Business context and reporting period
The supplied filing is Oaktree Capital Group, LLC’s audited Form 10-K for the fiscal year ended December 31, 2012, filed March 14, 2013. Although the request metadata names Brookfield Oaktree Holdings, LLC and “2012 Q4,” the filing itself identifies Oaktree Capital Group, LLC and reports the full fiscal year; quarterly data are also provided. Oaktree is an alternative investment manager with one investment-management segment and $77.1 billion of AUM at year-end.
Oaktree’s GAAP statements consolidate most managed funds despite Oaktree’s generally small economic interests in them. Consolidated revenue and cash flows therefore include substantial fund activity and should not be read as equivalent to the management company’s own operating performance or available cash. Segment results, ANI and distributable earnings are management-defined measures and are not GAAP measures.
Financial and operating metrics
| Metric | FY 2012 | FY 2011 |
|---|---|---|
| Segment revenue | $1.411 billion | $1.052 billion |
| Management fees | $747.4 million | $724.3 million |
| Incentive income | $461.1 million | $304.0 million |
| Investment income | $202.4 million | $23.8 million |
| Adjusted net income (ANI), Operating Group | $717.3 million | $428.4 million |
| ANI attributable to OCG | $114.4 million | $48.8 million |
| Fee-related earnings | $307.3 million | $315.0 million |
| Distributable earnings | $672.2 million | $488.5 million |
| GAAP net income (loss) attributable to Oaktree Capital Group, LLC | $107.8 million | $(96.0) million |
| GAAP consolidated total revenue | $145.0 million | $155.8 million |
| GAAP consolidated total assets | $43.87 billion | $44.29 billion |
Segment revenue rose about 34%, led by higher incentive income and investment income. Management fees grew about 3%, while fee-related earnings fell about 2%. Segment operating expenses were $662.7 million, including $330.1 million of compensation and benefits and $222.6 million of incentive-compensation expense. FY 2012 GAAP consolidated results included $6.672 billion of net income, largely attributable to consolidated fund investors; after non-controlling interests, $107.8 million was attributable to Oaktree.
Year-end AUM was $77.1 billion, up 2.9% from $74.9 billion. Management fee-generating AUM was $66.8 billion, approximately flat year over year; incentive-creating AUM fell 6.1% to $34.0 billion. Uncalled commitments were $11.2 billion. Oaktree reported $2.138 billion of fund-level accrued incentives, an off-balance-sheet estimate of potential incentive income, not a guaranteed receivable or cash amount.
Cash and cash equivalents attributable to the segment were $458.2 million; including U.S. Treasury and government agency securities, the amount was $828.8 million. Corporate debt obligations were $615.2 million. A $500 million revolving facility was undrawn at year-end. Consolidated funds separately had $491.6 million of borrowings, generally nonrecourse to Oaktree. Segment liabilities totaled $965.7 million. Management stated that available liquidity was sufficient for operating needs and commitments for at least the next 12 months.
Consolidated operating cash flow was $7.0 billion, but principally reflected consolidated fund investment sales and maturities; it is not a measure of cash generated solely by Oaktree’s management business. The company reported $424.1 million of total distributions to Class A and OCGH unitholders in 2012. Class A distributions attributable to 2012 quarters totaled $2.94 per unit, including $1.05 per unit for the fourth quarter declared in February 2013 and paid March 1, 2013; $2.31 per unit was declared during calendar 2012.
Material changes versus the prior comparable period
- Segment ANI increased to $717.3 million from $428.4 million, primarily on $178.6 million more investment income and $157.1 million more incentive income, partly offset by lower fee-related earnings.
- Incentive income rose 51.7% to $461.1 million. Tax-related incentive distributions were $200.7 million, broadly level with 2011; non-tax-related incentive distributions increased to $260.4 million, principally from real estate and control-investing realizations. Evergreen-fund incentive income rose to $41.6 million, including $40.5 million from Value Opportunities.
- Investment income increased to $202.4 million from $23.8 million, reflecting stronger fund returns and increased income from Oaktree’s one-fifth interest in DoubleLine, including performance-fee income.
- Fee-related earnings declined to $307.3 million from $315.0 million as expenses grew faster than management fees. Compensation and benefits rose 7.1%; general and administrative expense increased 8.4% at the segment level.
- Oaktree’s attributable GAAP result moved from a $96.0 million loss to $107.8 million of income. A major factor was the drop in equity-based compensation expense to $36.3 million from $948.7 million, as units issued in the 2007 restructuring completed vesting in January 2012.
- Fund-level market performance improved markedly: consolidated funds recorded $4.561 billion in realized gains and $835.2 million in unrealized appreciation in 2012, versus $1.744 billion in realized gains and $3.065 billion in unrealized depreciation in 2011. These gross consolidated fund results largely accrue to fund investors, not Oaktree.
- Closed-end fund distributions reached a record $12.7 billion, reducing their AUM, while $9.6 billion in market-value gains and $6.5 billion in new commitments supported total AUM growth. Opps IX raised nearly $5.0 billion but had not begun its investment period at year-end.
Outlook, commentary, risks and unusual items
- Management described 2012 as a period of recovering markets, low interest rates and investor demand for yield. It noted record corporate bond issuance and low defaults, limited bargain opportunities in distressed debt, and continued opportunities in real estate, principal investing, power and mezzanine strategies.
- New or developing offerings included Enhanced Income Fund, global high-yield bonds, strategic credit, a successor real estate-debt strategy and an emerging-markets distressed-debt fund expected to begin managing assets by mid-2013. Oaktree stated it does not intend to provide earnings guidance and does not expect steady earnings growth.
- Results and cash generation are volatile because incentive income depends on fund performance, realizations, preferred-return hurdles and high-water marks; investment income also varies with markets. Management may limit fundraising, reduce fees or return capital where it believes opportunities do not justify additional AUM.
- Key risks include global market and credit conditions, fundraising and redemptions, competition and fee pressure, retention of key professionals, illiquid and subjective fund valuations, conflicts across funds and capital structures, leverage and counterparty exposure, foreign-exchange movements, regulation and tax-law changes. Oaktree estimated a 10% decline in fund investment values could reduce segment management fees by about $18.7 million and investment income by about $128.7 million; the effect on closed-end incentive income was not readily quantifiable.
- The December 2012 refinancing established a five-year $250 million term loan and $500 million revolver. The bulk of the term-loan rate was fixed at a blended 2.60% for the first four years through swaps. Oaktree reported compliance with its debt covenants at year-end.
- One-time or unusual items included a $7.1 million tax expense from remeasuring deferred tax assets, partly offset by a $6.3 million reduction in the tax-receivable-agreement liability recorded as other income; a $0.8 million debt-issuance-cost write-off; and a $1.7 million write-off of corporate-investment receivables. The 2012 GAAP result also reflects the large reduction in legacy equity-compensation expense.
- The tax receivable agreement requires payment to OCGH unitholders of 85% of specified realized tax savings. At year-end, the filing reported a $134.953 million liability associated with the agreement, including obligations related to the 2007 offering and 2012 IPO. The filing’s estimates of future aggregate payments assume sufficient taxable income and no material tax-law changes.
- A lawsuit, Kaplan Industry, Inc. v. Oaktree Capital Management, L.P., sought damages exceeding $800 million. Oaktree said the claim was without merit and exposure was remote; the company stated that no pending legal actions were expected to have a material impact on results, cash flows or financial condition.
- The independent auditor issued an unqualified opinion on the financial statements. Management reported effective disclosure controls at the reasonable-assurance level; the 10-K did not include a Section 404 internal-control assessment because of the newly public company transition period. A previously identified significant deficiency in cash-flow classification controls was reported as remediated in 2011.
Most important facts an investor should verify
- Confirm the filing entity and period: this is Oaktree Capital Group, LLC’s FY 2012 10-K, not a Brookfield Oaktree Holdings, LLC filing or a standalone Q4 report.
- Reconcile segment measures (ANI, fee-related earnings and distributable earnings) to GAAP attributable net income, and distinguish them from consolidated fund results that largely belong to third-party investors.
- Assess the sustainability and cash realization of 2012 incentive income and investment income, including the $2.138 billion fund-level accrued-incentive balance and the amounts tied to fund valuations and future realizations.
- Review fee-generating AUM, fundraising, fund liquidation distributions, redemption flows and the timing of Opps IX and other new strategies for implications to recurring fees.
- Check corporate liquidity, debt maturities, revolver availability, covenants, capital commitments and the tax receivable agreement’s cash-payment burden; do not treat consolidated fund cash or operating cash flow as freely available to Oaktree.
- Monitor valuation uncertainty and Level III exposure: consolidated funds held $19.9 billion of Level III investments at year-end, with values dependent on material unobservable assumptions.
- Review the status and potential developments in the $800 million-plus Kaplan litigation, tax uncertainties, regulatory changes, key-person risks and the company’s post-IPO internal-control reporting.
- Consider governance and dilution: principals controlled approximately 97.6% of voting power as of March 2013, and substantial OCGH units were exchangeable for Class A units or equivalent consideration subject to restrictions and board approval.