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Oak Capital Group Primer

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June 12, 2014 – Comments (0) | RELATED TICKERS: OAK

Board: Oak Capital Group

Author: EightTrack4

I've been long OAK for some time. Happy to share some (random) thoughts:

1) As others have mentioned, OAK is a publicly traded limited partnership, so limited partners (shareholders) will receive a K-1. Blackstone (BX), another alternative manager, published a mock K-1 on the Investor Relations; BX is the most complex K-1 I've seen but one can see what's in store with OAK ownership.

In 2012 and 2013 as far as I know, OAK has not generated UBTI income (too much creates taxation within a tax-deferred IRA). OAK is theoretically safe for IRAs but there is no assurance that it will last (I would think a position below 1000 shares would be safe in IRAs in any case, barring ownership of other UBTI generating MLPs).

OAK produces an estimated K-1 and then produces an final K-1 by June 30. To be clearer, you will not be able to file your taxes if you hold OAK in a taxable account until receipt of the K-1 by end of June.

2) OAK's core product are their distressed debt funds. 1.5% and a carry fee of 20% of gains above an 8% to its investors. Historically they have done well, although today's low interest rates and aggressive Federal Reserve cut down distressed opportunities.

Since OAK sizes its funds to fit the opportunity it has been difficult to grow rapidly based on its core products. (unlike regular mutual funds, the financial incentive is to maximize carry even at the cost of a larger fund). For example, Bloomberg published a report this week suggest that OAK downsized their latest principal fund product (buying distressed debt with the direct desire to take ownership) due to a lack of perceived opportunities.

On the other hand, OAK's latest distressed fund IX, although delayed, has finally gone "live" for billing purposes and in the last quarter has shown an impressive return. I will explain why in #3.

3) All CUSIP-investing is difficult at the moment? What do I mean by that? Anything with a CUSIP - equity or debt products that trade on an exchange - is likely overpriced/fully priced. The key to private equity like OAK and others is their ability to source investments off-CUSIP. OAK has traditionally accomplished this with "platform" investments: sometimes literally creating or expanding businesses suffering from capital restrictions. They've done this in shipping; student housing in London; in the past they did this in aviation (leasing). Again, off-CUSIP opportunities. This is how private equity is going to gain substantial market share against traditional asset managers in the years ahead (if they succeed).

4) Why is distressed debt a good business with 20% returns when done properly? Imagine a good business (operations) with a poor, over leveraged financial structure. You buy enough senior debt at a discount to take ownership if the company goes bankrupt: a) the company does not go bankrupt and you can taken out at par (making a solid return), b) the company goes bankrupt and you emerge with ownership after shedding debt and other obligations in Chapter 11.

Of course, the fact that most bankruptcies take place in economic downturn or industry downturns, leaving you with ownership just as the economy/industry conditions change for the better is a nice plus.

5) Oaktree/Marks is not Berkshire Hathaway/Buffett. First of all, Marks is younger. More important, Marks is not the crucial investor - Bruce Karsh is the senior manager of their distressed debt products. Also, Oaktree has done a terrific job of putting together investing teams. OAK will miss Marks but it is not the end of the world by a long stretch.

6) Step-outs. OAK is adding new products that will add AUM (strategic debt, real estate, even equity investing). OAK is cautious which means they may grow slower, but they are well managed and usually put up enviable returns that maximize carry income opportunities, even at the cost of AUM gathering. Two problems: newer products tend to be lower risk with no or little carry income potential; also, the large Opps VIIb fund that powered distributions in the last 12-18 months is largely consumed ... will it be possible for OAK to recreate the magical returns absent the wonderful economic conditions for distressed debt that the Great Recession presented?

Their recent purchase of another asset management firm specializing in power/infrastructure investing is illustrative of both OAK's approach and its thinking. OAK already has a "power" group, but not in physical assets. Given the extraordinary capital needs in power (nat gas for example) OAK and other firms are going to try to reap 20+ percent returns by going off-CUSIP investing in this area.

They've also bought a bit of a Chinese asset management/banking firm that will help expand their distressed debt franchise into China. Given the explosion in emerging market corporate debt, the opportunity is clear, although different bankruptcy laws and traditions could be problematic.

7) Downside: OAK and other PE managers are not pleased with the analyst approach for valuation: mutual fund multiple on fee income; single digit multiple on carry income; add investment income or other assets. Low carry multiples are a drag on valuation. I have my own private opinions on how this will be resolved but suffice it to say this is a current difficulty.

Furthermore, OAK's distribution is sure to be cut in 2014 from 2013. Given their European waterfall model (carry income recognition) combined with their conservative distribution strategy, expect the next few quarters to show smaller distributions (given current trends and market conditions). Valuation systems that emphasize near-term distributions may not be kind to OAK. Those that read this far certainly have the ability and inclination to determine whether the current price accurately tabulates OAK's future cash flow.

Hopefully this will be a decent primer for those who wish to investigate OAK further. Don't have anything else to add.

ET 

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