S&P Downgrades Och-Ziff (OZM) to 'BBB-'; Outlook is Negative
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S&P Global Ratings said it lowered its issuer credit ratings on Och-Ziff Capital Management Group LLC (NYSE: OZM), as well as OZ Management LP, OZ Advisors LP, and OZ Advisors II LP (collectively, these three partnerships are referred to as the operating group), and Och-Ziff Finance Co. LLC to 'BBB-' from 'BBB'. The outlook is negative. At the same time, we lowered our senior unsecured debt ratings to 'BBB-' from 'BBB'.
The company recently announced that it has reached settlements with the Department of Justice (DOJ) and the SEC, resolving their investigations into the firm's former private investment business in Africa and a 2007 investment by the Libyan Investment Authority in certain of the company's funds. Och-Ziff will pay a penalty of $213 million to the DOJ and disgorgement of $199 million to the SEC, totaling $412 million. The company has previously reserved for these amounts. This amount will be paid using cash on hand and an investment of $400 million made by certain of the company's partners through a perpetual preferred stock offering.
"The downgrade reflects our view that the $400 million preferred issuance, which will be used to finance the announced settlement, will weaken the company's financial risk profile such that we expect debt to adjusted EBITDA to be 1.5x to 2.0x over the next two years," said S&P Global Ratings credit analyst Sebnem Caglayan.
Och-Ziff continued to experience asset outflows and challenged investment performance in the last 12 months due to the declining investor appetite for hedge funds and an overhang caused by the pending investigation. As of Sept. 1, 2016, assets under management totaled $39.2 billion. This was a decrease of $8.8 billion from $48.0 billion as of June 30, 2015. As of August 2016, the OZ Master Fund, the company's largest multistrategy fund, only generated an estimated net return of 0.36%.
We view the company's perpetual preferred units as hybrid capital with "intermediate" equity content. In alignment with our classification of these units, we treat half the issued amount as debt and half as equity, and half of the units' distributions as interest expense and half as dividends.
The negative outlook reflects our expectation that we could downgrade Och-Ziff in the next 18-24 months if continued significant outflows and lagging investment performance results in further substantial reduction in assets under management and EBITDA, and deterioration in the company's business risk profile. We could also lower the ratings if we forecast that the company will operate with higher leverage, such that we expect debt to EBITDA to exceed 2.0x, or a reduction in interest coverage, such that EBITDA-to-interest is below 10x, on a sustained basis.
We could revise the outlook to stable in the next 18-24 months if the company reverts to positive net flows for several consecutive quarters while stabilizing investment performance. An upgrade is highly unlikely unless the improvement in asset flows and investment performance is significant, resulting in leverage below 1.5x on a sustained basis.
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