Business context and reporting period
Oaktree Capital Group, LLC (NYSE: OAK) filed this unaudited Form 10-Q for the three months ended March 31, 2019. It is a global alternative investment manager focused on credit, private equity, real assets and listed equities. The filing reports consolidated results that include certain managed funds; much of those funds’ assets, liabilities and earnings belong to third-party investors and are non-recourse to Oaktree.
Key financial metrics
| Metric | Q1 2019 | Q1 2018 / comparison |
|---|---|---|
| GAAP revenue | $266.4 million | $337.3 million; down 21.0% |
| Management fees | $169.9 million | $185.4 million; down 8.4% |
| GAAP incentive income | $96.5 million | $151.9 million; down 36.5% |
| GAAP net income | $184.4 million | $137.4 million |
| Net income attributable to Oaktree Class A unitholders | $47.3 million; $0.66 per unit | $52.7 million; $0.78 per unit |
| Distributable earnings (non-GAAP) | $233.9 million; $1.46 per Class A unit | $194.0 million; $1.18 per unit |
| Fee-related earnings (non-GAAP) | $39.6 million; $0.24 per unit | $58.5 million; $0.36 per unit |
| Class A distribution declared for quarter | $0.75 per unit | $0.76 per unit |
Distributable earnings are a non-GAAP measure and include realized incentive income; they exclude unrealized incentive income and several other items. The divergence from GAAP revenue reflects, in part, the timing of incentive-income recognition. GAAP consolidated net income also includes investment results attributable to non-controlling fund investors.
Cash flow and liquidity: Consolidated operating activities used $56.5 million, compared with $147.7 million provided in Q1 2018; investing activities provided $151.8 million and financing activities used $112.1 million. These cash flows include consolidated funds and are substantially affected by their investment transactions. At March 31, Oaktree and its operating subsidiaries had approximately $500.2 million of cash and $457.7 million of U.S. Treasury and other securities, about $958 million combined, and no borrowings on the $500 million revolving facility.
Debt and balance sheet: Oaktree’s debt obligations were $746.1 million, representing $750 million principal net of issuance costs; it reported compliance with financial covenants. Separately, consolidated funds had $865.1 million of borrowings under credit facilities and $4.16 billion of CLO debt, which are non-recourse to Oaktree. Total assets were $10.56 billion and total liabilities $7.03 billion. Adoption of the lease accounting standard added $109.3 million of operating lease assets and $139.2 million of lease liabilities; the filing says this gross-up did not affect operating results.
Operating metrics: AUM was $118.6 billion, down 0.8% from year-end 2018 and from $121.4 billion a year earlier. Management fee-generating AUM was $100.3 billion, up 2.2% from year-end but below $102.0 billion a year earlier. Incentive-creating AUM was $34.4 billion. Uncalled investor commitments were $18.3 billion, including $12.6 billion not yet generating fees.
Material changes versus the prior comparable period
- GAAP revenue declined, mainly from lower management fees and incentive income. Management attributed lower fees primarily to closed-end funds in liquidation; open-end fund net outflows also weighed on fee revenue.
- GAAP net income increased, supported by higher interest and dividend income, improved unrealized investment results and stronger investment income. Despite this, Class A net income and earnings per unit declined, primarily reflecting lower operating profits and the allocation to preferred unitholders.
- Distributable earnings rose 20.6%, mainly because realized incentive income was higher. Fee-related earnings fell 32.3%, primarily due to lower management fees and higher compensation and benefits expense.
- General and administrative expense under GAAP rose 44.2% to $47.6 million; management cited costs associated with the Brookfield transaction. In the non-GAAP measure, the transaction costs are excluded.
- AUM fell during the quarter, primarily due to open-end fund net outflows and closed-end fund distributions, partly offset by market gains and growth in Oaktree’s pro-rata DoubleLine AUM.
Outlook, commentary, risks and unusual items
- Brookfield transaction: Under the March 13 definitive agreement, Brookfield proposed to acquire approximately 62% of Oaktree’s business. Class A unitholders may elect $49.00 cash or 1.0770 Brookfield Class A shares per Oaktree unit, subject to proration so neither form exceeds 50% of aggregate consideration. OCGH holders are to sell 20% of their units on the same consideration terms; OCGH is expected to retain the remaining 38% of the business. Closing was anticipated in Q3 2019, subject to unitholder approval, regulatory approvals and other conditions. This is a stated expectation, not a completed transaction.
- Management described Q1 financial markets as rebounding from Q4 2018 declines. Incentive-creating closed-end funds had a blended gross return of 2.5% for the quarter (2.4% including Highstar Capital IV). Returns are gross, not investor net returns.
- No specific full-year earnings or revenue guidance is provided. Management said available cash, operations and the undrawn revolver were expected to be sufficient for operations and commitments for at least the next 12 months; distributions remain discretionary and could be suspended if cash flows were insufficient.
- Incentive income is volatile and depends on fund performance, realizations, investor distribution waterfalls and market conditions. Fund-level accrued incentives were $1.425 billion, but are not recognized company revenue until recognition criteria are met; timing and realization are uncertain.
- Market, valuation, liquidity, financing, counterparty and foreign-exchange risks may affect fees, incentives and investment income. A 10% decline in market values was estimated to reduce quarterly NAV-based management fees by about $6.8 million; the filing estimates a $339.3 million decline in investment income under a separate 10% fair-value stress scenario.
- Commitments included $524.3 million of Oaktree commitments to funds and $12.6 million of consolidated-fund investment commitments. Contingent consideration could total up to $36.1 million, with a reported fair value of $6.6 million. Tax authorities were examining certain returns; the company said up to approximately $2.9 million of accrued Operating Group taxes could possibly be released over the next four quarters. Oaktree reported no pending legal or regulatory actions expected to have a material financial impact and no material changes to annual-report risk factors.
Important facts for investors to verify
- Merger approvals, regulatory conditions, proration mechanics, expected closing timing and final consideration elected by unitholders.
- Whether open-end fund outflows and closed-end fund liquidations continue to reduce fee-generating AUM and management fee revenue.
- How much fund-level accrued incentive income is ultimately realized, and the related compensation expense and cash distribution timing.
- Oaktree-only liquidity and covenant headroom, keeping non-recourse consolidated-fund debt and cash distinct from corporate obligations and liquidity.
- Use of non-GAAP distributable earnings and fee-related earnings alongside GAAP results, including the effects of transaction costs, preferred distributions and consolidation.