stock market

Fortress Sees Salvation in Stock Market as Funds Shelved

(Bloomberg) — For someone who made his fortune taking companies private, Wesley Edens has long been fond of the public markets.

Eight years ago, his Fortress Investment Group LLC became the first major U.S. private equity firm to get a listing on the U.S. stock exchange, giving outsiders an option to participate in fees earned by the once-secretive industry for running leveraged buyout funds. The move paid off for Edens and his four partners, who extracted $ 1.7 billion in dividends and private stock sales from Fortress before the offering. Buyers of the shares weren’t as lucky, as the stock has slumped by more than half since then.

Now Edens, 53, who runs Fortress’s private equity business, is again turning to public markets, this time to replenish the assets overseen by his unit, which was slow to raise new investment funds after the financial crisis. While rivals such as Blackstone Group LP and Apollo Global Management LLC have raised new flagship pools rivaling those gathered before the crisis, Fortress in 2009 gave up similar efforts as paper losses in prior funds mounted.

Edens instead gathered about $ 6 billion in the past three years, mostly in investment vehicles that are public or set to go public, such as real estate investment trusts and holding companies. He says it’s the future of private equity.

“We are way ahead of the crowd,” said Edens, sitting in a glass-sided conference room at Fortress’s Manhattan headquarters, dressed in faded jeans and a black knit pullover. “If you ask our big competitors what they are most focused on, I bet they’ll say permanent capital,” he said, referring to the public vehicles.

Trailing Peers

Edens’s wager is crucial for a firm that was primarily known for its private equity business when it went public in 2007, selling shares at $ 18.50 each for a $ 7.4 billion market value. Edens was the firm’s rainmaker, generating 60 percent of the firm’s $ 552 million in pretax distributable earnings and overseeing about half its assets that year. Today, his group oversees about $ 1 billion less, despite a 36 percent rebound in assets to $ 17.1 billion since the depths of the crisis.

Fortress’s competitors have surged in size and reaped record profits in the same time. Blackstone’s buyout group has more than doubled since 2007, and the firm’s total holdings have almost tripled to $ 290 billion. Apollo’s assets have quadrupled to $ 160 billion.

‘Less-Than-Zero’

Fortress’s firmwide assets, including uncalled capital, have about doubled in that span to $ 74 billion as of Sept. 30. Most of the growth came from Logan Circle Partners LP, a traditional money manager it bought in 2010. Fortress has two other groups, a distressed-credit business with $ 18 billion in assets led by Peter Briger Jr., and a $ 7.5 billion liquid hedge fund unit run by Michael Novogratz. Briger’s has delivered the steadiest profits. The liquid hedge fund group’s earnings have seesawed, plunging last year on trading losses after a strong 2013.

Fortress’s stock has fallen 57 percent since the company’s February 2007 IPO, to $ 7.92 last week. Blackstone, which went public the same year and also saw its stock slump initially, has since rebounded and reached a record high on Feb. 3.

Fortress’s stock price suggests investors don’t see any value in the private-equity business that Edens runs, said Christopher Kotowski, an analyst at Oppenheimer & Co.

“The market puts a less-than-zero value on the private equity piece,” said Kotowski. He said it’s unlikely that the three funds Edens raised from 2004 to 2007 will ever produce performance fees because of their low returns.

Funds Trail

Edens’s taste in buyouts is distinctive, running toward companies brimming with properties such as ski resorts, railroads and retirement centers. It took a toll on Fortress during the real estate-driven slump.

Buyout firms such as Fortress traditionally raise money from pensions, endowments and wealthy families through private investment funds. The firms use the funds to buy companies and sell them after a few years, take a share of the profits and return the rest to investors. The more successful they are, the more likely it is that clients will commit to new funds.

Research firm Preqin ranks Fortress’s 2006 and 2007 funds in the bottom 25 percent of peers started in those years, and the 2004 pool in the lower 50 percent. Edens says his funds should be compared with real estate private-equity funds. By that gauge, each beat the majority.

Exceeding Hurdles

The returns “are nothing to be ashamed of,” Edens said, predicting that the funds eventually will net annualized gains exceeding 8 percent, their hurdle for earning incentive fees.

The funds, which had raised a total of $ 11 billion before the crisis, have rebounded in recent years as markets rallied. As stocks and real estate rose last year, the funds benefited from investments in consumer lender Springleaf Holdings Inc., mortgage servicer Nationstar Mortgage Holdings Inc. and railroad and property company Florida East Coast Industries LLC.

Springleaf is Fortress’s highest-returning private equity deal, producing a $ 2.4 billion, or 19-fold, unrealized gain on the firm’s 2010 investment. By the end of last year’s third quarter, the funds were up as much as an annualized 6 percent after fees.

‘Most Returns’

Giving up on raising a new, general buyout fund was a choice, Edens said, not a decision forced by lack of interest among investors.

“I believe 100 percent I could raise as much as I wanted to in a traditional fund,” said Edens, his voice rising. “The best way to make investors the most returns is not in that form,” he said, referring to Fortress stockholders.

Edens believes his shift to permanent-capital pools could fire up Fortress’s share price. That’s because stocks of firms that oversee such vehicles typically command higher valuations than those of traditional private-equity managers. Once investors see the earnings Fortress gleans from them, its market value might double from $ 3.4 billion currently, he said.

Public investment vehicles, such as REITs, raise money by selling shares, which are then traded on an exchange and can be bought by anyone. Unlike the private funds, which typically must return investors’ capital after about a decade, these vehicles don’t have to return it at a given date, which is why they’re sometimes called permanent capital. If investors want to cash out, they simply sell the shares.

Fortress has about $ 5.8 billion in assets and commitments in seven such vehicles, accounting for a third of his group’s assets. Assets in traditional private-equity funds have declined to less than $ 12 billion from $ 15.8 billion at the peak.

“They need to do something new to maintain relevance,” said Stephen Ellis, a Morningstar Inc. analyst. “The strategy has a lot of potential.”

Blackstone, Apollo

Permanent-capital vehicles aren’t new. Blackstone, Apollo and other buyout firms have hatched dozens of U.S.-listed corporate-lending vehicles known as business development companies and a smattering of mortgage pools. Both firms have continued to gather traditional funds, as Blackstone completed raising a $ 16.2 billion pool in 2012 and Apollo amassed $ 18.4 billion in 2013.

In 2006, KKR & Co. became the first U.S. firm to float a pure private equity fund, listing it in Amsterdam. At one point the largest-ever public buyout fund, KKR Private Equity Investors LP sank to as low as $ 1.97 a share in 2009 after raising $ 5 billion in an IPO priced at $ 25 a share three years earlier. It was delisted in 2010 when KKR absorbed it.

Edens Undeterred

U.S. regulations have made the vehicles less feasible for buyout investing than for lending and real estate. For buyout funds listed in the U.S., at least 60 percent of their holdings must be majority stakes in companies or hard assets such as oil refineries or ships, and the holdings must be kept long-term — requirements that most buyout shops judge too onerous.

Edens isn’t deterred. Since he resumed fundraising in 2011 after a four-year hiatus, he has garnered commitments for a permanent vehicle focusing on transportation and infrastructure and for spinoffs of Newcastle Investment Corp. that held follow-on stock offerings, as well as for more-conventional funds focusing on mortgage-servicing rights and Italian distressed debt. Edens started using Newcastle, an existing REIT, to raise money and buy assets that he then turned into separate investment vehicles through stock offerings.

Mostly Receptive

The market has been mostly receptive to Edens’s new vehicles. Newcastle Investment has more than tripled in value since being re-purposed, when including shares and dividends from three spinoffs. These include New Residential Investment Corp., a REIT that buys houses, which has gained an annualized 12 percent with dividends since going public in May 2013, and community-newspaper owner New Media Investment Group Inc., which has returned 82 percent since being listed a year ago. New Senior Investment Group Inc., a senior-housing REIT, is down 10 percent from its November debut. Another permanent pool, Fortress Transportation & Infrastructure Investors LLC, which manages $ 996 million, last year filed to go public.

Edens has staked $ 150 million of his personal fortune and colleagues added $ 50 million for the latest permanent-capital pool, Fortress Equity Partners LLC, a startup targeting energy-related infrastructure, health-care and financial-services buyouts.

Edens’s group is producing higher pretax distributable earnings than Briger’s for the first time in years — $ 190 million through the first nine months of 2014, or 59 percent of the total.

Permanent Capital

The permanent-capital vehicles bring in revenue similar to those of a standard fund: an annual management fee of 1.5 percent of invested capital, plus a 25 percent cut of investment gains after returns surpass 10 percent. If they achieve 21.5 percent returns, Fortress would pocket $ 25 million a year after expenses for each $ 1 billion raised, Edens said.

For Fortress’s stock, that could mean at least an extra $ 1.2 billion in market capitalization for each $ 3 billion deployed, compared with about $ 450 million if the cash were devoted to private funds, according to Edens.

His estimate is based on five permanent-capital managers — American Capital Ltd., Fifth Street Asset Management Inc., Medley Management Inc., NorthStar Asset Management Group Inc. and Teekay Corp. — that recently traded at an average of 18 times earnings before taxes, interest, depreciation and amortization, or Ebitda, more than twice the multiple investors usually apply to traditional buyout funds.

Specific Industries

Fortress’s permanent vehicles are a ways from reaching the marks he envisages. They pulled in $ 91 million of revenue last year through September and $ 26 million in profit. That compared with $ 53 million of revenue and $ 21 million of earnings in the same period during 2013. The funds’ combined assets could grow to $ 10 billion to $ 20 billion “if we perform well,” Edens said, without specifying a time frame.

The vehicles’ focus on specific industries may make it “tough to be nimble” when trends shift, said Meghan Neenan, a Fitch Ratings credit analyst. That could weigh on their market valuations, she said.

None of that fazes Edens, who said his formula of forming a private fund and then fashioning a strong record before taking it public could ease the difficulties such vehicles tend to face gaining traction as stocks.

“I don’t have a Plan B, and I don’t need one,” Edens said. “Plan A is going to work out.”

To contact the reporter on this story: David Carey in New York at dcarey13@bloomberg.net

To contact the editors responsible for this story: Christian Baumgaertel at cbaumgaertel@bloomberg.net Josh Friedman, Pierre Paulden

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