Improving Balance Sheet Makes Fortress a Buy: RBC

Equity research firm RBC Capital Markets published a report on Fortress Investment Group LLC (NYSE:FIG) on Wednesday, may 28th. RBC analyst Bulent Ozcan highlights Fortress’ ongoing transition to a “balance sheet light” model as well underway and a compelling reason to consider investing in the company.

Beginning of multi-year balance sheet reduction for Fortress

In the report, Ozcan argues we are now seeing the beginning of the multi-year balance sheet clean up process. He highlights that Brookdale Senior Living, Inc. (NYSE:BKD) announced yesterday that Fortress Investment Group LLC (NYSE:FIG) was undertaking a secondary offering of 19.4 million shares to buy out Fortress’ ownership in BKD. Close to 17.6 million shares in the offering will sold by Fortress-controlled funds.

Fortress shares offer value

According to Ozcan, Fortress Investment Group LLC (NYSE:FIG) is an under-appreciated stock. He points out investors receive an option on incentive-based earnings at minimal cost. Given fee-based earnings of $0.39 over the year and using a 17X PE multiple, RBC estimates that Fortress shares should be worth at least $6.63 right now. Ozcan also points out the company has $2.97 per share in net cash and investments on its balance sheet. Furthermore, there is currently about $2.10 of gross undistributed incentive income, which is likely to grow over time.

Potential catalysts for Fortress

The RBC report also outlines several potential catalysts that could lead to share price appreciation for Fortress Investment Group LLC (NYSE:FIG). First, Ozcan says the firm’s hedge fund performance has been excellent and “could lead to earnings surprises”. He also suggests that incentive income could surpass current expectations.

Second, Ozcan argues the restructuring of Newcastle Investment Corp. (NYSE:NCT) and Eurocastle Investment Ltd. (AMS:ECT) (OTCMKTS:EUIVF) is likely to improve incentive income generation. He also mentions Fortress Investment Group LLC (NYSE:FIG) has recently “reset high watermarks and could earn incentive income.”

Third, Ozcan highlights that Fortress Investment Group LLC (NYSE:FIG) is a strong credit franchise. The firm has produced a 22% internal rate of return since inception, and realizations could accelerate given fewer high-return investments to choose from. He points out there is $928 million of unrealized incentive income in the business.

Fourth, it’s quite possible that Logan Circle Partners will increase AUM and fee rates as it expands into equities. Ozcan argues the market currently places little to no value on Logan Circle Partners.

The RBC report concludes with a sanguine summary valuation and rates Fortress Investment Group LLC (NYSE:FIG) as Outperform. “Assuming a 50% discount on undistributed incentive income, investors buying the shares around $8 are potentially getting value of $11 – with the optionality of growing undistributed incentive income. This seems attractive to us.”