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Alternative IPO

Private equity IPO? Shareholders want AUM but clients want performance. Permanent capital also reduces incentives to manage risk. Why would a private equity firm go public? Reasons cited for private equity IPOs don't offer legitimate rationales why investors would want to buy though initial sell-side hype will ensure enough do.

It does offer compelling arguments to short sell which I, and some larger entities I advise, will be doing the same day the stock can be borrowed. There are irreconcilable differences between equity owner and limited partner interests. Serving two masters usually fails.

Is the "first" listing of a US-based alternative asset manager really an opportunity for investors? Yes it is for short sellers but NOT buyers. I'll be keeping track of the patsies that risked client capital buying such toxic waste at crazy valuation. Listing a fund product like MW Tops or BH Macro in Europe might make sense. But why the firm itself? Management and performance fees and ten year lockups on over $17.5 billion of private equity can't pay for growth? Another $9 billion running bottom tier "hedge funds" on which to charge yet more fees. It needs a "stable" $600 million? An amount less than taken in through annual fees.

Reliable performance at low risk is ALL firms need to generate if they desire permanent capital. There's NOTHING new about alternative investment firms being listed. Hedge funds like Berkshire Hathaway and Man Investments have been public for many years. Goldman Sachs, Morgan Stanley and most of the bulge bracket all have large alternative asset management businesses. It has usually been more profitable to sell picks and shovels to gold miners than to actually be a gold miner.

Are Fortress' earnings and growth prospects really more than twice as "good" as Goldman Sachs, which trades at a much lower valuation? Investors could also do a lot worse that put on a long BRKA/short FIG pair trade after the first day pop. A fifty year track record of 22% per year is more impressive than a five year track record of just 14% per year and that with the markets having been very easy to repackage beta as "alpha" since the bottom 2002. The markets are going to be VERY difficult for the long-biasec crwod soon. The FORWARD LOOKING prospects for Fortress are dire which probably explains why the founders want out. You would do well follow them and get short.

Interesting also is a firm with origins firmly in private equity being "spun" as a hedge fund firm. Clearly someone thinks characterizing Fortress as a hedge fund would achieve a higher valuation than private equity. They are probably right but Fortress' hedge funds haven't been around very long and aren't any good. Nearly 70% of Fortress AUM is private equity funds NOT hedge funds. Private equity is dependent on the heavy leverage of a compliant credit market. Where's the hedge?

It is rare to see such "altruism". Kindly sharing fees with the public while disclosing some of the inner workings of a successful, so far, primarily private equity firm. Also noteworthy is people that quit Blackrock and Goldman Sachs to establish Fortress even claiming going public will allow them to retain and motivate employees! An absurd claim. If anything the opposite happens after the liquidity event of an IPO.

Why would a firm that has raised over $26 billion in various areas of private and structured finance want to subject itself to the ongoing hassle of a public listing? It is, of course, a free market and if the Fortress founders want the dubious ego boost of ringing the NYSE bell that is their choice, but why? If an asset manager performs, capital is permanent - in fact the firm should be turning money away. Those who focus on performance pay attention to AUM growth, those who focus on asset gathering do not which hurts anyone who hasn't redeemed yet.

Permanence, people, capital, currency? There are many investment managers on the Forbes 400 running very successful private firms. The Fortress IPO would appear to have little to do with incentivizing staff or creating liquidity. The carry fee structure takes care of that as all those hedge fund billionaire lists remind us. With AUM at over $26 billion, annual management fees should be over $520 million or so with perhaps a billion more in performance fees each year, if they make money(!), so there is substantial income to reward employees, retain talent and build the business.

Goldman GS going public several years ago did not stop people leaving for their own or other firms, so why does Fortress think being public will allow it to attract people? The credibility of a public listing? Anyone as successful as Fortress at raising capital is not going to be enhanced by having the FIG ticker. A sense of permanence? Going public achieves NO certainty of any firm staying around. If Fortress funds performance falter, the assets will be gone and so will the fees. I have NEVER once heard a preference from an institutional investor regarding whether an asset manager was privately held or publicly listed. If anything, being a listed stock is a negative for LPs as shareholders tend to focus on AUM growth not performance.

Then there is this wish to create a legacy, a self-sustaining firm. Questionable how an IPO is necessary for this since there are plenty of far larger, much longer established asset management complexes around that are NOT public. And why raise equity capital to do deals rather than grow organically or funding acquisitions with fee-generated cash? As the pundits remind us of "high" active management fees, successful money managers are very cash generative.

To cite just a few that have NOT done an IPO, Renaissance Technologies, Bridgewater, GMO, Fisher Investments, Capital Group and Fidelity among many others, seem to have built sustainable PRIVATE businesses. Cargill, the large commodities trader, thrives as a private concern. Kleiner Perkins and Sequoia Capital appear able to raise new funds and soldier on as a non-listed venture capital firms. I doubt the BEST hedge funds intend to go public, despite the trial balloons leaked to the media by overenthusiastic investment banks. Some lower tier hedge fund firms may try to IPO but NOT the good ones.

In assessing IPOs investors often make mistakes. The investment banks gussy up a firm to look its absolute best, the offering documents accent the positive and of course there is lots of pre-planted positive commentary during the so-called "quiet period". A frequent analyst error is extrapolating historical numbers. In 2001 Fortress had $1 billion AUM and now it has $26 billion, but there is NO CHANCE whatsoever that they will be managing $625 billion in 2011, despite the implied power law growth. The first page of the prospectus states that "earnings" since 2003 have supposedly grown at 109% per annum. Again there is zero probability of such growth continuing. In REALITY, Fortress' AUM and earnings will likely be much LOWER going forward.

A 38% IRR is CLAIMED for Fortress' private equity funds but that is past performance that IPO investors will NOT be participating in. There is no guarantee future private equity returns won't be negative in the future, especially when Fortress will be occupied with stricter compliance, Sarbanes-Oxley, clueless equity analysts demanding information and quarterly earnings disclosures. Investors in the IPO need to remember they are not buying past performance, they are betting on future returns. With dependence on a good economy, rising credit costs, high valuations, more competition and regulators belatedly taking a look at private equity, mean reversion in that particular "asset class" looks a CERTAINTY. Blackstone, Texas Pacific, Carlyle and KKR shouldn't wait too long before the IPO window for them closes - permanently.

IPOs are, of course, sold, not bought. The energy put into marketing an issue rapidly gets dissipated. Brokers move on to sell something else and the media will no longer be highlighting the story. The investment banks have been calling up anyone remotely IPO-able all year so the scarcity value of the Fortress deal will be very temporary if the offering goes well. No doubt large private equity firms are watching closely aiming to follow suit, but I would be surprised if the better hedge fund firms are looking to join the IPO queue although presumably low quality ones like the idea, particularly at these absurd valuations.

IPOs serve a useful capital raising function in many industry sectors. But asset managers have NO need to go public if they are confident of future fund performance. When I look at a prospective IPO I like to ask at roadshows "Do you really need the money?". Fortress might have once been a good firm but do they REALLY need YOUR money to build their business? Aren't the fees on over $26 billion enough to pay the bills and keep the staff happy?

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