What is Under that FIG Leaf? Distributions and More Distributions

Fortress Investment Group (FIG) is a controversial hedge fund manager that either analysts love or they hate.  A share price at $7.50 and a dividend yield of 4.5% would seem to reward shareholders with a longer-term horizon.  However, FIG is not without issues.

A good two sentence overview from their press release:

Fortress Investment Group LLC is a leading, highly diversified global investment firm with approximately $62.5 billion in assets under management as of March 31, 2014. Founded in 1998, Fortress manages assets on behalf of over 1,500 institutional clients and private investors worldwide across a range of private equity, credit, liquid hedge funds and traditional asset management strategies.

Like many of its peers in the alternative investment field, Fortress Investment Group is structured as a LLC, much like a MLP, where unit holders receive a K-1 tax form. 

FIG generates revenue based on fees charged for their investment services.  As shown below, the bulk of AUM, along with revenue growth is in its fixed income programs. Going forward, this segment should continue to be the driver for growth in AUM to over $115 billion by 2017. 

The following chart taken from its 1st qtr. 2014 press release outlines the major business sectors by Assets Under Management (AUM). 


The latest investor presentation dated 2013 can be found in the link below:


Earnings per share are expected to increase from $0.80 per unit in 2013 to between $0.94 and $1.28 by 2017.  Distributions are expected to grow from $0.30 per unit, for a 37% payout ratio, to a minimum of $0.55, for a 58% payout ratio, in that timeframe as well.  Consensus price targets range from $10.50 to $11.50, but FIG has a high beta at 2.5, so investors could expect a volatile ride up.

While these estimates vary widely, it is important for investors to understand the structure and use of units as a management compensation vehicle.  FIG has two classes of units, Class A and Class B.  Class A is publically traded while Class B, also known as Operating Group Units, is not. Class B units are owned by management and are a used as an important compensation tool.  Not only do they receive equal distributions, but B units are sometimes bought back by the firm, or are swapped, directly or indirectly, for publically traded A units.   For example, in March 2014, FIG announced that it will sell 23.2 million newly issued Class A units in a secondary offering, with proceeds used to buy Fortress Operating Group Units from management. At $7.50 a share, the value of the purchase of Class B units would be around $175 million.  As of the end of the 1st qtr, there were 229 million Class A and 226 million Class B shares outstanding.  As shown, management owns a substantial percentage of total units outstanding  and this ownership provides them with a valuation of $1.7 billion of units and an annual income flow of $67 million.

Management is definitely on the same page as us lowly Class A unit holders.

Credit Suisse offers an interesting thesis:

Our Outperform Thesis: We remain Outperform on the FIG stock given that (1) FIG has almost $3 per share in net cash/investments. We think FIG will look to return capital to shareholders as their illiquid PE and credit fund investments on B/S return capital to LPs (which includes FIG). This will be source 1 of dividends going forward. (2) We estimate FIG will earn between $0.50 and $1.40 per share over the next five years and will target a dividend payout of earnings (source 2) around 50-80% (with a larger dividend payout occurring in 4Q – starting in 4Q14). So after adding dividend source 1 and 2 – we think FIG may be returning a very large amount of cash to shareholders over the next five years ($2.50 to $4.00 range or ~45% of current share price). (3) We think the core FIG business (x-the large excess capital balance) is worth about ~$11-12 - supported by $8-9 in value from mgmt. fee-based revenues (~$0.40 in normal year x 20x multiple – these fees are growing quickly and generally have very high persistency) and $3 in value for performance-fee-based EPS (~$0.50 in norm year x 6 multiple).

On the other side of the fence, Morningstar offers a down-in-the-mouth assessment of FIG in their most recent review.

The aftermath of the 2008-09 financial crises has changed Fortress Investment Group permanently, and we don't think for the better. We believe Fortress' reputation was severely damaged as the firm used side pockets to prevent redemptions on its most illiquid investments and suspended redemptions at its major Drawbridge Global fund at the height of the crisis. These actions as well as poor returns angered investors, who pulled out billions in capital over the next few years.

Fortress' struggles mean that its outlook is very different from many of its peers. The company raised only about $9 billion in new capital for its alternative funds over 2011-13. This level of fundraising is far lower than peers that raised several times more in new capital and consequently have stronger growth prospects. Believing that the firm will continue to face challenges with client inflows, we anticipate that Fortress will struggle to raise enough capital to offset our forecast level of redemptions and realizations as its funds age. As a result, we expect alternative assets to reach just $43 billion in 2017 from $40 billion in 2014, leaving the majority of Fortress' most valuable assets under management and earnings power to be largely stagnant in the near future.

Instead, we think the bulk of Fortress' growth over the next few years will come from its traditional fixed-income business, Logan Circle, which was acquired in 2009. We expect AUM for the segment to reach about $36 billion in 2014 and $70 billion in 2017, which will be roughly 60% of Fortress' total AUM and far greater than 2009's $11.5 billion. Inflows will be driven by fund performance, which is in the industry's top quartile, but Fortress earns only about 14 basis points (versus 150-200 basis points plus performance fees at its alternative funds) on the capital. Separately, the company recently hired a group of managers who have experience managing $20 billion of equities, believing it can charge investors 60 basis points to participate in the new strategy. However, given the significant difference in fees, we still expect the contributions of this segment to be around 10% of distributable earnings in 2017.

I fall on the side of Credit Suisse and think the current price offers adequate future total returns. With a payout ratio in the 50% range and high-end earnings estimate of $1.28, the distribution could grow to $0.64 a unit.  With a payout ratio of 80% and low-end earnings estimate of $0.95, the distribution could be $0.76 a unit.  Either way, the yield on cost could explode from a current 4.5% to between 7.5% and 10.0%.  

Oh, by the way, the firm has $2.2 billion in cash and investments and $1.2 billion in liabilities.  This equates to net cash and investment assets of $2.83 per unit, or about 37% of the current share price. Looking for a future high-yielder with additional capital gains potential?  FIG may fit the bill.

Disclosure: I am long FIG and the company is followed by Guiding Mast Investments monthly newsletter. 

I appreciate your time and interest in Guiding Mast Investments, George Fisher