DeA Capital — Alternative manager with strong asset support

DeA is a leader in AAM within Italy. It has more than €11.6bn in AUM across its integrated AAM platform, comprising private equity, real estate and NPLs, and also operates as an investor, in its own funds managed and directly, from its permanent capital base.

DeA is majority-owned by De Agostini, a private group, owned by the Boroli and Drago families, with operations in the media, gaming and services 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 73.4%.

In recent years, it has been DeA’s strategy to reduce its direct private equity investments and deploy the capital to support the growth of its AAM platform, while also returning significant amounts of excess cash to shareholders. AAM has stronger growth prospects, greater earnings visibility and more stable cash flows than direct private equity investment, and has the potential to be more highly valued by the market; 2017 saw further good progress in this strategy. The AAM platform mainly comprises DeA Capital Real Estate (formerly known as IDeA FIMIT), a 64.3%-owned subsidiary managing €9.4bn in real estate funds, and DeA Capital Alternative Funds (formerly known as IDeA Capital Funds), which manages €2.2bn of private equity funds. In addition, 80.0%-owned SPC provides NPL management, and the 45%-owned associate IRE provides property services to the real estate sector, including DeA.

DeA’s net asset value at 31 March 2018 was €482.7m, or €1.90 per share, before the May payment of 0.12 (c 30m) in dividends. The net assets of the AAM business (31%), investments in private equity and real estate funds (32%), and a significant net financial position (22%), together represent 85% of the NAV. The direct investment portfolio account represents the balance of 15%.

On a global basis, low interest rates continue to stimulate demand for alternative assets (private equity, real assets, hedge funds) from investors seeking sustainable yields, although, as we discuss below, the group has had to deal with a number of headwinds particular to the Italian environment. A global report produced by PwC (Alternative asset management 2020: Fast forward to centre stage) in 2015 shows that alternative assets have been growing at twice the rate of traditional investments over the past decade and forecasts further growth of c 8% pa to 2020.

The AAM platform provides a wide range of products on a multi-asset platform across private equity, real estate and NPLs. It has a proven capability to structure and launch innovative products and benefits from a deep knowledge of, and extensive contacts within, the Italian market. The AAM platform comprises:

The overall strategy for the AAM division is aimed at consolidating DeA’s existing leading position within Italy, while also exploring opportunities for selectively expanding into other countries within Europe. The latter would be targeted at taking advantage at the ongoing growth in the alternative asset subsector within the broader asset management industry, further expanding DeA’s base of investors as well as broadening its product range. DeA also seeks to expand its presence in the NPL segment. During the past two years, the components of DeA’s AAM platform have begun to work more closely together in areas such as investor servicing and marketing, while the subsidiary businesses have been rebranded (under the DeA Capital Real Estate and DeA Capital Alternative Funds banners) in an effort to raise investor awareness of the group as an integrated AAM platform across private equity, real estate and NPL management.

DeA Capital Real Estate is the largest independent real estate manager in Italy, with a c 20% share by AUM (Exhibit 2). AUM has been on a growth path since Q216, following a period of weakness as Italian pension funds reduced their property weightings and fixed-term funds (launched before the global financial crisis) matured. Net management fees in FY17 were €41.4m, representing an average fee margin of c 45bp of AUM, a level that we expect to be broadly maintained during our forecast period. Reserved (or segregated) funds represent around 90% of the €9.5bn AUM, with the three listed funds, which primarily appeal to retail investors and for which fee margins are higher at c 65bp, accounting for the balance.

DeA’s leading position in real estate management has its origins in the 2011 merger of its First Atlantic Real Estate business into FIMIT, to form IDeA FIMIT, which has since become DeA Capital Real Estate.

DeA Capital Real Estate specialises in core real estate investment strategies, targeting income-producing real estate that is bought and then held for the long term; however, it also offers value strategies. Value strategies look for opportunities to benefit from improving the income stream and value of the property acquired. Overall, it seeks investments in transactions with low risk, stable returns and low volatility. As a result, its portfolios are focused on good quality real estate assets in large Italian cities (c 60% by value in Milan and Rome), with a significant share of the total (c 68%) represented by office buildings and bank branches.

DeA Capital Real Estate’s appeal to institutional investors such as pension funds, insurance companies, sovereign wealth funds, corporations and banks, both from Italy and from abroad, is enhanced by its strong market positioning in Italy. The investor base comprises c 100 institutional investors, representing c 90% of all investments and more than 70,000 retail investors.

Business development is focused on expanding existing funds, launching new core and value initiatives, and expanding the product range. During 2017, six new funds were launched, and in January 2018, DeA broadened its product offering with the closing of the Special Opportunities I fund, which has net assets of €200m that will be allocated to the purchase of non-performing secured loans via securitisation vehicles. This €200m is not included in the Q118 AUM total as investment had not commenced at that date. DeA has only a very small ownership of its traditional funds managed but has subscribed €20m (10%) to the innovative new Special Opportunities 1 fund. The remaining commitment was underwritten by Apollo Global Management, one of the leading global players in alternative investment.

Management sees opportunities to enhance profitability through the rationalisation of smaller and overlapping funds, while introducing innovative product innovations to complement traditional funds and raise the blended average fee margin.

DeA Capital Alternative Funds is a leading player in the somewhat more fragmented Italian private equity management sector. The €2.2bn of assets managed are the responsibility of a substantial team of 37 investment professionals. The 10 funds managed by the team are shown in Exhibit 5, and comprise funds of funds, co-investment funds, thematic funds and credit funds.

Across the funds of funds, DeA has relationships with general partners that are invested in c 700 companies through 80 funds worldwide. Through its directly managed funds, DeA supports the management teams of c 30 direct investee companies.

DeA’s investor base comprises more than 260 limited partners, including high net worth/entrepreneurs as well as institutional investors.

Fund launches in recent years have been in the areas of thematic funds and credit funds, driving a gradual shift away from funds of funds, which have proven less popular with investors. Looking forward, DeA anticipates a regular stream of new fund launches, with a seeding commitment of c 10%, consistent with its experience of recent launches. Our forecasts look for flat AUM through FY19 but the extent to which new fund launches are able to offset the expected run-off of older funds of funds remains an area of uncertainty.

We provide a summary of the AAM division’s earnings and our forecasts in Exhibit 6. The accounting treatment of the merger of DeA’s First Atlantic Real Estate business into FIMIT in 2011 created a material balance of goodwill and other intangibles, and non-cash recurring amortisation and impairment of these balances has affected the reported earnings of the division in recent years. This makes it more difficult to track the underlying progress and so we provide an adjusted earnings measure-making allowance for the following items:

AUM in both private equity and real estate has been growing organically and steadily since Q216, increasing from €9.5bn at the end of Q116 to €11.6bn at end-Q118. We expect both to continue to add assets, primarily through new fund launches, with real estate continuing to show the stronger net AUM growth and private equity facing the headwind of older funds of funds maturities. Fee margins relative to average AUM have declined in both private equity and real estate in recent years as a result of competitive pressures and mix changes, but have recently appeared to stabilise and we forecast this to continue. Although we express private equity fee margins relative to the readily available AUM, defined as total fund commitments, the actual basis for earnings may often differ. Most fees are based either on AUM or the fund-level NAV, although other arrangements also exist. For Q118, management has indicated that the ‘asset base’ on which the fees for that quarter were earned was €1,549m, compared with AUM of €2,160m.

Edison-adjusted Q118 net earnings of €1.8m were c 12% below the Q117 level and represent c 18% of our full-year forecast. However, as noted above, these include c €1.1m of pre-tax negative valuation movement on own real estate funds held or c €0.5m after tax and minorities. We do not forecast future adjustments, either positive or negative, of this nature. Our assumption that this negative item does not recur accounts for c 5pp of the 7% increase in adjusted earnings that we forecast for FY19, with cost growth broadly keeping pace with management fee growth.

As management continues to focus on growing the AAM platform, the business should be highly scalable with any additional AUM and fee growth having a disproportionate impact on profitability.

DeA’s private equity investment portfolio amounted to €227.1mn at end-Q118, including real estate and private equity fund investments of €156.7m and direct investments of €70.4m. DeA’s fund commitments are mainly to the private equity funds, with an end-Q118 value of €144.0m (see Exhibit 6). Just €2.6m of DeA’s end-Q118 net assets were allocated to own managed real estate funds. The total fund investments also include €10.1m of legacy investment in a group of externally managed venture capital funds.

The end-Q118 direct investment portfolio of €70.4m included:

The private equity investment operations have been substantially liquidated and the remaining investments refocused in recent years in a way that can be summarised as follows:

The primary purpose of the division is to support the development of the AAM activities and enhance the returns on shareholder capital. On balance, the amount of capital committed to the operation is likely to continue to reduce, providing significant net cash flow to support continuing shareholder distributions.

A summary of the historical and our forecast financial statements (prepared under IFRS) is shown at the back of this report in Exhibit 15. The application of IFRS accounting principles to DeA’s operations has historically created a fairly complex picture, and although changes in the application of IFRS will make this simpler in future, we continue to suggest that investors focus on:

Our expectations for the AAM division are discussed in detail earlier in this report, and in this section we provide details on our NAV and cash flow forecasts.

The majority-owned AAM businesses are fully consolidated within the income statement and separately disclosed within the divisional reporting. The AAM accounting is very clear, although as noted above, their carrying value includes an amount of goodwill, subject to an annual impairment test. Non-cash impairment has had an impact on the reported AAM divisional results and group results in recent years, for which we make adjustment. It is the application of IFRS accounting to the investment portfolio, other than the AAM platform, that has historically added complexity to DeA’s consolidated accounts as a result of the following:

Within the AFS assets, Migros, Crescita, and IDeaMI are valued at their quoted market prices. The valuations of the unquoted fund investments are management estimates based on their best judgement and estimation, using techniques that are common to the private equity industry.

Although the reporting of fair value movements on AFS investments in the income statement (rather than other comprehensive income) is a simplification, we would argue against relying on the income statement as a guide to performance and value creation, as it will continue to include volatile capital movements.

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 investment portfolio. We assume a normalised growth in the carried value of all of the fund investments (whether carried as AFS, consolidated, or equity accounted), an approach that differs from the way that these assets are actually managed, which seeks to maximise IRR, but we believe it to be a useful way to capture at least some of the returns that may be earned over time. We assume:

Somewhat conservatively, we have assumed no changes in the value of (or income from) the quoted investments, Migros, Crescita and IDeaMI.

At 31 March 2018, the holding company net financial position (defined as holding company cash and cash equivalents, available for sale financial assets, and financial receivables less current and non-current liabilities) was €105.8m or c 22% of NAV. At a group level, including net financial assets within the subsidiaries, it was higher still, at €170.5m.

As can be seen in Exhibit 7, the net financial position has been transformed from negative to positive during recent years and has remained strong. During the period, operational cash flows, the proceeds from divestment of direct holdings (GDS, Sigla, part-Migros) and net reimbursements from fund investments have exceeded new direct investment (Crescita, IDeaMI), a high level of dividend distribution (c €30m pa currently) and strong share repurchase activity (a cumulative €42.3m since the beginning of 2013, including €2.9m in Q118).

Our expectation of continuing net reimbursements from fund investments is included in the net financial balances shown in Exhibit 7. In 2017, fund capital reimbursements of €61.5m exceeded capital calls of €20.0m by €41.5m. In Q118, the net positive balance was €17.9m and we assume €41.5m for the full year and an additional €20.0m in FY19. The main driver of this positive fund cash flow remains the maturation of a number of the older funds as discussed above. For 2018, we have included the new €20m fund commitment (10% of the total) that DeA has made to support the launch of the Special Opportunities Fund 1 (real estate NPLs) and although we have not attempted to forecast these in Exhibit 8, further commitments to new funds are likely. The table provides significant comfort on the ability of DeA to continue to pay high dividends while meeting its existing commitments to funds and continuing to invest in its businesses.

Overall, our forecasts for the net financial position through 2018 and 2019 should be viewed as illustrative, as they assume no further purchases or sales of direct investments, although these are likely, or strategic investments in the AAM platform. In particular, we would note the potential for a medium-term exit from the remaining Migros investment as the investment vehicle through which the stake is indirectly owned reaches maturity. The carrying value of the remaining Migros investment was €37.4m at end-Q118.

We have made only small changes to our FY18 forecasts following the recent Q118 results release, and introduced an FY19 estimate for the first time. We have been slightly more cautious about private equity fee margins (now looking for these to remain flat) and also assume slightly higher recurring costs than previously. As noted above, the c €1.4m reduction in our FY18 AAM adjusted earnings estimate is substantially driven by the €1.1m Q118 mark-to-market adjustment for the units held in the Conero real estate fund. For FY19, we have conservatively estimated modest net growth in AUM and fees, offset by cost growth.

FY18 NAV per share is reduced versus our previous forecast as a result of the Q118 decline in the value of the Migros stake, which more than offset asset value growth elsewhere in the portfolio. Our year-end NAV is based on the Q118 valuation for Migros, rather than the current market value, although we allow for the post-Q118 further decline (equivalent to c €0.04 per DeA share) in the valuation analysis below.

DeA’s share price reached a 52-week high of €1.60 in May, ahead of the €0.12 DPS payment for the 2017 financial year. The dividend payment coincided with Italian equity market volatility resulting from political uncertainties. As a result, the share price discount to the Q118 NAV per share (ex-dividend) is again c 30%, and the discount to our sum-of-the-parts (SOP)-based fair value is c 26%. The prospective yield (using Edison forecast 2018 DPS of €0.12) is more than 9%.

Our fair value for DeA is €1.72 per share, based on an SOP valuation, and allowing for the €0.12 per share dividend paid to shareholders on 23 May 2018. Our SOP compares with the Q118 IFRS NAV per share of €1.78, also adjusted for the dividend since paid.

The updated SOP fair value is lower than the adjusted €1.80 (€1.92 less the €0.12 dividend subsequently paid) that we last published on 26 March 2018, with the reduction equally spread between the market valuation of the Migros stake and our peer-based earnings multiple valuation of the AAM division, reflecting a slight decline in the sector multiple for consensus earnings.

The components of our SOP valuation, the components of which are shown in Exhibit 10.

Within the SOP, and discussed below, we value the AAM division at €0.56 per DeA share, using a peer comparison-based earnings multiple discussed in detail later in this section. Most of the other values are as reported at Q118 with the exception of the Migros stake, which we adjust to the current market value.

DeA’s investments in own private equity and real estate funds, of which c 95% is investment in DeA managed funds, represent a further €0.62 per share, based on the Q118 NAV. Taken together with our AAM division valuation, these core AAM activities (AAM and supportive co-investment in own funds managed) represent €1.18 per share or 69% of our fair value. Adding the holding company cash position would increase this to 86% of our fair value.

The components of our fair value suggest to us that DeA should be compared with other alternative asset managers. However, noting DeA’s still large investment portfolio, a comparison with the listed private equity fund sector also shows a significantly larger than average discount to NAV for DeA, again indicating that the recent pull-back in the share price may provide an attractive entry point.

Our valuation of the AAM division is based on the application of what we believe to be a suitable multiple to our forecast for net income after minority interests. To establish a suitable multiple, we consider the consensus P/E multiples for a number of alternative asset managers, specialist and conventional asset managers in Europe and North America.

The range of consensus multiples is wide, although the averages indicate that both the market P/E and P/BV valuations of the alternative/private equity managers is higher than that for the conventional asset managers, while dividend yields are lower. This would be consistent with the faster growth of alternative assets under management, which is widely expected to continue.

Our valuation of DeA’s AAM division is equivalent to 14.3x 2018 adjusted net earnings. To arrive at this, we have taken the average of the market average P/E multiples for the alternative/private equity managers for both 2018 and 2019.

At €143.1m, our valuation is only slightly lower than the IFRS book value of €148.8m at 31 March 2018, lending support to the valuation of the remaining intangible assets carried in the balance sheet.

Compared with the broader asset management sector, on a 12-month view, DeA’s share price performance is in line with the average for all companies shown in Exhibit 12, although below the average for the alternative/private equity managers; however, noting that DeA is well above average yield, on a total share price performance basis, the gap largely disappears.

Our SOP valuation values the Migros stake at the recent price of TRY18.9 per share and an exchange rate of TRY5.27 versus the euro. This compares with a price of TRY23.78 per share and an exchange rate of TRY4.88/€ reflected in the end-Q118 NAV.

To manage its share price discount to NAV, DeA has an active and ongoing share repurchase programme. Share repurchases by value have averaged €8.2m pa in the three years to end-2017 (2017: €8.0m) and were €2.9m in Q118. The company now holds c 53m shares in treasury, a little more than 17% of the total, with authorisation to buy back up to 20% of the total.

DeA’s financial results and prospects are very sensitive to financial market conditions. These affect its ability to realise divestments, raise new funds and find new investment opportunities, and will also influence the valuations of its investments, AUM and asset management fees. Although not immune from market fluctuations, the growing significance of AAM within the overall group, driven by recurring fee revenues, is likely to reduce the overall sensitivity to market fluctuations.

The valuations of the underlying investments in the private equity funds and those direct investments that are in unquoted investments are based on a rigorous but ultimately subjective assessment by management, with inevitable uncertainty about realisable values.

The indirect investment in Migros has been subject to the considerable volatility of the Turkish equity and foreign exchange markets, although DeA’s stake has been significantly reduced over the past year at a valuation well ahead of the current level. At end-Q118, it represented €0.15 per share or less than 8% of NAV.

Any disruption to markets, as witnessed during the global financial crisis, could be expected to slow the pace at which the PE funds are able to realise investments and reimbursements capital, and could have a noticeable effect on the net balance of capital calls and reimbursements with a negative impact on group cash flow.