2023-09-13 23:09:24 ET
Summary
- Blue Owl Capital is among the best mid-sized asset managers. The company grows its AUM constantly, while maintaining permanent capital at respectable levels.
- Last quarter, OWL has proven my thesis, delivering strong results. Fee relate earning and AUM increased notably.
- The most critical pillar in the company's portfolio is private credit. In an environment with a significant driver behind OWL's success.
- The company distributes dividends with higher-than-average yields. Expecting future earnings growth, cash returned to the shareholders will keep rising.
- That said, OWL deserves a strong buy rating due to its business qualities and growth prospects offered with a discount of 23%.
Thesis
Blackstone ( BX ) dominates the alternative investments landscape. However, there are other quality propositions in the segment. Blue Owl Capital ( OWL ) is among the new players with tremendous growth potential. The company has advantages over its bigger peers: a high permanent capital to AUM ratio, a robust fee structure, and a capable management team.
OWL had a solid last quarter, realizing impressive AUM and fee-related earnings growth. I expect the company to maintain its growth rate due to its high exposure to debt assets. Higher interest rates for longer and significant portions of corporate debt due in the next few years will create a strong demand for alternative financing.
OWL is a high-quality alternative asset manager for sale at a low price and offers a 4.5 % dividend yield. Hence, I give a strong buy rating.
Company Overview
Blue Owl is a sizable company with a $150 billion AUM, including $119 billion permanent capital. Its portfolio is invested in private credit, GP strategic capital, and real estate. The chart below from the last company financial report represents OWL`s portfolio structure:
OWL is involved in the explosively rising private credit and direct lending industry. This market segment has great appeal due to the safeguards offered by a highly diversified portfolio of senior secured and conservatively underwritten loans in high-quality middle-market companies usually funded by private equity sponsors. General Partnership funding is the second pillar in its portfolio. It is divided between minority stakes and debt financing.
Lastly, its real estate branch has built a reputation in this industry by providing clients with great total returns. It focuses on the triple net lease market. The latter is efficient and safer for funds like OWL to manage its real estate portfolio. The expenses (taxes, insurance, and maintenance) are transferred to tenants. Thus, the owners have more time to focus on essential activities such as investments.
The credit division is by far its most significant, with $73.8 billion in assets. With $50.9 billion in AUM, its GP Strategic Capital section comes in second, followed by its Real Estate business with $24.8 billion in AUM. All three segments have grown significantly over the last year.
OWL now has stable revenues and a significant percentage of permanent capital. At the same time, OWL's permanent funds comprise more than 80% of its assets under management. For comparison, Blackstone's permanent capital accounts for only 38% of BX's total assets under management.
This is crucial because OWL faces significantly less redemption risk than Blackstone. BX has experienced a flood of redemptions from its private market REIT this year amid widespread worries about rising interest rates and falling commercial real estate valuations. OWL's high percentage of permanent capital protects against such events.
The fee structure of OWL is also intended to be more profitable in earnings from fixed fees while forgoing carried interest on its funds. In contrast, a sizable amount of Blackstone's revenues comes from carried interest and performance fees. This suggests that while business is booming, BX's earnings stream grows due to the combination of performance fees and fee-related earnings, which results in extraordinarily high returns for shareholders. However, during lean economic times, BX's revenue stream typically declines, leaving only the revenue stream related to fees behind once performance fees have virtually disappeared.
OWL's revenue stream, in contrast, is far more dependable because of its higher fee-related earnings and lack of carried interest. As a result, OWL will continue to deliver surprising consistency in profitability to shareholders in both favorable and unfavorable economic times.
Q2 2023 results
Q2 was successful for OWL. The most important is stable AUM growth. In all three themes, the company recorded increased investor interest. OWL had shown strong results last quarter .
To keep stable growth of AUM, capital inflows must exceed outflows. Redemptions have been exceedingly rare because a large proportion of permanent capital has prevented them. Due to its high amount of permanent capital, OWL had a significant advantage over rivals who, on average, raised $2 for every dollar of outflows.
Additionally, fee-related earnings increased to over $400 Million in the second quarter—this is 26 % YoY growth. One of the reasons behind that is OWL continues to impose some of the highest prices in the industry. Due to their product's unique features, they can charge an average fee of 1.5% on fee-bearing assets under management, which is almost 50% higher than Blackstone.
Going deeper into details, credit and real estate contributed to more than two-thirds of earnings growth.
I expect the credit segment to be the best-performing segment in the OWL portfolio. A large percentage of corporate debt is due next year, and the companies must refinance it. Hence, demand for alternative options will rise, too.
Shareholders
I want to highlight two things in the company`s shareholder structure: the small float and directors' ownership. The image below from the Market Screener shows the OWL shareholder composition.
The small float makes it easier to push stock prices in one direction. It is cheaper to move 32 % of shares than 99 %. Skin in the game is crucial for me as an investor and analyst, especially for investment vehicles. Here, the slogan Eat your cooking is valid at least twice.
Company Financials
Asset managers’ balance sheets are easily deciphered because they are asset-light businesses. The OWL balance sheet offers downside protection despite the $ 1.75 billion debt. The table below illustrates the company's liquidity and solvency metrics. The data is from the OWL Q2 report .
Quick ratio | 2.37 |
Current ratio | 2.35 |
Long-term debt/Equity | 26.9 % |
Total debt/Equity | 38.1 % |
Total liabilities/Total assets | 47 % |
The company`s debt is well diversified by maturity and has an adequate cost of 3 %. Below is shown OWL's debt structure.
The most significant part of the debt has to be repaid after 2030. Credit rating by Fitch S&P is another confirmation of the company's standing. Triple B counts for investment-grade bonds.
Let`s how OWL performs compared to the industry`s average. The image below shows the company's performance (ttm) against the industry's average.
Gross Profit and FCF margins prove OWL's capabilities to generate strong results. However, ROE and net income per employee could be better. With a growing AUM and solid fee structure, those figures will look way different a few quarters from today. A possible return on investment of 8% by 2025, or a price gain of 80% from the $12 share price today, with a dividend yield of 4.6%. OWL dividend metrics are shown below.
Although those numbers are pretty high, OWL will continue to expand at this rate unless the macroeconomic and fundraising circumstances drastically worsen.
Company Valuation
I use the Dividend Discount Model and relative valuation against similar companies to estimate assets management firm value. The metrics I use are EV/AUM, EV/Revenues, and EV/dividend.
To calculate OWL value with the Dividend Discount Model, I have to measure the price of the company's equity and levered beta.
To obtain those numbers, I use the following steps and assumptions from Professor Damodaran's website :
- Risk-free rate equals the 5Y average of USA long-term Government bond Rate, 2.2%.
- Growth rate, g, equals the 5Y average of the USA long-term Government bond Rate, 2.2%.
- USA's equity risk premium is 5.00 %.
- Investment and asset management unlevered Beta 0.48
- OWL Debt/Equity ratio 38.3 %.
- USA`s effective tax rate is 25 %.
- OWL dividend (ttm) $ 0.53
1. Calculate Levered Beta with the formula below:
Levered Beta = Unlevered Beta * (1+D*(1-T)/E).
2. Calculate the discount rate (discount rate as the cost of equity) using the resulting value for leveraged beta. The formula I use is:
Cost of Equity = Risk-Free Rate + (Levered Beta * Equity Risk Premium).
3. Calculate the Terminal Value of dividends considering the Cost of Equity and Expected dividend growth:
Terminal Value = Dividend per share * (1 + expected dividend growth) / (Cost of Equity – Expected Dividend Growth)
4. Calculate the Present Terminal Value assuming a constant discount rate for ten years.
For OWL, I get the following results:
Intrinsic value per share = $ 16.01
Current market price = $ 12.21 (Sept 13, 2023)
Based on expected cash flows from dividends, OWL market price offers a 23 % margin of safety. I will compare OWL with similar-sized asset managers. The image below shows valuations for Northern Trust Corporation ( NTRS ), Franklin Resources ( BEN ), The Carlyle Group ( CG ), and Patria Investments ( PAX )
Using EV/EBITDA and EV/Sales OWL is expensive. Another metric I like to use is EV/AUM and EV/FRE. The former estimates how much I pay for every dollar in AUM. However, OWL`s dividend yield is better than its peers except for PAX.
Risks
The most significant risk for every asset manager is excess funds redemption. OWL AUM consists of 79 % permanent capital, thus having only 21 % exposed to redemption risk. Another significant risk is economic risk. OWL investment performance is correlated tightly with interest rates. The higher the rates, the better the returns on its debt funds. However, real estate performance is inversely correlated to interest rates; thus, the growing cost of funding will adversely affect company real estate investments.
Conclusion
OWL is among the best mid-size alternative asset managers. It has a robust capital structure with 79% permanent capital, fee charges are higher than the industry average and has management with skin in the game. The last quarter's results have added credibility to my bull thesis. I expect stable AUM growth in the following quarters with rising fee-related earnings. On top of that, OWL distributes dividends with above-average yields. Based on the dividend discount model, the company is undervalued by 23%. OWL receives a strong buy rating due to its qualities offered at a great price.
For further details see:
Blue Owl Capital: Do Not Invest With Fund Managers, Instead Own Them