Tuesday, February 13, 2007

Why buy when smart guys are selling ?

I was reading Roger Ehrenberg’s review of the valuation and rationality of Fortress IPO which was a blockbuster success on Wall Street.

For the uninitiated, Fortress Investment Group LLC, which manages $30 billion, became the first private-equity and hedge-fund manager to sell shares on U.S. markets and promptly emerged as one of the hottest initial public offerings in years. Its shares, issued at $18.50 apiece, opened for trading at $35 amid frenzied demand and closed at $31 -- 68% higher than its IPO price.

With its stock offering, Fortress is essentially inviting the public to share in the fees it earns managing private-equity and hedge-fund assets. At the end of 2005, the company's then-$7.6 billion in hedge fund assets (a hoard that has since grown) ranked it the 36th-largest fund globally.

What took me by surprise was Ehrenberg’s shock (“ Investors, are you stoned ?“ asks the Wall Street veteran) when the public market offered 40x valuation to Fortress’ shares.

I’ve commented my views to the blog post but then I couldn’t elaborate since I am a strict observer of blog ethics ( always be brief with comments ). But then I came across this wonderful piece in LA Times which squarely settles Ehrenberg’s misgivings.

To sum up, Fortress despite being a Hedge Fund manager went public because :-

a) a presence in Public Market gives it a perceived longevity, besides credibility ;

b) having a publicly traded stock allows its employees to turn their stakes in the company into income. In a partnership as Fortress had been, it was difficult to cash out. In a public company, it's a simple matter of selling shares. ;

c) it is a well timed move since hedge funds returned fantastic results in the year that had gone by ( 2006 ) and Fortress in particular enjoyed a great year itself ( earned $88 mm in the first half of 2006 ). Further, If Goldman was letting the public into its business after 130 years as a highly profitable — and secretive — private partnership, the insiders must have known that was as good as it would get.

d) Fortress is essentially inviting the public to share in the fees it earns managing private-equity and hedge-fund assets ; conversely if the following years turn out to be not as good as those gone by, it’s risk gets evenly distributed across a larger investor base.

e) Being publicly traded will increase the odds of gaining "permanence" as an investment manager. It will also attract high quality accredited investors and Board managed Pension and University funds which by their charter are barred from investing directly in lowly regulated vehicles like hedge funds which are not transparent.

f) The hedge fund and private-equity businesses are becoming ever more competitive as the number of players mushrooms. A serious shakeout is inevitable. When it happens, the firms with the deepest pockets will have the best chance of surviving.

But the question remains. Would you buy when these smart guys are selling ?

1 comment:

informationarbitrage said...

Krish, the points raised in the LA Times article are points I've raised in various posts on Information Arbitrage. My only point is that, from an objective perspective, a 40 P/E is not reflective of the underlying value of the asset. I get sentiment, scarcity value, the reasons why Fortress issued shares and how the shares could be trading at 40x. I just think the inevitable will occur and that growing into their P/E will be almost impossible. Just one person's view. Best, Roger