ZachStocks

Last time I wrote about Fortress Investment Group, the news on the initial Bear Stearns hedge funds had recently broken and the market volatility was only just beginning. This was also the same week that Blackstone (BX) came public and arguably at the very top of the liquidity cycle that has garnered so much press. The stock (FIG) had pulled back from its initial IPO pop, and looked as if it was setting up a basing pattern and finding support. However, there was more selling to come and I was quickly stopped out of my original position.

On Tuesday (8/14) the company reported earnings and investors were able to hear more information on what is going on within the funds and investment programs that make up Fortress’ investment portfolio. The company reported $0.25 in “distributable earnings per share” adjusted for taxes. This is a measure of economic value produced for shareholders as GAAP earnings per share are basically meaningless because of realized and unrealized gains and losses that go into GAAP earnings but are based more on timing of sales of assets than on growth in enterprise value.

One of the most encouraging items was the Assets Under Management (AUM) which totaled $43.3B and is up 70% from a year ago. The company also breaks out “management fee paying AUM” which takes out assets the company invests in its own products. This measure was $28.6B also up nearly 70%. The firm was successful in marketing some new products and closed initial funding of new hedge funds with ample cash to invest. It is likely that the company will be able to put this new capital to work buying severely depressed securities and realizing some significant values if managers competently allocate these resources over the next few months.

The basic breakdown of assets are as follows:

• Private Equity - 54% of assets
• Hedge Funds - 36% of assets
• Castles (Real Estate) - 10% of assets

Since Private Equity is the largest portion of assets, it is understandable that investors were disappointed that this segment did not add much at all to distributable earnings. However, a closer look shows that this is an illiquid area that does not have a regular stream of income. Most income is recognized in this arena when assets are sold, and there is no public market for many of their private investments to allow the company to “mark to market” their holdings. There was a special note, however, that the company sold a position that will be recognized as early Q3 income which realizes $56m in income. This represents over a third of the income for the whole firm in Q2 so it appears this was more of a timing issue than a weakness in the Private Equity segment.

Management took some question as to their leverage and liquidity position and the answers were very reassuring for conservative investors. It appears most of the hedge fund portfolios are operating on a non-leveraged basis and the primary hybrid hedge fund area was stated to be employing 0.3 to 1 leverage (meaning only 30 cents exposure for every dollar under management). This is positive on two fronts. One, the company can meet redemption requests without selling assets at distressed levels. Two, the company has cash to buy these assets at distressed levels when management feels confident the risk/reward ratio is attractive. Having flexibility means the world to competent managers who recognize opportunity is close at hand.

During the quarter, the company was able to refinance its credit facility to give them more access to capital (the line now stands at $1b) and also the new line is at a better rate. Management stated this new facility could be helpful in funding future redemption requests or for investment purposes. Obviously we don’t want the company to become too leveraged (see the Global Liquidity article), but the flexibility should be a significant benefit to the company during uncertain times.

I recently purchased a small amount of stock above 20 and hedged it with September calls and would not recommend buying at this point with the overall market becoming so dicey; but I do believe this name should be on an investors watch list for when the macro picture becomes clearer. Management appears to be talented and motivated, opportunity seems to be abundant, and the portfolio managers appear to have positioned themselves on the right side of the liquidity spectrum. Stay on top of this name and watch for strength to signal a good buying opportunity.

FD: Author has a long position in FIG and BX

FIG Notes

Additional Reading:

Blogging Stocks thinks investors may remain jittery.