Fitch Expects to Rate Ares' Mandatory Convertible Preferred Stock 'BBB-(EXP)'

Published: 2024-10-09 05:37:19 ET ARES

Fitch Ratings has assigned an expected rating of 'BBB-(EXP)' to the mandatory convertible preferred stock expected to be issued by Ares Management Corporation (A-/Stable).

Proceeds from the issuance are expected to be used to partially fund its acquisition of GLP Capital Partners' international business (GCP International), excluding its operations in Greater China. Fitch views the partial equity method of funding the acquisition favorably.

The proposed mandatory convertible preferred stock is subordinated to any existing and future debt but senior to common shares. Distributions, when and if declared, will be payable quarterly at a fixed annual rate and are cumulative and payable in cash, common stock or through any combination of both, as determined by Ares. Unless distributions have been declared on the mandatory convertible preferred shares, Ares may not declare or pay distributions on its common shares. The mandatory conversion date is expected to be Oct. 1, 2027.

Key Rating Drivers

Ares' ratings reflect its solid competitive position as a global diversified alternative IM, sustained margin improvement, experienced management team, solid investment track record, strong and predictable fee-related earnings given meaningful fee-earning assets under management (FAUM) and modest leverage.

Rating constraints for the industry include the 'key person risk' institutionalized in many limited partnership agreements; reputational risk, which can affect a firm's ability to raise future funds; and legal and regulatory risk that could alter the alternative IM industry. Rating constraints specific to Ares include lower fee-related EBITDA (FEBITDA) margins relative to higher-rated peers and lower historical incentive income, albeit emerging, and an above average payout ratio.

Fitch also notes continued challenging macroeconomic conditions, including slowing economic growth, inflationary pressures, geopolitical risk and potential uncertainty surrounding the U.S. elections, all of which may continue to pressure investment performance and fundraising.

The Stable Outlook reflects Fitch's expectation that Ares will continue to generate stable management fees and maintain operating margins within Fitch's 'a' category earnings and profitability benchmark range, retain FAUM through the raising of new and expansion of existing funds with leverage at-or-below 2.5x, and retain a solid liquidity profile in order to fund operations, meet co-investment commitments to the funds and service debt.

RATING SENSITIVITIES

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

A sustained deterioration in the FEBITDA margin below 30%;

Material declines in investment performance that adversely affect fundraising;

A sustained increase in leverage above 2.5x;

Weakening interest coverage or materially weakened balance sheet liquidity;

A key-person event, and/or a legislative or regulatory event that negatively affects the company's ability to raise FAUM and generate fees.

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

Maintenance of a FEBITDA margin above 40%;

Increased fee revenue diversity

An improved ability to generate incentive income;

Maintenance of leverage below 2.5x and interest coverage above 8.0x.

DEBT AND OTHER INSTRUMENT RATINGS: KEY RATING DRIVERS

The expected mandatory convertible preferred equity rating is three notches below Ares' Long-Term Issuer Default Rating (IDR) of 'A-', reflecting the deeper subordination and loss absorption characteristics of the securities relative to subordinated debt. The expected rating incorporates two notches for the deep subordination and one notch for the going-concern loss absorption nature of the securities.

Fitch expects to afford the instrument 100% equity credit given its required conversion to common equity, its subordination to debt and the predetermined date of conversion, which is not tied to a trigger event. Fitch will assess final terms of the security to ensure they comply with 100% equity credit treatment in accordance with Fitch's 'Corporate Hybrids Treatment and Notching Criteria' dated Nov. 12, 2020, prior to finalizing the rating.

DEBT AND OTHER INSTRUMENT RATINGS: RATING SENSITIVITIES

The expected mandatory preferred rating is linked to the IDR and is expected to move in tandem with it.