Description

Apollo Global Management

I’ve previously written up Athene twice on VIC, having been an owner since 2014, prior to its IPO when it was the sole asset of AP Alternative Assets, an Apollo vehicle listed on the Euronext in Amsterdam. For background, I would recommend you read those write ups, along with catabrit and afgtt2008’s write ups on APO.

During my ownership period, the business performance of Athene has been extraordinary. It’s been a compounding machine, with mid-teens growth in earnings, book value and AUM, since its IPO. However, the return on my shares to date, whilst solid, has been far less inspiring. Despite a multi-year track record of successful execution in both liability gathering and credit asset investing, the market has grown increasingly skeptical of Athene’s business model, resulting in a large de-rating in its earnings multiple that has hampered my overall returns, notwithstanding the strong business growth.   

The market’s skepticism largely revolved around principal-agent concerns on the relationship between Apollo and Athene, as well as Athene’s novel investment strategy and credit portfolio (particularly how it would perform during times of market stress). Apollo management has clearly been frustrated with the situation for some time. In 2019, they increased their ownership stake in Athene, whilst getting rid of the super-majority voting structure to align their voting rights with their economic interest. These moves were clearly done to assuage investor concerns, but didn’t see any material improvement in investor sentiment.

Early last year, management took the far more dramatic step of completely merging Apollo and Athene in an all-share transaction. Management outlined the strategic rationale for the combination as follows:

1.  Alignment:  Since the beginning, the market has always taken a highly skeptical view of the Apollo/Athene relationship, believing that Apollo has always prioritized the growth of Athene’s portfolio to increase their base management fee, even if this growth was either unprofitable and/or a riskier for Athene shareholders. With the merged entity now owning the credit portfolio, there was now complete alignment between Apollo and Athene.

2.      Athene Contract risk:  Apollo had material customer concentration risk with Athene being by far its largest customer. Whilst, Apollo has always had material control over Athene, the merger would completely excise any perceived contract risk that was impacting Apollo’s FRE multiple.

3.      Corporate structure/governance clean-up: Following the merger, the joint company is moving to a full C-Corp, with one share / one vote structure. The better governance structure along with a larger combined market cap, increases index eligibility and investability.

4.  Addressing Athene undervaluation: Apollo management have spelt out numerous times they view Athene as being undervalued. Their hope is that the merger would remove some of the roadblocks to the market realizing fair value.

To be honest, as an Athene holder I had mixed feelings about the transaction. I’d been a long suffering shareholder in an asset I thought was trading at a material discount to fair value, only to see a large portion of this value transferred to Apollo shareholders.  Nevertheless,  it’s not like Apollo hadn’t taken strides to improve the valuation gap over the years and the all-share transaction would allow me to at least somewhat participate in the upside of the merged-entity, whilst potentially acting as a positive revaluation catalyst post-transaction.

However, Apollo shares barely moved on the announcement (the market clearly didn’t share my view that Apollo was getting $1 for 50c), and have not moved appreciably since the announcement on both company specific and macroeconomic concerns. I believe possible reasons for continued under-valuation are largely a result of the following factors:

1.      Asset-lite to Asset Heavy: Apollo’s incumbent shareholder base went from owning a nice asset-lite easy to analyze fee stream, to all of a sudden being saddled with a large insurance asset/liability portfolio, with all the associated complex insurance accounting (even though the actual economics of the spread business is relatively simple to understand).

2.      Concerns over credit portfolio: The merger doesn’t seem to have resolved any of the concerns the market had with Athene’s credit portfolio, whilst recent macroeconomic concerns over a potentially Fed-induced recession haven’t helped matters.

3.      FRE vs SRE income: If you take the view (which I don’t), that Apollo was over-charging in fees to manage Athene’s portfolio (ie, the fee amounts charge were in excess of any potential alpha being generated),  then Athene’s credit portfolio is generating a sub-economic return for the associated risk. Looking at the alts space, it’s clear the market applies a higher multiple to fee-related earnings vs balance-sheet intensive earnings. So if the market feels that Apollo’s FRE is being inflated relative to SRE (spread related earnings), on what now amounts to an insider non-arms length transaction post-merger, the logical conclusion may be that the reported FRE is no longer a ‘real’ number.  

Notwithstanding the above concerns, I remain very bullish on the long term prospects of Apollo Global as an investment. The transaction itself combined with some recent developments and my previously articulated constructive view on Athene address many of the above investor concerns related to the combined entity and Athene specifically.

1.      Future Athene growth to be driven by third-party AUM:  Looking at the 2026 asset growth target’s that Apollo have set, it is increasingly looking at third party vehicles to increase spread-based AUM, which should lower the balance sheet intensiveness of future Athene growth. Apollo first started this with ADIP in 2019, whereby certain third party investors would co-invest alongside Athene in new block re-insurance or PRT transactions. Based on the success of the first fund, they are looking to launch a second of between $3.5-$5bn equity. Athene is also looking to launch AAA (Apollo Aligned Alternatives) – a product to be distributed by their global wealth platform, that similar to ADIP will allow high net worth individuals to invest alongside Apollo and Athene. As Marc Rowan said on Apollo’s last conference call “ADIP has performed extraordinarily well. As I sometimes joke with some of you, those in particular who have had a more negative view of retirement services, it's such a negative business that investors compete and pay us fees to be able to invest in retirement services.”   As Athene continues to growth this business it 1) increases the proportion of higher multiple FRE earnings from the growth in Athene’s AUM and 2) demonstrates that third party investors are willing to pay similar or even higher fees than Athene, which both validates the ‘realness’ of Apollo’s reported FRE number, whilst also demonstrating that investors see the alpha generation in Apollo’s investment acumen.

2.  Signaling effect on soundness of Athene book: Whilst the market clearly disagrees, I thought Apollo's willingness to merge operations with Athene represented a hugely positive signal as to the quality of Athene’s book. Furthermore, the alignment between Apollo and Athene should also send a strong signal to future third party investors, and support the channels that Apollo is looking to build here.

3.      Validity of investment strategy/track record: Management has insisted over the years that the excess spread that Athene has historically been able to generate on its credit portfolio is the result of its willingness to take on illiquidity/structural/complexity risk, rather than going down the credit curve. This has historically been met with a great degree of market skepticism. My comfort with Athene’s strategy comes from my previous professional background in hedging illiquid credit risk on the corporate loan portfolio of an investment bank and being on the wrong side of this trade. I mentioned this in the Q+A of one of my previous write ups, but I genuinely believe that if you don’t need to worry about liquidity or mark-to-market risk (which Athene doesn’t due to its captive liabilities), and you have the entire fixed income market as your playground, it is absolutely possible for a superior credit investor like Apollo to generate the spread it historically has over an equivalent liquid IG benchmark (+30bps net of fees according to management), without taking on much additional credit risk.  I’d also note managements’ strong performance during market dislocations, should the macro environment deteriorate from here, with Athene excess capital position, and management previously successfully capitalizing on previous episodes of spread widening.

Valuation

Apollo currently trades at slightly over 10x multiple of management’s 2022 EPS forecast of $5.50, If you assume a mid-teens multiple on FRE income, this implies the current multiple the market is assigning to SRE income is between 5-6x.

Management is forecasting 2026E EPS of >$9.00, which even at the current low multiple would generate a five-year IRR of >12%. I view the current implied multiples on both FRE and SRE to be too low (particularly on SRE). If you assumed a 20x multiple and 10x multiple respectively on management’s 2026E forecasts for FRE and SRE respectively, an investment in Apollo would generate ~20% five year IRR. (For an FRE based to a large degree on permanent capital AUM that is expected to grow mid-teens, 20x strikes me as a very reasonable multiple.)

The above also doesn’t take into account Apollo’s current over-capitalized position, potential buybacks from the excess cashflow that a more capital-efficient Athene is expected to throw off and the healthy ~3% dividend yield Apollo pays. Also, Apollo’s Retirement Services update in June indicates that SRE is tracking above previously provided management forecasts.  

Catalyst

Earnings Growth