Brookfield Oaktree Holdings, LLC quarterly report, Q3 FY2012

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Brookfield Oaktree Holdings, LLC — Filing Summary

Registrant identity: The supplied filing is for Oaktree Capital Group, LLC, not Brookfield Oaktree Holdings, LLC. Verify that this is the intended filing.

Business context and reporting period

Unaudited Form 10-Q for the quarter and nine months ended September 30, 2012. Oaktree is a global alternative investment manager focused on distressed debt, corporate debt, control investing, convertible securities, real estate and listed equities. It reported $81.0 billion of AUM at quarter-end. Class A units began trading on the NYSE in April 2012; principals retained 98% of combined voting power after the IPO.

GAAP results consolidate many funds in which Oaktree has only a minority economic interest. Fund investment results and assets therefore appear gross, with substantial amounts attributed to fund investors and other non-controlling interests. Segment measures below exclude fund consolidation and are non-GAAP where indicated.

Financial and operating highlights

  • Consolidated results: Q3 revenue was $31.9 million, down 14.9% from $37.5 million; net income attributable to Oaktree was $25.2 million versus a $36.5 million loss. For the first nine months, revenue was $98.2 million versus $119.8 million, while attributable net income was $68.5 million versus a $67.0 million loss.
  • Segment results: Q3 adjusted net income (ANI) was $157.7 million versus $3.3 million; nine-month ANI was $496.9 million, up from $351.7 million. Q3 fee-related earnings were $73.0 million versus $79.6 million; nine-month fee-related earnings were essentially flat at $235.5 million versus $235.4 million. Distributable earnings were $120.4 million for Q3 versus $109.4 million, and $434.0 million for nine months versus $439.1 million.
  • Revenue drivers: Segment management fees rose 5.2% in Q3 to $182.6 million and 4.5% for nine months to $562.7 million. Segment incentive income was $59.2 million in Q3, up from $33.7 million, but $250.9 million year to date, down from $271.9 million. Segment investment income was $62.8 million in Q3 and $150.4 million year to date, versus a loss of $86.1 million and a loss of $19.5 million, respectively, in 2011.
  • Fund performance and AUM: AUM increased 11% from $73.0 billion at September 2011 to $81.0 billion, principally reflecting market appreciation and new commitments. Management fee-generating AUM was $66.2 billion, up from $63.4 billion a year earlier but below $67.0 billion at December 2011. Incentive-creating AUM was $37.1 billion.
  • Margins and expenses: Q3 fee-related earnings were about 40% of segment management fees, compared with about 46% in Q3 2011; nine-month fee-related earnings were about 42% of fees in both periods. Compensation and benefits increased 26% in Q3, partly due to higher bonus accruals and 13% headcount growth. Equity-based compensation fell sharply as pre-IPO OCGH units completed vesting in January 2012.
  • Cash and liquidity: Oaktree-level cash was $310.9 million; cash plus U.S. Treasury and government agency securities was $671.7 million. Consolidated cash-flow statements reported $3.48 billion of operating cash flow for nine months, but this includes substantial fund activity and is not equivalent to cash generated by the management company. The filing does not provide a directly comparable standalone operating-cash-flow figure here.
  • Debt: Corporate debt obligations were $618.9 million, down from $652.1 million at year-end 2011. The $250 million corporate revolving facility was undrawn and expires in January 2014; the company reported compliance with financial covenants. Consolidated funds had $52.0 million in revolving borrowings, generally nonrecourse to Oaktree.
  • Distributions and capital: Nine-month distributions declared were $1.76 per Class A unit. After quarter-end, Oaktree declared a $0.55-per-unit distribution, payable November 20, 2012. The board retains discretion over distributions, and management stated distributions could be suspended if operating cash flow were insufficient.

Material changes, outlook, risks and unusual items

  • Consolidated results improved substantially from 2011, when fund investment values fell sharply. Q3 2012 included $1.1 billion in realized fund gains and $809.0 million in unrealized appreciation; nine-month figures were $2.9 billion and $1.4 billion, respectively. These are largely fund-level results and predominantly attributable to fund investors, not Oaktree’s Class A holders.
  • Management attributed improved fund results to stronger financial markets in 2012 compared with the sharp declines in 2011. It gave no formal numeric earnings or AUM guidance. It anticipated higher public-company compliance, insurance and reporting costs after the IPO.
  • Fund-level accrued incentives were $2.14 billion gross at September 30, 2012, compared with $1.52 billion a year earlier. These amounts are contingent, off-balance-sheet indicators, not recognized revenue; realization and timing are uncertain.
  • Fair-value risk is significant: $18.8 billion of consolidated fund investments were Level III at quarter-end, requiring significant unobservable inputs and management judgment. Oaktree cautioned that realized proceeds could differ materially from reported values.
  • A state tax-rate change led to a one-time second-quarter tax expense of $7.1 million and a $6.3 million reduction in the tax receivable agreement liability, recorded as other income. Management reported a 19% effective tax rate on Class A income for nine months excluding the one-time expense, or 24% including it.
  • Oaktree disclosed a lawsuit seeking damages exceeding $800 million over alleged conduct involving a portfolio company acquired by a fund. The company said the case was stayed pending related arbitration, believed the claim was without merit and assessed loss exposure as remote. It reported no other legal actions expected to have a material impact.
  • Commitments included $310.5 million of Oaktree capital commitments to funds and $474.4 million of consolidated-fund investment commitments. A leased corporate aircraft arrangement could expose Oaktree to up to $10 million for a sale-value shortfall if it does not exercise a purchase option at lease termination in 2015.
  • Management identified market, valuation, liquidity, foreign-exchange, interest-rate and counterparty risks. Its sensitivity analysis estimated a 10% decline in fund investment values would reduce fund unrealized appreciation by $4.1 billion, with no direct effect on Oaktree-attributable net income under the stated assumptions; it estimated a $125 million reduction in segment investment income under a separate 10% fair-value decline scenario.

Most important facts for investors to verify

  1. Confirm that Oaktree Capital Group, LLC is the intended registrant given the metadata’s different company name.
  2. Separate management-company economics from consolidated fund results; focus on segment ANI, fee-related earnings and distributable earnings alongside GAAP net income.
  3. Assess the sustainability of management fees and incentive income, including liquidation-related fee declines, fund flows and the contingent nature of accrued incentives.
  4. Review Level III valuation assumptions and the extent to which reported fund appreciation translates into realizations and Oaktree revenue.
  5. Check the $618.9 million corporate debt balance, maturity schedule, covenant headroom, undrawn revolver availability and funding needs for commitments.
  6. Monitor the large damages claim, tax receivable agreement obligations, and whether post-IPO costs or distributions change materially.