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OZM - Och-Ziff


walkie518
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MCAP: $417.9M

Shares Out: 184.84M

Price: $2.27/sh

Avg Vol: 1.39M/Day

 

 

There is certainly some risk here, but blood is in the streets.  My thesis rests on the company not going private a la SAC capital and management can keep the lights on.

 

At its peak, Och-Ziff had $47B of AUM internationally.  As of March 1, 2017, Och-Ziff disclosed managing $33.7B.  The redemption activity at the Och-Ziff funds resulted from client exodus resulting from scandal: rogue employees' nefarious relations with Libyan officials.  The story is long and has been covered in the papers so I won’t belabor.  This resulted in a ~$412m fine for the company and a sullied reputation. 

 

Och-Ziff raised preferred equity from the remaining management to fund the fine.  I would guess that Dan Och himself paid most though filings indicate that a few of the senior executives took part.  The preferred pays no distributions for 3 years.  After 3 years, the shares have a distribution step-up.  This approach appears to protects preferred shareholders from interest rate moves and opportunity cost, but the result is free money for Och-Ziff for a three year period to mend its wounds. 

 

Subsequent to the scandal, there has been a material shake-up among the top brass.  Och-Ziff needed to reconfigure, but given the firm’s soiled reputation, incentives needed to be appropriate.  It’s hard to convince someone of talent to join a firm that’s redeeming more than it’s raising without the right incentive structure.  Being the largest shareholder, Dan Och also wanted to align the interests of both shareholders and the asset managers.  After the stock had quartered, the incentive plan was finalized.  Included was a 7% net dilution to existing shareholders that the market did not take well.  What the market didn’t digest, however, is that managers do best when the stock does best.  Och-Ziff’s stock has to either go up 125% over the next six years or the incentives evaporate.  Dan Och engineered a program where the stock price has to move upwards of 20% on average over the next six years for the managers to get their awards.

 

Redemption activity is still a scare, but up until March 1, investors have had plenty of time to exit.  There may be some investors still waiting for lock-up periods to end, but Och-Ziff has been able to raise fresh capital despite the headlines.  If the firm doesn’t implode and keeps more than $30B under management, today OZM trades around 3x my estimate for earnings.  This stock is not for the faint of heart and the firm has a very complex capital structure, but the risk/reward seems in favor of shareholders.

 

Thoughts?

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You say the redemption activity was caused by the FCPA scandal, but the performance -- at least the relative performance -- of the Master Fund has also not been good for many years.  To be fair, though, I understand that they are pursuing a lower volatility strategy that underperforms in bull markets but significantly outperforms in bear markets.

 

So, two main questions:

 

1) What is going to stop the AUM slide? 

 

2) What is your estimate OZM's "earnings," which of the various different types of asset manager "earnings" (distributable earnings, economic income, etc.) are you estimating, and how did you estimate that? 

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1) What is going to stop the AUM slide? 

 

I speculate that redemption activity has plateued since AUM has been steady for the first three months of the year. This scandal has been all over the news for some time now and I think the LPs that want to redeem that can have redeemed.  The fear is that the 3-yr rolling redemption policy may defer some LPs exit.  Of course there can always be more.  However, OZM raised $1B for a US CLO and ~413m EUR for a European CLO in December. 

 

2) What is your estimate OZM's "earnings," which of the various different types of asset manager "earnings" (distributable earnings, economic income, etc.) are you estimating, and how did you estimate that?

 

My figure is a very rough one as the pieces of the puzzle do not all fit together.  My thesis rests more on OZM staying alive when Mr Market treats the stock like it should go to $0. 

 

The toughest part is to know how future redemption activity impacts carried interest.  What we do know is that the funds are reducing management fees to 1% on AUM.  This is the easy part as OZM had $33.7B in AUM by March 1, $33.6B by Feb 1, and $33.5B by Jan 1.  Say this number remains steady, OZM gets $337m in fee revenues. 

 

Carried interest is near impossible to determine, but hurdles are typically near interest rates according to the 10K...for the last number of years, bonds rates are pretty easy to beat.  One can only assume that the longer term rates of return will be commensurate with future returns.  Since inception of the master fund, annualized gross returns were roughly 17% and net returns to LPs were roughly 12%.  These are surely big numbers, but they are published figures.  Say OZM does 10% rather than 17% annualized over a ten year period.  Provided there isn't another Libyan issue and AUM grows commensurate with economic gains, AUM doubles in 10 years assuming that 7% goes to LPs and the 3% (2% carried interest as a % of AUM and the 1% management fees) to OZM.

 

With $33.7B AUM, assuming the firm can focus and return to low double-digit returns, I see ~$900m of revenues coming into the firm.  Should OZM return to historical returns the revenue number is more akin to previous years.  At around the same AUM in 2013, OZM showed nearly $1.9B in revenues.  Then expenses plus taxes were a little more than $900m.  Sure, it won't be easy so far from the last recession, but these are smart people with reputations that need mending. 

 

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Those are earnings that require an almost best case scenario to play out.  Historically, large hedge funds almost never return to their double digit returns for many reasons.  It's incredibly difficult to attract analysts and PM's to work at a shop like OZM (management has already sold out and has minimal skin in the game but simply collects massive pay packages at the expense of public holders).  All the best analysts and managers are likely at other shops taking that alpha away from hollowed out places like OZM. 

 

I think a better approach to estimating earnings would come from chopping down more of the multi-strat AUM and give no value to future incentive fees, throw some decent value on the real estate and CMO funds and see where it lands.  Last time I did that exercise I ended up with about $2.50-3.00 of value.  So there's maybe some margin of safety but not much and I would say there's a very low probability of the bull case working out.  Plus you'll have to add in the preferred which will start to get expensive in a few years.  I'd probably be interested in buying this around $1.50.

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You may be right, maybe they will never reach historical returns, but I do believe there are a lot of levers to pull and there is a lot of money under management that they can figure something out that works.  And of course, the preferred issuance could be a drag, but any distributions to those who funded will look bad.  (That said, if you spread the anticipated distributions over the entire term of the pref shares, you get a different number too as far as drag.)

 

The credit funds appear to be doing well as are the real estate funds.  Raising $1B and an additional 413 EUR in the face of scandal says something about the firm. 

 

The new compensation arrangement is also interesting as it implies and assumes the fund can return to its previous stature--they seem to believe that the incident is behind the firm. 

 

And sure, I'd love to buy shares at $1.50 since I do not think they will go inside out.  What if it goes private?  Paying $3/sh won't cut it and arguably neither would paying $5 without a winning class-action case? 

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Those are earnings that require an almost best case scenario to play out.  Historically, large hedge funds almost never return to their double digit returns for many reasons.  It's incredibly difficult to attract analysts and PM's to work at a shop like OZM (management has already sold out and has minimal skin in the game but simply collects massive pay packages at the expense of public holders).  All the best analysts and managers are likely at other shops taking that alpha away from hollowed out places like OZM. 

 

I think a better approach to estimating earnings would come from chopping down more of the multi-strat AUM and give no value to future incentive fees, throw some decent value on the real estate and CMO funds and see where it lands.  Last time I did that exercise I ended up with about $2.50-3.00 of value.  So there's maybe some margin of safety but not much and I would say there's a very low probability of the bull case working out.  Plus you'll have to add in the preferred which will start to get expensive in a few years.  I'd probably be interested in buying this around $1.50.

 

I think zero value to incentive fees is extremely punitive. The RE and credit funds are growing rapidly and generating strong IRRs, so there is no reason to doubt their income fee generating ability. To say also that the Multi-Strat will never generate a dollar of incentive income is also extremely harsh. OZM also has some tax assets with decent value. I think the risk-reward at current prices is great, but this should be treated as a more speculative, small position. Also, I disagree with the view that it's difficult to attract talent. Och Ziff is still full of very smart people-their main problem was too much AUM, and I think that problem is beginning to resolve itself. 

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You're right I'm being extra punitive but these alt managers have a habit of trading at a negative implied future carry value as the business deteriorates.  If all you did was buy KKR, BX, and APO when they traded at negative carry you'd have made a killing.  Here you have a situation where the bread and butter profit driver (which I think involves a lot of random luck and noise when you're dealing with tons of risk management and diversification at $20B) is still in free-fall.  The fees coming from RE and credit are nothing compared to what they can pull in from the multi-strat in good times.  Just by browsing through their multi-strat holdings I get the sense that they'd need to lose at least half of that AUM to start outperforming again.  I imagine the stock won't do too well if they can't outperform in that fund or if they lose half that AUM.  It's really hard to turn these funds around.  Comp pools will keep drying up and the smartest guys will simply leave to start their own shop and make a lot more money with less AUM.  And it's the easiest story to tell why you left OZM.  The RE and credit funds are doing well but so are RE and credit funds across the entire industry.  I'd have to measure their flows relative to the rest of their peers but I think it's less even with better performance. 

 

But it seems like investors are approaching this like an option and from that standpoint it could be interesting.  I guess I see less of a chance of the upside realizing itself.  At $1.50 or so I wouldn't care about the lack of crazy upside or them sucking at the multi-strat, it would be more than priced in and it would be pretty investable for a position size that could move the needle. 

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  • 2 months later...

I believe David Abrams (Seth Klarman protégé); Mario Gabelli; Jim Simons; and the boys at Two Sigma have all invested in this stock recently. While this isn't a reason to invest on it's own, it may give you some confidence that they at least share your view.

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  • 10 months later...

Net of unrecognized incentive income and their investments in CLOs, this thing is trading below 2X 2017 Distributable Earnings. Am I missing something?

Blackstone purchased GSO for 6% of AUM when it was a $10Bn shop. The implied value of their Credit strategies is ~3% of AUM (net of incentive income and CLOs), leaving the other two fund families for free. I just don't see whatever the market is implying will happen here.

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Net of unrecognized incentive income and their investments in CLOs, this thing is trading below 2X 2017 Distributable Earnings. Am I missing something?

Blackstone purchased GSO for 6% of AUM when it was a $10Bn shop. The implied value of their Credit strategies is ~3% of AUM (net of incentive income and CLOs), leaving the other two fund families for free. I just don't see whatever the market is implying will happen here.

There are questions about performance, redemption activity, and leadership.  I think it's overblown $/$ but the business has its challenges...

 

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The only funds experiencing performance issues and redemptions are the Multi-Strat funds. I think an argument can be made that you are receiving those for free at current prices. The Credit and RE funds have performed well and have scope to grow AUM and generate returns going forward.

 

Leadership is an issue. They should be using their massive cash balances to repurchase shares, but that obviously won't happen. Despite this, Dan Och has personally engaged in a number of shareholder friendly actions (waiving tax receivable payments, cancelling his own stock, etc.), and all the senior guys have significant ownership. 

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The only funds experiencing performance issues and redemptions are the Multi-Strat funds. I think an argument can be made that you are receiving those for free at current prices. The Credit and RE funds have performed well and have scope to grow AUM and generate returns going forward.

 

Leadership is an issue. They should be using their massive cash balances to repurchase shares, but that obviously won't happen. Despite this, Dan Och has personally engaged in a number of shareholder friendly actions (waiving tax receivable payments, cancelling his own stock, etc.), and all the senior guys have significant ownership.

 

Take a look at page 22 of the most recent 10-Q. ~61% of their management fees last quarter came from the multi strategy funds (44.4M out of a total of 72.4M). I think the market is right to be concerned about AUM loss.

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The only funds experiencing performance issues and redemptions are the Multi-Strat funds. I think an argument can be made that you are receiving those for free at current prices. The Credit and RE funds have performed well and have scope to grow AUM and generate returns going forward.

 

Leadership is an issue. They should be using their massive cash balances to repurchase shares, but that obviously won't happen. Despite this, Dan Och has personally engaged in a number of shareholder friendly actions (waiving tax receivable payments, cancelling his own stock, etc.), and all the senior guys have significant ownership.

 

Take a look at page 22 of the most recent 10-Q. ~61% of their management fees last quarter came from the multi strategy funds (44.4M out of a total of 72.4M). I think the market is right to be concerned about AUM loss.

 

Yes but the other 28 million a quarter is enough to support the entire valuation.  You can value it by AUM or by earnings. 

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Exactly. Since we don't have segment-level margin information for each fund, I'm just going with a quick % of AUM valuation for Credit and RE. If 6% of AUM was fair for GSO (immediately prior to the financial crisis), then <3% of AUM should be a fair price for OZ Credit and RE.

 

Also, I don't think the Multi-Strat should be totally discounted. Do people really think 10% gross returns, 1/15 fees at $10Bn of AUM is that unrealistic? That is a 0.3% market share for one of the most well-known funds in the business. If we consider that to be a 'steady-state' level of performance and AUM, this stock is obviously undervalued.

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31% of our assets under management are in Institutional Credit Strategies, which includes our CLOs, and have not historically generated a material amount of incentive income.

 

Im not so excited about flows into credit.

 

Given how much of the companies revenue comes from incentive fees from multi strat if they start treading water then the company wont earn anything.

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  • 3 months later...

Reaching new lows today. Anyone have any thoughts?

AUM has held above $30B across various strategies.  Multistrat is still a problem as LPs have trickled out (3 yr lock-up period upon signing I believe).  Real Estate and CLOs have done well.  I'm interested to see how multristrat does over the next few months.

 

The worst of it must be over, but there is a lot of negativity on the name and spat with Och's (former) protege, and there is still a little more redemption activity expected in the big fund. 

 

The pref shares will be an overhang.  The way it was presented was to treat the prefs like another source of financing, but if Och wants to bleed the LPs, he has that right.  The question is if he is a good steward despite the brouhaha. 

 

That said, I think it's attractive here given that mgmt is aligned with the price of the stock (though if it stays this low for a long time the good ones will leave?).

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  • 1 month later...

Who is puking this thing out? It seems unlikely that this is trading down because of fundamentals, as AUM seems to be stabilizing and performance is  better than what certain other high-profile funds have posted.

It's unclear and you're correct...it doesn't seem there has been a material decline in AUM.  On the other hand, I don't have a table for who's window to redeem opens and when.  It's feasible that someone knows when such and such institutional client is exiting that might make a mark on AUM.

 

At the same time, the pref shs are an overhang and management is a little bit of a mess. 

 

That said, I think they're trying to fix this issues without giving the firm's internal problems too much media attention.  Maybe investors are catching a whiff?

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  • 7 months later...

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