DeA Capital — Balance sheet supports growing AAM platform

DeA Capital (DeA) is the leading independent (non-bank) platform operator in AAM in Italy, providing a broad range of products and services for institutional investors. At 30 June 2020 combined AUM (including c €7.6bn managed by Quaestio Capital Management, in which DeA is the largest shareholder, acquiring a 38.8% stake in November 2019) were c €22.5bn.

Within the alternative investment area, DeA is engaged in the promotion, management and development of real estate, credit and private equity funds, as well as multi-asset/multi-manager investment solutions. Its growing AAM platform combines experience, know-how and market reach to support the sourcing of investments, the structuring of often complex transactions and the ability to distribute these to a broad investor base.

An investment portfolio of €343.2m at 30 June 2020 comprises the equity of the AAM businesses (€207.5m) and a portfolio of alternative investments (€135.7m). The portfolio of alternative investments mainly comprises ‘platform investments’, mainly investments in own-managed funds and supporting the AAM platform and its development.

DeA shares are listed on the FTSE Italia STAR section of the Milan Stock Exchange and the company is majority owned by De Agostini, a large Italian private group of companies owned by the Boroli and Drago families, with operations in the media, gaming and services sectors. De Agostini owns 67.1% of DeA and the free float is 30.4%.

DeA’s NAV at 30 June 2020 was €425.4m, or €1.63 per share, after an annual distribution to shareholders in June 2020 of €0.12 per share (c €30m). The consolidated financial position was €97.2m and adjusting for subsidiaries the holding company net financial position was €71.3m/€0.27 per share (c 17% of NAV). Outstanding capital commitments to private equity funds are c €69m, although management expects only a minority of this is likely to be called due to the maturity of the funds involved. This suggests further scope for continuing AAM investment and distributions.

The significance of the AAM business, with its growing stream of recurring income, as the driver of the group financial performance and valuation can be seen in Exhibit 3. We examine the AAM business, the alternative investment portfolio and the group valuation in detail later in the report.

DeA remained operationally and financially robust during H120 despite the impacts of the COVID-19 pandemic. From an operational standpoint, the adoption of smart-working practices enabled it to successfully navigate the lockdown and restricted working practices that have followed. The disruptive effects of the pandemic on the global economy and financial markets have thus far had a limited impact on DeA’s financial results, with H120 NAV per share of €1.63 little changed on the end-FY19 level of €1.64, adjusted for the June shareholder distribution of €0.12 per share, which went ahead uninterrupted. Although the platform investments saw fair value reductions of €10.3m, focused on platform fund investments, this was partially offset by the non-platform investments. Importantly, fund development activities continued, with two new real estate funds launched in June and two new private equity funds closing after the period end.

Given the resilience thus far displayed by the business, there was no impairment of the €126.3m of goodwill and intangibles on the balance sheet, primarily linked to the AAM platform and the prospects for future fee income.

Over the past year DeA’s asset management platform has experienced a significant growth in AUM, broadening of product capability and widening of customer reach, primarily driven by the Quaestio transactions that were agreed in July 2019 and completed in November 2019. The transactions included:

Meanwhile, DeA has continued to invest alongside the core AAM platform management companies (DeA Capital Real Estate, DeA Capital Alternative Funds, and Quaestio Capital) in the internationalisation of its real estate management capabilities (reported as part of ‘other AAM’ in Exhibit 3), most recently launching a start-up German-based subsidiary to cover the German and Austrian markets, complementing similar ventures launched in the past couple of years in France, Spain/Portugal and Poland.

Exhibit 4 provides a summary of the structure and activities of the AAM platform. The wholly owned subsidiaries (DeA Capital Real Estate and DeA Capital Alternative Funds) focus on private, non-quoted alternative assets in the real estate, private equity and credit areas. The Quaestio Capital associate (held through an investment in the Quaestio holding company), now focused on traditional liquid investments, contributes €7.6n of non-consolidated AUM to the combined AUM of the group (Exhibit 1).

DeA Capital Real Estate is Italy’s largest independent real estate asset management company, and with AUM of c €9.7bn it accounts for the vast majority of DeA’s real estate AUM of €9.9bn (the balance represents assets managed by the early-stage, pan-European businesses under development). DeA Capital Real Estate has 51 funds under management (including two listed funds) and specialises in core real estate investment strategies, targeting income-producing real estate which is bought 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 with a significant share of the total 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.

DeA Capital Alternative Funds is a leader in the somewhat more fragmented Italian private equity management sector. It manages a range of alternative investment funds (funds of funds, theme funds and credit funds) with AUM of €5.0bn. 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 are of older vintage and in their disinvestment phase, and have proved 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.

The acquisition of the Quaestio NPL asset management business accounted for most of the c €2.5bn increase in AUM in FY19, adding the Atlante and Italian Recovery Funds with AUM of €2.4bn. Prior to the Quaestio transaction, DeA’s investor base comprised more than 280 limited partners, including high net worth individuals/entrepreneurs as well as institutional investors, and management expects the product and marketing agreement with Quaestio will further expand its investor reach.

Quaestio Capital is mainly active in investment solutions for institutional investors (particularly bank foundations and pension funds) with AUM of €7.6bn. It operates a multi-asset/multi-manager platform through which a pool of manager mandates can be accessed by investors, allocating assets on the basis of specific risk/return objectives. The platform provides full visibility of the investments to support risk management and generates significant administrative, accounting and tax simplification.

The primary purposes of DeA’s alternative investment portfolio are to support the development of the AAM activities and enhance the returns on shareholder capital. At end-H120 it amounted to €135.7m, focused mainly on ‘platform investments’ but including some other alternative investments. The other investments are a mix of legacy investments (Kenan and the venture capital funds) and more recent opportunistic investments directed at enhancing returns on the balance sheet capital. In addition to the investment portfolio, €46.0m of investment in DeA managed real estate funds is held within the DeA Capital Real Estate subsidiary (comprising €44.3m of the funds held at fair value as well as a €1.7m interest in the Venere real estate fund held as an associate).

At end-H120 the platform investments amounted to €103.2m, of which €95.3m related to investments directly into 11 owned-managed private equity, credit and real estate funds, shown in Exhibit 6.

A key purpose for the platform investments is to sponsor the new fund initiatives by providing seed capital and DeA expects to make a seeding commitment of up to c 10% of total commitments for new fund launches. This is lower than has historically been the case and due to the heavier commitments to older fund launches, the average of DeA’s commitments to the current managed funds is closer to 20%.

During H120 the value of the platform investments reduced by €14.8m, which included net reimbursements of €4.3m and a fair value reduction of €10.3m.

Total outstanding commitments in respect of the platform fund investments amount to €61.4m, although a substantial proportion of this relates to older vintage funds (more than half to pre-2010 vintages) that management considers unlikely now to be called. Additionally, these older funds are likely to be a net contributor to group cash flow as investment realisations are made and capital reimbursed. Since H120 DeA has committed c €25m out of a total commitment target of €400m to the two recent new private equity fund initiatives.

In addition to own-fund investment, DeA targets selective investment in new private equity transactions but, in contrast to earlier transactions, on a co-investment/club basis with a smaller (€25–30m) ticket size. A recent example of this is the FY19 €5.0m co-investment in Alice Pizza alongside IDeA Taste of Italy fund I. Other platform investment of €2.9m includes minority co-investment by DeA in real estate vehicles recently promoted by DeA Capital Real Estate France.

The €32.5m of other alternative investments comprise two legacy investments and two investments related to more recent special purpose acquisition company (SPAC) investment. The two legacy investments are:

The more recent SPAC-related investments include:

DeA recently published results for the six months ended 30 June 2020 (H120). The key trends and developments include:

A summary of the historical and our forecast group financial statements (prepared under IFRS) is shown at the back of this report in Exhibit 13. In addition to the AAM performance, the IFRS results include the contribution from holdings/eliminations as well as changes in the fair value of DeA’s fund and direct investments. The latter contribute significant volatility in the group’s reported results. We continue to suggest investors focus on:

We have presented our AAM division forecasts in line with the management income statement shown in Exhibit 3. The core net operating result includes DeA Capital Real Estate, DeA Capital Alternative Funds and DeA’s share of earnings from Quaestio Capital, all adjusted for amortisation of purchase price allocation (PPA) and other non-recurring items, including the investment result from fund holdings. ‘Other’ AAM includes the contribution from the 41%-owned property services associate YARD and the newly created pan-European real estate platform subsidiaries/associates in France, Spain, Germany and Poland, all of which are in the investment phase and loss-making. ‘Other AAM’ also includes (adds back) the adjustments in respect of PPA and non-recurring items that are made to the core net operating result.

Our modelling is based on AUM and the appropriate fee margins as a percent of AUM, but it is worth noting that there is a difference between the headline AUM and the actual fee-earning asset base. DeA publishes both and at end-H120, the fee-earning asset base was €4.2bn for alternative funds compared with €5.0bn AUM, and in real estate it was €8.5bn compared with €9.6bn AUM. For the directly managed private equity and credit funds, AUM is defined as total investment commitments, whereas the actual basis for management fees may be AUM or the fund-level NAV; and in some cases, other arrangements exist. Similarly, in real estate, there is a difference between published AUM, based on the gross assets managed, and the fee-earning asset base. In real estate, the difference mainly arises because some funds generate fees based on net rather than gross assets.

While DeA’s expanded market presence, enhanced product capability and plans to leverage its Quaestio investment are positive indicators for AUM growth, the longer-term economic impact of the COVID-19 pandemic and its effect on new fund launches remains difficult to predict (despite the progress year to date). The older vintage funds should also be expected to run-off over time. As a result, our forecasts for this year and next assume broadly flat AUM and average fee margins.

From our discussion with the company, we expect that investment in the pan-European real estate platform development will continue to be c €2.5–3.0m per year over the forecast period and we have allowed for this with only modest revenue benefit. In Exhibit 7 this is reflected in the ‘other’ segment loss, with investment costs partly offset by other activities including 45%-owned associate YARD.

Given the uncertain economic environment we have no longer included notional ‘normalised returns’ on DeA’s investment in our group forecasts, some of which are reported in the AAM division. We will continue to include these on a trailing basis as reported but exclude these from the net operating result.

For the YARD associate (41%), we continue assume an annualised contribution to DeA of c €0.4m (reduced from c €1.0m previously), implying a c 3–4% margin on revenues (H120 contribution to DeA €174m). For the Quaestio associate (39%), we estimate that the loss of €0.6m attributable to DeA included c €0.4m of non-recurring reorganisation costs and, looking forward, we have for now assumed no contribution.

Exhibit 7 shows our IFRS forecasts for the ‘core’ AAM platform management companies (DeA Capital Real Estate, DeA Capital Alternative Funds and Quaestio), the adjustments to get to underlying earnings (PPA, investment results and other non-recurring items, and tax and minority effects), and the resulting net operational income. We then show the residual AAM division contribution and the divisional IFRS result.

For the core AAM platform, we forecast FY20 net operational income of €15.9m, compared with €14.6m in FY19 and €7.5m in H120. For FY21 we forecast €16.6m. We forecast the net loss from the underlying ‘other AAM’ operations to increase this year, primarily because we do not assume a repeat of the transaction fees earned in 2019. Adding back the adjustments made to the core AAM platform earnings, we forecast the AAM divisional result on an IFRS basis at €13.0m in FY20 and €12.5m in FY21.

We have re-worked the AAM presentation in Exhibit 7 to better track the company’s management income statement presentation (Exhibit 3) and as a result it does not compare directly with our previous format. We previously forecast Edison adjusted AAM earnings of €13.5m for FY20. The earnings adjustments are similar and this would be the equivalent of the AAM divisional earnings of €12.4m shown in Exhibit 7 plus the net earnings adjustments of €0.9m, a total of €13.4m. We had not previously published an FY21 forecast.

In Exhibit 8 we show a summary of our group forecasts using the management income statement format. These forecasts, less distributions, are the primary drivers of our NAV forecasts.

Importantly, we have made no assumption about investment returns, positive or negative, in respect of the investment portfolio. This is not to imply there will be no returns but recognising that the timing and quantum of these is more uncertain, especially in the near term. It also focuses our forecasts on the AAM business, which we expect to be the driver of earnings and valuation. We had previously assumed a normalised annual growth in the value of the fund investments (whether consolidated or equity accounted), but had attached no return assumption to the quoted investments in Migros, Cellularline and IDeaMI.

The current level of shareholder distributions (c €31m), which we assume will be maintained in respect of the current year, is not covered by recurring income and expenses and without the benefit of investment returns we show a declining NAV per share in FY20 (€1.65 per share compared a post-distribution €1.63 at end-H120) and FY21 (€1.55 per share). It is entirely possible that positive investment returns may offset some, or all, of this reduction.

The current level of distribution was set some years ago in the context of the company’s strategic rebalance away from larger, capital consumptive private equity investments and towards less capital-intensive asset management activities. The cash flows from the divestment of historical private equity investment were applied to investment in growing the AAM platform and returning excess capital to shareholders (by generous distributions and share repurchases). While the balance sheet and liquidity levels remain strong and the continuing wind-down of older fund investments should continue to support cash flows, over time it is possible that the company may seek to rebalance distributions to a lower level.

We estimate a 10% increase/decrease in the value of the alternative investment portfolio would increase/reduce NAV per share by c €0.05.

Our forecast cash position reflects the group results above and dividend payments. We have assumed no new investments, operational or portfolio, and no net investment/divestment from the alternative investment portfolio. As noted above, DeA expects only a minority of the outstanding fund commitments to be called, while perhaps up to €60m of reimbursements from older vintage funds may be expected in the next three to four years. Even on this conservative basis we forecast a consolidated financial position at end-FY20 of €96.8m and €71.8m at end-FY21 (end-H120: €97.2m).

DeA has a share repurchase programme in place with a target of acquiring up to 20% of the c 266m ordinary shares outstanding. The H120 treasury share position stood at c 5.5m shares. At the current discount to NAV, repurchases would be accretive and we would expect them to contribute to discount narrowing. However, DeA’s ability to execute on repurchases is constrained by currently reduced trading liquidity in the shares and limitations on the proportion of daily volumes that repurchases may represent.

DeA shares trade at a P/NAV of c 0.7x, the lowest in the peer group shown in Exhibit 10. At the same time, DeA’s yield of c 10% (with distributions supported by a strong holding company financial position rather than recurring earnings) is the highest in the group. This suggests there is significant value potential not captured in the current share price. In part, this reflects a low return on equity (ROE) compared with the peer group, partly but not wholly explained by the depressing effect of high liquidity. A continued successful deployment of resources into the further growth of the low capital intensity AAM platform, while continuing to reward shareholders with attractive distributions, should enhance ROE.

We have divided Exhibit 10 into two groups. The first is a narrow group of companies that DeA management believes most closely resemble its own strategy of combining AAM for third parties with balance sheet investment (both co-investment in funds managed and direct investment) supported by permanent capital. We have also included a broad range of other private equity, specialist and conventional asset managers, many of which focus on ‘balance sheet-light’ third-party asset management. Given this mix of strategies among its peer group, combining widely differing reliance on ‘recurring’ asset management earnings and balance sheet-driven investment earnings, we would caution against focusing on any particular valuation multiple.

DeA’s share price performance over the past 12 months is very slightly below the narrow and broad peer groups, although this does not adjust for its higher yield.

The equity of the AAM platform companies is carried at €207.5m in the H120 financial statements and includes c €126m of goodwill and intangible assets. This is equivalent to a 13.0x multiple of the FY20e net operating result and 12.5x the FY21e result.

Obviously an investor cannot access the core platform earnings in isolation and so it is reasonable to also include the other AAM result, although noting that this is currently burdened by investment costs related to the pan-European real estate build-out. Based on the underlying earnings for the total AAM division (including ‘Other AAM’ but excluding PPA, investment gains/losses and other non-recurring items), the AAM equity is equivalent to a 16.0x multiple for FY20 and 15.4x for FY21.

This suggests to us that in broad terms the AAM equity carried within the NAV of the group fairly matches the underlying fair value of the AAM platform, measured in terms of earnings capacity and fair market multiples.

DeA’s financial results and prospects are very sensitive to financial market conditions over the short to medium term. Financial market conditions directly affect its ability to launch new funds, find new investment opportunities, make divestments and influence the valuations of its investments. Although AAM is not immune from these market fluctuations, its growing significance within the overall group and the increasing share of recurring fee income within revenues is likely to reduce the overall sensitivity of reported earnings 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. External managing partners for the fund of funds apply British Private Equity and Venture Capital Association guidelines to private equity investments and, for directly managed funds, DeA is subject to Bank of Italy regulations, which management believes are potentially stricter as they are based on the lower of cost or realisable value (ie do not include unrealised gains).

Annual shareholder distributions of c €31m are in excess of likely recurring earnings but are supported by the significantly positive holding company net financial position. As a proxy for recurring earnings, our forecast for the AAM division net earnings in FY20 is €13.0m. Any extended disruption to markets could be expected to slow the pace at which the alternative investment funds are able to realise investment and reimburse capital and this could have a noticeable effect on the net balance of capital calls and reimbursements with a negative impact on group cash flow.