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Oaktree Deal Raises Distress About Private Fund IPOs

Greggory Warren, a senior stock analyst with Morningstar, says that because of their complicated limited partner structure and the potential that firms won't easily be able to raise new funds to replace ones that are expiring, stock investors may be better served investing in traditional asset managers like Franklin Resources (BEN), Invesco (IVZ), Affiliated Managers (AMG) and Blackrock (BLK) with more direct earnings streams.

"At the end of the day you are better off being invested in one of those fund [managers] than you are investing in the units of these publicly traded firms," Warren concludes.

Oaktree's IPO filing shows that while its closed-end funds have posted an internal rate of return of nearly 20% on over $50 billion in invested capital in 2011, overall earnings available to prospective shareholders -- called distributable earnings -- fell over 20% to $488.5 million from $635 million in 2010.

Still, investors have reason to consider tapping the proprietary investment style of firms like Oaktree, which is diminishing as a component of bank earnings as new regulations like the Dodd Frank Act kick in. There isn't a single analyst sell rating among the five publicly traded alternative investment management firms. That's because analysts argue that stock investors don't fully appreciated what they are getting with shares in private equity firms.

"Across our capital markets coverage universe, the shares of the alternative asset managers -- Apollo, Blackstone and KKR -- are among the most volatile of all firms that we cover. Yet from our perspective, there are unique features of these business models that make them among the most defensive and stable franchises across our coverage," wrote Credit Suisse analyst Howard Chen in a February note assessing how the sector should be valued.

While firms' preferred earnings measure is called "economic net income," which represents management fee earnings and quarterly marks to unrealized investments -- less performance attributable to direct fund investors, taxes and compensation expense -- Chen argues that investors should focus on the cash that firms earn for shareholders via fees and their interest in realized investment gains. It is these cash earnings that helps give firms like KKR and Blackstone above 5% dividend yields and that can drive share prices higher. IPO Desktop president Francis Gaskins told TheStreet that Oaktree's dividend yield could exceed 7% based on its filings.

Over the next three years, Chen expects Apollo, Blackstone and KKR to increase their fee earning assets under management, with 2012 being a watershed year of 20%-plus growth. Meanwhile, performance fees on assets under management are expected to rise to nearly 3% from sub-2% levels by 2014, adding billions in revenue for the three firms. Chen highlights Apollo as benefiting the most from growing management and performance fee earnings.

For more on how Oaktree and other distressed debt investors are poised to profit from financial crisis investments, see 10 once-bankrupt companies primed for a comeback.
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