Strong cash used to grow asset management

DeA Capital is a leader in the Italian AAM sector. It manages assets of around €11.4bn across its integrated AAM platform, comprising private equity, real estate and NPLs, and operates as an investor in its own funds managed, and invests directly, from its permanent capital base. The group is majority-owned by De Agostini, a family-owned private group founded in 1901, itself owned by the Boroli and Drago families. De Agostini operates in the media, gaming, services and, through DeA Capital, AAM sectors. De Agostini has a 58.3% stake in DeA and, through the loyalty share scheme approved by shareholders in 2015, has a voting interest of around 70%.

In recent years, DeA has been reducing its ‘large ticket’ direct private equity investments and refocusing on supporting the growth of its AAM platform, investing in new capabilities and seeding new fund launches. AAM has good growth prospects as low interest rates continue to stimulate demand for alternative assets (private equity, real assets and hedge funds) from investors seeking sustainable yields. The AAM platform mainly comprises DeA Capital Real Estate, in which DeA has recently increased its ownership to 94% from 64.3%, the leading real estate manager in Italy with AUM of €9.1bn (measured by total managed assets) and DeA Capital Alternative Funds, which manages €2.3bn (measured by total commitments) of private equity funds. In addition, 80.0%-owned SPC provides NPL management and the 45%-owned associate YARD provides property services to the real estate sector, including DeA. Key strategic goals for the AAM business are to further expand the base of investors and the range of products offered and DeA recently announced the creation of DeA Capital Real Estate France, a first step in creating a pan-European real estate platform.

DeA has a strong and liquid balance sheet. Net asset value at 30 September 2018 was €463m, or €1.83 per share. The net assets of the AAM business (31%), investments in private equity and real estate funds (27%), and a significant net financial position (30%), together represent 88% of the NAV. The direct investment portfolio account represents the balance.

For a detailed analysis of DeA Capital and its strategy, please see our June Outlook note.

Q3 saw growth in AUM and a continuation of strong cash flows, primarily driven by net reimbursements from mature fund co-investments. Investment performance was held back by negative revaluation movements on the residual indirect stake in Migros, the listed Turkish retailer. The majority of the fund investments showed gains, but these were offset by negative adjustments on two real estate funds. Since the end of the quarter, DeA has proposed the cancellation of 40m treasury shares, which we view positively. More significantly, it has increased its stake in DeA Capital Real Estate from 64.3% to 94.0% at what we believe to be favourable price. The key Q3 highlights were:

On 21 November 2018, DeA announced that it had completed the acquisition of an additional c 29.7% of DeA Capital Real Estate, from minority partner INPS, increasing DeA’s ownership to c 94.0%. We believe this development is positive as it underlines DeA’s focus on the growth of its AAM platform, increases the share of AAM earnings within the group, appears to us to be attractively priced, and is a significant move towards simplifying the DeA corporate structure. The divestment by INPS is in line with its strategy, initiated in 2017, to gradually dispose of non-core real estate investments. The remaining 6% is owned by Fondazione Carispezia, a private foundation that remains one of the main shareholders in the Italian bank, Credit Agricole Carispezia.

The consideration for the acquisition of the stake is €40m, based on the book value of DeA Capital Real Estate, wholly financed from DeA’s significant internal cash resources. In addition, there is a maximum earn-out of €4.5m over the three-year period 2019-2021 which is subject to DeA Capital meeting undisclosed set targets for new assets under management.

We estimate that DeA is paying between 9.7x and 11.7x our forecast underlying earnings for FY19 to acquire the additional stake in DeA Capital Real Estate. The additional (forecast) post tax, pre-minority adjusted earnings acquired are €2.3m. In addition to assumed investment gains, our adjusted earnings adds back the recurring non-cash purchase price amortisation (PPA) in relation to the intangible value of customer relationships that was recognised on formation of the real estate subsidiary. In calculating the acquisition multiple, we adjust the acquisition cost for the 30 September value of the additional share of available for sale fund investments, owned by DeA Capital Real Estate, that have been acquired (c €17.2m). This adjusted acquisition cost (an amount of between €22.8m and €27.3m) represents the amount paid for the additional earnings.

DeA is proposing to cancel 40m of the 52.9m treasury shares (c 17% of the shares outstanding) that it has acquired over the past few years under its ongoing share repurchase programme. Although this will have no impact on reported liquidity, NAV, earnings, or EPS, as the treasury shares are deducted from this calculation, we welcome the move as we believe it shows that management believes its significant net positive financial position is sufficient to support its current growth plans without the need to reissue the shares. Should this situation change, management can make the case for new share issuance based on the merits of the investment opportunity. As the shares are in any case withdrawn from the market, cancellation should have no negative impact on share trading liquidity.

The reason for the cancellation is that with ongoing repurchases, the free float has recently fallen beneath the minimum level that is required to maintain DeA’s listing in the STAR market segment of Borsa Italiana’s Mercato Telematico Azionario (MTA) equity market. This segment of the market is dedicated to mid-sized companies with a market capitalisation of less than €1 billion, which voluntarily adhere to comply with the requirements to:

To restore and maintain compliance with these requirements, DeA will propose the cancellation of shares to shareholders at an extraordinary general meeting, planned for April 2019. Meanwhile, the parent company De Agostini has already waived 50% of its double voting right entitlement on the shares that it owns, awarded under the company’s shareholder loyalty programme. Assuming shareholder approval for the share cancellation, Exhibit 3 shows the effect on the number of shares and the parent company voting position, which is broadly unchanged as a percentage.

We have made a number of relatively small adjustments to the AAM earnings estimates to reflect recent trends, but the main change is an increase in attributable earnings resulting from the reduced minority interests.

Our assumptions for AUM are little changed although we have slightly reduced our expected average fee margins in line with recent experience. Forecast management fees are lower as a result, but the effect on adjusted earnings, before minority interests, is partly offset by lower forecast expenses, again reflecting recent experience. It should be noted that the fall in expenses that we forecast, from FY18 to FY19, is more than accounted for by the assumed non-repetition of the provisions taken in FY18 within DeA Capital Real Estate. Reported earnings also benefit from a higher forecast other income/expense related to the notional return assumed on fund investments, which have increased to c €57m as a result of the €18.5m investment by DeA Capital Real Estate in the Tessalo fund in Q3. These notional returns are stripped out of adjusted earnings figure, which is also adjusted for non-cash purchase price amortisation (PPA) and other one-off items.

Our forecast adjusted earnings is reduced by c 5% for the current year (to €10.0m) but in FY19 a full year impact from the reduction in minority interests more than compensates for our underlying earnings reduction, leaving adjusted attributable earnings c 12% higher.

In addition to our estimates for the AAM profit contribution, our NAV forecasts seek to capture at least part of the potential for growth in NAV from the majority of the investment portfolio that is not captured within the AAM segment. This includes the private equity fund holdings and the direct investments (Kenan Investments/Migros, Crescita/Cellularline and IDeaMI).

We assume 7.5% per year ‘normalised’ growth in the carried value of all of the private equity fund investments and 4% per year for real estate funds (substantially representing the expected income returns), whether carried as available for sale investments, consolidated or equity accounted. We believe this to be a useful way to capture at least some of the returns that may be earned on these investments even though our approach differs from the way these assets are actually managed, seeking to maximise IRR. Our forecasts assume no change to the last published value (or income from) the quoted investments, Migros (Kenan Investments), Cellularline (formerly Crescita) and IDeaMI, but in our valuation (see below) we do adjust these to market values.

In Exhibit 5, we break down our group forecasts (shown in Exhibit 12) by segment, as reported by the company, which feed through into our NAV forecast. The most significant change relates to the Private Equity segment where our normalised return methodology described above does not adjust for a reversal of the negative investment returns in Q318.

Exhibit 6 shows a summary of some of the key group level forecasts. The strong cash generation in Q3 can be seen in the relatively modest reduction in the forecast holding company net financial position, despite the €40m cash payment related to the real estate minority interest acquisition. Given the strong cash flow, we continue to expect further strong dividend distributions. The slight reduction in our forecast NAV per share reflects the Q3 investment returns discussed above.

DeA shares trade at a significant discount of 30% to the Q318 published NAV per share of €1.83, a larger discount of 34% to our adjusted NAV per share of €1.94. DeA’s P/NAV of. c 0.7x is the lowest of the peer group shown in Exhibit 7. We have divided this peer group into a ‘narrow group’ of companies that DeA management believes mostly closely resemble its own strategy of combining alternative asset management for third parties with balance sheet investments supported by permanent capital, both co-investment in funds managed and direct investment. We have also included a broad range of other private equity, specialist and conventional asset managers, many of whom focus on ‘balance sheet light’ third-party asset management. Given this mix of strategies amongst its peer group, combining widely differing reliance on ‘recurring’ asset management earnings and balance sheet-driven investment earnings, we would not suggest focusing on any particular valuation multiple. Before examining the DeA valuation in more detail, we first explain our adjusted NAV calculation.

Our adjusted NAV replaces the stated book value of the alternative asset management platform with our assessment of a fair value based on P/E multiples observed across a group of both alternative and more conventional asset management companies listed in Exhibit 7. We also mark to market DeA’s quoted investments. The acquisition of minority interest in DeA Capital Real Estate has a positive impact on our adjusted NAV, which is increased from €1.91 to €1.94, as discussed below:

The P/NAV valuation of DeA is the lowest of the peer group shown in Exhibit 7. DeA has the additional benefit of strong cash flow from maturing investments to support a high level of distribution, in excess of recurring income, representing a yield of c 9%. However, the near-term downside from the strongly liquid balance sheet is that at current interest rates it acts as a drag on overall returns as can be seen from the NAV total return analysis in Exhibit 9 (the annual change in NAV during the period plus shareholder distributions). Compared with our last published NAV total return forecasts, FY18 is reduced (due to the Q3 investment moves discussed above), but FY19 is increased as a result of the acquisition of minority interests.

The immediate catalyst to a re-rating of DeA shares is the recognition by investors of the low inherent valuation of the company. But more than that, the successful continuing deployment of this excess capital has the potential to lift overall returns and accelerate the growth of the potentially more highly valued AAM platform.