Business context and reporting period
The supplied filing is Oaktree Capital Group, LLC’s unaudited Form 10-Q for the quarter and nine months ended September 30, 2015. This differs from the requested company name, Brookfield Oaktree Holdings, LLC; verify the intended registrant. Oaktree is an alternative investment manager focused on credit, distressed debt, control investing, real estate and other strategies. AUM was $100.2 billion at quarter-end.
Oaktree consolidates many funds it manages despite holding only minority economic interests. Accordingly, consolidated assets, liabilities and earnings include substantial amounts attributable to third-party fund investors and should not be read as the standalone scale or performance of Oaktree’s management business.
Financial results and key metrics
Amounts below are in millions of dollars except per-unit data. GAAP consolidated results include fund investment activity; segment measures are non-GAAP.
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Consolidated revenue | $50.5 | $54.2 | $152.8 | $146.2 |
| Net income (loss) attributable to Oaktree | $1.9 | $18.9 | $60.0 | $101.9 |
| GAAP net income (loss), consolidated | $(1,766.6) | $(579.0) | $(800.2) | $2,268.5 |
| Adjusted net income (ANI), segment | $20.6 | $95.1 | $261.3 | $476.8 |
| Distributable earnings, segment | $90.6 | $137.2 | $342.4 | $486.5 |
| Fee-related earnings, segment | $48.5 | $63.5 | $158.2 | $184.8 |
| Distributable earnings per Class A unit | $0.49 | $0.78 | $1.87 | $2.79 |
| GAAP net income per Class A unit | $0.04 | $0.43 | $1.27 | $2.41 |
- Q3 consolidated net loss reflected $2.36 billion of unrealized depreciation on consolidated fund investments, partly offset by realized gains and investment income. The corresponding unrealized loss was $1.64 billion in Q3 2014.
- Nine-month unrealized depreciation was $3.27 billion, versus $168.4 million in the prior-year period. Fund investment results are largely allocated to non-controlling fund investors; Oaktree-attributable income is a more relevant measure of its share of earnings.
- Management fees were $181.9 million for Q3 segment reporting, down 6.5%, and $555.5 million for nine months, down 2.9%. Segment incentive income was $16.9 million for Q3 and $231.0 million for nine months, down 80.4% and 47.3%, respectively. Tax-related incentive distributions contributed materially to nine-month incentive income in both years.
- Q3 and nine-month segment ANI declined 78.3% and 45.2%; distributable earnings declined 34.0% and 29.6%. Oaktree attributed the decreases mainly to lower net incentive income, weaker investment income and lower fee-related earnings.
- At September 30, total assets were $54.86 billion and total liabilities $12.10 billion. These totals include consolidated fund investments of $47.68 billion and fund-level obligations; non-controlling redeemable fund interests were $40.94 billion.
- Oaktree’s corporate debt was $850 million, unchanged from year-end 2014. Corporate cash and cash equivalents were $421.7 million and U.S. Treasury securities $656.1 million. The company reported $1.1 billion of cash and Treasuries and an undrawn $500 million corporate revolver. Its segment balance sheet showed $417.2 million of cash.
- Consolidated funds had $6.23 billion drawn under credit facilities and $2.35 billion of CLO debt at quarter-end. These fund obligations are generally nonrecourse to Oaktree. Oaktree reported compliance with its financial covenants and ability to draw the full corporate revolver.
- Consolidated cash and cash equivalents were $3.25 billion at period-end, but include fund cash. Consolidated operating cash flow was a use of $2.17 billion for nine months; the filing attributes this presentation substantially to consolidated funds’ investment purchases and sales. It is not a standalone measure of Oaktree’s operating cash generation.
- Class A distributions declared were $0.50 per unit for Q3 in the statements. Separately, the filing reports a subsequent $0.40-per-unit distribution declared October 29, payable November 12.
Material changes versus the prior comparable period
- Markets weakened sharply in Q3: the S&P 500 returned -6.4%, U.S. high-yield bonds -5.5%, and emerging-market equities -17.9%. Oaktree’s closed-end funds returned -2.8% gross for the quarter; year-to-date gross return was 0.7%.
- AUM fell 2.8% from June 30 to $100.2 billion, mainly because of $3.7 billion in market-value declines, closed-end fund distributions and open-end fund net outflows. It was up 10.4% from December 31, 2014, led by closed-end fund fundraising and leverage.
- Management fee-generating AUM was $76.5 billion, down 2.7% from June and 2.0% from year-end 2014. Incentive-creating AUM was $33.2 billion, down 2.1% from June and year-end 2014. Uncalled commitments were $20.1 billion, versus $12.4 billion a year earlier.
- Q3 management fees reported in the consolidated statements fell 13.1%, while GAAP attributable net income fell 89.9%. Segment performance measures also fell sharply, reflecting lower incentive income and investment returns.
- Corporate investment value was $1.47 billion at September 30. The filing notes $300 million of unrealized investment income proceeds, including $150 million in closed-end funds in liquidation.
Outlook, risks and unusual items
- Management said available cash, operations and the undrawn revolver should fund operations and commitments for at least 12 months. It stated that distributions could be suspended if operating cash flow were insufficient; distribution amounts remain discretionary and may vary materially.
- No specific earnings or revenue guidance was provided. Oaktree was marketing several closed-end funds, including Opportunities Funds X and Xb and Real Estate Opportunities Fund VII. Of $14.0 billion in potential management fee-generating AUM associated with selected fundraising funds, only $524 million was fee-generating at quarter-end.
- Oaktree expected a proposed exchange of approximately 13 million OCGH units into Class A units in the second half of November 2015, subject to conditions and a unitholder vote. The proposed Class A units would be subject to a three-year lock-up, with releases in quarterly increments. It also expected generally to grant Class A units rather than OCGH units as employee compensation starting with the 2015 year-end review. These plans were not reflected in the quarter’s financial statements.
- Management anticipated a one-time compensation expense of about $4 million in Q1 2016 from other compensation-plan changes. Adoption of revised consolidation accounting in 2016 was expected to significantly reduce consolidated fund assets, liabilities and redeemable interests, but not Oaktree-attributable net income.
- Highstar acquisition contingent consideration was capped at $60 million; its fair value was $29.2 million at September 30, and $1.9 million of expense was recognized for the first nine months. The undiscounted obligation was presented as $31.6 million in the contractual-obligations table.
- Oaktree’s funds held $28.25 billion of Level III investments, requiring significant unobservable inputs and judgment. Valuations may differ materially from eventual sale proceeds. A 10% decline in fund investment values was estimated to reduce unrealized appreciation by $4.8 billion; estimated quarterly management fees would fall about $6.6 million, while the effect on incentive income was not readily quantifiable.
- A 100-basis-point rate increase was estimated to raise annualized interest expense on fund variable-rate debt by $84.3 million. Oaktree’s own corporate interest expense was not expected to be materially affected, given its hedges, while higher rates could increase annualized interest income on corporate cash and Treasuries by $10.8 million.
- Other exposures include foreign-exchange movements, counterparty and financing risks, fund redemptions, fundraising and realization timing, and volatility in investment marks and incentive income. The filing reported no material pending legal action and no material change to previously disclosed risk factors. Disclosure controls were assessed effective.
Most important facts to verify
- Confirm the intended issuer: the request names Brookfield Oaktree Holdings, LLC, but the supplied filing is for Oaktree Capital Group, LLC.
- Reconcile the sharply different GAAP consolidated loss, Oaktree-attributable income and non-GAAP segment measures; review the effects of fund consolidation and non-controlling interests.
- Assess whether lower incentive income, weaker investment performance and declining fee-generating AUM persist, and how much of accrued fund-level incentives can ultimately be realized.
- Review corporate versus fund-level liquidity and debt separately, including the restrictions, nonrecourse terms, capital commitments and maturity schedule.
- Evaluate the sensitivity of Level III valuations, market declines, leverage and currency movements, and monitor the proposed unit exchange and compensation changes.