DeA Capital — Update 13 May 2016

DeA Capital an alternative asset manager with a specialisation in real estate and private equity. It has been selling its holdings of private equity investments and in 2015 distributed a large portion of the cash received as a special dividend. Private equity amounted to 62% of its investment portfolio at the end of 2015, down from 73% at the end of 2013. It will continue to make further disposals from its direct portfolio of private equity investments. It will reinvest the redemptions from its fund investments into new fund investments so that the total invested in funds remains broadly consistent. It is not undertaking a fire sale and will take a measured approach to reducing its private equity investments as market conditions allow.

Progress at developing its asset management business has been hindered by adverse conditions, especially at its real estate manager, FIMIT, which managed €7.9bn of assets at the end of 2015, down from €9.0bn at the end of 2014. Many of its funds have a limited life and are maturing, while its main customer base, Italian institutions, is heavily overweight real estate and is not currently investing in the asset class, partly because of new regulations requiring more diversification. FIMIT’s attempt to launch a REIT targeted towards international investors at the turn of the year was thwarted by adverse market conditions and the issue was cancelled, incurring some cancellation costs, which were almost fully booked in 2015.

Its private equity manager, IDeA Capital Funds, has been more successful, and has launched new direct funds as its fund of fund offerings, which have fallen out of favour with investors, are redeemed.

DeA Capital has valued its private equity investments, both direct and indirect, at its estimate of their fair value. This is a subjective exercise and so subject to uncertainty, but DeA Capital takes some comfort from its experience that those disposals that it has completed were made in line with their valuations. We have estimated the value of its alternative asset management businesses based on a P/E multiple of project earnings for 2016, with the peers being the large asset managers in UK, US and Italy. Together, these fair values produce a SOP valuation of c €1.93 per share. Its shares are currently trading at a c 32% discount to this, but the valuation is subjective.

DeA Capital has announced a €0.12 dividend for 2015. While this is not covered by earnings from its asset management business, it does have further direct PE investments to sell (€88m at end FY15), as well as IRE, is real estate advisory business and it has €133.8m of cash resources If DeA Capital could monetise more of its private equity investments and succeeds in developing its asset management business, the discount to our SOP could narrow, and its dividend yield fall.

DeA Capital is sensitive to financial markets and investors changing asset class preferences.

DeA Capital is one of Italy’s largest alternative investment operators with activities in private equity and real estate. At the end of 2015 it owned a private equity portfolio, which was valued in its accounts at €282m and comprised direct investments valued at €88m and funds of €194m. It also owns three alternative asset management companies, which are:

DeA Capital was set up in its current form in early 2007 and was at first only active in private equity, building up the bulk of its portfolio in 2007 and 2008. It believed that by investing its own “permanent” capital it would have an advantage relative to traditional private equity funds (which typically have predetermined durations of around 10 years) in timing the entry and the exit of its investments, thus enabling it to create greater value over the medium and long term. DeA Capital extended its activities to alternative asset management by acquiring a stake in an alternative asset manager in 2007, as well as a stake in First Atlantic Real Estate, a real estate management company, in 2008, which it merged into another real estate manager, FIMIT, in 2011 to form the current IDeA FIMIT, in which it holds a 64.3% stake. The strategy behind the expansion into alternative asset management was to gain exposure to more regular income flows from management fees as returns from private equity tend to be infrequent.

When DeA Capital was launched, listed private equity vehicles traded at a premium to net asset value, but this premium collapsed with the financial crisis. Discounts on listed private equity funds reached an average of more than 60% at the low point in 2009 with a significant recovery subsequently, although the average fund still stood at a discount of c 30% in early April 2016 (source: Morningstar). DeA Capital’s discount followed a similar move during the crisis, but has not recovered as much since.

Management was unhappy with this situation and decided in early 2013 to overhaul its strategy and do the following in order to reduce the discount:

Management believed that part of the reason for the large discount to its NAV was investor uncertainty over the valuation of its direct holdings, and that by reducing these holdings that uncertainty would reduce and the discount narrow. While this may be the case, it should be noted that there is still uncertainty over the valuation of other assets in its investment portfolio. Its holdings of private equity funds are stated in its accounts at an estimate of fair value, which is a subjective measure as the funds are not listed on an exchange. The funds are valued by their managers and DeA Capital’s own management then considers the appropriateness of those valuations. Management has said that there are secondary transactions in many of these funds and they are carried out around the fair values that it uses in its accounts, which provides some comfort about the valuations used. It should also be noted that redemptions from the funds amounted to around €50m in 2014 and 2015. The holdings of the asset management companies are stated in the accounts at their equity value, subject to impairments, and this accounting measure may not reflect the economic value of the assets. Consequently, reducing direct private equity investments reduces some of the problems of using the published NAV as a measure of value, but does not eliminate it. In our valuation section, we use a sum-of-the-parts (SOP) approach to estimate the fair value of DeA Capital.

In 2015 DeA Capital completed the sale of half of its stake in Migros, a Turkish retailer, which gave it €107.7m of cash and a capital gain of €46.3m. This follows the disposal of another large holding in 2014, in GDS, which gave it cash of €169m, though a negative value adjustment of €59m in that year. Direct private equity investments were reduced to 19% of the investment portfolio at the end of 2015, from 48% at the end of 2013.

DeA Capital made further progress in strengthening its net financial position in 2015, which amounted to €133.8m at the end of 2015, from €57.8m at the end of 2014. Net financial position is defined as cash and cash equivalents, available for sale financial assets, financial receivables less non-current liabilities and current financial liabilities. This improvement was achieved after paying a €82m dividend to DeA Capital shareholders in 2015 in line with its strategic aim to return cash to shareholders from the disposal of its private equity interests.

DeA Capital’s direct investments at the end 2015 were composed of three companies, as shown in Exhibit 1, below. Migros is a large Turkish food retailer and in 2015 achieved revenues of TRY9.4bn and EBITDA of TRY602m. DeA Capital is reducing its holding in Migros, having reduced its stake by half in 2015 for €107.7m, which was received in July 2015. Migros is a listed company in Turkey and DeA Capital’s holding is valued at its market value. In 2015 the share price of Migros on the Istanbul exchange fell 23.1% in Turkish lira terms and 31.8% in euros.

Sigla Credit provides salary-backed loans and personal loans throughout Italy. At the end of 2015 it had €35m of loans outstanding and earned net profit of €1.2m for the year. In Q415 DeA Capital launched a process to sell its holding, which is currently classified in “assets held for sale” and valued at the lower of initial carrying value and estimated realisable value.

DeA Capital’s management has stated that it will not make further direct PE investments, while smaller (€10m to €30m) co-investments will be made on an opportunistic basis along with its managed funds.

DeA Capital owns holdings in private equity fund of funds and funds, which amounted to €194.1m at the end of December 2015, down from €203m at the end of 2014. Some 95% of the funds are managed by IDeA Capital Funds SGR, its own private equity fund manager. The funds were acquired to provide DeA Capital shareholders with a good return and to act as seed money for the funds. Over 90% of the funds were started before 2009 and just three funds (IDeA I FoF, ICFII and IDeA Opportunity Fund I) account for 86% of the total value of the investments. Exhibit 2 provides details on the funds.

DeA Capital has found that investor appetite for its PE fund of funds in Italy (61% of its total at end 2015) has fallen in the last few years, as interest for this asset class has diminished and international PE fund of fund specialists, such as Partners Group from Switzerland, have entered the Italian market. It has responded to this market development by launching specialist PE funds investing directly in companies. The most notable of these is IDeA Taste of Italy fund, which invests in specialist Italian food companies that are seeking capital to expand their production and/or distribution and was launched in December 2014.

In 2015 capital calls to DeA Capital from the funds, at €19.9m, were below reimbursements of €55.2m, with the vast majority of the reimbursements being paid out by the three largest and older funds as DeA Capital reduces its exposure to private equity funds. In our balance sheet forecasts we have assumed that reimbursements exceed capital calls by around €20m per year.

One measure of the success of a PE fund is its total value to paid in ratio (TVPI), which compares the returns made with the investment. It is calculated as the sum of realised investments and the net asset value of unrealised investments divided by the total investment cost. According to management, IDeA I Fund of Funds has a TVPI ratio of 1.3x, ICF II a ratio of 1.5x, but IDeA Opportunity 1 Fund a ratio of 1.0x, indicating mixed success for its funds. It has not disclosed similar information for its other funds as they are in too early a stage of development for the ratio to be meaningful.

The majority of DeA Capital’s PE (and venture) funds are classified in DeA Capital’s financial statements as available for sale financials assets and measured at fair value, with changes in fair value posted directly to shareholders’ equity until realised when they are put through the profit and loss account. There are two exceptions: AVA, which is 27.27% owned and is classified as an associate and equity accounted; and the IDeA Opportunity Fund I, which is 46.99% owned and fully consolidated, with changes in its fair value put through the profit and loss account regardless of whether they are realised.

There is not a listed market for any of DeA Capital’s PE (and venture) funds and fair values are determined by the directors, based on their best judgment and estimation and after having received the fund managers’ valuation reports. In estimating the fair values they look at recent transactions, transactions involving similar instruments and valuation models, but the values they assign to the assets could differ significantly from those obtained when the assets are eventually sold. Management has said that there is an OTC secondary market for some of their funds, which tends to support the values used in the financial statements.

DeA Capital is developing its asset management activities to service both Italian and international investors. Its current activities comprise the following:

IDeA FIMIT is the largest independent real estate asset management company in Italy, with a c 20% market share at end June 2015 of AUM of Italian real estate funds, according to Assogestioni. It has €7.9bn of AUM and 37 managed funds (including five listed ones), 80 institutional investors and 70,000 retail investors. Retail investors account for around 18% of the total AUM. The key statistics of its portfolio of funds is shown in the following exhibit.

IDeA FIMIT has not achieved growth in its AUM in recent years and its AUM is likely to decline further in 2016 and 2017, despite the increase in interest from international investors in Italian real estate. According to property consultancy CBRE, international investors have been responsible for 75% of purchases in the last year. IDeA Fimit has had some success in selling funds to international investors such as Colony, Blackstone and York but traditionally these investors have not been a core market for IDeA FIMIT and sales so far have been small; but have started. Demand from its traditional Italian institutional investors has been weak for two main reasons:

IDeA Capital Funds manages €1.6bn of private equity funds, in eight funds: four single manager and four multi-manager (fund of funds). The multi-manager funds accounted for around 65% of the total at the end of 2015.

Funds of funds have suffered decreasing investor interest and pressure on pricing, with fees roughly halving since the financial crisis. IDeA Capital Funds has shifted its focus to direct funds, notably thematic funds that can attract interest also outside Italy, since fund-raising in Italy has proved rather difficult in recent years. These funds also have a strong focus on Italian investments, notably in smaller companies where DeA is likely to have more expertise. IDeA Capital Funds launched the €100m Energy Efficiency and Sustainable Growth (EESS) fund in 2011, followed by the Taste of Italy fund, which focuses on Italian food and beverage companies that require development capital to expand outside Italy.. Overall, despite the pressure on fees on funds of funds, the total revenue margin should remain relatively stable given the shift in mix in favour of the higher fee direct funds.

Innovation Real Estate (IRE) is active in property management, facility and building management, project and construction management, as well as asset management (ie improving the rental condition of buildings, optimising management costs to maximise the return on property investment). Its managed property portfolio comprises 50% office buildings, with the remainder split between other segments. IRE is also for sale, or at least DeA Capital is looking for a partner to manage it and develop it independently. It reported €4.4m profits for FY15; at a multiple of 12.7x (see valuation section below), DeA Capital’s share of its value would be around €54m.

At the end of 2015 AUM at DeA Capital asset management companies had declined to €9.5bn, from €10.5bn at the end of the previous year, mainly because of the liquidation of funds at IDeA FIMIT as discussed previously. We expect a further decline in 2016 as more funds are liquidated and the REIT issue, which would have added to the funds, has been cancelled. We tentatively expect a rise in AUM at IDeA FIMIT in 2017, with possibly the launch of a new REIT. IDeA Capital Funds AUM rose 11% in 2015 as a result of its launch of thematic funds and the acquisition of rights to manage a €112m fund (Investitori Associati) and we expect further growth in 2016 and 2017.

In 2015 management fees declined in aggregate by 6%, with a 17% increase in fees earned by IDeA Capital Funds not offsetting the 12% decline at IDeA FIMIT. The fee rate at IDeA Capital Funds increased 4% to 107bps due to the higher rates on the new thematic funds. In contrast, IDeA FIMIT’s fee rate declined by 7%, reflecting increased competition in the market. We expect that fee rates will remain at comparable levels in 2016 and 2017 and with the movements in assets discussed above we expect management fees will fall 8% in 2016 and rise 1% in 2017. Income from services is earned by the IRE property management business and declined 4% in 2015, with less property being managed, particularly that from IDeA FIMIT. We expect further small declines in 2016 and 2017. After adjusting for other items and intersegment services, revenue declined 5% in 2015. We expect a decline of a similar amount in 2016 and flat performance in 2017.

Total expenses increase from €71.2m in 2014 to €120.3m in 2015, leading to a fall in profits after tax, from €9.5m in 2014 to a loss of €37.3m in 2015. A large part of the expense increase arose from additional intangible amortisation and impairment charges, as DeA Capital reassessed the carrying value of these assets on its balance sheet in light of reduced revenue and profit expectations for these businesses. There were also a number of significant negative items in 2015, mainly at IDeA FIMIT, including €2.8m in costs for the aborted REIT, redundancy charges of €1.2m and contract penalties of €0.6m.

The intangible amortisation and impairment charges arose as follows:

After adding back PPA amortisation, SFP and goodwill impairment, adjusted profits after tax fell by 20% to €15.6m. We expect a further decline in 2016 with lower fees only slightly offset by a reduction in the negative significant items that affected the 2015 results. We expect a small rise in 2017, but this is tentative and depends crucially on higher AUM.

Our preferred valuation measure for DeA Capital is a sum-of-the-parts (SOTP), which we show in Exhibit 6. Most of DeA Capital’s private equity investments are valued at fair value in its accounts, but it should be remembered that this is the management’s subjective valuation. Its alternative asset management subsidiaries are valued at their equity value. We have replaced the equity value of these companies with our estimate of their fair value, which we have calculated as our estimate of their 2016 earnings multiplied by a P/E ratio of 12.7x, which is an average multiple of US, UK and Italian asset managers less a 12% discount to account for the early stage of development of the DeA Capital asset management activities. With a forecast of adjusted profits of €10.6m in 2016 (after deducting minority interests) for DeA Capital’s asset management businesses, we now value them at €134.6m. This is lower than our previous valuation of €182.2m on 23 November 2015, due to a fall in earnings expectations for DeA Capital’s asset management activities and a slightly higher P/E multiple of 12.7x vs 12.4x previously. The net result is a SOP of €1.93 per share, from €2.10 previously.

Exhibit 7 shows the consolidated DeA Capital financial statements, prepared in accordance with IFRS, which are implemented as follows:

As a consequence of the varying accounting treatments of its activities, we believe investors should focus mainly on the segmental profit and loss accounts in assessing the performance of the asset management businesses and the changes in fair value of its investment funds and its direct PE investments. These are discussed in the following sections: Direct PE investment portfolio (page 4), Investment in PE funds (page 5) and Alternative asset management (page 8).

On 12 May 2016 DeA Capital announced Q116 results. The net asset value was €2.08 per share up from €2.07 at year end 2015. Assets under management at end Q116 was €9.5bn, the same as at end 2015.

DeA Capital announced a dividend of €0.12 per share for 2015, which results in a payment of around €32m based on 265m shares outstanding. With net income for 2016 of €24m, there is a shortfall of €8m, but we expect that for the next two years DeA Capital will receive net reimbursements from its fund investments of around €20m per year, considerably more than the shortfall and it has €133.8m of cash resources.