Hedge Fund Manager Och-Ziff Capital declines after IPO

By HedgeWorld Staff | Wednesday, November 14, 2007

NEW YORK (HedgeWorld.com)—The downward pressure on publicly listed hedge fund stocks did not discourage Och-Ziff Capital Management Group LLC from going public on Wednesday [Nov. 13], but the market did not embrace the initial public offering. Och-Ziff listed its shares on the New York Stock Exchange under the ticker symbol "OZM."

Priced at $32 per share on Tuesday [Nov 12], the 36 million newly issued shares sank 6.25% on their first day of trading to close at $30.65, as the market's appetite for alternative investment firms' stocks continues to sour. While New York-based Och-Ziff is a brand name in the alternative investment sector, the firm failed to convince stock market investors.

"It's another debacle," said Scott Sweet, senior managing partner at IPO Boutique, a Lutz, Fla.-based advisory firm, in an interview.

Och-Ziff Capital Management Group LLC was founded in 1994 by Goldman Sachs alumnus Dan Och and the Ziff family. During those 17 years, the firm's assets grew quickly, reaching $30 billion today.

But according to Francis Gaskins, IPO analyst at advisory firm IPODesktop.com, that growth is already slowing. "It will be hard for them to continue to build assets as they are clearly underperforming," said Mr. Gaskins in an interview. Indeed, Och-Ziff underperformed the Standard & Poor's 500 Index for the past one-, three- and five-year periods. "Investors in the Och-Ziff funds would have been better off buying the S&P 500 Index," said Mr. Gaskins.

To be fair, that is based on a five-year trend and on absolute terms. Since inception, Och-Ziff has outperformed the S&P index, noted Sam Snyder, a senior research analyst at Greenwich, Conn.-based advisory firm Renaissance Capital LLC. "They gave a consistently positive risk-adjusted return, with a third of the volatility of the S&P," he said.

In mid-morning trading Wednesday, after only a few hours in a flat market, Och-Ziff's stock was already down 4%, at $30.75 per share. Throughout the day, the stock price kept falling.

The pricing established Tuesday night was above the midpoint of the $30- to $33-per share price range established by Och-Ziff's prospectus.

"A pricing at $32 per share is nuts. This deal was really not in good shape," said Mr. Sweet. Whether the deal was mispriced by the Street or whether investors' appetite faded away is unclear.

Och-Ziff's is the third significant U.S. hedge fund IPO so far this year. But hedge fund IPO fever that prevailed earlier now seems to be breaking. It is not that the IPO market has slowed down; quite the contrary, said Mr. Snyder. "Up until two weeks ago, we've seen the highest IPO volume in the past seven years," he said.

But alternative investment firms as public entities do not seem to be all that attractive to public investors, said Mr. Gaskins.

There are several reasons for that, one being the poor performance of other hedge fund IPO stocks this year.

In February, Fortress Investment Group LLC listed on the New York Stock Exchange at a $31-per-share initial price. Today, Fortress shares have lost 45% of their initial value. The second large IPO was The Blackstone Group LP in June, which also started at $31 per share Previous HedgeWorld Story. At $22.34, the stock is now down 28%.

When Och-Ziff first filed for its IPO in July, the firm had planned to raise $2 billion through the share offering Previous HedgeWorld Story. Then, the credit crunch pushed Och-Ziff to reconsider the size of its original offering, and last month it cut the offering in half to 1.15 billion shares.

While hedge funds remain popular and continue to attract billions of dollars from institutional investors into their private pools of investment, this enthusiasm is not shared by stock market investors. Some may have been disenchanted by the way those stocks traded in recent months, reflecting in some case speculative bets more than fundamental value.

"There is still a lingering hangover with the poor performance that Blackstone has exhibited that surely will spill over to possible buyers," said Mr. Sweet. He added that with Blackstone, "hedge funds got out at $36, leaving the rest of the market holding the bag." He was referring to a $17 million trade that took place within the first couple of days of Blackstone's listing.

"The first trade on Blackstone was one of the biggest blocks in IPO history. It had to come from major institutional investors or hedge funds that flipped the stock, getting out at a profit and calling it a day," he said.

That does not appear to have happened with Och-Ziff, what with the 6.25% share price decline today. But some IPO experts don't see the Och-Ziff listing as "another debacle," as Mr. Sweet put it.

For Mr. Snyder, Och-Ziff is the most profitable among the alternative investment managers that went public this year. He added that Och-Ziff has less private equity exposure than Blackstone or Fortress. "It's a plus because private equity has been slammed this year with deals getting delayed."

Another attractive feature of Och-Ziff, Mr. Snyder said, is that the firm has no exposure to the credit market. He said that a year ago, paid attention to tight credit spreads and the covenant-lite loans, thus reducing its credit exposure to nearly zero.

But apparently the market did not notice. Prior to going public, Och-Ziff was able to secure a large share of sales to a foreign investor, mimicking the transaction in which Blackstone sold a 10% equity stake to the Chinese government. In Och-Ziff's case, the buyer was Dubai International Capital LLC, a subsidiary of Dubai Holding LLC, majority-owned by members of the ruling family of Dubai.

"They are trying to make a big thing out of the Dubai stake—but it is window dressing," said Mr. Sweet. "It looks good on paper. But in this environment, it does not prove anything really. Just because someone in Dubai believes in it, doesn't mean the rest of the market will. Look at China with Blackstone."

This week, both Blackstone and Fortress reported disappointing earnings. On Monday, Blackstone announced a net loss of $113.2 million for the third quarter, missing its earnings target Previous HedgeWorld Story. On Tuesday Fortress also reported a third-quarter loss.

Because Blackstone's and Fortress' stock are doing so poorly, some questioned the validity of pricing Och-Ziff on the higher end of its announced price. "If Blackstone was now trading near its offering price, I could understand pricing Och-Ziff at $32. But it doesn't make sense with Blackstone nine points down from its offering price," said Mr. Sweet. He added that Blackstone missing its earnings target two days ago "sealed Och-Ziff's fate."

He said, "Goldman through channels says [the Och-Ziff IPO] is oversubscribed. But these economic times do not favor this kind of alternative investment vehicle."

The market may also have grown tired of bad publicity. In both the Blackstone and Och-Ziff deals, the IPOs amount to big paydays for their owners. Stephen Schwartzman, chairman and chief executive of Blackstone, made $1 billion from his firm's IPO proceeds. In the July filing, Och-Ziff disclosed that its owners had borrowed $750 million for themselves through a loan.

While all of the IPO proceeds pocketed by the partners will be reinvested into the Och-Ziff funds, to some observers the IPO remains a money-making scheme. "Putting the money back into the fund is the first step of taking it home," said Mr. Gaskins.

With this in mind, one may wonder whether other hedge fund managers planning IPOs will follow through with their plans, or if the bad performance of the existing stocks will deter them.

In July, Kohlberg Kravis Roberts & Co. filed for a $1.25 billion IPO Previous Reuters Story. The company kept quiet during the summer. As of Monday, KKR seemed to be on track to pursue its IPO plans, as indicated by an amendment to its prospectus filed on that day with the Securities and Exchange Commission.

Hedge fund AQR Capital Management was rumored to be planning an IPO this summer. Lately, press reports speculated that the Greenwich, Conn.-based firm would postpone its plans due to performance problems. The firm denied that it was suffering from bad performance and declined to comment on its IPO plans Previous Reuters Story.

But this was before today.

"If you look at the KKR, the Carlyle, the Texas Pacific, AQR, all of the alternative investment firms rumored to go public, I seriously doubt that it will happen any time in 2008," said Mr. Sweet.

For Mr. Gaskins, Och-Ziff put a high tag price on its shares just because it could. "They have a lot of clout on Wall Street from all those brokers for whom they generate commissions," he said. "They priced as high as they could, but they have damaged the environment for the KKRs."

A spokesman for Och-Ziff declined to comment, saying that the firm was still in the quiet period.

Goldman, Sachs & Co. and Lehman Brothers were the lead underwriters for the offering while Merrill Lynch & Co., Morgan Stanley, Citi, Deutsche Bank Securities and JPMorgan served as book-runners