Tags
% of AUM, alternative assets, asset managers, dry powder, Ex-Cash Ratios, FIG, Fortress Investment Group, high dividend yield, incentive fees, Logan Circle Partners, Price/Cash, RailAmerica, share buyback
In May, I published a series on alternative asset managers, which culminated in a write-up of my latest purchase (at the time), Fortress Investment Group (FIG:US). Based on its net cash/investments per share, plus a fund management valuation of 6.3% * $46.4 bio of Assets under Management (AUM), I pegged FIG at a Fair Value of $7.80 per share. Based on FIG’s $3.11 share price at that point, this offered substantial Upside Potential of 151%. This turned out to be v fortunate timing, as I caught the 2012 bottom (in fact, pretty much the 3 yr low) for FIG:
On Thursday, the share price again traded down to & held the key $4.08-19 support zone (for the past 5 mths), and then rallied strongly to close at $4.38. That’s a 41% gain vs. my write-up price 7 mths ago. And a 53% gain vs. my own net entry price (inc. dividends). I’m sure many readers (new or old) who were interested, but perhaps missed the boat on buying FIG, are now ready to give up & move on to the next idea..! But why? First, my $7.80 Fair Value still offers a 78% Upside Potential – pretty damn excellent for a US mid/large cap stock with zero debt! Second, fair value’s a moving target…we need to take a closer look at what’s been happening with Fortress since.
As with all asset managers, we first look at AUM: Fortress is definitely firing on all cylinders here! End-September AUM stood at $51.5 bio, which compares to $43.7 bio at the beginning of the year, and is up +18% yoy. And this actually downplays their actual fund-raising success in the past year! Unlike some of its peers (bear in mind if you’re doing any comparative analysis), Fortress doesn’t include uncalled/non-fee earning commitments (‘dry powder‘) in total AUM. This dry powder was $3.2 bio last year, but has since more than doubled to $7.2 bio. I don’t include this dry powder figure in my valuation, but obviously it’s a significant & reassuring source of new AUM to come.
Next comes Performance: Considering the average hedge fund’s up just +3% YTD 2012, Fortress has blown the lights out! Virtually all their hedge/credit funds are, by comparison, reporting double digit returns this year (with some PE funds earning 20%+). Logan Circle Partners, its fixed income manager, also continues to outperform benchmarks in virtually all strategies. Fortress has also won awards left, right & centre this year. And since quarter-end, they’ve reported a very successful divestment of a PE holding, RailAmerica (RA:US), to Genesee & Wyoming (GWR:US) for $1.4 bio.
And next we look at Financial Stability: As of end-Sep, FIG cash was $254 mio, investments were $1,200 mio, and debt was $181 mio. This equates to $1,273 mio of net cash/investments. Clearly, FIG’s outstanding commitment of $154 mio to its funds (in the years to come) poses no threat to liquidity. However, we need to make a couple of subsequent adjustments. First, Fortress repaid all debt in October. This doesn’t affect net cash, but it removes a minor risk from the balance sheet, grants some additional flexibility, and has an incrementally positive impact on earnings.
Second, the divestment of RailAmerica resulted in Fortress receiving aggregate proceeds of $182 mio. Only $17 mio was carried as an investment, the balance was classified as a receivable and/or was simply a previously unrecorded gain. This increases net cash/investments by a net $165 mio to $1,438 mio.
Finally, we’ve just heard news of Robert Kauffman‘s retirement. This prompted the buy-back of his entire 51.3 mio share stake, at a discounted $3.50 share price. Of course, the real benefit here is the buyback of approximately 10% of the company’s outstanding shares at a far more substantial discount to intrinsic value. The total cost was $179 mio, mostly funded through a promissory notes issuance. Presumably these notes will be retired with cash on hand in 2014. This reduces the most up-to-date estimate of net cash/investments to $1,258 mio.
Now, let’s revisit my valuation of the asset management business itself. I recommend you read my previous write-up, but to briefly summarize: In the past 2 FYs, management fees averaged 1.20% of AUM. Incentive fees were far more volatile, of course, so I considered a 5 yr average of 0.74% of AUM the most useful metric to reference. Fund Management Distributable Earnings (DE) (broadly equivalent to operating profit) was 36% of total fees, which I thought deserved a 3.25 Price/Sales multiple. This produced a fund management (ex-cash) valuation of 6.3% of AUM (i.e. 1.94% of AUM in total average fees * 3.25 P/S).
So, how do the numbers compare in 2012?
OK, well, YTD we have $348 mio & $164 mio in management & incentive fees, respectively. With an average $47.4 bio of AUM YTD, this equates to 0.98% of AUM for management fees & 0.46% of AUM for incentive fees. No need for alarm at the drop in the management fee rate – it simply reflects Logan Circle’s increasing slice of the AUM pie (they have a much lower fee structure). [Logan has actually proved to be a marvelous acquisition/integration for Fortress – AUM have almost doubled from $12 to $21 bio since they were acquired in 2010. This may bode well for possible future acquisitions].
This lower management fee rate may well prove permanent, so let’s adopt it instead. On the other hand, I think it’s quite reasonable to continue assuming an average 0.74% of AUM for incentive fees over time. With fund management DE of $172 mio YTD at 34% of total fees, I’ll also continue to assume a 3.25 P/S multiple. This lowers my fund management valuation to 5.6% of AUM (1.72% of AUM * 3.25 P/S). Depending on your perspective, you may consider this to be an aggressive or conservative valuation… I’d argue it might prove to be relatively conservative, in due course:
– Post-financial crisis, I think Fortress has done a marvelous job maintaining & increasing AUM. Noting this, and their success in 2012, certainly bodes well for their continued progress in fund-raising & AUM
– My valuation incorporates none of Fortress’ $7.2 bio of dry powder
– Fortress just announced the successful close of Fortress Japan Opportunity Fund II with $1.65 bio in assets. Some/all of this total will be a fresh addition to the next AUM/dry powder figures
– As we’ve seen with some of its peers, Fortress’ increasing scale & superior relative performance (particularly in 2012) are likely to attract an increasing/disproportionate share of inflows from investors/institutions
– Fortress currently has $651 mio of embedded incentive income in its funds, of which the vast majority remains unrecorded in DE
– Current FIG results are dragged down by Logan Circle, which appears to have been run on a low-fee/break-even basis since acquisition. This allowed them to focus v successfully on an accelerated increase in AUM. It’s reasonable to expect a significant increase in Logan’s fee rates & profit margins in due course
– FIG’s current annual dividend is $0.20 – an attractive 4.6% yield. However, current (annualized) pre-tax DE is $0.48, and FIG’s committed to a top-up dividend for year-end. If we assume, say, about a 1/3 of the incremental earnings are paid out, we could see a $0.10 top-up payment. This would, of course, re-base investors’ expectations to a $0.30+ annual dividend, and a 6.8% yield would provide strong support for the share price
– The asset management industry has well established market/M&A multiples. On average, a high quality fixed income manager might attract a 0.67%-1.0% of AUM valuation, while a top-class alternative asset manager could command anything from 7.5%-10% of AUM, or even higher. Using mid-points of these metrics, and noting a 21:31 split in favour of alternative assets, this is further confirmation of a potential 5.6% of AUM valuation for FIG
So, putting all this together:
$51.5 bio AUM * 1.72% Total Fees * 3.25 P/S + $1,258 mio Net Cash/Inv = $4,136 m / (519.1 m – 51.3 m) Shares = $8.84 Fair Value per share
This offers fresh Upside Potential of 102%. I’ve now added to my FIG holding, increasing my portfolio stake to 4.9%.
- Fortress Investment Group (FIG:US)
- Mkt Price: $4.38
- Mkt Cap: $2,049 mio
- Div Yield: 4.6%-6.8% (based on a $0.20-0.30 dividend)
- Price/Cash: 1.63
- Ex-Cash % of AUM: 1.5% of AUM
- Tgt Mkt Cap: $4,136 mio
- Tgt Div Yield: 2.3%-3.4% (based on a $0.20-0.30 div)
- Tgt Price/Cash: 3.3
- Tgt Ex-Cash % of AUM: 5.6%
- Tgt Price: $8.84
- Upside Potential: 102%
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26-Sep-13: Trimmed my Fortress Investment Group $FIG portfolio holding from 5.9% to 5.4%
12-Feb-13 Trimmed my Fortress Investment Group $FIG stake from 6.2% to 5.4%
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Well, bjk, let’s see what develops – personally, I think Fortress need to be making plans for a $3+ bio fund focused on European distressed assets, among other fund-raising opps.
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Isn’t FIG becoming a low-margin bond fund? Fundraising outside of Logan is less than impressive, hard to tell where growth is due to NAV appreciation (there has to be a word for that) or fundraising, and growth in credit was negative. If these guys are such hotshots, where is the PE/hedge fund growth? Nearly all of the growth is coming from the low-margin Logan Circle, and this has been the case for quite a while. Maybe LC margins will improve, but that remains to be seen. The rest of the business just hasn’t been growing, and that’s been true for years. The buyback was good news, but this looks like dead money.
Ah yes, Fortress is a company people love to hate – I got a lot of emails from readers earlier this year, expressing similar aversion(s) to FIG at $3 odd… I don’t think fund gains/performance & Logan’s increasing AUM are something to be unhappy about – both have been resounding success stories in the past year! In fact, the logic & timing of the acquisition of Logan & its team now appears to be marvelously astute.
I don’t agree fixed-income managers are low-margin: They’re low fee, of course, but a good manager can still earn 20-40% operating profit margins – just like an equity fund manager. Superior fee structures mean good alternative managers can extend the upper range of potential OP margins to 50-70% – on the other hand, their profitability is more volatile, and they generally have a much larger fixed cost base.
Note a fresh $1 billion raised by Logan, vs. Fortress’ alternative funds, will still be incrementally positive to my valuation above. Obviously, a $1 bio of alternative funds raised would far more valuable though, so I absolutely agree we can all wish for that instead! The last few years for Fortress, as with many businesses & managers, appear to have been spent consolidating (FIG has eliminated $0.5 bio of debt), maintaining AUM, and investing, restructuring & harvesting profits. Now’s clearly the time for a fresh/accelerated drive in alternative fund-raising, and if you review recent progress & earnings transcripts FIG are certainly focused on/highlighting that very opportunity – particularly in areas likes MSRs, transportation, Japan/Europe, etc.
Meanwhile, $1.25 bio of net cash/investments gives them plenty of potential firepower, and an ex-cash 1.5% of AUM valuation provides a huge margin of safety if things don’t turn out as positively as I would hope.
Cheers
The real mystery here is why credit and PE aren’t growing. PE, according to last earnings report: 20% appreciation in NAV and 16% growth in assets = net outflows. Credit was in absolute decline, down 3% yoy. PE and credit hedge fund are where the real money is, and they’re in decline. The move into LC actually looks like a bit of a surrender. If FIG can’t grow the PE and hedge fund in this environment, why not? What’s wrong? 5.6% of AUM when the high margin business is in decline seems rich. If I want to buy a bond fund manager, ART or LM are much cheaper.
“Christoph M. Kotowski – Oppenheimer & Co. Inc., Research Division
A couple of things. One is, I’m wondering between the sale of RailAmerica and other presumed sales coming out of Funds III, IV and V, should we expect to see the base management fees in the Private Equity sector kind of decline steadily in the next 2 or 3 years?
Wesley Robert Edens – Principal, Co-Chairman of the Board, and Member of Management Committee
Yes, generally, the way the fund works is that after the commitment period, their fees are calculated on invested capital as opposed to committed capital. So the natural pace of the management fees, they would decline as those funds returned capital and goes down. That, of course, assumes no additional fundraising, which is obviously not the plan. So the direct answer is I don’t think management fees are going to go down because we think that we’re going to continue to raise capital, invest capital and make money, that’s our business. But specifically, the funds, they work as you described. So they do decline as you return capital in these older funds.”
That explains the lack of growth in PE.
Thanks, yes, I liked those comments from Wes. A near doubling of Logan’s AUM in 2.5 years certainly sounds like victory, not surrender. I don’t much worry about the AUM mix in the future – I’ll just price it accordingly. As for fund appreciation vs. fund-raising, it requires a pretty even mix of both to be successful – i.e. performance helps fund-raising, and fund-raising ultimately requires performance.
If you want to home in on their alternative AUM, I’m v pleased with Fortress’ performance in this regard: They IPO’d in 2007, but obviously everybody’s plans for investment gains, fund in-flows & fund-raising were put on ice during 2007, 2008 & Q1 2009. Markets had to bottom out before there was any chance of moving ahead. At end-Q1 2009, alternative assets were $26.5 bio & $1.8 bio of dry powder, totaling $28.3 bio. They’re now reached $30.8 bio & $7.2 bio of dry powder (all of which is presumably non-Logan), a total of $38.0 bio. I’m very happy with that kind of progress, and will be even more delighted if Fortress can duplicate anything like that kind of result in the next few years.
That certainly puts FIG at the other end of the spectrum from, say, ART whose AUM is melting away faster than an ice cube in the Sahara… The only real hope I see for ART shareholders is for GAM to grudgingly buy it back. Looking ahead, as I said when FIG was trading near $3, we’ll just have to wait for the share price to confirm the correct investment thesis here.
SPY has nearly doubled since Mar 31 2009 (adj close $73). So flat AUM while the market has doubled . . . Put a 50% haircut on equity and value the AUM at 4% and you get ~$5. Sounds about right.
But Wexboy, don’t take it personal . . . just a stock. There’s a bear case and a bull case, and you made the bull case.
Thanks, Matt – I should really try that to do that!
I really like your blog, but may I suggest you use less bold type? It makes my eyes hurt trying to read it. Other than that keep up the good work. Thanks,