Institutional Investor's Alpha Magazine - May 2008 - (Page 32)

“The ﬁrm needs to have greater ﬂexibility to manage long-term succession issues, and we fully recognized that.” that their business would fail without them. One sign: He began parceling out equity in the ﬁrm long before the IPO. By the time Och-Ziff went public, 18 full partners and 27 junior partners owned stakes (Och held 148.3 million shares, or 48.5 percent, himself). Och also made sure that with the IPO every employee received a stock grant that vests over the coming four years, to provide additional incentive to stay. He’s proud that since inception Och-Ziff has a 90-plus percent employee retention ratio among investment professionals, but he doesn’t like the idea of keeping anyone in a job they don’t enjoy. “I’ve always thought about locking people in as the wrong concept,” Och says. “The key is not to take them for granted. I don’t want someone staying here because they’re locked in — I want to make this place so attractive in every way, shape and form that they absolutely want to be here.” FOR AN UNASSUMING, intensely private executive like Och, going public has not been without costs. For the first time he must hold quar— DANNY TRUELL, CIO, terly earnings calls and proWELLCOME TRUST vide visibility into the inner workings of his business. With seven analysts on the line on April 30, Och explained the ﬁ rm’s ﬁ nancials, discussed the development of the emerging-markets investment platform and other strategies, ﬁelded probing questions about earnings — OchZiff reported a generally accepted accounting principles net loss of $268.1 million in the ﬁ rst quarter, largely because of costs associated with the IPO — and clariﬁed his plans to build his asset base. “The challenge, when you get a company like OchZiff going public, is that the model is more complicated to understand from a quarterly earnings standpoint than a traditional asset management ﬁrm, which makes it harder to value,” says Gregory Fleming, president and COO of Merrill Lynch, who has known Och for nearly a decade. “Incentive fees, coupled with management fees, make proﬁts much lumpier and less predictable, so the education of the buy side is higher — but that doesn’t mean that a company as well positioned as OchZiff can’t thrive in the public market over time.” Och’s four core funds held up well in the ﬁ rst three months of this year, which saw the total return of the S&P 500 sink 9.45 percent. The OZ Master Fund fell 0.84 percent, while the OZ Global Special Investments Master Fund lost just 0.60 percent. The Europe and Asia funds were down 1.74 percent and 2.61 percent, respectively. Although quarterly asset inﬂows were positive, totaling $263 million, total assets under management fell slightly, from $33.4 billion at the end of 2007 to $33.3 billion by March 31, largely as a result of performance-related depreciation (by May assets were back at $33.4 billion). Och-Ziff ’s share price, however, has continued to fall. CFO Frank is quick to emphasize that the firm uses a simple financial model as a means of tracking its economic income over time — management fees plus incentive fees less operating expenses. That income totaled $85.9 million in the ﬁrst quarter of 2008, a 15 percent increase over the same period a year earlier. But Wall Street is narrowly focused on the ﬁ rm’s GAAP numbers, which haven’t been good. For the ﬁ rst quarter of 2008, the ﬁ rm reported a GAAP net loss of $268.1 million, or $3.62 per class-A share. That follows a GAAP net loss of $915 million for all of 2007. Those losses are largely because of costs associated with the preparation for the IPO and other noncash expenses related to the reorganization — namely the ongoing amortization of partners’ equity interests in the ﬁ rm’s operating subsidiaries. As those shares vest, Och-Ziff projects, the adjustments will result in GAAP net losses every quarter through 2012. Och’s plans to build his global financial business rest on the potential growth in the ﬁ rm’s fee revenues — particularly its management fees, because incentive fees are perilously hard to predict. Och-Ziff charges a 20 percent incentive fee and management fees ranging from 1.5 to 2.5 percent, which, after paying for the costs associated with running the ﬁrm, were split among the partners before the IPO. Post-IPO, Och-Ziff is passing along almost all of its distributable earnings to shareholders in the form of dividends. This way the partners themselves reap the beneﬁt of the rich dividends alongside Och-Ziff ’s outside shareholders. And — as the ﬁrm grows and potentially becomes more proﬁtable — those dividends should rise, increasing the value of the stock and attracting new shareholders. Without strong investment returns the model doesn’t work. But if performance is good, assets and fees will grow and Och-Ziff will satisfy its shareholders and continue to attract high-proﬁ le fund investors seeking consistent, uncorrelated returns. At the end of 2007, the full-year dividend was a whopping $1.61 a share, earning Och $238.8 million. To keep the company’s earnings growing, Och and his team must develop new products, attract new investors and boost assets under management — all the while delivering consistently strong risk-adjusted returns. Wall Street expects nothing less: The global equity research team at Lehman Brothers projects that OchZiff ’s assets under management will grow to $41 billion this year and to $50.5 billion by the end of 2009. That won’t be easy, given the grim headlines this spring about hedge fund implosions in the U.S. and Europe. These have cooled investors’ interest in the industry, although Och-Ziff ’s reputation for strong risk management and strategic planning may help it stand apart. Still, industry 32 • INSTITUTIONAL INVESTOR’S ALPHA • MAY 2008

Table of Contents Feed for the Digital Edition of Institutional Investor's Alpha Magazine - May 2008

Institutional Investor's Alpha Magazine - May 2008 Contents Letter from the Editor Longs & Shorts Pension Corner: Send in the Clones The Good Guys: Outside the Box Cover Story: Welcome to Oz Interview: The Tipping Point Regulation: When Sentinels Go Astray Strategies: Taking Credit Research Center: The Hedge Fund 100 Book Excerpt: Shoot the Messenger Alpha Bytes: VaR Enough? Unhedged: Commentary: Not Your Father's Activist

Institutional Investor's Alpha Magazine - May 2008

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