DeA Capital — Strategic delivery

DeA is a leading participant in the fragmented Italian alternative asset management industry with total alternative assets under management of c €11.7bn at 31 December 2017. It has historically focused on real estate and private equity, to which non-performing loan (NPL) management has more recently been added, and which management intends to expand further. 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 €250m as at 31 December 2017. In recent years, it has been DeA’s strategy to reduce its direct private equity investments and deploy the capital in support of the growth of its alternative asset management (AAM) activities, 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 alternative asset management businesses were recently rebranded to underline its close working relationship within an integrated platform that seeks to 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 €9.5bn in real estate funds, and DeA Capital Alternative Funds SGR (formerly known as IDeA Capital Funds), which manages €2.2bn of private equity funds.

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.

DeA’s net asset value at 31 December 2017 was €489.4m, or €1.91 per share, comprising the net assets of the alternative asset management business (30%), investments in private equity and real estate funds (35%), and direct investments (16%), with a significant net financial position accounting for almost all of the balance (19%).

The investment portfolio at end FY17 was valued at €396.5m compared with €448.8m at end FY16. The main reduction was seen in the private equity investment portfolio (€249.9m at end FY17 compared with €281.5m at end FY16) while the reduced investment in the alternative asset management platform largely reflects the goodwill impairment.

The investment Migros, held through DeA’s 17.11% investment in Kenan investments, was reduced twice during the year. In May, Kenan exercised an option to sell 9.75%, generating cash proceeds of €17.8m (with the equivalent of €4.0m retained within Kenan, in escrow, until 2020 to cover potential tax liabilities), and in November an additional 7.3% was sold by way of an accelerated book-building, generating proceeds of €12.2m. The sales reduced Kenan’s holding in Migros from 40.25% to 23.2%. Migros continues to trade well and fair value gains, including FX effects, added €8.7m in the year.

During Q117, DeA made its first direct investment for several years, co-investing c €8m in a 5.8% stake in a newly formed and listed special purpose acquisition company (SPAC) named Crescita. In Q417 c €25m was co-invested in another newly listed Italian SPAC (IDeaMI), jointly sponsored by DeA and Banca IMI, and jointly owning c 16% of the share capital. In addition to ordinary shares in the SPAC’s, DeA owns special shares that may be converted to ordinary shares on beneficial terms following a business combination with a suitable target.

The value of investments in private equity and real estate funds, almost entirely managed by DeA’s own alternative asset management platform, reduced from c €203m to c €171m during the year, with anticipated capital reimbursements from mature funds significantly offsetting the drawing of outstanding commitments. Capital reimbursements were €52.7m for the year (€32.1m in Q4) while DeA invested a total of €11.7m (€4.8m in Q4), making a net positive balance of €41.0m. The underlying value of the fund holdings increased, driven by the Taste of Italy fund.

While AUM grew c 10% to €11.7bn, average AUM grew 13% to €11.2bn, implying some benefit still to follow through into 2018 from 2017 AUM growth. This growth in AUM continues the trend that began in Q216 after a period of weakness in real estate funds in particular, which included the liquidation of maturing fixed-term real estate funds and a reduction in the property investment weighting of Italian pension funds. Fee margins were also pressured during this period. 2017 has been something of a transition year, as the trend in average AUM and revenues takes time to adjust. The division has also been affected by the reduction in DeA’s ownership (from 96.3% to 45.0%) and deconsolidation of the property management and brokerage company (now an associate), IRE. Our forecasts for the division in 2018 are little changed overall (higher revenues and higher costs), with underlying earnings forecast to grow strongly.

2017 AUM growth was seen in both private equity and real estate AUM, with the former benefitting from the launch of the €300m Corporate Credit Recovery Fund II (CCR II) in December 2017. During Q4, two new real estate funds were also launched (a total of six during the year) but the Q4 AUM impact of the two funds launched was neutralised by the liquidation of a mature fund (Delta Fund). In January 2018, DeA capital Real Estate completed the closing of the Special Opportunities I fund, which has assets of €200m that will be allocated to the purchase on non-performing secured loans via securitisation vehicles.

The divisional results appear largely in line with our expectations other than for the additional fee impact from the CCR II closing that we had not allowed for, and a goodwill impairment of €34.2m in respect of the goodwill established some years ago by the corporate merger that established DeA’s real estate asset management business. In 2011, DeA’s First Atlantic Real Estate was merged into FIMIT, to form IDeA FIMIT, which has since become DeA Capital Real Estate. After minority interests, the impact was to reduce stated NAV by c €0.09 per share. The impairment reflects an acceptance that fee levels are unlikely to return to historical levels rather than any change in current trading performance or immediate prospects. Remaining goodwill in respect of the real estate business is €62.4m, of which €40.1m is attributable to DeA shareholders, and DeA believes this is conservatively struck. Certainly, our own estimated valuation for the alternative asset management platform as a whole (see below) is ahead of the new carried value, and unaffected by the non-cash goodwill adjustment. Including private equity, total group goodwill is €93.7m, of which €71.4m is attributable to DeA shareholders.

The goodwill impairment has a significant impact on the reported AAM earnings, and in Exhibit 6 we show a reconciliation to underlying earnings. In addition to goodwill impairment, we adjust for the result on the financial equity instruments that were acquired with FIMIT. These represent the carried interest in the funds that FIMIT had previously managed and were acquired separately, with DeA taking a 35% stake, lower than the 64.3% it took in the ongoing activities. The 2017 result on the financial equity instruments was a negative €7m after tax (DeA’s share c €2.5m) and we exclude this from the underlying result that is the basis for our valuation. DeA has a remaining exposure of c €8m, which it hopes to receive over time, depending on the associated fund returns. The final adjustment that we make is 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 2011 merger.

Without the goodwill impairment (€0.09 per share), end FY17 would have been above our forecast, benefitting from higher returns from the investment portfolio than we had allowed for. Closing AUM and alternative asset management fees were also above our forecasts. The holding company cash position was lower than in our forecast as we had not factored in the c €25m Q417 investment in IDeaMI.

We have edged up our expectation for 2018 closing AUM and also the fee margin, which on an underlying basis were higher within DeA Capital Alternative Funds (private equity) than we had allowed for. The additional revenue assumed within AAM for 2018 is partly offset by higher assumed costs but increase by 2%.

We will review our estimates with the publication of the annual report, and introduce a 2019 estimate at that time.

We have updated our SOP valuation, which replaces the book value of DeA’s investment in the alternative asset management business (including goodwill) with our estimate of fair value, and also marks to market the investment in Migros. The SOP valuation is not affected by the goodwill impairment and benefits from the slight increase in expected AAM earnings. The Migros share price is now a little lower than at end FY17 (€24.2 as at 22 March 2018 compared with €27.6 at end FY17), representing a small negative adjustment compared with the end FY17 NAV shown above. For the alternative asset management business we use an unchanged 13.7x multiple of FY18 adjusted earnings (derived from a peer comparison analysis), giving a value of €153.8m, slightly ahead of the end FY17 book value of €146.6m. The SOP value per share, now €1.92 compared with our last published €1.87 following the Q317 results, continues to closely track the published NAV per share.

The discount to the last published NAV has narrowed to a three-year low, but at 23% still provides potential for further revaluation, particularly considering the continuing shift towards asset alternative management over the period and the continuing attractive dividend yield. The discount on the LPX50 index of European private equity funds is c 6%.