Business context and reporting period
Oaktree Capital Group, LLC’s unaudited Form 10-Q covers the quarter and six months ended June 30, 2013. Oaktree is a global alternative investment manager focused on credit, distressed debt, control investing, real estate and other strategies. The filing identifies Oaktree Capital Group, LLC—not Brookfield Oaktree Holdings, LLC—as the registrant. Its statements consolidate many managed funds, so consolidated totals include substantial assets, liabilities, income and cash flows belonging to outside fund investors.
Financial performance and key metrics
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Consolidated revenue | $52.4 million | $29.2 million | $95.0 million | $66.3 million |
| Net income attributable to Oaktree Capital Group, LLC | $56.6 million | $24.7 million | $114.1 million | $43.3 million |
| GAAP net income per Class A unit | $1.71 | $0.84 | $3.61 | $1.66 |
| Adjusted net income (Operating Group, non-GAAP) | $297.0 million | $165.5 million | $632.7 million | $339.1 million |
| Distributable earnings (Operating Group, non-GAAP) | $313.2 million | $176.4 million | $608.2 million | $313.7 million |
| Fee-related earnings (Operating Group, non-GAAP) | $60.2 million | $82.2 million | $124.4 million | $162.5 million |
Operating Group adjusted net income and distributable earnings rose substantially, chiefly on higher incentive income and investment income. Fee-related earnings declined as management fees fell and operating costs increased. These non-GAAP segment measures exclude consolidated-fund results and are not directly comparable to consolidated GAAP revenue or income.
- Revenue drivers: Segment incentive income rose 162% to $338.1 million in Q2 and 247% to $665.2 million for the first half. Opps VIIb accounted for $272.5 million and $467.7 million, respectively. Segment management fees fell 3.3% in Q2 and 3.5% for the first half, mainly because liquidating closed-end funds sold assets; open-end fund fees increased.
- Expenses and margins: Incentive income compensation rose with incentive income. Compensation and benefits also increased, partly reflecting 9.2% headcount growth and higher phantom-equity expense. The filing does not provide a conventional consolidated operating-margin measure; consolidated expenses include fund-related amounts and incentive compensation.
- Fund investment results: Consolidated funds recorded $832.0 million in realized investment gains and $111.8 million in unrealized depreciation in Q2. For the first half, realized gains were $2.03 billion and unrealized appreciation was $909.7 million. Most fund investment income and gains accrue to outside investors.
- Cash flow: Consolidated operating cash flow was $4.47 billion for the first half, versus $2.69 billion a year earlier. It includes fund investment purchases, sales and maturities and is not a measure of cash available solely to Oaktree. Consolidated cash and equivalents ended at $2.89 billion, including $2.69 billion held by consolidated funds.
- Liquidity and debt: Oaktree and its operating subsidiaries reported $196.2 million of cash and $938.1 million of Treasury and government securities, or about $1.13 billion combined, against $592.0 million of debt. The $500 million corporate revolver was undrawn. Consolidated funds separately had $1.51 billion of credit-facility borrowings, generally nonrecourse to Oaktree. Oaktree reported covenant compliance and stated its liquidity sources should meet working-capital needs for at least 12 months.
- Assets under management: AUM was $76.4 billion at June 30, down from $78.8 billion at March 31, 2013 and $78.7 billion a year earlier. Management fee-generating AUM was $64.6 billion, and incentive-creating AUM was $32.1 billion. The quarterly AUM decline primarily reflected $4.7 billion of closed-end fund distributions.
- Capital returns and issuance: The May 2013 offering issued 8.05 million Class A units at $53.50 each, generating $419.9 million net proceeds, which were used to acquire interests in Oaktree’s business from existing holders; Oaktree retained none of the proceeds. First-half distributions declared were $2.46 per Class A unit. On August 6, Oaktree declared a further $1.51 per unit distribution, payable August 20.
Material changes, outlook, risks and contingencies
- Management described generally strong markets early in 2013, followed by a Q2 setback amid concern over Federal Reserve bond-purchase tapering. It said profitable realizations and elevated asset prices left attractive distressed-debt opportunities relatively scarce, while identifying selected opportunities in European middle-market companies, commercial real estate, shipping and power.
- No specific earnings or AUM guidance was provided. Oaktree emphasized that incentive income, investment values, fund-raising, realizations and distributions are volatile and their timing is uncertain. It expected existing cash, operations and the revolving facility to support operations and commitments for at least 12 months.
- Market sensitivity is material: management estimated that a 10% decline in consolidated-fund investment values would reduce fund unrealized appreciation by $3.8 billion, with no direct impact on Oaktree-attributable net income in that scenario. It estimated a $116.7 million reduction in first-half segment investment income under a 10% decline in relevant investment fair values. Fund leverage, rates, currency movements, liquidity and counterparty exposures are additional risks.
- Valuation uncertainty is notable: $19.5 billion of consolidated-fund investments were Level III at June 30, including substantial equity and real estate holdings valued using significant unobservable inputs. Actual realization values may differ materially from reported fair values.
- A pending lawsuit, Kaplan Industry, Inc. v. Oaktree Capital Management, L.P., seeks damages exceeding $800 million. Oaktree says it believes the claim is without merit and any loss exposure is remote; the case is stayed pending related London arbitration. Management reported no other pending legal actions expected to have a material effect.
- Oaktree disclosed $258.3 million of its own undrawn fund commitments and $906.8 million of consolidated-fund potential investment and credit commitments. It also reported $2.13 billion of accrued fund-level incentives not yet recognized as company revenue; these are contingent on future performance and other conditions. Certain tax examinations could potentially reduce accrued Operating Group taxes by approximately $6–$8 million within 12 months.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. It reported no material changes to the annual-report risk factors.
Important facts for investors to verify
- Confirm the entity and security being analyzed: the filing is for Oaktree Capital Group, LLC, and its stated period is the quarter ended June 30, 2013.
- Separate Oaktree’s Operating Group economics and liquidity from consolidated fund assets, debt, cash flows and investment gains; most consolidated-fund earnings belong to non-controlling investors.
- Assess how much of the sharp increase in earnings and distributions depends on incentive realizations, particularly Opps VIIb, and whether those levels are repeatable.
- Track declining fee-related earnings, management fee-generating AUM and closed-end fund asset sales against new commitments and flows.
- Review Level III valuation assumptions, consolidated-fund leverage and the status of the lawsuit, commitments, tax examinations and tax receivable agreement obligations.