about how you think expenses might trend in 2017? And then tied to that, what kind of incremental expenses should we be expecting from ACAS?

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Mike McFerran, Ares Management L.P. - CFO [7]

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Sure. As we highlighted in the call, Q4 was a little elevated at $32 million of G&A, but I think a year ago we specified our objective was to keep on an average basis, G&A at $30 million or better. With the year coming in at under $115 million we achieved that. So I still think that $30 million or so number is a good proxy looking forward.

With respect to ACAS, the primary step-up in expense will be the addition of both permanent and some transitional professionals, both on the investment team and operations side. Beginning with the first quarter, we think that would have an impact on comp expense of about $4 million, but would actually run down during the course of the year as some of those transitional employees run off.

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Chris Harris, Wells Fargo Securities, LLC - Analyst [8]

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Thank you.

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Operator [9]

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The next questioner today is Patrick Davitt with Autonomous. Please go ahead.

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Patrick Davitt, Autonomous Research LLP - Analyst [10]

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Thanks for taking my question. Do you still stand by the 30% margin guidance you gave last quarter with ACOF turning on?

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Michael Arougheti, Ares Management L.P. - President [11]

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We do.

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Patrick Davitt, Autonomous Research LLP - Analyst [12]

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Great. And then more broadly, as the chances of reduced regulatory and capital constraints on the banks have gone up, could you try to frame the evolution of that group as a competitor? In other words, how competitive were they pre-crisis in your business and to what extent you benefited from the post crisis bank regulatory regime. And within that vein, any thoughts you have about potential headwinds as those constraints are removed, if they are?

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Michael Arougheti, Ares Management L.P. - President [13]

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I would just clarify. I think the conversations that are happening are less about bank regulatory capital relief and more about bank regulatory relief. And the reason I highlight that is a lot of the conversation is about partial rollbacks of existing regulation coupled with the potential for actually higher equity capital requirements. So I think it's important that when we speak about what the potential outcomes are here that we do separate the conversation about capital commitment or capital requirements versus the regulatory framework particularly because Basel III is still in implementation and a large driver of that.

I think it's also important to start the conversation on this about the history of these asset classes that we're now demonstrating leadership in. And if you really track the evolution of the private credit markets, the biggest driver of this opportunity was bank consolidation in the US and the simultaneous scaling up of capital in the hands of nonbank providers over the course of the last 20 years.

So if you go back and just look at, for example, the number of banks, the percentage of leveraged loans getting made within the banking system versus getting made without, leading up to the financial crisis, there was already a meaningful shift in where these loans were getting made. I think post the crisis, whatever marginal assets were still within the banking system did find their way out. So I think the question then is what could catalyze them to go back. And a couple comments on that.

One, I think the banking model right now, particularly if you are having a conversation around the increased equity capital requirements, is largely I believe going to be focused on reducing the cost of compliance and simplifying their businesses, and benefiting from rising rates as opposed to wholesale changes in asset strategy. As you can appreciate at Ares, we have he very deep relationships within the banking sector and in our conversations we have not had any meaningful indication that asset strategies will change.

One of the reasons I think that they won't change is a lot of the infrastructure that folks like Ares have developed around aggregating and managing these assets has actually already left the banking sector. And whether you're talking about the scale of that infrastructure or the compensation schemes around how you incentiveize people outside of the banking system I think it's hard to put it back in.

Number two, another way to think about this is the banks are actually already accessing this asset class but they're doing it in partnership with us. Maybe this is semantics. But I don't actually view the banks as competitive, I view them at symbiotic and good partners of ours. And when you look at how we fund ourselves across our entire ill liquid credit platform, we're actually borrowing from the banks against our collateral. It is more efficient in my opinion for banks to allocate capital into these asset class as either a portfolio lender, re-discount lender, securitize, where there's more efficiencies of scale, more variability of expense and better ratings which lead to higher ROEs against increased regulatory capital.

So I'm hopeful that to the extent that there is an easing that increases folks' appetite within the banking sector to allocate more to these types of asset classes that will actually do it in partnership with us as opposed to in competition with us. So long way of saying we're watching it by -- I actually think it will probably be a net positive for the business, not a negative.

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Patrick Davitt, Autonomous Research LLP - Analyst [14]

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Great answer. Thank you.

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Operator [15]

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Our next questioner today is Greg Siegenthaler with Credit Suisse. Please did ahead.

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Jordan Freelander, Credit Suisse - Analyst [16]

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Good afternoon, everyone. This is Jordan [Freelander] filling in for Craig. Where do you guys see your biggest product holes now? Could you update us quickly on your appetite for M&A?

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Michael Arougheti, Ares Management L.P. - President [17]

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Sure, product holes, we've talked about this on prior calls. We don't view that we have significant gaps in our product set. So where we're seeing opportunity is more in adjacent or step-out strategies leveraging something that we already do well.

I mentioned in our prepared remarks this junior capital direct lending fund. That's a new step-out strategy. It will have a meaningful amount of capital put behind it, but we're able to do it leveraging our existing capabilities.

So I think where we see gaps, it's more where can we expand the margins of stuff that we already do well as opposed to wholesale new markets to go after. In terms of M&A, we've had a very good experience on the M&A side I think as people know, both within ARCC acquiring Allied and ACAS to scale up that business and also at Ares Management in acquiring capabilities and people that we feel are additive to our business and bring a capability that we don't have. So I think M&A will continue to be a part of the opportunity set, both at the management Company and within the three business lines as we scale up the business.

As we talked about before, it sounds simple to say it but the filter for us is pretty straightforward. We need to acquire things that bring new capabilities that we don't have that we feel can make our business better. We need to have high conviction that we can actually make their business better by bringing them new distribution or new information and relationship capabilities that they don't have.

It has to be highly strategic. It has to be financially accretive and I think most of all it has to be a great social and cultural fit for us. And that may sound simple, but when you canvas the market for opportunities, it's very hard to check all four of those boxes. So we're constantly looking at opportunities but the bar is very, very high for us.

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Jordan Freelander, Credit Suisse - Analyst [18]

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Great. Thanks. And then just one quick follow-up. Can you gives us some more color on your thoughts on the retail segment and update us on some of the initiatives you're taking to break into this channel?

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Michael Arougheti, Ares Management L.P. - President [19]

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Sure. So we think of attacking the retail markets slightly differently than I think some of the ongoing conversations that folks are having around liquid alts and smart beta ETFs and hedge fund replication ETFs. When we think about retail, largely where we're focusing is building off of our core capabilities in the BDC closed end credit fund and mortgage REIT space.

We view each of those structures as highly scalable and probably one of the most efficient ways for traditional retail investors to get access to alternative product and ill liquid assets. So you're going to continue to he see us growing our existing vehicles and likely building off of our track records there to hopefully look at new strategies within those structures.

Two, on the upper end of the market in terms of the high net worth and mass affluent channel, we have very good capital markets relationship was the Street and we are constantly distributing product through the private banks and the wire houses into the traditional retail market.

And then lastly, we are in the early stages of developing what we think is a very compelling joint venture with a firm called [Scion Securities] in the non-traded space. I think as people know, that market's gone through a fair bit of disruption, given some of the competitive dynamics in the space and some of the regulatory issues in the sector around [DOL, fiduciary] and others. But we see that as a very significant opportunity to take our core alternative product into a segment of the retail space that we're not currently in.

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Jordan Freelander, Credit Suisse - Analyst [20]

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Great. Thanks for taking my questions.

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Operator [21]

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Our next questioner is Michael Cyprys with Morgan Stanley. Please go ahead.

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Michael Cyprys, Morgan Stanley - Analyst [22]

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Good afternoon. Thanks for taking the question. Just curious if we could turn to direct lending for a moment, an area of growth for you, you've been talking to. Just curious if you could talk a little about the competition within the direct lending space, maybe contrast US versus Europe and how the competition is evolving. Certainly others are getting into the space and citing this as a growth area. How much is that impacting how you guys are going about growing and how is it impacting pricing and deal flow?

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Kipp DeVeer, Ares Management L.P. - Head of Credit Group [23]

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I can take that, this is Kipp DeVeer. Thanks for the question. Just a couple of facts. We've been building the business in direct lending both in the US here since 2004 and in Europe since 2008. And we do think we have some pretty significant competitive advantages in that business. And we talk about them pretty often with our investors so we're happy to share them here with you all.

The scale of our capital base is definitely an advantage for us. The size and the breadth of our team is a significant advantage for us. So to put that in perspective, the direct lending business today between the US and Europe is north of $30 billion of assets under management. We have roughly 150 people directly engaged in that business in 10 offices in the US and Europe which allows us to compete effectively.

The US business is invested in north of $30 billion of capital on behalf of investors over the last 12 or 13 years. And that track record and that relationship network that we built, along with obviously the platform and the reputation of our people is something that has continued to allow us to compete extraordinarily well despite, to your point, dramatic inflows into the asset class and increasing competition.

So is it harder than it was 10 years ago? It is. Do we still think it's a fabulous business? We do. I think that in Europe, as you're probably aware, things are just much, much less well developed. We're not as far along.

So to grow our US direct lending business, we've done many some, to Mike's prepared remarks, step-out strategies focusing on larger borrowers where we see real opportunities on the junior side with a private fund that we're raising and we've gone the other way as well. We've actually created some strategies in the asset based financing world and the securitization business where we're originating smaller ABL deals and smaller private securitizations that probably used to be bank business that really isn't anymore.

So in the US the growth is has really been adding people on top of solidifying the advantages and widening the fairway as I like to describe it. Europe, we benefited from just a very significant first mover advantage, starting in 2008 with something unique here, I think. When we spoke about direct lending to investors in 2008 and 2009 in Europe it was very, very new and unique in its approach. That market's become more crowded but I worry less there about competition because I just think that there's more running room.

I don't think we'll ever get to a point where direct lending really takes share from the banks the way that it has here in the US because I do believe that both in the UK and in Europe, the banks will continue to want to be in the lending business, where here in the US banks really don't want to be in the middle market lending business. So hopefully that's a helpful compare and contrast on the two and thoughts around why we're so excited about our business and our positioning.

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Michael Cyprys, Morgan Stanley - Analyst [24]

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Great. Thanks, Kip. Just a follow-up there on direct lending. Maybe correct me if I'm wrong, but I think historically, your business has been a little bit more sponsor driven in terms of the type of product in lending that's gone on. Can you just update us on what that mix is today, how that's trended historically and how you see that evolving over the next five, 10 years, is there an opportunity to broaden out beyond sponsor finance?

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Kipp DeVeer, Ares Management L.P. - Head of Credit Group [25]

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Yes, I think perceiving us as having led with a sponsor business in both the US and Europe I think is accurate. Europe is probably a bit more heavily weighted towards sponsored finance than the US these days. Believe it or not, the non-sponsored business is something that we've always been engaged in here, so we do do deals directly with companies and those tend to be owned in the US either by families or by entrepreneurs. So that has been a focus and will remain a focus of ours. But I think we don't market it as consistently perhaps as others who say we pursue a non-sponsored strategy.

To be clear, in the US, we have a whole host of different verticals that we're engaged in. So we have portfolio companies that are as small as $10 million of EBITDA and portfolio companies that have $200 million of EBITDA. Again, size wise, very broad. Sponsored, non-sponsored, with he have a dedicated power and project finance team. We have a dedicated oil and gas team. We have a dedicated life sciences, venture, technology team. So there are ways to continue growing, both through industry specialization and also just broadening out the business.

Europe, I think, actually is a fabulous opportunity for non-sponsored. And what we found is as your capital base grows and as your reputation and track record kind of is continuing to be well received in the market, non-sponsored business tends to find you as much as you can find it through your relationship network and your origination. As you're probably aware, there are loads and loads of UK and European based companies that are mid-market businesses that aren't sponsor owned and I think we've continued to put resources against that effort going forward.

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Michael Cyprys, Morgan Stanley - Analyst [26]

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Great. Thanks, Kipp. Really appreciate it.

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Kipp DeVeer, Ares Management L.P. - Head of Credit Group [27]

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Sure.

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Operator [28]

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The next questioner today is Mike Carrier with Bank of America-Merrill Lynch. Please go ahead.

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MIke Carrier, BofA Merrill Lynch - Analyst [29]

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Thanks guys. On the DE or the distribution outlook, we have pretty good visibility given what you guys mentioned in terms of the outlook for FRE. Just on the incentive side and the realized portion, Mike, you mentioned the one investment, the Clayton Williams. When I look at the overall portfolio on what can generate like performance fees, just wanted to get a sense on how that looks maybe relative to 2016, how seasoned it is. I know everything's predicated on the market backdrop and timing so it's tough to gauge, but just wanted to get some sense, just because there was some decent activity in 2016 and obviously with that investment, there's some in 2017. Just wanted to get any color around that.

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Mike McFerran, Ares Management L.P. - CFO [30]

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Sure. Look, I think we're in an environment where asset prices where they are is an attractive realization environment. So you gave all the caveats I would otherwise give in your question. So I'm not going to repeat them. But look, we have a fair -- we have $169 million of accrued performance fees, just under half of those are in funds past their reinvestment period. So those are fees that will be monetized more quickly than funds early on in deployment.

And I also want to highlight and I think Mike mentioned, or we mentioned this in our prepared remarks, that if you think about our undeployed AUM, or undeployed AUM that's incentive eligible, it was $19.2 billion in funds that were already incentive generating. I think there's a lot of dry powder there in funds that are already over their hurdles as well as stuff that's built up on the balance sheet.

As far as timing between Q2, Q3, Q4, that is hard to give you a good prediction on. I think we've said in the past, if you look at the $169 million that we have, if I was to give you the back of the envelope over a couple years, it's not unreasonable.

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MIke Carrier, BofA Merrill Lynch - Analyst [31]

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Got it. Okay. Just as a follow-up, there's a lot of potential change out there, whether it's on regulation or on taxes. So just wanted to get your guys' updated thoughts, I know we don't have anything that's concrete, but just how you guys are thinking about different scenarios with tax reform and potential conversion for you guys. And then on regulatory reform, anything or any update on leverage in BDCs and if that did increase, what that could potentially mean in terms of an opportunity for you. I'll take the first part related to tax reform and what our considerations are around corporate structure. As a publicly traded partnership, clearly we pay a lot of attention to it. And discussion around corporate tax rates going down to 20% to 25% made the prospect of reassessing our corporate structure increasingly intriguing. There's a lot of moving pieces that are being talked about and until we see something probably more advanced it's hard for us to have a clear view on.

However, I would he highlight that if you think about when we articulate our business, most of our revenue is already being taxed through corporate blockers. So a decrease -- a meaningful decline in corporate tax rates would be completely beneficial to our unit holders and, again, probably be a good inflection point to reassess corporate structure and potentially make the flip to a C-Corp.

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Michael Arougheti, Ares Management L.P. - President [32]

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With regard to BDC legislation, I do believe that that is a fantastic opportunity for ARCC and Ares Management. It has been building momentum for many years. I think with the new administration and then the bipartisan support that we're seeing in both houses of Congress, our view is that the likelihood and probability of seeing some BDC legislative support is increasingly higher than it was a year ago.

Just one data point on that. If you look at the Financial Choice Act that was put forward by Chairman Hensarling, the BDC legislation fits prominently within that proposed legislation. I think as folks know, it got as far as passing the House financial services subcommittee a year ago and was beginning to make its way through the legislative process. Obviously the election interrupted that, but we feel that it is now moving in the right direction.

To Kipp's point about the boundaries of our opportunity continuing to grow and expand, clearly if there was legislative relief to increase leverage at BDC, that would allow us to be much more impactful at lower yield and lower risk segments of the market in a way that we heretofore haven't been able to really go after. And getting at that part of the market would be pretty straightforward to us, given the built out infrastructure we have around origination and portfolio management. So don't know quite how to handicap it, but I think the probability has gone up dramatically. We do sense good bipartisan support and obviously the SEC historically had been a little bit of a constraint to progress and I think even that constraint is, if not lifted, is at least moving in the right direction as well.

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MIke Carrier, BofA Merrill Lynch - Analyst [33]

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Okay. Thanks a lot.

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Operator [34]

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The next questioner today is Patrick Davitt with Autonomous. Please go ahead.

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Patrick Davitt, Autonomous Research LLP - Analyst [35]

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Thanks for the follow-up. Just have a quick one on the potential tax benefit. Am I right in assuming there's no potential negative impact there, right? It's all icing.

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Mike McFerran, Ares Management L.P. - CFO [36]

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There's no potential negative impact. We highlighted in our prepared remarks that we don't know the outcome. Because of the potentially material nature of this, we have submitted a request to the IRS to affirm the treatment of this and we hope to hear back preferably before our next earnings call for Q1 results, but we can't be certain of that.

But I think as we laid out in our prepared remarks, practically, we think there's two alternatives. One is being able to treat it as an immediate deduction and the second would be to amortize over a period of time. If it was treated as an immediate deduction what that would mean is we effectively would have deduction that would exceed what we think would be -- well, if I just looked at 2016, our taxed income in 2016 that deduction would be larger then.

So looking forward, it wouldn't be unrealistic to think that 2017 would have no corporate taxes paid on management fees and we probably also have a recapture of 2015 and 2016 taxes paid through some amended returns. Probably give you the range of magnitude of that. We think it would be upwards of $0.40 to $0.45 impact on distributable earnings per common unit.

So again, a one time deduction would be pretty significant. If it was over let's say 15 years, that impact we guess would be probably closer to $0.03 per year on a distributable earnings per common unit after taxes.

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Patrick Davitt, Autonomous Research LLP - Analyst [37]

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Very helpful. Thanks.

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Operator [38]

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Our next questioner today is Robert Lee with KBW. Please go ahead.

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Robert Lee, Keefe, Bruyette & Woods - Analyst [39]

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Great. Thank you. And you answered most of my questions but just real quickly, and I apologize if you went through this, because I came on late. But did you at all quantify the Clayton Williams impact on accrued and maybe what you would -- your thoughts are for DE impact Q2 and beyond?

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Mike McFerran, Ares Management L.P. - CFO [40]

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With respect to Clayton Williams, the impact on the accrued, it would be as far as -- (inaudible) for DE, what our funds would receive is a mix of cash and equity from Noble Energy, that exact mix we're not sure of today. Assuming -- so you have kind of the variable of what Noble Energy stock prices are in the future after the close of that transaction, and when we modify that stock in the future, what the prices are. If we look at the stock price of Noble Energy on the day of signing of that deal, assume it was converted -- that equity was converted to cash on that date, the carry combined with our GP interest in the fund would have contributed effectively $40 million to distributable earnings whenever it subsequently is monetized. We think would happen over several quarters post closing.

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Robert Lee, Keefe, Bruyette & Woods - Analyst [41]

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Great. Thank you. That was my only question right now. Thanks.

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MIke Carrier, BofA Merrill Lynch - Analyst [42]

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Thanks, Rob.

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Operator [43]

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The last questioner today Is Alex Blostein with Goldman Sachs. Please go ahead.

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Grayson Barnard, Goldman Sachs - Analyst [44]

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This is Grayson Barnard filling in for Alex here, and I think most of our questions were answered. Just the last one on expecting the uptick in realization activity, just wanted to get your thoughts on the impact of management fees and how you're thinking about that impacting the run rate and FRE margins going forward. Thanks.

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Mike McFerran, Ares Management L.P. - CFO [45]

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I think if I understand your question, if realizations increase, what does it do to management fees? For our more mature funds that are past investment periods, it reduces management fees. However, obviously that's why we raise successor funds.

So using our private equity business as an example, we no longer earn management fees on our second private equity fund. Any residual realizations coming from there would have no reduction of management fees. Realizations coming from our more recent vintages of our private equity funds would have a reduction as once a past investment period were paid on committed capital. But as long as we're effectively raising successor funds, which we do, that are larger than predecessor, it should be net positive to FRE.

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Grayson Barnard, Goldman Sachs - Analyst [46]

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Got it. Thanks.

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Mike McFerran, Ares Management L.P. - CFO [47]

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Then obviously PRE benefits from the realizations.

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Operator [48]

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This will conclude the question-and-answer session. I would like to turn the conference back over to Michael Arougheti for any closing remarks.

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Michael Arougheti, Ares Management L.P. - President [49]

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Great. Well, we said it once but we'll say it again, we thank everybody for their continued support and appreciate everybody's time today and we look forward to speaking to you guys in a couple months. Have a great day.

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Operator [50]

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Ladies and gentlemen, this concludes our conference call for today. If you missed any part of today's call, an archived replay of the conference call will be available through March 24th, 2017 by dialing 877-344-7529, and to international callers by dialing 1-412-317-0088. For all replays please reference the conference number which is 10099239. An archived replay will also be available on our webcast link located at the home page of the Investor Relations website. Thanks for you attending and you may now disconnect your lines.