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%