They say depression hits the hardest around the holidays and Fortress Investment Group (FIG) can certainly vouch for the validity of the statement. While the stock is still trying to hang onto its range just below the IPO price, it has been under pressure most of the quarter in line with a volatile financial sector.

A cursory glance over the third quarter earnings report shows a mixed bag of fundamentals. Assets Under Management (AUM) continue to grow above a 50% clip which should be impressive to any analyst. The firm usually charges a 1% management fee which yields a very steady and impressive earnings flow. But the management fee is only the base of revenue which pales in comparison to the lucrative incentive allocation the fund receives on gains realized for investors.

Incentive allocations were relatively light for the firm as a whole with only one large deal making up the most of this category. The company completed its liquidation of Crown Castle shares which it has been holding since 2002 when it purchased the company for $120m. After this final distribution, the company has netted a cool $1.7 billion return for a truly successful private equity transaction. These are the type of transactions that net huge incentive allocations including large payouts to employees which helps with recruitment and retention of top talent.

Looking into the fourth quarter, management was less than optimistic on any other blockbuster sales of previous investments as the overall markets are not offering attractive opportunities to liquidate private equity or hybrid hedge fund holdings. This means the company will likely only report management fee income for the fourth quarter which is likely a disappointment to short-term holders of the stock. However, the actual investments of the private equity team continue to be held on the company’s books and while patience may be tested, the long-term picture will still include selling these companies at substantial gains.

Instead of talk of distributing holdings, management appeared very excited about the potential for investment in the next year. After closing the books on a new fund which raised $5b, management is now in the process of setting up a few more vehicles expected to collect $10-15b for new investment. Depressed valuation and a lack of liquidity in the market will likely cause companies who are desperate for capital to sell out to FIG for very attractive prices. This will in turn set Fortress up to reap windfall gains a few years down the road when the company is able to turn the businesses back out at much more attractive multiples. Having liquidity during times of financial stress creates a foundation for long-term success.

In reading through the transcript for the conference call, I was surprised to hear one analyst question management on the “over-collateralization” of one of the investment portfolios. The analyst obviously believed that the fund would be more profitable with a greater degree of leverage. The CEO calmly noted that he prefers not to go out of business during times of market stress. This underscores the strength of conservative management who is cautious about how they financially structure the company. With a difficult credit environment and an illiquid market for which to price private investments, it is important to have a large margin for error which Fortress appears to have set up quite nicely.

Fortress and Blackstone both operate under a cloud of uncertainty when it comes to taxation. While congress continues to debate how to tax partnerships that have come public, there has been no real progress and so it remains to be seen how these companies will be treated for tax purposes. While this has a material effect on long-term earnings, the profitability of Fortress should make the stock attractive even at higher tax rates.

Fortress is unique among its competitors in that it attempts to distribute the majority of earnings to investors in the form of dividends. The current dividend is set at $0.90 annually (broken into 4 quarterly payments). Jefferies suggests that the dividend will likely average $1.00 in 2008 and 1.20 in 2009. While it is rarely a good idea to buy a stock simply because of the dividend yield, an attractive cash flow will likely help support the stock price at this level especially with rates dropping and income hard to find in financially stable vehicles.

While FIG shares will certainly have their share of volatility over the next year, I believe the current price allows for an attractive spot to initiate positions and I would get even more constructive if the stock were able to break above its $18.50 IPO price with strong volume. The short-term picture has a few questions to be answered, but the long-term future for the company appears to be bright.

FIG Notes

FD: Author does not have a position in FIG