Oaktree Capital’s Sale to Brookfield is a Bad Deal for Oaktree Shareholders

When Oaktree Capital Group (OAK) and Brookfield Asset Management (BN 2.37%) combine, the resulting company will have $475 billion in assets under management, making it one of the largest alternative asset managers in the world, topping even Blackstone (BX), which has long been the behemoth in the alternatives industry.

The deal combines Oaktree's expertise in credit with Brookfield's expertise in equity investments, building a company that can cross-sell a full suite of strategies to its clients.

But the way in which these two companies are combining treats Oaktree's public owners like second-class citizens, forcing them to sell their ownership of the company for $49 per share even as most Oaktree insiders, managers, and private owners will be able to retain a majority of their ownership of the firm for years to come.

Why this deal stinks

You can think of Oaktree Capital Group as having a dual-class share structure not unlike Berkshire Hathaway and Alphabet, where there are two types of shares, each with a proportionate claim to the business’s earnings, but a disproportionate claim to voting power on matters that affect the company.

If you are a public shareholder (technically, a unitholder, but I'll refer to these "units" as "shares" for simplicity) of Oaktree Capital Group, you own the Class A shares, which have very little voting power, but together lay claim to roughly 46% of the company’s earnings power. The company’s managers, employees, and other insiders, generally, all own the Class B shares, which have a disproportionate amount of voting power relative to their share of the company’s earnings power.

The table below simplifies the ownership structure:

Data source: Page 20 of Oaktree's annual report.

In short, when the business’s profits are split up at the end of the year, there is no meaningful difference between having 100 Class A shares or 100 Class B shares. However, when it comes time to vote on an important matter -- like whether Oaktree should sell itself to a competitor -- the owners of the Class B shares hold virtually all the power.

Voting power is something that is seemingly abstract and irrelevant, until it isn’t. It certainly mattered on Wednesday when Oaktree Capital Group decided to sell out to Brookfield for $49 per share. The board of directors approved the deal, and public shareholders essentially have no say, since their shares entitle them to less than 8% of the vote on matters like this.

Here’s the problem…

Ordinarily, when a company is acquired by another, everyone cashes out at the same time and the same price. That is, all shareholders are treated equally. Whether you hold class A or class B shares generally doesn’t matter.

In the case of Oaktree Capital Group’s transaction, all shareholders are not being treated equally. The Class A shareholders (the public) will be forced to sell all their shares of the company to Brookfield for an amount approximating $49 in cash, or 1.077 shares of Brookfield. As for the Class B shareholders (insiders), they will only sell 20% of their holdings to Brookfield for $49, and will retain the other 80% of their holdings.

Put another way, the Class B shareholders have decided (because they have the voting power) that $49 is a good price at which the Class A shareholders should be forced to sell 100% of their stake, even though the Class B shareholders are only selling 20% of their ownership at that price. That’s…not a great look, but it gets worse.

In the words of Howard Marks, Oaktree's founder and the face of the firm, Class B owners will receive "a very valuable option to sell, not an obligation" over a period that generally spans from 2022 to 2029, thus giving Class B owners the option to sell when it is most advantageous to them, a privilege that, of course, isn't being extended to any of Oaktree's Class A shareholders.

In fairness, there is another side to the story. Brookfield wants Oaktree’s Class B owners to stick around because those owners are insiders -- founders, managers, and employees. It’s all about aligning interests between those who work for Oaktree and those who will own it (Brookfield). Oaktree's clients who entrust it with more than $120 billion of wealth would naturally want the people who are managing their money to have a vested interest in generating good performance.

Investors should be open to that view, but it’s easy to see why a Class A owner may feel slighted by this deal.

It wasn’t supposed to be this way

The thesis for owning Oaktree was that it was different. Sure, it operated in an industry known for treating owners like just another bid for the stock, using liquid stock as currency for outsize compensation. And yes, speaking categorically, alternative asset managers haven’t exactly been great investments, but that was primarily because they tend to go public at opportune times.

But Oaktree wasn’t that, everyone thought. Oaktree was a company that built a sterling reputation as taking care of clients, employees, and owners, all at the same time.