DeA Capital — Accelerating strong cash flow supports dividends

DeA Capital (DeA) is a leading participant in the fragmented Italian alternative asset management industry with total alternative assets under management of c €11.6bn at 30 September 2017. It has historically focused on real estate and private equity, to which non-performing loan (npl) management has been added more recently with a further c €0.3bn of AUM. Although currently small, the npl sector has good potential for further development, and management has ambitions to grow this activity into a third leg to the asset management platform over time. The investment division invests the group’s own permanent capital both directly via strategic stakes in companies and indirectly via funds, overwhelmingly managed by the group’s asset management division. The investment portfolio amounts to c €269m as at 30 September 2017.

De Agostini, a group with other investments in the media, gaming and services sectors, is the major shareholder with a 58.3% stake, and 73.7% of the voting rights; De Agostini is in turn owned by the Boroli and Drago families.

The alternative asset management businesses were recently re-branded to underline their close working relationship within an integrated platform that seeks to further grow its activities and broaden its reach outside of Italy. The platform comprises DeA Capital Real Estate SGR (formerly known as IDeA FIMIT), a 64.3%-owned subsidiary managing €9.7bn in real estate funds, and DeA Capital Alternative Funds SGR (formerly known as IDeA Capital Funds), manages €1.9bn of private equity funds.

DeA’s net asset value at 30 September 2017 was €502.3m, or €1.96 per share, comprising the net assets of the alternative asset management business (33%), investments in private equity and real estate funds (38%), and direct investments (16%), with a significant net financial position accounting for almost all of the balance (13%).

During Q317, NAV per share gave back some of the gains generated earlier in the year but adjusted for dividends subsequently paid was ahead of the level at 31 December 2016. A retracement in the Migros share price during the period accounted for the majority of the movement while as we discuss below, the decline in the private equity/real estate funds NAV substantially represents cash distributions during the quarter, with the holding company net financial position increasing to €67.7m from €60.4m at H117 and an adjusted (for €31.2m in dividends subsequently paid) €48.5m at the beginning of the year. Within the alternative asset management (AAM) division, assets under management (AUM) continued to grow, albeit modestly, and underlying performance was as expected.

Key highlights of the Q3 performance were:

Subsequent to the Q3 close, DeA’s investment partner through which it is invested in Migros has completed the sale of 13.0m Migros shares at a price of TL26.0 per share which we estimate will generate cash proceeds to DeA of c €12.0m (see below). In the following sections we provide an update on the developments and our forecasts for the alternative asset management division and the investment portfolio respectively.

Within the alternative asset management business, real estate funds continued to grow in Q317, lifting overall AUM to c €11.6bn despite a small decline in private equity AUM. The €11.6bn excludes c €0.3m of assets managed by the 80% owned non-performing loan manager, SPC.

Four new real estate funds have been launched during 2017 (including the Broggi fund and the second tranche of the Trophy Value Added fund) and growth in these new funds was the main driver of the Q3 real estate AUM increase of c €0.3bn. While we expect the maturity of older funds of funds to reduce private equity AUM over the medium term (and reflected in our FY18 estimates), 2017 has been relatively stable. The small decline (c €0.4bn) in private equity funds in Q317 actually reflects the strength of underlying credit quality in the non-performing loan segment of the corporate credit recovery fund (IDeA CCR 1) which has reduced the scope for parallel refinancing loans.

Fee margins across both private equity and real estate were slightly improved in the quarter.

Year-to-date, the headline results have been affected by several non-recurring items including a write-down of goodwill relating to SPC; write-downs on financial equity instruments that are largely attributable to minority shareholders; and write-downs of units in some of the portfolio funds. In Q3 the write-down in financial equity instruments contained within net profits was €1.6m (year-to-date €6.1m), of which c €1.0m (64.9%) is attributable to minority interests. Other than this non-cash write-down, the divisional costs continued to run slightly below our estimates.

A summary of the key changes to our alternative asset management forecasts is shown in Exhibit 5. Our adjusted net profit is adjusted for PPA and the SPC goodwill write-down but not the other charges and write-downs referred to above.

We have slightly trimmed our private equity fee revenue estimates for the current year to reflect the possibility that the planned launch of a second corporate credit recover fund may now fall in 2018 rather than the current year. While a reduction in our expense assumption more than off-sets this, it is not by enough to compensate for the Q3 write-down of equity instruments that was not in our forecasts. Forecast 2017 reported and adjusted earnings are reduced as a result but the effect of one-off items falls away in 2018. For 2018, we continue to look for further growth in real estate AUM but for private equity AUM to decline with maturing funds of funds. Compared with our previous estimates however there is a c 2% increase in revenues and earnings.

As can be seen in Exhibit 3 above, during Q317 the net assets of the direct and fund investment portfolio reduced from €291.6m (€1.13 per share) at 30 June, to €268.9m (€1.05 per share). The reduction significantly reflects the positive balance of fund reimbursements over capital calls (hence the increase in the net financial position) as well as some negative valuation movements.

In Exhibit 6 we break down the movement in detail and note that cash movements represent a €0.4 per share reduction in the value of the investment portfolio while valuation movements/impairments account for €0.05 per share. The small rounding error is attributable to the reduction in share count during the quarter resulting from share repurchases. It is the valuation movement of €0.05 per share, offset by retained earnings from the other group activities, that contributes to overall group NAV per share movement from €2.00 to €1.96 during the period.

The investment in Migros accounted for c €0.03 of the NAV decline in the quarter. This is held indirectly through DeA’s 17.11% investment in Kenan Investments, which in turn owned 30.5% of Migros at 30 September but has subsequently reduced its stake to 23.2%. The recent sale represents the second reduction in Kenan’s Migros stake this year. At the beginning of the year it owned 40.25% but in May exercised an option to sell 9.75% at an effective price of TRY30.2 per share, very close to the year high. This transaction generated cash proceeds for DeA of €17.8m, with €4.4m retained by Kenan in escrow until 2020 to cover any potential tax liability that may emerge. The transaction triggered a €3.8m realised gain in the P&L account, with €4.4m charged to the fair value reserve through other comprehensive income, resulting in a small (€0.6m) reduction in NAV.

On 21 November 2017 an additional 13.0m Migros shares were sold by way of an accelerated book-build at a price of TRY26.0 per share. The shares sold represent 7.3% of the total outstanding shares in Migros, with the Kenan stake falling from 30.5% to 23.2%. DeA’s 17.11% stake in Kenan is unchanged. The exact proceeds attributable to DeA will depend on the TRY/EUR exchange rate but at a rate of TRY4.66/EUR we estimate that DeA will receive c €12.0m, included in our full year FY17 forecast. Similar to the option sale in May, we would expect DeA to book a realisation gain through the p&l account, offset by a negative reduction in the valuation reserve through other comprehensive income, with potentially a small impact on NAV per share. This has not been disclosed and is not shown in our p&l and other comprehensive income forecasts.

The price of Migros has weakened in recent weeks along with the Turkish market and the Turkish lire, reacting negatively to increased political tensions. As discussed in detail in the Valuation section, we estimate a current market value for DeA’s share of the remaining Migros stake at €41.0m. Despite the recent set-back in Turkey, year to date the investment has still shown a positive performance as shown in Exhibit 7.

Our approach to analysing DeA’s financial performance is to focus on:

While investment returns will fluctuate from period to period, sometimes quite markedly, our group NAV forecasts assume normalised growth in the carried value of all fund investments (AFS, consolidated, and associate). Although this approach does not mirror management’s IRR-based approach to investment, we believe it is a useful way to model some of the expected returns that may be earned. Our unchanged assumption is a 7.5% pa growth in value (fair value gains less impairments) for all funds with the exception of real estate funds (the Venere associate and the IDeA FIMIT AFS funds) where we assume c 4%. These assumed changes in value feed into our NAV forecasts via other comprehensive income in respect of the available for sale fund investments, and the associate line of the P&L in respect of the equity accounted Venere and IDeA EESS. For the consolidated IDeA OFI the returns are split fairly equally between net profits consolidated in the P&L account and fair value gains that are reported in other comprehensive income, although for modelling purposes we assume that future returns all pass through other comprehensive income.

The decline in investment portfolio value and NAV during Q3 feeds directly through to our forward looking NAV forecasts that are shown in Exhibit 8 alongside our revised AUM and earnings forecasts for the Alternative asset management division.

The key change to our forecasts is the significant uplift in the holding company net financial position, mirroring a similar move in the consolidated financial position, including the subsidiaries. While we continue to factor in the expectation that the agreed sale of Sigla for €11.8m will complete by the year-end, the drivers of the uplift are the further sell-down in Migros and the prospect of an increased net positive balance between fund capital calls and reimbursements. As shown in Exhibit 9, taking into account the positive balance generated in Q317 and the positive indications for Q417, we have increased our estimated net positive balance for cash flow from the fund investments in the current year to c €40m from €7.7m previously. In view of this strong current year performance, we have trimmed our forecast for next year to a positive €20m from €30m previously. The medium-term prospects continue to be supported by an expected acceleration in reimbursements from older, mature funds.

We have made no assumptions about new direct investment or new fund commitments (none year-to-date), although we would expect DeA to continue to participate in future fund launches as these occur and continues to explore opportunities for attractive new direct investment. Before any such additional investment commitments, we see the current level of fund commitments being fully covered by the forecast consolidated net financial position by the end of 2017.

We show the recent trend and our forecasts for the net financial position, both at a group and holding company level, in Exhibit 10. It is the holding company net financial position that supports cash distributions to shareholders.

To capture both the net asset value of DeA’s investment portfolio and a fair trading value for the alternative asset management activities, we use a sum-of-the-parts (SOP) approach to value DeA. Our updated SOP value is €1.87 per share (previously published €1.91). There are two differences with the company’s own NAV analysis shown in Exhibit 3:

Having reached a high of TRY30.5 per share during August 2017 (similar to the effective price of TRY30.2 at which DeA exercised its option to sell 9.75%), both the market valuation of Migros shares and the value of the Turkish lire relative to the euro have since declined with rising Turkish political uncertainty. We have adjusted for the November sale of Migros shares and have valued the remaining Migros holding at TRY24.88 per share (based on the 22 November 2017 close, with the shares having weakened in response to the Kenan/DeA share sale). The Turkish lire has continued to weak versus the euro and our valuation is based on TRY4.66/EUR compared with TRY4.21 at 30 September. The value of this 23.2% stake is €37.8m (€0.14 per DeA share), to which we add €3.2m in other net assets within the Kenan holding company through which the stake is held, mainly represented by the €4.4m of proceeds from the recent sale of Migros shares that will be held in escrow by Kenan until up to 2020. The market value of DeA’s holding in Crescita is unchanged from 30 September at €8.3m.

Our valuation of the alternative asset management business is based on the application of what we believe to be a suitable earnings multiple to forecast underlying net income after minority interests as shown in Exhibit 4. To establish a suitable multiple, we consider the consensus P/E multiples for a number of private equity, specialist and conventional asset managers in Europe and North America. The average multiple of next year earnings across all categories has increased to 13.7x from13.5x since our last published report, and we have applied this to our forecast for DeA’s AAM underlying 2018 earnings with a small positive impact on valuation. Combined with our slight (2.0%) increase in forecast underlying AAM earnings, this results in a value of €150.8m (previously €145.7m), lower than the balance sheet net asset value of €165.7m (shown in Exhibit 3) including goodwill and other intangibles. The balance sheet value is equivalent to 15.0x FY18e underlying earnings.

DeA’s share price rose strongly earlier in the year, reaching a high of €1.59 in May (or €1.47 adjusted for the dividend that was paid soon after) before falling back. The shares began to climb again after the positive H117 results but have since weakened despite the strongly positive cash flow in Q317 (and expected again in Q417) and continuing progress in AAM (leading to a modest increase in forecast earnings).

The share price discount to published NAV and to our modified NAV or SOP is 35% and 34% respectively. This remains above that of the broader private equity fund sector, as represented by the LPX50 index of 50 leading listed private equity funds (see Exhibits 13 and 14).

DeA continued to repurchase shares during Q3, acquiring 1.35m shares at a cost of €1.829m or an average c €1.36 per share, and has continued to acquire shares in Q4. There are now 50.3m shares held in treasury, representing 16.4% of the total. The share repurchase programme is aimed at managing this discount and runs in parallel with ongoing high cash distributions to shareholders (we expect DeA to again distribute €0.12 per share in respect of the current financial year which represents an attractive dividend yield of almost 9%). Although the treasury holding has steadily increased, for now there has been no negative impact on trading liquidity in the shares. Having averaged c 160,000 shares per day through 2016, average daily trading volume reached c 600,000 shares per day in H117. Although this has slowed slightly since, the year-to-date daily average trading volume remains significantly ahead of last year at c 450,000 (source: Bloomberg, 15 November 2017).

More fundamentally, we would expect continuing evidence of growth in the alternative asset management business to have a positive impact on valuation and the discount, along with the prospect for continuing net distributions from the relatively diverse and mature investments in private equity funds.