Business context and reporting period
This is Oaktree Capital Group, LLC’s audited Form 10-K for the fiscal year ended December 31, 2017, with comparative results for 2016 and 2015. The request metadata names Brookfield Oaktree Holdings, LLC, but the filing identifies Oaktree Capital Group, LLC as the registrant. Oaktree is an alternative investment manager focused on credit, distressed debt, control investing, real estate and listed equities. Its revenue comes primarily from management fees, incentive income and returns on corporate investments.
Financial performance and key metrics
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| GAAP revenue | $1.470 billion | $1.126 billion | +30.5% |
| GAAP net income attributable to Oaktree | $231.5 million | $194.7 million | +18.9% |
| GAAP earnings per Class A unit | $3.61 | $3.11 | +16.1% |
| Adjusted net income (non-GAAP) | $701.1 million | $572.4 million | +22.5% |
| Distributable earnings (non-GAAP) | $716.3 million | $526.6 million | +36.0% |
| Fee-related earnings (non-GAAP) | $223.9 million | $255.9 million | -12.5% |
| AUM at year-end | $100.2 billion | $100.5 billion | -0.3% |
| Management fee-generating AUM | $80.6 billion | $79.8 billion | +1.0% |
GAAP management fees fell 6.2% to $726.4 million, while incentive income more than doubled to $743.4 million. The increase was driven principally by $427.8 million of incentive income from Principal Opportunities Fund IV, which began paying non-tax-related incentives in 2017. The filing does not provide a single directly comparable operating-margin measure; non-GAAP fee-related earnings are one measure of baseline profitability.
Cash and U.S. Treasury and other securities at Oaktree and operating subsidiaries totaled $658 million at year-end, against $746 million of their debt obligations; no borrowings were outstanding on the $500 million revolving facility. Consolidated debt also included $862 million of fund credit-facility borrowings and $3.220 billion of CLO debt, which are fund obligations and generally nonrecourse to Oaktree. Consolidated operating activities used $336.3 million of cash in 2017, principally reflecting investment purchases by consolidated funds; this is not a measure of cash available to the management company. Management said liquidity sources were expected to cover requirements for at least 12 months.
Oaktree declared $3.21 per Class A unit for 2017 in its financial statements; it subsequently declared a $0.76 fourth-quarter distribution, bringing distributions associated with fiscal 2017 to $3.34 per unit. The board retains discretion over distributions.
Material changes versus prior comparable period
- Distributable earnings rose substantially, primarily due to higher incentive income and cash proceeds from investments. Fee-related earnings declined as management fees fell, mainly because older closed-end funds entered liquidation.
- AUM was nearly flat: market gains, the BDC acquisition and favorable currency translation were offset by closed-end fund distributions and open-end fund net outflows. Open-end funds had $3.0 billion of net outflows.
- Oaktree became adviser to two publicly traded BDCs in October 2017, paying $320 million in cash. The transaction added $2.1 billion to year-end AUM and increased future amortization expense.
- In December, Oaktree issued $250 million of 3.78% notes due 2032 and redeemed $250 million of 6.75% notes due 2019. A cross-currency swap reduced the stated annual interest cost to 1.95%; the early redemption produced a $22 million pre-tax make-whole charge.
- Comparisons with 2015 are materially affected by adoption of consolidation guidance in 2016, which deconsolidated substantially all managed funds. Fund-level assets, liabilities and revenues in GAAP statements therefore changed significantly; management’s non-GAAP measures exclude fund consolidation.
Outlook, commentary, risks and unusual items
- Management reported $8.9 billion of gross capital raised in 2017 and $20.5 billion of uncalled commitments. Of that amount, $12.7 billion was shadow AUM not yet generating management fees. Oaktree did not expect its largest component, $8.8 billion relating to Opportunities Fund Xb, to begin generating committed-capital fees before the fourth quarter of 2018.
- Management expected approximately $20 million of 2018 compensation and general and administrative expense growth related to the Infrastructure team, reflecting the end of subsidies from a legacy Highstar fund rather than an increase in the team’s overall costs.
- The Tax Act produced a net $33.2 million reduction to GAAP and adjusted net income attributable to Oaktree: $178.2 million of additional tax expense from deferred-tax remeasurement, partly offset by a $145.1 million benefit from remeasuring the tax receivable agreement liability. The tax impact remained provisional pending further guidance and tax-return work.
- Management estimated $192.1 million of future distribution reductions associated with tax receivable agreement payments through 2039, including an estimated $15.6 million reduction to fiscal 2018 distributions, subject to assumptions and possible increases from further unit exchanges.
- Key risks include volatile and realization-dependent incentive income; fund performance, capital raising and redemptions; illiquid and judgmentally valued investments; competition and fee pressure; key-person departures; leverage, interest rates and counterparty exposures; regulatory and tax changes; Brexit; cybersecurity; and conflicts of interest. The filing also describes concentrated control by senior executives, limited Class A unitholder influence and potential dilution from unit exchanges and incentive plans.
- The independent auditor issued an unqualified opinion on the financial statements and internal controls. Oaktree reported no pending legal or regulatory proceedings expected to have a material impact on its consolidated financial statements.
Important facts for investors to verify
- How much 2017 incentive income is repeatable, and how much depended on Principal Opportunities Fund IV’s realization and distribution timing.
- Whether flat AUM, open-end fund outflows and closed-end fund liquidations will pressure management-fee revenue, and when shadow AUM will begin generating fees.
- Cash available to Oaktree itself, distinct from cash and debt held in consolidated funds; also review the company’s debt covenants, capital commitments and distribution capacity.
- The assumptions supporting the provisional Tax Act accounting, deferred tax assets and projected tax receivable agreement payments.
- The timing and valuation uncertainty of accrued fund-level incentives, which are not recognized revenue until applicable recognition criteria are met.
- The stated distribution figures: $3.21 declared during 2017 versus $3.34 associated with fiscal 2017 after the subsequent fourth-quarter declaration.