OAK - Oaktree Cap Group LLC

[Packer16]

There is a talk by Martin Fridson (a good HY analyst) who estimated the distressed market in the next default cycle will be about $1.6 trillion.  If you are CFA his talk was at one of there recent conferences that you have access to via your account.

 

Packer

10649_Fridson.pdf

[giofranchi]

I would have to believe the same would apply to OAK as well.

 

I guess so. And I guess also Fairfax will be a great beneficiary. Their US government bonds portfolio is making a lot of money now that yields are getting lower and lower. Money that might be redeployed in some distressed debt opportunities once “the fallout” finally occurs. ;)

 

Gio

 

[giofranchi]

There is a talk by Martin Fridson (a good HY analyst) who estimated the distressed market in the next default cycle will be about $1.6 trillion. 

 

Thank you Packer!

 

The default counts projected for the 2016-2019 period are really impressive, especially if compared to the historical default counts during the Great Recession…

 

In his presentation Fridson says “Projected Global Default Volume 2016-2019”, but then only refers to the US and Europe in the section “Which Region Offers Best Value?”… What about Japan, China, and emerging markets in general?

 

Cheers,

 

Gio

 

[giofranchi]

Marks on lessons from oil crash:

 

I’m working on a memo. And it’ll be not about oil, but it will be about the lessons of oil. And one of the lessons that we’re learning again now is how fast things can change in the investment world. There was an economic philosopher, Rudiger Dornbusch, who said it takes a lot longer for things to happen than you think that it can, but then they happen much faster than you thought they would. And that’s the way things go in the investment world.

 

 

Gio

valuewalk.com-Howard_Marks_On_Lessons_From_Oil_Crash_Russian_Crisis_TRANSCRIPT.pdf

[giofranchi]

The Lessons of Oil

 

 

Gio

The_Lessons_of_Oil.pdf

[VersaillesinNY]

Howard Marks: «Investing is like playing tennis » Dec 23, 2014

 

http://tablet.fuw.ch/article/howard-marks/

[giofranchi]

Howard Marks: «Investing is like playing tennis » Dec 23, 2014

 

http://tablet.fuw.ch/article/howard-marks/

 

Thank you for posting this.

I love tennis, and I think I can say I am still a good tennis player! ;)

 

Gio

 

[giofranchi]

Medley Management stung by downgrade; Oaktree upgraded - 10:07 AM

 

Stephen Alpher, SA News Editor

•Medley Management (MDLY -7.9%) has struggled since its September IPO, and falls further today as KBW pulls its Outperform rating and cuts the price target to $16 from $19.50.

•While were on alternative asset managers, KBW at the same time upgrades Oaktree Capital (OAK +0.7%) to Outperform. The trouble in the energy patch should be manna to the distressed asset studs at Oaktree.

 

 

Gio

[KCLarkin]

Medley Management stung by downgrade; Oaktree upgraded - 10:07 AM

 

Stephen Alpher, SA News Editor

•Medley Management (MDLY -7.9%) has struggled since its September IPO, and falls further today as KBW pulls its Outperform rating and cuts the price target to $16 from $19.50.

•While were on alternative asset managers, KBW at the same time upgrades Oaktree Capital (OAK +0.7%) to Outperform. The trouble in the energy patch should be manna to the distressed asset studs at Oaktree.

 

This might be the best way to play the O&G crash. Distressed debt is probably a better play than equity at this point in the cycle but I have no interest in distressed debt.

 

 

Gio

[Picasso]

I decided to short a fair amount of OAK.  When I get my butt kicked by Howard Marks, you guys can all laugh.  But I don't see much upside from the $55 level, if at all.  Between their incentive fee hurdle, their investment portfolio, and the retail investors piling into OAK, I think this could be a pretty good risk/reward on the short side.

 

I think the stock should trade a lot closer to $40.  Good luck to all and may the trading gods have mercy on my soul.

[Liberty]

I decided to short a fair amount of OAK.  When I get my butt kicked by Howard Marks, you guys can all laugh.  But I don't see much upside from the $55 level, if at all.  Between their incentive fee hurdle, their investment portfolio, and the retail investors piling into OAK, I think this could be a pretty good risk/reward on the short side.

 

I think the stock should trade a lot closer to $40.  Good luck to all and may the trading gods have mercy on my soul.

 

Isn't shorting a good business, even if you think it's overvalued by over 25%, dangerous? Wouldn't it be easier to find a bad business that is overvalued (ideally with a catalyst) to short if shorting is what you want to do?

[Packer16]

Is the $40 price target based upon current AUM?  These guys are counter cyclical players, like Baupost, who have a good reputation.  They have a large field (O&G) for restructuring and if the market blows up I would not be surprised to see this go up like FFH.  If the markets go up these guys will mine the O&G and EM markets.  In either case I see AUM going up (not good for a short) and a large customer list waiting for Oaktree to invest money for them

 

Packer

[Picasso]

When I have some time this weekend I'll run through my numbers for OAK.  I should have probably prefaced my short with how I short things.  I'm not an idiosyncratic shorter because I do a lot better finding good longs than finding a good short.  I'm just not good at the whole investigative shorting approach. 

 

Rather I like to balance out my other investments with big, liquid, hard to lose type shorts where worst case they go up with my other holdings and reduce my exposure without having to sell things down and pay taxes.  So obviously there are better shorts than OAK but I can't spend the time finding them.

 

As far as OAK being counter-cyclical, it does not mean the value that is lost in the E&P sector is immediately priced into the current value of the stock price.  They will raise more capital over the next couple years but they are in the middle of a big $10 billion raise that is already targeting that market.  The market is well aware of this capital raise and I doubt they'll be able to keep raising those large amounts of capital without showing success on the current round.  So I think it's in the stock price.  I based the $40 on AUM after the big capital raise. 

 

One of their best growth drivers, DoubleLine, has recently said they are looking to close off to new capital this year.  While it will likely start off with just the main fund it will probably extend to other parts of their business.  Gundlach has stated repeatedly he would rather manage around $50 billion and do it well than manage hundred of billions.  So the estimates people put on that business are probably a bit high.  Their recent closed-end funds have done poorly and as a result will probably be unlikely to tap new closed-end capital.

 

Given current interest rates against their flat 8% hurdle, their big push into Europe while the Euro has eroded, and a few high level exits in the past year, I am seeing warning signs. 

 

It might be dangerous to short a good business that I think is overvalued by 25% but I think the downside is less than 5%.  If the stock goes above $58-59 and stays theres for a while I am probably out of my position. 

 

Nevermind the fact that Barron's, Cooperman, Kass, and other good contrarian indicators like the stock.  I think that stacks the odds a bit more in my favor.

 

I like these kinds of shorts even though others might like to locate 80-100% overvalued type stuff. 

[giofranchi]

Thank you, Picasso!

I would really like to know your thesis about OAK. I mean: are you shorting it only on the basis of valuation, due to some short term concerns, or do you think the business has some serious flaws and tailwinds for the long term?

Because, given the environment we seem to be heading into, to me it seems very few are positioned to prosper as much as OAK.

Of course, in the short run everything might happen... And OAK's stock price might trade closer to $40-$45 like you have said!

 

Cheers,

 

Gio

[plato1976]

short oak?

wow, we may not be sure if oak is a very attractive investment

but, ... short oak ?

 

Thank you, Picasso!

I would really like to know your thesis about OAK. I mean: are you shorting it only on the basis of valuation, due to some short term concerns, or do you think the business has some serious flaws and tailwinds for the long term?

Because, given the environment we seem to be heading into, to me it seems very few are positioned to prosper as much as OAK.

Of course, in the short run everything might happen... And OAK's stock price might trade closer to $40-$45 like you have said!

 

Cheers,

 

Gio

[Picasso]

Also keep in mind that OAK has paid around $9.75 in distributions with another being announced in February that will push it over $10 since the new listing off the Goldman exchange. 

 

When you include those distributions the stock is closer to $66.  I notice investors are just looking at the lagging price and assuming the stock has lagged.  In fact it has compounded around 17% with reinvested distributions since the listing.

 

There have also been expectations that the new CEO would create some kind of insurance entity within OAK.  They mentioned on the last conference call that this is not the case. 

 

It is a bit arrogant on my part to think now is the time for future underperformance but I like the setup.  Private equity stocks with a lot of expectations tend to fall fast when expectations aren't met because most of the earnings are not tied to recurring management fees.

[Packer16]

You do understand that Oaktree gets both a management fee and a carry for all of the investments it manages.  Thus a good portion of the fees are recurring.  I could see your rationale with this type of set up and momentum investor but I put Oaktree in same league as Baupost, an opportunistic value investor.  I don't want to be short management and incentive fee stream for an opportunistic value manager at the end of a bull market (when distress is beginning especially with a $trillion+ in distressed assets in this next cycle in part because the last one was cut short by the Fed - see Marty Fridson's presentation on HY market for source) that is for sure.  Another thing to note about Oaktree is the largest funds are raised when there is distress in the market and they run off in good times, that is why the performance fees are now running down.  At the next crisis, these guys AUM will go up again.

 

Packer

[Picasso]

You do understand that Oaktree gets both a management fee and a carry for all of the investments it manages.  Thus a good portion of the fees are recurring.  I could see your rationale with this type of set up and momentum investor but I put Oaktree in same league as Baupost, an opportunistic value investor.  I don't want to be short management and incentive fee stream for an opportunistic value manager at the end of a bull market (when distress is beginning especially with a $trillion+ in distressed assets in this next cycle in part because the last one was cut short by the Fed - see Marty Fridson's presentation on HY market for source) that is for sure.  Another thing to note about Oaktree is the largest funds are raised when there is distress in the market and they run off in good times, that is why the performance fees are now running down.  At the next crisis, these guys AUM will go up again.

 

Packer

 

As of last quarter for the roughly $93 billion they manage only $35 billion was entitled to carry.

 

Also you have $1 billion of accrued incentives that would dry up if the market went south.  There will be an offset by new AUM which is why everyone considers this a counter cyclical business. 

[giofranchi]

As of laster quarter for the roughly $93 billion they manage only $35 billion was entitled to carry.

 

But this is actually something I like for the long run: the less AUM are entitled to carry now, the more opportunities to grow them in the future. At least that's how I see it!

 

I would like to know if there is something you worry about for the long run in OAK's kind of business... In other words, money management has been until now a great business in general, and OAK has been among the most profitable in the industry. Do you see those two things change in the future? If yes, why?

 

Thank you!

 

Gio

[giofranchi]

I would like to know if there is something you worry about for the long run in OAK's kind of business... In other words, money management has been until now a great business in general, and OAK has been among the most profitable in the industry. Do you see those two things change in the future? If yes, why?

 

I ask this because imo it is always dangerous to short a stock whose underlying business has great prospects for the long run. Even if it is intended to be only a short term trade.

Look at Fairfax, for instance: until the end of last year it was making no money, or worse still in 2013 it actually lost money… Then, all of a sudden it experienced a very profitable year in 2014! Who would have predicted such a good 2014 at the end of 2013? Almost nobody… Yet, those who decided to short Fairfax at the end of a bad year (2013) clearly made the wrong decision.

 

Gio

 

[giofranchi]

Another reason why I am very interested to know if someone has a convincing bear thesis for OAK’s long term prospects is that I am absolutely aware it could fall back to the $40 level… Then, what should I do? If long term prospects are bright, like I think today, I would be buying a lot, averaging down aggressively. Otherwise, I would probably just hold my investment and wait for a better price to sell it.

I might be missing something about OAK’s long term prospects, and therefore I would gladly hear and evaluate the thesis of anyone who is bearish about them.

 

Thank you!

 

Gio

 

[Picasso]

Gio,

 

I don't think anyone is concerned about the long-term prospects for OAK.  I just think you have a brick wall over $57 and a lot of ways to get down to $40 over the next couple years. 

 

The more I looked at their business, the more I realized how silly it is to pay a similar multiple to other asset managers.  OAK is in the 2 steps forward, one step backward business.  It is kind of like a churn rate on a subscription business.  They are constantly in the process of returning massive amounts of capital to investors (the one step backwards) while raising new assets (two steps forward).  On the roughly $93 billion they manage, they collect around $1 billion of management fees which net of expenses is around $350 million.  What multiple do you want to give that $350 million given that business dynamic?  From my cursory glance at other private equity stocks, a lot of the returns came from the distributions while the stocks traded at below market multiples.  This makes sense given the proof of returns is uncertain and so as a partner you get rewarded from actual success versus a high current market value on the partnership units.  So I think the $350 million of net income should be worth maybe 10-12x.  On the high end that is worth around $4.2 billion.

 

So you have $4.2 billion of asset manager value, $800 million of accrued incentives net of taxes, $800 million in Doubleline, and some cash on the balance sheet net of debt for around $6 billion of value.  On 153 million shares I get a share price of $39. 

 

Some investors want to add the value of the future incentive fees.  This is where I think there is a lot less value than the difference between the current share price and $39.  Their 8% hurdles are going to be an absolute killer to any future carry.  As of right now the 30-year Treasury is at 2.34%.  How much risk are they willing to take on to get 15% returns?  15 years ago the 30-year was at 6%+ which let them only earn about 2% of excess return before collecting a fee.  Today they need almost 6% of excess return.  That is a lot of excess return for a $40 billion manager.  So I think the incentive driver is not going to be worth a heck of a lot, if at all. 

 

And so the argument goes that if the market heads lower they can raise a lot of money and the share price should reflect that.  However the value of the current asset management base will decline and the accrued incentive will also drop.  And the value of the new assets shouldn't reflect until they begin investing and earn fees/carry.

[giofranchi]

Some investors want to add the value of the future incentive fees.  This is where I think there is a lot less value than the difference between the current share price and $39.  Their 8% hurdles are going to be an absolute killer to any future carry.  As of right now the 30-year Treasury is at 2.34%.  How much risk are they willing to take on to get 15% returns?  15 years ago the 30-year was at 6%+ which let them only earn about 2% of excess return before collecting a fee.  Today they need almost 6% of excess return.  That is a lot of excess return for a $40 billion manager.  So I think the incentive driver is not going to be worth a heck of a lot, if at all. 

 

Well, if this is true, it implies they have been greatly aided by the secular bull market in bonds that’s coming to an end. But I suspect if you ask Marks he would say he doesn’t agree with that view completely. I think his answer would be: we believe that excellence in investing exists and could be achieved, and we will go on finding good value propositions just like we have done in the past.

 

The market of government bonds is very different from the market they usually find their greatest bargains in. Actually, I would almost say they move in opposite directions: the market of government bonds does very well in a risk-off environment, instead the market of high yield bonds does very well in a risk-on scenario. I wouldn’t be surprised to see distressed-debt spike upward and at the same time to see government bonds yields setting new lows! Therefore, OAK will have a large opportunity to deploy huge amounts of capital at high rates of return, even if government bonds around the world keep yielding less and less.

 

And so the argument goes that if the market heads lower they can raise a lot of money and the share price should reflect that.  However the value of the current asset management base will decline and the accrued incentive will also drop.  And the value of the new assets shouldn't reflect until they begin investing and earn fees/carry.

 

Here I might agree with you… Yet, who really knows? The stock market is a discounting machine: in a crash everything gets turned into a relative game, and everyone is looking for a safe place to park his/her money. A money manager which is rapidly increasing its asset under management might not be perceived as a bad risk/reward proposition after all… Even if actual results might be some quarters away… Especially if compared to a lot of other businesses which, instead of growing, must shrink their operations!

 

Gio

 

[Picasso]

The government bond spread versus junk or distress is important for different reasons. 

 

One, it impacts how other investors will look at distressed debt.  In the past they might be willing to do deals at 20% whereas today they would be willing to do a deal at 12.5%.  It crowds out investment for value investors looking for previous returns.  It is obviously still possible but I would say unlikely when you manage $40 billion.  There have been instances of this in the past year for Oaktree.  I can pull up links to different assets they were outbid on from the likes of Blackstone or other specialty players.  Even their venture into single family was much shorter than they expected due to the crowding out effect.

 

Two, it is very unusual to take on low levels of risk and get 12% excess returns over long periods of time.  That is where we are today.  For Oaktree to earn its historical performance figures, they need to earn over 12% above what the market says a long term risk-free rate is.

 

Three, this is not just a US story but rather a global issue of falling rates.  It is not like they can get around the problem by investing in other parts of the globe.  Or maybe they can in emerging markets.  But that goes with saying they will probably take on more risk.  I mean geez, one of their last big distressed deals was on MCP.  The stock was at $2.5 when they did the deal and it currently sits at $0.34 today.  When you have to do distressed deals on rare earth miners, I think the potential investment pool is drying up a tad.

 

And lastly I attached a overlay of the 30-year yield versus OAK.  I do not think it is coincidental that the stock peaked at the same time the 30-year was at 4%. It is more or less my bet that the two will play catch up.

[thepupil]

The government bond spread versus junk or distress is important for different reasons. 

 

One, it impacts how other investors will look at distressed debt.  In the past they might be willing to do deals at 20% whereas today they would be willing to do a deal at 12.5%.  It crowds out investment for value investors looking for previous returns.  It is obviously still possible but I would say unlikely when you manage $40 billion.  There have been instances of this in the past year for Oaktree.  I can pull up links to different assets they were outbid on from the likes of Blackstone or other specialty players.  Even their venture into single family was much shorter than they expected due to the crowding out effect.

 

Two, it is very unusual to take on low levels of risk and get 12% excess returns over long periods of time.  That is where we are today.  For Oaktree to earn its historical performance figures, they need to earn over 12% above what the market says a long term risk-free rate is.

 

Three, this is not just a US story but rather a global issue of falling rates.  It is not like they can get around the problem by investing in other parts of the globe.  Or maybe they can in emerging markets.  But that goes with saying they will probably take on more risk.  I mean geez, one of their last big distressed deals was on MCP.  The stock was at $2.5 when they did the deal and it currently sits at $0.34 today.  When you have to do distressed deals on rare earth miners, I think the potential investment pool is drying up a tad.

 

And lastly I attached a overlay of the 30-year yield versus OAK.  I do not think it is coincidental that the stock peaked at the same time the 30-year was at 4%. It is more or less my bet that the two will play catch up.

 

Picasso, I agree with a lot of what you are saying, but I think it's tough to argue that 12-13X (7-8% yield) is the right multiple on the fee annuity stream, while also pointing out the general decline in rates of return for risk assets. Perpetual fee annuity streams (particularly those indexed to assets that generally go up with inflation and don't require capex to maintain) are high multiple, high duration assets. Can't you make an argument that

 

1) OAK's AUM and mgt fee annuity will keep up with inflation (2%-3%)

 

2) OAK's fee annuity is $350MM

 

If you pay 20X for the mgt fee (get a 5% return + 2% from growth over time) you make a reasonable equity return

 

This argument makes the mgt. fee alone worth $46 / share + $10 (Doubleline + Accrued incentives), gets you to the stock price.

 

I realize that 20X may be a lot to pay for that annuity stream  and I do not own this stock, but it just seems there are lower quality companies and business models to short on valuation. I think the Russell 2000 is a more compelling and easier short than OAK.