Description

Athene Holdings

Overview

·        I had previously written up Athene in September 2018 at a share price of $49. Back then, the share price traded at a P/B and forward P/E of 1.1x and 7x, respectively, which I thought was a very cheap valuation for a company that had historically compounded equity and earnings at a mid-high teens since inception and one I believed had a robust business model to continue to compound at similar rates in the future.

·        Despite continued improvement in earnings power and book value accretion, the share price floundered in a range of between $40-50, and was already quite cheap ever before the COVID sell-off that occurred in March of this year. The current share price is now almost 30% below my initial write-up and now trades at P/B and FY19 P/E of 0.7x and 5.2x, clearly reflecting concerns around credit asset impairment.

·        Notwithstanding the very real concerns around the potential stress that COVID may inflict upon the asset portfolio, the timing was somewhat fortuitous, given Athene had undertaken a series of transactions in the lead up (Athene/Apollo, creation of ACRA, preferred issuance) to accumulate significant dry powder for growth that had yet to be deployed. These transactions were also important, in terms of at least partially addressing some of the principal-agent concerns around the Apollo- Athene relationship held by investors.

·        Under most reasonable stress scenarios, the asset impairments should be manageable, given the strong credit quality of the book. Meanwhile, Athene (as it has done throughout its history) has opportunistically used the current environment to play offense: Undertaking M&A, originate deposits at juicy on-the-margin returns and re-purchase shares at attractive levels.

·        In summary, I think Athene represents the opportunity to buy a business that is fundamentally better than it was two years ago, at a much cheaper price.  The transactions that occurred since my initial write-up have both addressed concerns over Athene’s business model, whilst also giving it the balance sheet strength/dry powder to not only survive, but thrive in a COVID stressed environment, which should result in higher normalised earnings power in a Post-COVID world.

Company history and business Model recap

Athene has been written up a number of times on VIC, both as a long (sas7, me) and a short (pcm983).  I would direct you to those write-ups for a more comprehensive background on Athene, but below is a brief company history and business model description I’ve pinched from my previous write-up.

Company history - from my September 2018 write-up

Athene was founded in 2009 by Apollo Global Management to opportunistically purchase fixed annuities from motivated sellers as a result of the ZIRP and heightened regulation in the aftermath of the GFC. It grew to around $15bn of assets in less than 3 years – it acquired Liberty Life Insurance Company, Investors Insurance Corporation and Presidential Life Corporation. However, the most transformative of the transactions occurred in December 2012 when Athene announced the acquisition of Aviva USA., paying a purchase price of $1.55bn - or 57% discount to book value - to increase assets from $15bn to $60bn.

Whilst block reinsurance/M&A account for the majority of the company's early asset growth, Athene has

developed strong organic growth through its retail channels, and has a multi-channel distribution platform for sourcing assets via both organic and inorganic means.

Its organic growth mainly comprises its retail franchise, which offers primarily fixed annuities (FA) and fixed indexed annuities (FIA) through independent marketing organisations, banks and broker dealers. Athene also undertake flow reinsurance, where it targets return similar to its own products (priced for mid-teens ROE).

Inorganic growth has been done mainly via block reinsurance/M&A - the most recent deal being Athene's acquisition of Voya's $19bn fixed annuities book. Management have also identified pension risk transfers as a source of growth. This is whereby a large organisation with a pension obligation pays Athene a lump sum in order to remove the obligation and Athene invests the proceeds with the goal of making an investment spread over pension payments.

As at 30th June 2020 Athene manages ~$137bn in assets.

Business model

Athene's business model is fairly simple at heart - it simply wishes to return more on its asset portfolio (predominantly investment-grade credit) than it pays out in premiums to policyholders. Unlike traditional insurers, Athene allocates a higher proportion of assets to structured credit and alternatives in order to

derive higher yield.

The company targets mid-teen ROEs, which is achieved through generating an after-tax ROA spread of 1.2-1.3% and leveraging this 11-13x.

Fundamental improvements since initial write-up

·        Athene/Apollo transaction: In October 2019, Athene and Apollo announced a strategic transaction, whereby Apollo would acquire an incremental 18% stake in Athene for $1.55bn in cash and equity. For the cash leg, Athene would sell shares at a 10% premium to its late October 2019 trading price for $350mn. For the equity leg, Athene would sell $1.2bn shares, for a 7% interest in Apollo, the value of which at the time represented a 2.3% premium to Athene’s share price. The purpose of the transaction was to:

o   Convert Athene to a single share class, and get rid of the super voting structure

o   Bring Apollo’s economic ownership in-line with its voting power, and increase alignment between the two companies

o   Expand investor universe and allow Athene to be eligible for index inclusion (S&P 500)

Athene management believed that the super-voting structure was deterring potential investors and a key reason for Athene’s chronic under-valuation, after canvassing investor feedback. Whilst its always annoying to get diluted, the signalling effects of the transaction were powerful. Firstly, it was clear that Apollo viewed Athene shares as being undervalued and was willing to increase its economic interest, at the expense of losing its super-majority powers. Secondly, whilst the majority of Apollo’s economic interest in Athene was likely still from management fees, post this transaction that calculus would be more closely aligned, as Apollo would own 30% of Athene after the transaction, making it a significant investment.

As it turned out, the timing of the transaction, also turned out to be quite fortuitous for Athene shareholders, as the transaction closed in Q1 2020, essentially providing Athene with $1bn in excess capital, at a very favourable valuation on the eve of market turmoil (both in absolute terms, as well as charting the relative share prices of Apollo vs Athene).

·     Creation of ACRA: In May 2019, Athene announced the creation of ACRA (Athene Co-Invest Reinsurance Affiliate), a separately capitalized sidecar vehicle that allows third-party investors to co-invest with Athene in new block re-insurance or PRT transactions. Essentially Athene puts up 1/3 capital versus 2/3 by the third party investor, with the investors getting a first-look at certain new transactions that Athene may be contemplating. At least to start, the estimated size will be $4bn, which could support liability growth of $48bn. The benefits to Athene shareholders are the following:

o   Acts as dry powder to undertake large transactions, without requiring Athene to raise equity

o   Reduces capital drag for Athene shareholders, as less requirement to hold excess capital for future transactions

o   Provides fee income to Athene, as they receive a 15bps wrap fee on the liabilities supported by third party capital. On $48bn of liabilities, this represents $70mn - whilst not material at this stage, its also nothing to sneeze at. More importantly, it serves as further proof that  Apollo is a true value-add partner to Athene, and the fees paid by Athene to Apollo are more representative of an arms-length type relationship (given private investors are essentially willing to play Apollo fees + Athene wrap) 

Impact of COVID

·        Before discussing the potential impact of COVID on Athene’s credit asset portfolio, it is important to note the financial strength that Athene entered this global pandemic (primarily as a result of the above mentioned transactions). As noted by Athene’s Bill Wheeler at a GS Conference in December 2019 (the last pre-covid quarter), “So ACRA, we have $3 billion of third-party commitments. We expect to top out at $4 billion relatively soon. So if you think about the excess capital that we have, and we define excess capital as the amount above 370% NAIC RBC ratio, as of the third quarter, we had about $1.8 billion of excess equity capital. But then at 10/1, we put in the Lincoln deal and pension risk transfer deal in that freed up into ACRA. And that's funded 2/3 by ACRA, 1/3 by us. So the 2/3 that ACRA's funding freed up another like $550 million of capital. So that's $2.3 billion of excess equity capital. Then the Apollo transaction, the stock swap, the elimination of dual shares, which will close in the first quarter, after charges for the holding of Apollo stock will give us another $1 billion. So we're going to have close to $3.5 billion of excess equity capital after the Apollo transaction closes. We have more than $2.5 billion of unused debt capacity. So that gets you close to $6 billion. And then ADIP is $4 billion of third party. So we have close to $10 billion of buying power, which could fund close to $100 billion of opportunity.”

·        On March 25, 2020, Athene was one of the first financial services to pro-actively provide a detailed update to the market on the current state of the portfolio, in-light of the market disruptions around Covid. In addition to Athene highlighting their strong liquidity position, balance sheet strength and ability to play offense in a crisis, they had Apollo portfolio managers across major key verticals of the credit asset book (RMBS/CLO/CML) and also provided output from various portfolio stress tests. I highly recommend listening to the call or seeing the presentation, however the TLDR is that it is a highly-rated portfolio, with strong collateral backing and with a manageable exposure to covid-sensitive industries. Athene management continued to re-iterate what sas7 and myself have highlighted in our previous write-ups – that the additional spread Athene generates on its asset portfolio, is primarily achieved through complexity and illiquidity risk (appropriate given their long-dated liability maturity profile) and not through going down the credit curve. Their stress-tests estimate OTTI loss of between $1-2bn – the larger estimate being a ‘Lehman-type’ scenario with additional stress), and this is before accounting for the $1bn+ in annual earnings power to offset this. On their Q2 2020 earnings call, current OTTI is tracking at less than 2bps. Meanwhile, the market dislocations have offered opportunities for Athene on several fronts. On their Q1 2020 earnings presentation, Athene noted that on-the-margin net investment ROA had improved by 40bps on organic deposits, given the more favourable spreads – with A and BBB corporate bonds, offering an additional of spread 40 and 110bps respectively, versus pre-covid levels. On their Q2 2020 earnings call, Belardi noted, “we are not only built to weather the current storm, we are also built to capitalize on it. Since our inception, we have extolled the virtues of holding excess capital with a view that profitable growth is most available when capital is most scarce. Our second quarter performance is a testament to that fact. During the quarter, others in the industry without our strategic asset management advantage and significant deployable capital were forced to pull back from new business origination. Preliminary estimates from LIMRA report that industry fixed annuity volumes fell 4% quarter-over-quarter, while our retail sales increased 44% by comparison. We are incentivized by profitability at Athene, not volume. By simply executing our business strategy, which includes maintaining our pricing discipline, pivoting opportunistically across our funding channels and supplying capital to support new business, we were able to generate record quarterly organic volumes of nearly $7 billion at a 27% return, a record combination for Athene.”

·        In the second quarter of this year, Athene was also able to execute a massive re-insurance deal, purchasing $27bn in annuities from Jackson National, as parent Prudential looked to exit that business. Athene was able to utilize ACRA for the transaction (37% Athene funded / 63% third-party investors), which should pro-forma improve future net invested assets and profitability by 9%, as they redeploy the asset portfolio. This continues to demonstrate Athene’s ability to execute transactions in times of market disruption, and even pro-forma for the transaction, Athene still has $7.1bn of excess capital (+$80bn in liability purchasing power).

Valuation

·        Athene currently trades at a FY19 P/E and current P/B of 5.2x and 0.7x, respectively. As has been mentioned in previous write-ups, I believe Athene’s proven ability to compound book value and earnings at mid-high teens deserves a premium to book valuation. However, even just a move to adjusted trailing 1.0x book value from current levels, would represent a 40% appreciation from current levels.

·        Looking out a few years, when taking into account Athene’s ability to grow assets and compound earnings, it is hardly crazy to imagine a scenario where its forward-looking operating earnings would cover 35-50% of the current equity market capitalization  (assumes mid-teens asset growth to $250-300bn at 1.2% ROA). If Athene were ever garner a reasonable earnings multiple, this would imply +100% share price appreciation.

Catalyst

Continued Growth in Earnings and BVPS