Oaktree: The Brookfield Deal

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About: Brookfield Asset Management Inc. (BAM), OAK
by: Bram de Haas
Summary

Oaktree is being acquired by Brookfield Asset Management.

The firm is more or less taken private at a ~12%-16% premium.

The stock trades at $49, leaving ~2% on the table.

However, the distribution comes in March already which could be interesting to hold out for.

Oaktree Capital (OAK) is getting acquired by Brookfield Asset Management (BAM) in a sort of going private deal. Certain insider unitholders at Oaktree will still retain control of 38% of Oaktree Capital. Brookfield seeks to acquire the other 62%. I'm not thrilled with this because Oaktree Capital is one of the names I expected to own for a long time. It also served as a creative type of hedge because it has been under-raising assets because its distressed operations have nothing to do with central banks sustaining all types of zombie operations. I wrote it up in the special situations report in May 2017 and October 2018 and also publicly in February of 2019. This article intends to discuss whether to sell your shares or hold them into the acquisition.

Here are what I view as the key issues to think about:

Marks and Karsh retain control

Howard Marks, Bruce Karsh, and other members of Oaktree Capital Group Holdings, L.P. will own 38% and retain operating control of Oaktree.

This is why it is essentially a go-private. Insiders are giving up some units, but mostly outside unitholders are getting bought out by Brookfield at a low premium of between ~12.4% and ~16%. That's extremely far below average takeout premiums. That's also reflecting the go-private nature because these tend to happen at much lower premia. There is also a last $1.05 distribution, though.

From the press release:

Oaktree Class A unitholders can elect to receive for each Oaktree Class A unit either $49.00 in cash or 1.0770 Brookfield Class A shares to enable them to stay invested in the overall business.

BAM is trading at $45.92, meaning you get a tiny premium if you take the shares. The premium is so small it is not worth the additional risk to just sell your shares for cash currently in the market at $49.

It could be worth it to take the shares for tax reasons. Although the firms are distinct and each has its own idiosyncrasies, they do share certain positive attributes. I rate the acquiring asset management firm, and its CEO Bruce Flatt, extremely high and you don't have to sell because you're afraid to be swallowed by some subpar institution.

Chart Data by YCharts

Both Brookfield and Oaktree will continue to operate their respective businesses independently, partnering to leverage their strengths – with each remaining under its current brand and led by its existing management and investment teams. Howard Marks will continue as Co-Chairman of Oaktree, Bruce Karsh as Co‑Chairman and Chief Investment Officer, and Jay Wintrob as Chief Executive Officer. Howard Marks and Bruce Karsh will continue to have operating control of Oaktree as an independent entity for the foreseeable future. In addition, Howard Marks will join Brookfield's board of directors.

Largest alternative firm

BAM and OAK will together have approximately $475 billion of assets under management. That means it will only be rivaled by Blackstone (BX) in size. Jonathan Gray of Blackstone and Bruce Flatt have both called size a competitive advantage. Something I do question, but it may be a relative advantage compared to mid-size firms.

CEO Commentary

Here's what Flatt said:

As we continue to strategically grow Brookfield, we are thrilled to be partnering with Oaktree and with its exceptional management team whose credit business is second to none. This transaction enables us to broaden our product offering to include one of the finest credit platforms in the world, which has a value-driven, contrarian investment style, consistent with ours.

Oaktree is very focused on credit which makes it a very attractive acquisition for an alternatives firm that isn't so big in that area. BAM will have to reckon it only owns 62% which makes it slightly less attractive to cross-sell Oaktree's funds.

Marks said:

The opportunity to join forces with Brookfield is ideal. Our firms share a culture that emphasizes both investing excellence and integrity, and our businesses mesh without overlapping or conflicting. The rest of Oaktree management and I are excited about the combination of support and independence we expect. We look forward to having Brookfield's contribution to our ability to serve our clients, and to doing the same for them.

I consider both firms examples in the investment industry and totally buy into the cultural/philosophical mesh here. Usually, this is all to be taken with a grain of salt, but Oaktree really wouldn't jive to the same extent with most of the other large U.S. PE shops. That's one of the reasons why I don't think we should expect anyone to come in with a higher bid.

Distribution

Oaktree can pay one last distribution of $1.05 per unit. That distribution takes the return to about ~2%. Interestingly, this is the March distribution. A 2% additional return by waiting a few extra days is definitely worth it. But where will the market trade this afterward? I think the market will leave at least a 1% spread. But still waiting for that distribution could be like a 12% to 20% annualized return.

Additional distributions may be paid if the transaction hasn't closed by September 30, 2019. That's almost 7 months from now. It is expected to close in the third quarter before that date.

Done deal

Oaktree unitholders have to approve, but 92% of Oaktree's voting rights have been committed to the transaction. I don't think there are many regulatory constraints. These are a U.S. and a Canadian firm. They are in industries that have competition far and wide and neither has a large market share. They are financial institutions, but asset managers are not systematically important.

Summary

The annualized return will end up in the 3%-6% range over the entire deal close. I'm guessing, it will end up in the lower end of the range. Most of that return comes from a distribution which may have tax implications. This is not a very attractive return. However, quite a bit of the return will come on very short notice. That part could have a very high annualized return depending on what kind of spread the market will assign the deal afterward.

Sometimes, you can at least hope for a 3rd party to come over the top and pay a fatter premium. Especially, as this is a very low premium. However, I don't think that can ever happen here. Oaktree's insiders are willing to continue under the wing of Brookfield because they are an exceptional cultural match. They would never sell out to a higher bid from a firm that isn't a match to the same extent. I'd estimate the odds of a higher bid as extremely low. Below 5%. At the same time, I think there is virtually zero risk (below 5% for sure) that the deal doesn't close.

If you like a 4% very secure return, this could be an option for you. I rarely see cases that I view as such a lock. Were the deal to break anyway, the downside isn't terrible either because the premium is so low. It can be interesting to hold until the distribution because worst case scenario the market drops the stock with the amount of the distribution. I can imagine this could be especially interesting if you pay few taxes on distributions (but take note OAK is a partnership with tax idiosyncrasies).

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.