Monday, May 10, 2010

Fortress Investment Group (NYSE:FIG): Increasing bottom-up focus amid top-down worries; upgrade Fortress to Buy - Goldman Sachs

Goldman Sachs is upgrading Fortress Investment Group (NYSE:FIG) to Buy from Neutral and are raising their 12- month price target to $7.50 (prev. $5.00)

Firm notes they upgrade is based on 1) at 6X 2011 P/E, they believe the stock is pricing in minimal incentive fees even though most funds are at or above their highwater marks; 2) FIG should participate in the renewed investor appetite in alternatives, highlighted by $890 mn of new gross third-party capital raised in 1Q (11% annualized organic growth); 3) They believe FIG will continue to roll up smaller asset managers to diversify its business (highlighted by the recent Logan Partners deal), leveraging its global distribution capabilities, and 4) the company’s balance sheet continues to strengthen as FIG total debt is down to $370 mn, while cash and investments now sit at $1.1 bn, leaving the door open for re-introduction of distributions.

Firm raises their 2010/2011/2012 EPS estimates to $0.51/$0.75/$0.82 from $0.40/$0.60/$0.65 on better 1Q 2010 results (result $0.16 vs. their estimate of $0.07) and an improving outlook for incentive fees given the first is at or above its highwater marks across most of its strategies. Goldman's price target goes up on higher estimates and a greater probability of incentive fees. Key risks: unfavorable changes in the PTP tax structure, market volatility, potential reversal in the firm’s investment performance.

Valuation is not pricing in potential incentive fees even though highwater marks are in sight
At current levels, Goldman believes FIG’s valuation is not pricing in potential performance fees, even though the firm is getting close to its highwater marks. Specifically, FIG trades at just over 6X 2011 P/E versus OZM at 7.7X and BX at 10.7X . Adjusted for the firm’s investments, FIG’s EV/AUM is 5.7% on 2010 AUM estimates versus 9.5% for BX and 24.8% for OZM – a level which they believe does not price in much more than FIG’s sticky management fees and on balance sheet net cash and investments. Said in another way, using the value of management fees and on balance sheet investments plus cash (net of debt) as the “floor” value for alternative managers, the firm sees the least potential downside for FIG.

Accordingly, Goldman's sum-of-the-parts analysis suggests 12-month price target of $7.50, or an implied P/E of 10X on their 2011E EPS. The analysis assumes 13X FIG’s management fee related earnings of $0.22 per share (in line with traditional asset managers current multiple), $1.42 per share in net cash and investments on FIG’s balance sheet and just 6X the firm’s incentive/investment income.

Notablecalls: I suspect FIG has the power to bounce back pretty violently, to the tune of 10-15%. This would put $4.80 - 5.00 levels in play (or possibly higher).

Note that Goldman is out positive on the whole Asset Manager group saying many of the stocks have overshot to the downside and valuations are attractive, with 45% upside to Buy rated stocks.

Conviction Buys include: BX & BEN.

I would prefer buying FIG after the open on a pullback.

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