Fortress Investment Group's (FIG) CEO Randal Nardone on Q2 2016 Results - Earnings Call Transcript

| About: Fortress Investment (FIG)

Fortress Investment Group LLC (NYSE:FIG)

Q2 2016 Results Earnings Conference Call

July 28, 2016, 10:00 AM ET

Executives

Gordon Runte - MD and Head-IR

Randy Nardone - CEO

Dan Bass - CFO

Jude Driscoll - CEO-Logan Circle Partners

Pete Briger - Co-Chairman and Head-Credit and Real Estate

Wes Edens - Co-Chairman and Head-Private Equity & Permanent Capital

Analysts

Craig Siegenthaler - Credit Suisse

Brian McKenna - JMP Securities

Operator

Good morning. My name is Rob and I will be your conference operator today. At this time, I would like to welcome everyone to the Fortress Investment Group Second Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions]

Thank you. Mr. Gordon Runte, Managing Director, Head of Investor Relations, you may begin your conference.

Gordon Runte

Hey thanks Rob. Good morning, everyone. Thanks for joining us for the Fortress Investment Group second quarter 2016 earnings conference call. We issued our press release and earnings supplement this morning and both of those documents are available on our website.

We’ll begin our call today with brief opening remarks from Fortress Chief Executive Officer, Randy Nardone; and Chief Financial Officer, Dan Bass. We'll then hear from Jude Driscoll, Chief Executive Officer of Logan Circle Partners; Pete Briger, Fortress Co-Chairman and Head of Credit and Real Estate; and Wes Edens, Fortress Co-Chairman and Head of Private Equity & Permanent Capital.

Before we begin, let me cover just a few items. First, statements made today that are not historical facts may be forward-looking statements and these statements are by their nature uncertain and may differ materially from actual results. So, we strongly encourage you to read the forward-looking statement disclaimer in today’s earnings release in addition to the risk factors in our quarterly and annual filings.

Second, we will be discussing some non-GAAP financial measures during the call today. The reconciliations of those measures can be found in the earnings supplement. And lastly statements are made as of today, July 28, 2016, and will not be updated subsequent to the call. As always should you have any questions, after today’s call, please contact me directly at the number on our press release.

With that, let me hand off to Randy.

Randy Nardone

Thanks Gordon and thank you everyone for joining us today. Fortress had a strong second quarter. Our businesses remain active and well-positioned and we feel very good about our prospects of the full year.

Here's the highlight. Pretax DE was $0.26 a share, that's up over 60% from the first quarter this year, driven largely by strong realizations and incentive income in our credit DE funds.

Fee paying AUM was roughly unchanged at a little over $70 billion, despite returning over $1 billion to our limited partners. Dry powder remains over $7 billion.

Gross undistributed incentive income increased by 16% to about $1.2 billion. The big change on the quarter reflected value appreciation in Fortress Equity Partners, which drove PE embedded incentives to over $200 million. Wes will provide more detail on this in a few minutes.

The net value of investments in cash on our balance sheet increased to nearly $1 billion at quarter end. Coupled with unrecognized incentive income on a net basis, we closed the quarter with over $3.90 a share in embedded value. That's over 80% of our share price today.

Our base quarterly dividend of $0.09 a share implied a yield of over 7%, that's not counting potential top-ups. As a reminder, we paid out a $0.11 top-up last quarter and we paid out over 100% of DE in dividends and buybacks since 2012.

With a strong first half of 2016, we're well-positioned to continue to deliver meaningful value to shareholders. We move into the second half of the year with strong levels of activity and productivity across our core businesses.

And so we're optimistic about the rest of the year. Dan?

Dan Bass

Thanks Randy. Good morning everyone. From a financial perspective, the second quarter had a number of positives and can be characterized by a bottom-line earnings be double-digit growth in embedded incentive income and increased realization activity in our funds.

With that let me discuss the results in more detail starting with earnings. Pretax DE was $101 million or $0.26 per share in the quarter, displaying year-to-date total of $165 million or $0.42 per share. We recognized a $131 million of incentive income in the quarter more than doubling the first quarter amount. Multiple businesses contributed to that result.

In the quarter, we recorded $85 million of incentive income from our credit PE funds, our third highest quarter ever in that business. $33 million from our credit hedge funds and $14 million in our PCBs, including $9 million from NRZ and $3 million from New Media.

With this result, our credit business has now recorded $178 million of incentive income in the first six months this year. This represents year-to-year growth of 13% and helped drive our highest first half of pretax DE in that business.

One final point on earnings. In the second quarter, our margins increased significantly from the first going 31% to 36%. The uptick in margin was a result of lower operating expenses and greater incentive income.

A few points on AUM. As you heard earlier AUM was down slightly in the quarter to $70.2 billion. Strong fund performance contributed about $1.4 billion to AUM, while at the same time, we returned over $800 million of capital to our investors and had a decline of about $900 million in our affiliated managers and co-managed funds.

Undistributed incentive income, the value here is increased by an impressive $160 million, or 16% in the second quarter. Importantly, we saw growth in each of our businesses with our PE funds leading the way. An increase in the NAV of our Fortress Equity Partners fund was the main driver. A market-up in one of the fund investments triggered the increase.

On incentive eligible NAV in the quarter, our incentive eligible math reached $22.8 billion. This is growth of about $1.6 billion or 8%. This growth was primarily driven by the increase of Fortress Equity Partners that I just discussed, and over $1.1 billion of DBSO capital once again moving past it's respective high watermarks. Additionally, we have another $2 billion of capital within 1% of their respective high watermarks.

So, quick comments on fund performance. In the second quarter, the majority of our funds performed very well. PE fund investments appreciated by about 8%. Our main DBSO fund was up 2.8%. Credit PE funds strategies built on already impressive IRRs and nearly all Logan Circle strategies outperformed their respective benchmarks.

Shifting to the balance sheet. The value of our balance sheet is represented by net cash investment was up slightly $2.42 per share in the quarter. We think this is a positive result in a tough market environment.

Looking at the individual component, cash was up, investments were down slightly, and our debt was unchanged in the quarter. On taxes, as it stands today, we still expect our tax rate to be close to the 20% guidance I previously provided.

It is possible that it could move a few percentage points either way in the last five months of the year, depending on our mix of earnings.

In closing, let me recap what was really a solid quarter. We experienced growth in nearly all of our important financial metrics. This includes significant growth in both in -- [Indiscernible] of income and incentive eligible NAV.

The potential for incentive income generation remains very strong. We generated over $130 million of incentive income in the period and we have nearly $23 billion of assets currently eligible to generate incentive income with another $2 billion plus within 1%.

And finally, continued realization activity could lead to a significant amount of balance sheet distributions in the future.

Thank you. I will now hand it over to Jude.

Jude Driscoll

Thanks Dan. Second quarter at Logan Circle was another good one building on our first quarter momentum. Our AUM was up, our funds once again performed well and the business increased profitability with what I believe is a lot of upside.

Let me give you a little more insight. First on AUM, our AUM grew about 4% in the quarter, and is now grown by over 9% in the first half of the year. The growth came largely through performance, gains across all of our strategies.

Although search activity was light in the second quarter, our recent conversations with perspective clients have picked up in IFP [ph] traffic has been robust. We expect all of our strategies will be very attractive to allocate us over the coming quarters.

Switching to fund performance. During the second quarter, 14 of our 16 strategies outperformed respective benchmark. And for the year, 13 of these strategies have exceeded benchmarks by over 40 basis points. This includes seven of our eight strategies that have assets over a $1 billion.

A few comments on our outlook for growth. Like every manager, we expect continued asset rotation and potential outflows. We believe we're very well-positioned overall. On the incoming side, we have a strong pipeline driven primarily by the demand for our higher fee strategies with several large mandates that are close to funding.

So, we feel good about our ability to track new clients, generate net inflows and decrease the proportion of AUM in our higher fee strategies.

Finally, I'm very excited about where this business has come financially. Our bottom-line contributions to Fortress earnings has continued to increase this year. And then with that, we keep progressing in our goal to be a larger and more predictable source of earnings for the company.

With that, I'll pass over to Pete.

Pete Briger

Thank you, Jude and thanks everybody for joining us this morning. Credit remains in a similar mode to earlier calls we talked about the market being uninteresting in general, no real sematic areas of interest for us. The market remains fairly high-priced, valuations are high. We have been in selling mode represented by the amount of incentive income we brought through this quarter.

I would say generally our investment pace is slow. We have a significant amount of dry powder for new investments and existing investments in excess of $6 billion. And the corporate default world is picking up but still low on an average historical basis. And I would say some from our standpoint, the market continues to be crowded and not place for us to have a significant pick-up in investment activity.

I would say you know our portfolio has done quite well on a record -- relative basis, okay on an absolute basis. And I would think that the existing portfolio will shrink some to the extent that the opportunity set remains where it is today, but again we're poised for change in the environment.

Turn it over to Wes.

Wes Edens

Great, now thanks Pete and thanks everyone. Solid quarter for us in the private equity and permanent capital vehicles. We begin for the quarter as both Randy and Dan mentioned the $809 gains in the private equity funds. The first month of the third quarter we had nearly not much again. I think as a last night almost $759 gain so.

Mark-to-market activity very good. You know the company that was an increase in undistributed carry that was meaningful. And one of the funds in particular and handful of liquidations either currently run the way in the legacy fund. So very, very solid first half of the year and I think it sets up well hopefully for very productive second half of the year focus.

In the legacy private equity funds will continue to be liquidation, the monetizations as a handful of very substantial investments that things [ph]. We are looking hard at creating a path of liquidity for -- in the current private equity investment business; the environment is a challenging one to find investments to buy.

We've got a number of strategies, where we are building businesses and we're very excited about the prospects for those and that was reflected in part by the valuation changes in the quarter. So there could be some good things I had there for sure.

The private equity -- the permanent capital you know vehicles, you know the growth of those businesses is our direct function of investment activity and while it's been sporadic, there are a handful of things that we think are promising. So, we'll -- have to see how plays out for the second half of the year.

So overall, a good solid start in the first half of the year and hopefully sets up well for the second half of 2016. Thanks.

Randy Nardone

Hey, Rob, if we could go to Q&A.

Question-and-Answer Session

Operator

Certainly. [Operator Instructions]

Your first question comes from the company of Credit Suisse. Your line is open.

Craig Siegenthaler

Thanks. It's Craig Siegenthaler here. Good morning, guys.

Randy Nardone

Good morning, Craig.

Craig Siegenthaler

I am just looking at the inception to-date net IRRs across the credit opportunities find 123. I noticed the consecutive declines and then kind of cross out with what [Indiscernible] said on their call yesterday. It's become increasingly difficult to generate high returns in a current very low rate environment. So I just wanted to get your perspective on the ability to generate returns that we've been accustomed to over the last 20 years on your next set of investments. And I think this is probably more of a peak question…

Pete Briger

Well, I would agree with what [Indiscernible] said for most part in that the investment environment today is uninteresting and so clearly when we say uninteresting that means that the return possibilities in the market unless we're able to do something exceptionally idiosyncratic are not that good.

So, we have to take what the market gives us were just not invest and I think for most part our decision is not to invest lion share opportunities that come our way because the investment return possibilities from a risk adjusted perspective are not that interesting. So, yes, I want to make this emphatically clear the types of returns that we saw in our FCO funds historically don't exist in the market today, is that clear.

Craig Siegenthaler

Yes, clear. And then just a follow up for Wes? Wes, can we get an update on all boarded the [Indiscernible] railroad business?

Wesley Edens

Sure. The -- it was done in earlier this week and we were very much also since for the first phase of the railroad delivery, expected to be in June of next year, so T minus ten and a half months in counting and everything looks very much on plan.

There is a tremendous amount of real estate activity that the company has added over -- it's about 1.5 square feet of real estate roadside development that is revisit the site down in South Florida, it looks like a big job site and that’s exactly what it looks.

So, very, very optimistic about what the prospects for that business are. And soon enough we'll have trains running in Florida on Pacific side first time in quite some time, so that’s great.

Craig Siegenthaler

Thanks for taking my questions.

Operator

Your next question comes from the line of Oppenheimer. Your line is open.

Unidentified Analyst

Yeah, good morning. I wonder Wes; I see on page nine, Fortress Equity Partners is at 6.7x invested capital what drove that?

Wes Edens

What’s driven by handful things, but there is primarily one investment that had a big diversion jump in the quarter. We got four investments that are all Greenfield investments companies, we have started basically from scratch in that fund and steer them within healthcare business to run the energy business and one of the energy investments in particular had a big diversion bonds.

Unidentified Analyst

And I mean, I'm looking at your March 10-Q and I saw it had AUM of 156 million, is that a fund that you can expand and have other outside investors drop down next to that?

Wes Edens

Yeah, right that is the business That’s the business plan for that we’ve been pretty clear on all along is to we see the fund and we have got an handful investments that are still in early stage.

Obviously, there is been some very, very substantial promise to them given a performance and then the goal is actually turn that into our larger multidimensional fund. And so we're very much on path with that as the plan. We continue to get that performance that we're shooting for.

Unidentified Analyst

Okay, all right. Thank you.

Operator

[Operator Instructions]

Your next question comes from the line of JMP Securities. Your line is open.

Brian McKenna

Hey guys, this is Brian McKenna for Devin. First on fund side, there is big financial incentive to see that funds cross into incentive eligibility. But with a drop in OneMain it seems quite a bit away. I guess the question is how patient will you be for the market to assign a value that you believe exist before you maybe think about plan B?

Randy Nardone

Yeah. We can’t really comment about the specifics of the company the report earnings next week and we are very, very happy with kind of how the whole process is going between OneMain and Springleaf. So, but the specifics of that investment, you really need to listen to the call and talk to the management there.

With respect to fund itself, all the legacy funds are in a mode of looking for liquidation at some point. And there's not an urgency to do so, and obviously we had a big run up in the last couple of months as we recovered some value there and we think that there is a lot of potential in that company going forward. It’s the biggest standalone consumer finance.

Balance sheet in Americans had great performance, has great managements, who are very, very excited about that, but there's investments in that fund as well. And so, you're right moving back up to where it was before the big financial win for us, but at the end of the day, weakly control the product markets. And so we're just very focused on the fundamental performance of the company which is really, really strong.

Brian McKenna

Okay. Got it. Thanks. And then next as we think about the growth potential of the firm longer term, are there any products that you are not in right now that are incredibly complementary or other initiatives that are far enough along that you can give some color on.

I know you've been thinking about adding some additional permanent capital strategies. Thanks.

Randy Nardone

We're always looking at new strategies and the firm is big and is diverse. I think the earnings you see out of the credit business, and PE business in the first half is reflects strength of that franchise.

The growth of the investment vehicles for us tends to follow the availability of great investments. And this is given very low interest rates and low volatility is a tough time to fund. You get really excited about the investment business, but as we all know, that can change very quickly.

Brian McKenna

Okay. Got it. That's it from me. Thanks for taking my questions.

Operator

[Operator Instructions]

There are no further questions that time. I will turn the call back to Randy for closing -- I apologize. We do have a follow-up from Credit Suisse. Your line is again open.

Craig Siegenthaler

Thanks. So, just one more question on the balance sheet. With the $2.40 of value, what are the next potential catalyst realization triggers that could unlock more excess capital getting returned to unitholders?

Randy Nardone

Well, I want to take. It's Randy. We have a page in our supplement that shows the vintage of some of the investment credit balance sheet and basically our job is to optimize the result. It's -- take them to account both proceeds and timing. We're working on a couple of things that we hope will turn into monetizations in the near-term. But can't focus, or comment specifically on realization timing.

Craig Siegenthaler

Got it. Thanks for taking all my questions.

Randy Nardone

Thanks Craig.

Operator

And now we have no further questions. Mr. Randy if you could continue to closing--

Randy Nardone

Terrific. Well, thanks everybody for your questions. We had strong second quarter and a solid first half of the year. Significantly levels of activity across our businesses. We feel really good about our ability to capitalize on emerging opportunities in a volatile market and uncertain market. That's what we do.

We move forward with potential embedded value pointing to potential for meaningful earnings outside. We believe we're well-positioned to continue to deliver meaningful value to shareholders and we're optimistic about our prospects of the full year. Thanks again for dialing in.

Operator

Ladies and gentlemen, thank you for your participation. This concludes today's conference and you may now disconnect.

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