All eyes on hedge funds as Fortress IPO sets the pace

One senior private-equity executive recalls the bemusement expressed by many Goldman Sachs bankers in March 2002 as they watched Peter Briger leave the blue-chip Wall Street group to join a four-year-old hedge fund and private-equity firm.

"Everyone was laughing at him," says the New York financier, making clear the mockery of Briger was directed not at his decision to depart Goldman but at his choice of destination. At Fortress Investment Group, Briger would have to share control - and profits - with Wes Edens and other executives who founded the business in 1998.

By contrast, if he had been a little more audacious, Mr Briger might have used his 15-year career at Goldman to start his own hedge fund.

Now those who were laughing are paying rapt attention. Fortress, a successful and respected private group managing about $30 billion (€23 billion) in investments, was little known outside Wall Street although well connected - it had John Edwards as an adviser until the former senator renewed his candidacy for the Democratic presidential nomination. But today, Fortress goes public with an expected valuation of some $7.5 billion in the New York Stock Exchange's first flotation of a hedge fund.

Mr Briger's former sceptics will be looking on as his ownership stake in the group translates into about $1 billion of value. That kind of payday could spark a rush to the public markets by executives at the growing number of privately held hedge fund and private-equity firms.

Fortress is hoping to sell about a 9 per cent stake in its initial public offering. Investors would not be buying Fortress funds directly but would benefit from profits the group generates from managing the funds. Its 13 private-equity funds have returned 39 per cent annually since their inception in 1999, while the group's hedge funds have made about 14 per cent a year, according to Fortress.

But performance fees are volatile and the asking price of between $16.50 and $18.50 for the shares on offer represents 18 to 20 times the group's expected 2007 profits - about twice the valuation of Goldman Sachs, the investment bank. That figure stuns some executives at public securities houses. One banker not working on the Fortress deal called the proposed valuation "very rich, to say the least".

Still, the heavy demand expected for Fortress shares has captured the attention of the US hedge fund and private-equity elite. The day Fortress filed its IPO papers with the Securities and Exchange Commission in November, an armada of couriers sped copies of the 320-page document to offices all over Manhattan and suburban Connecticut, home to many of the biggest hedge funds.

Lawyers and investment bankers began examining every detail of the filing so they could pitch to their own hedge fund and private-equity clients on following Fortress's lead. Many are currently seen travelling around town to meetings toting heavily annotated copies of the Fortress paperwork. The consensus is that if the Fortress IPO succeeds, the race to the public market will be on among some of the biggest hedge fund and buy-out groups.

Should private-equity groups go public they will still be able to manage their businesses in much the same way they do now. However, their holdings could be subject to greater public scrutiny than they are now, possibly impacting their ability to transform radically companies the way they do now.

The stated reasons for the expected wave of IPOs will be similar to those for Fortress, including the desire to create an institution that will not disappear when the founders retire. Stock offerings can also give hedge funds and private-equity funds a big infusion of capital, easing the burden on managers to go out and raise money for their funds from investors. A public traded stock would also give the investment groups a currency to use to make acquisitions and a compensation tool to attract and retain talent.

Two other, perhaps bigger, reasons lurk beneath the surface, however, and both have to do with timing. First, demand for investments beyond basic stocks and bonds remains hot and the flow of money pouring into capital markets around the world shows little sign of ebbing. But these conditions could change in an instant, making investors much less interested in buying shares in groups that manage private-equity and hedge funds.

Nevertheless, if the Fortress deal succeeds, the question on Wall Street will not be whether private-equity and hedge fund groups will go public, but which ones will be the first to move.

Yet all this planning will be in vain if Fortress shares tumble in their public market debut. At that point, private-equity executives will likely be scrambling to find a "plan B" for cashing in. The most likely outcome at the point may be a revival of plans to sell stakes directly to limited partners, as Carlyle did when it sold a 5.5 per cent ownership interest to Calpers, California's public pension fund. Hedge funds would also will seek partners to take stakes, such as JPMorgan did with Highbridge Capital.

But if Fortress shares perform well, the chances are it would not be long until the most private sector in finance is thrown open to the public.