DeA Capital — Growing AUM and NAV with cash for dividends

DeA Capital (DeA) is a leading participant in the fragmented Italian alternative asset management industry with total assets under management of more than €11.5bn at end-H117. It has historically focused on real estate and private equity, to which non-performing loan management has recently been added. The latter is currently small, but the sector has good potential for further development and management seeks 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 €292m as at end-H117.

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 platform comprises 64.3%-owned IDeA FIMIT, which manages €9.4bn in real estate funds, fully owned IDeA Capital Funds, which manages €1.9bn of private equity funds and, since June 2016, a controlling stake in SPC Credit Management, a restructurer and outsourced manager of non-performing loans (NPLs). The 45% owned associate, IRE, provides property management and brokerage services.

DeA’s net asset value at 30 June 2017 was €515.4m, or €2.00 per share, comprising the net assets of the alternative asset management business (31%), investments in private equity and real estate funds (40%), and direct investments (17%), with a significant net financial position accounting for almost all of the balance (12%).

Recently published half-year results to 30 June 2017 show a very pleasing increase in NAV per share, adjusted for dividends paid during the period, which was driven by the performance of the investment portfolio, as well as a continuation in the growth of assets managed by the alternative asset management division. Key highlights were:

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.

Alternative AUM continued to grow during Q217, continuing the positive trend that began early in 2016. The majority of the growth has come from real estate asset management although the private equity funds under management have shown a slight growth despite the expected drag from maturing, older generation funds.

During H117, the real estate asset manager, IDeA FIMIT, launched two new funds with AUM totalling c €800m and saw a net increase in AUM of c €650m to c €9.4bn. This was a stronger performance than we had expected and we have increased our expected AUM for both this year and next, looking for €9.7bn by the end of 2018. The market remains difficult and there is still some slight pressure on average fee margins, which we had previously hoped had stabilised. Our revised estimates look for a slightly slower growth in fee revenues as margin erosion offsets the faster AUM growth, but this is offset by lower costs. The headline results were affected by several non-recurring items including a write-down of financial equity instruments, largely attributable to minority shareholders but also write-downs of units in some of the portfolio funds. Our divisional profits shown in Exhibit 4 are also adjusted to add back the non-cash amortisation (purchase price allocation amortisation or PPA) in relation to the intangible value of customer relationships recognised at the creation of IDeA FIMIT through merger. We use this adjusted profit figure in our valuation.

The private equity manager, IDeA Capital Funds, saw small increase in H117 AUM to €1.94bn, which is a positive result given the ongoing run-off from older, mature funds. We continue to forecast essentially flat AUM over the next couple of years, looking for new fund launches to offset maturing assets. Management continues to plan for the launch of second corporate credit recovery fund later this year. As with IDeA FIMIT, revenue margins in IDeA Capital Funds are not as strong as we had looked for although a successful H2 fund launch would bring welcome distribution fees. We have made small fee reductions overall but again find ourselves able to offset this with lower expense assumptions.

The non-performing loan manager, SPC, in which DeA has an 85% shareholding, is small in a group context for now. The new management team is making some organisational changes, which include a more conservative valuation of expected future cash flows that resulted in a €2.4m write-down of the goodwill carried in relation to SPC and c €0.4m in one-off expenses.

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.

As can be seen in Exhibit 3, DeA’s €291.6m investment portfolio is split between its private equity and real estate fund investments (€204.4m) and its direct investments (€87.2m). It is the latter that has driven group NAV performance in H1, and especially DeA’s investment in Migros, a large Turkish food retailer. This is held indirectly through DeA’s 17.11% investment in Kenan Investments, which in turn owns 30.5% of Migros. Kenan owned 40.25% of Migros at the beginning of the year but in May exercised an option to sell 9.75% at an effective price of TRY30.2 per share (above the current price of c TRY25), generating immediate 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.

The Migros stake generated €17.7m in fair value gains in H1, almost €0.07 per share, and the carried value in the balance sheet was little changed over the period despite the partial sale.

Elsewhere in the direct investment portfolio, DeA has, since end-H117, agreed the sale of its 41.4% stake in Sigla Credit for €11.8m, very slightly above its carried value. Among other conditions that must be met for the sale to conclude is approval for the transfer from the supervisory authority. DeA expects to complete the transaction by year end and we have included this within our H217 cash flow assumptions.

DeA’s €7.8m participation earlier in the year in newly listed special purpose acquisition company, Crescita, is its first direct investment for several years. Crescita’s objective is to complete a business combination with a yet to be identified Italian target company within 24 months of listing or return the capital. At the end of H117, the 5.8% investment, including ordinary shares and warrants, was valued at €8.7m and we estimate a current value of €8.2m (26 September 2017).

DeA’s fund investments are primarily in funds managed by the group and primarily reflect management’s desire to utilise a strong capital base in providing seed capital support to its own-managed range of fund offerings. The investments include seven PE funds managed by the subsidiary DeA Capital Funds, two funds managed by the real estate management subsidiary IDeA FIMIT, and units in six externally managed venture capital funds.

There is considerable concentration of the fund investments in three of the funds (IDeA I FoF, IDeA Opportunity Fund, and to a lesser extent ICFII) that represent the older vintages (2009 and prior) of the DeA Capital fund stable and that are expected to see a continued increase in fund reimbursements and reduction in fund size over the next two to three years. The run-off should provide a significant boost to cash flow, available to fund investment support for new fund initiatives, continuing share repurchases, and dividends.

DeA made no new fund commitments in H117 and after capital reimbursements from the funds of €8.7m, capital commitment calls by the funds of €4.8m, and a small FX adjustment, outstanding undrawn capital commitments were €102.5m (end-2016: €107.7m), well covered by existing and forecast financial resources as we show below (page 7-8, Exhibits 8 and 9). Fair value movements net of impairments were c 0.9% (c 1.8% annualised) in H117.

As we noted in our June Outlook note, our approach to DeA is to focus on AUM and earnings progress within the alternative asset management division alongside the investment returns and NAV growth generated by the investment portfolio. We also pay close attention to the development of cash flow and of the holding company net financial position, as this will continue to drive cash returns to shareholders by way of share buy-backs and dividends.

We have discussed the changes to our alternative asset management division forecasts above, with intangible write-downs affecting this year’s result and for next year, higher forecast AUM and lower costs offsetting reduced expectations for fee margins.

In addition to the alternative asset management profit contribution, our group NAV forecasts also assume a 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 higher than forecast NAV growth in H117 leads to a slight increase in our forecast NAV per share.

In terms of cash flow, as noted above we have assumed that the agreed sale of Sigla for €11.8m completes by year-end as management hopes. The fund capital calls and reimbursements were a net positive €3.9m in H117 and we are forecasting a net positive €7.7m for the year (was €5.3m). For next year, we look for a net positive €30.0m, expecting that reimbursements from older, mature funds will accelerate. We have made no assumptions about new fund commitments (none in H117), although we expect DeA to continue to participate in future fund launches. Before any additional commitment decisions, we see the current level of commitments being fully covered by the forecast consolidated net financial position by the end of 2018. However, we should also note that our consolidated net financial position assumes no additional direct investment.

We show the recent trend in the group net financial position in Exhibit 9, which includes the H117 direct investment of €7.8m in Crescita and the €17.8m proceeds from the partial sell-down in Migros, both in H117, and the sale of Sigla in H217. Cash distributions are supported by the holding company net financial position rather than at the consolidated level. The latter adjusts for consolidated cash balances that form part of the group subsidiaries and although we do not specifically forecast this balance, we would expect it to broadly follow the trend in the consolidated cash balance. We forecast a very small dip the current year but for a healthy balance of c €100m, before any new investments, being maintained despite forecasting ongoing dividend payments at an unchanged level. We do not forecast share repurchases although they are to be expected. Although not shown in the forecasts, the Crescita investment indicates a renewed openness to direct investment on the part of management and further opportunities may well arise. Further divestment is also possible, and the decision of DeA’s partner Kenan to dispose of 9.75% of its stake in Migros may, in our view, indicate the direction of travel with respect to the remaining investment.

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. There are two differences with the company’s own NAV analysis shown in Exhibit 3:

Our updated SOP value is €1.91 per share (previously published €1.88). Within this, Migros is valued at the recent (26 September 2017) share price of TRY26.0, lower than the TRY27.6 reflected in the 30 June balance sheet valuation, with an exchange rate of €0.24/TRY. DeA’s share of the value of this 30.5% stake in Migros is €65.0m, to which we add €3.1m in other net assets within the Kenan holding company that holds the Migros stake, similar to our estimate as at 30 June 2017 and largely reflecting the €4.4m of proceeds from the recent sale of Migros shares that will be held in escrow by Kenan until up to 2020. DeA’s holding in Crescita ordinary shares is included within our SOP at €10 per share, again slightly lower than the value reflected in the 30 June 2017 balance sheet and DeA’s interest in the Crescita warrants has been included at a price of €2 per warrant.

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 5. 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 is 13.5x, the same as when we last published our SOP in June 2017, and we have applied this to our forecast for DeA’s AAM underlying 2018 earnings. This results in a value of €145.7m (previously €143.6m), which we note remains below the balance sheet net asset value of €161.8m shown in Exhibit 3. The balance sheet value is equivalent to 15.0x FY18 underlying earnings.

DeA’s share price rose strongly earlier in the year, reaching a high of €1.59 in May before falling back. The shares have again begun to increase after half-year results that we view positively. The discount to published NAV is 31% (similar to the discount to our SOP) and 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 12 and 13).

We note DeA’s ongoing share repurchase programme, aimed at managing this discount, which runs in parallel with ongoing high cash distributions to shareholders. At the AGM, shareholders approved an increase in the repurchase authorisation to a limit of 20% from 15%, allowing continued repurchases that have now reached 50.0m shares or 16.3% as at 25 September 2017. 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%.

More fundamentally, we would look to the renewed momentum and longer-term growth potential of the alternative asset management business, and the likely future net distributions from the relatively diverse and mature investments in private equity funds as catalysts for a potential re-rating. The improving liquidity in the shares should also provide support. Having averaged c 160,000 shares per day through 2016, average daily trading volume reached c 600,000 shares per day in H117 and although this has slowed slightly since, the year-to-date daily average remains significantly ahead of last year at c 500,000 (source: Bloomberg, 26 September 2017).