Fortress puts its spin on private-public conversion

When Fortress Investment Group LLC takes its private equity infrastructure fund public — expected as early as year's end, the alternative investment firm will provide limited partners instant liquidity.

Fortress also will be one of a number of alternative investment firms with a greater ability to expand their investor bases. The permanent capital provided through public investment vehicles is prized by alternatives managers because it takes general partners out of the expensive business of raising funds while also raising assets that help the firm's stock price.

Permanent capital also upsets the current balance of power, tipping it more in favor of general partners.

Fortress has put its own spin on the private-to-public trend.

A number of firms — Fortress among them — have converted private real estate investment trusts into public REITs, spun portfolios on their balance sheets into public vehicles and launched a variety of other publicly traded offerings. Other private equity funds have converted privately held private equity portfolios into publicly traded business development companies.

In this latest approach, Fortress plans to convert a private equity infrastructure fund into a publicly traded vehicle with the prior approval of the fund's limited partners, Fortress executives said.

Earlier this month, Fortress closed on an additional $600 million in commitments for its infrastructure fund, the now $995 million Fortress Worldwide Transportation and Infrastructure Investors. The fund originally had closed on $395 million last year, but was reopened this year, said Joe Adams, a New York-based managing director and chief investment officer of the infrastructure fund.

“We had more attractive investment opportunities than we had capital, leading us to do an additional private fundraise,” Mr. Adams said.

The investors in the second round of fundraising weren't investing in a blind pool because they were able to see the investments Fortress already had made. The fund had focused on middle-market value-added infrastructure, including the Montreal, Maine & Atlantic Railroad, a 480-mile railroad between Montreal and the east coast of Maine, according to Fortress' presentation to the Washington State Investment Board, Olympia.

These existing projects had provided an 18.5% gross internal rate of return, 12% net return as of Dec. 31 and a current dividend of 8%, Fortress' presentation materials show. Fortress was targeting 20% gross returns.

Officials knew the infrastructure fund could be taken public before they made the investment, said Kate Sandboe, corporate governance officer at the Washington State Investment Board, which oversees $100.6 billion in assets.

Indeed, the Fortress materials presented to the Washington board briefly mention a potential to convert to an “evergreen structure through public listing,” which would permit long-term ownership of infrastructure projects plus liquidity for investors, the materials said.

Executives at Fortress, which is a public company, told investors during a quarterly earnings earlier this year that it planned to take the fund public. Mr. Adams declined to speak about those plans.

“It has been done before. It's not the most common path that people choose,” Mr. Adams said.

While Mr. Adams declined to go into detail, he said in general the benefit for the fund is that it can hold infrastructure projects for an indefinite period of time but investors can liquidate their investment at any time. But there can be a downside for managers that take private funds public.

“Using other peoples' money for (private equity) funds can create multiple fee and carry interest (income) streams for managers,” said David Fann, president and CEO of San Diego-based private equity consulting firm TorreyCove Capital Partners LLC.

Mr. Fann was speaking generally, and declined to comment on the Fortress plan.

Arguably, carried interest, management fees and other fees that come with a private equity fund can be more lucrative than having one permanent capital vehicle, he said.

Addressing the balance of power issue, Mr. Fann said the need for limited partners disappears for private equity firms that raise permanent capital to make investments.

The hold times for portfolio companies in a public vehicle will be extended and measured based on return on investment or return on asset targets rather than be dictated by a fund life or the need to generate exits for fundraising purposes, Mr. Fann said.

Other industry insiders remain unimpressed by the liquidity features of the publicly traded vehicles.

“New structures are allowing timely mark-to-market (of portfolio companies), but I don't see that changing the (private equity) investment characteristics,” said Jacques Chappuis, chairman of AlpInvest Partners, the private equity fund-of-funds business of The Carlyle Group, speaking at PensionBridge's private equity conference in July. “Private equity being liquid, we have that already; it's called public equity.”

But Fortress executives have not been shy about their desire to increase their stockpile of permanent capital. “We think both the stability of (public vehicles) and the nature of the capital, i.e. its permanence, is one that should get a much higher multiple (for Fortress) and we think given visibility of that is something that we're going to be very focused on,” said Wesley R. Edens, Fortress co-founder, principal and co-chairman of the board of directors during the firm's July 31 quarterly conference call.

The public vehicles, including the infrastructure fund “can be much larger,” he said. “And I've said before that our aspirations for the permanent capital vehicles are to go from $5 billion to $10 billion to $20 billion ... But I think that the markets that they traffic in are very large.”

Other industry executives say the move toward publicly traded vehicles is part of the maturation of the asset class and investors' desire for liquidity.

“The asset class is maturing,” said Neil Campbell, global head of alternative investments of Tullett Prebon Alternative Investments, who is based in London. “It's a very cumbersome asset class.”

In any other asset class, investors buy and sell investments all the time. “In private equity, investors buy and keep and hope for the best,” Mr. Campbell said.

Eventually, Mr. Campbell said he foresees a time when investors will be buying and selling derivatives based on limited partnership interests in private equity funds as investors already do with hedge funds.

“If I put money down in a private equity fund, I'm stuck for 10 to 12 years,” he said. “If I could just buy the performance, why wouldn't I do that?” n