Ares Joins Sell-Off Bakeoff

Ares Management could be the next private equity firm to sell a piece of its management company to institutional investors, according to a source familiar with the situation. The Los Angeles-based firm is said to be early in discussions with potential buyers, and has not retained an investment bank.

“They seem to really just be testing the waters at this point,” the source said.

Ares manages several private equity and debt funds, plus a publicly-traded business development company called Ares Capital Corp. (Nasdaq: ARCC). Its first private equity fund had called down approximately 80% with a 27.1% IRR through the end of Q3 2006, according to investor CalPERS. Its second private equity fund closed just last year, and only had called down around 10% of its capital through the CalPERS reporting period.

An Ares spokesman said that the firm would have “no comment” on the sale process. But I have a few comments, because my job description demands it. Here we go, in notes format:

*** Ares is not unique in its pursuit of a management company stake, nor is it even part of a small club. Almost every reputable private equity firm around has begun putting feelers out about such a transaction, with the exception of a few that have already closed such deals in the past (Carlyle Group with CalPERS, for example). I even learned yesterday that a fund-of-funds is considering the option.

*** Only a fraction of these deals will ever get done. Some will obviously falter because the firms themselves back out, but the bigger issue will be a limited number of partners. I mentioned that Ares so far only has talked with a “small circle” of buyers, and the same statement could have been made for most firms engaged in such discussions. These would be large, long-term commitments – which leaves out almost everyone except for the largest pension funds, a few publicly-traded corporations and a variety of Middle Eastern interests. Of equal import, it is unlikely that many of these buyers would want to do more than one or two of these deals – at least until they’ve had some time to evaluate performance.

*** Why are so many firms interested? Because private equity has become the recent stock market boom’s consensus driver, and general partners are looking to cash in. Blackstone plans to do it via an IPO (and others may follow), but a small management company sale is generally viewed as the safer route (particularly if we’re nearing a private market peak).

*** There also is that pesky issue of tax treatment changes for capital gains. I don’t want to rehash the entire issue – although feel free to keep ripping me here – except to say that the prospect of lowered take-home profits is helping fuel this rush to sell. The obvious conflict, of course, is that it should have the exact opposite effect on buyers. So, unless pension fund managers opt to short legislative change, the tax issue is probably a wash for the purposes of this conversation.

*** One exception to the supply/demand gap could be a new OTC private market being devised by Goldman Sachs (sounds like a more organized and public version of the secondaries market), which is described in today’s Wall Street Journal. This is apparently the option that Oaktree is considering.

*** Finally, there is the overall issue of how such sales would affect the overall limited partner community. You know, the vast majority of investors either too small or too conservative to engage in such transactions. There really is no clear answer here. On the one hand, this could be a boon, with experienced/sympathetic LPs having a greater say in GP decision-making. On the other, these LPs could realize that their interests really are more aligned with GPs than with their LP brethren, and could prove punishing at worst, or irrelevant at best.