“The Fortress Has Cracks”

The public fortunes of Fortress and Blackstone don’t directly correlate to the eventual performance of KKR, but this still has to make Henry & Co. a bit queasy:

Citigroup today downgraded Fortress (NYSE: FIG) from “hold” to “sell,” saying that it estimates “private equity IRRs have declined by up to 30 percentage points in legacy funds since the firm’s last public disclosure.” Citi also wrote that Fortress would have trouble raising new capital, could be on the hook for up to $200 million in clawbacks and may be compelled to cut its dividends.

Part of this dour outlook is based on Fortress’ ongoing exposure to subprime mortgages — it called the bottom way too early — but Citi really seems to be aiming at the entire private equity industry. Not only with the IRR estimate — which is far deeper than I’ve seen elsewhere — but also with the suggestion that Fortress erred in not “harvesting private equity gains at their peak.” Citi says this cost Fortress between $6 billion and $7 billion, but also assumes the assets in question were liquid or quasi-liquid.

That’s a tough assumption, particularly given how hard it was to IPO a PE-backed company even before the credit crunch. My read would be that Citi was therefore overestimating Fortress’ value in the first place.