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Apollo Global: Compelling Sum-Of-Parts Value (NYSE:APO)

I’ve posted some bullish writeups on KKR (NYSE:KKR) (here and here) and Blackstone (BX) (here) in recent weeks, but Apollo Global Management (APO) might be my favorite long idea in the alternatives space. Negative news flow around key man Leon Black remains an overhang on the stock, but at current levels, I believe the valuation case is compelling. Specifically, at the current $43 stock price, Mr. Market appears to be assigning zero value to APO’s future and unrealized performance fee income value (assuming a conservative ~17x multiple on fwd after-tax fee-related earnings (FRE) and ~$1.2bn of net balance sheet value). With an ~5-6% dividend yield to boot, this leaves investors willing to take on some governance risk with many ways to win with APO.

Data by YCharts

FRE Strength vs. P-Fee Weakness

Apollo is a mixed bag, as the reported distributable earnings/share miss in 3Q showed. But despite the lower realized performance fees and net interest income this time around, I would highlight the stronger FRE result as a key positive. The $0.63/share in pre-tax FRE was a record, as higher transaction/advisory fees offset soft management fees, while the net of taxes, FRE margins were up a very strong ~3 percentage points YoY.

Source: Company Filings

That said, net realized performance fees were the key negative, once again down to zero on gross realizations of $17m, as APO continued to see no realized carry from Fund VIII monetizations due to the $1bn impairment/reserve taken in 2Q20. And with net clawback payable still elevated at ~$0.48/share (implying several legacy funds remain in clawback), the 3Q result was disappointing (for context, the QoQ change in net clawback payable can be seen in the chart below). Expect more of the same in 4Q20 and early 2021 – while Fund VIII is back in full carry, earlier vintages (e.g., Fund VII) continue to be in clawback. Context from the 3Q call below:

Carry or clawback is calculated, and it’s one or the other at the fund level. And so a fund that’s in carry does not have any clawback associated with it. So Fund VIII is clearly in carry, it has $0.76 of net carry on the balance sheet. The clawback is related to legacy funds. More than half the clawback is Fund VII. And then the rest of it is a variety of other funds.” – 3Q20 Transcript

Source: Investor Presentation

AUM Steady; Marks Positive

As of 3Q, AUM stood at ~$433bn (+4.7% QoQ) with fee-paying AUM at ~$34bn (+1.9% QoQ) on gross inflows of +$13bn for the quarter. This was led by ~$7bn into Credit, $4.1bn into Real Assets, and $1.7bn into PE. Key highlights from the quarter’s fundraising activity included the first close of Hybrid Value’s second vintage and initial closes for the second Infrastructure fund and Asia RE II, with Insurance driving much of the Credit inflows.

Source: Investor Presentation

While LTM performance continues to lag across the portfolio, marks were broadly positive in 3Q, with PE up ~8%, Corporate/Structured Credit up ~3.5%/~4.1%, Direct Origination up ~3.7%, and Real Assets up ~3.4%. That’s a good sign for fundraising ahead, with the next vintage PE fund likely in 2H21, in my view, assuming investigations into Leon Black’s prior business relations are cleared. Long term, I see continued steady fundraising ahead, particularly in credit and real assets amid rising institutional demand for yield.

Durable FRE Generation Backed by a Long-Dated Capital Base

To be clear, the risk of a fundraising slowdown is valid given the ongoing investigation, but I see limited risk of redemption. For one, private market investments tend to be contractual in nature – for instance, only ~3% of APO’s AUM can be redeemed within 24 months, and thus, client funds are sticky. Secondly, APO has ~60% of its AUM/~73% of fee-paying AUM in permanent capital vehicles (e.g., Athene and Athora), where fees are earned on gross invested assets. Given the long-dated nature of its capital base, I view APO as having one of the most resilient FRE streams in the space.

Source: Investor Presentation

For now, the updated guidance for FY21 management fee-related growth (part of FRE) stands in the ~7-9% range. Note that this incorporates a pause in third-party fundraising (a very conservative assumption on management’s part), with the rest of the YoY increase attributable to embedded growth, the redeployment of assets for insurance clients, as well as the deployment of dry powder.

Even in what we believe to be the very unlikely event of no third-party fundraising through 2021 but as a way to bookend the potential impact, the combined effects of annualization of our robust growth in 2020, expected ongoing organic growth and redeployment of assets for our insurance clients at current fee rates and ongoing deployment of dry powder across the platform will result in revenue growth in the range of 7% to 9% in 2021, assuming redemptions in transaction fees at levels consistent with 2020.” – 3Q20 Transcript

As I see room for a next vintage PE fundraise in 2H21 or so, with insurance M&A also likely, I feel comfortable underwriting >10% FRE growth for FY21. And there’s ample room for upside to FRE as well should APO execute on strategic insurance-related transactions (as it has done consistently in recent years).

Source: Company Filings, Author’s Est

Deep Bench Mitigates the Key Man Risk

Management deserves a lot of credit for tackling the governance overhang directly on the 3Q call, which should go a long way toward addressing concerns around AUM risk. Chairman/CEO Leon Black was on the call and made clear that his personal relationship with Jeff Epstein did not spill over to APO.

First and most important, Apollo never did any business with Epstein. Neither Epstein nor any company controlled by him ever invested in any funds managed by Apollo.” – 3Q20 Transcript

I take no view on the outcome of the investigation, but I would note that there’s plenty of mitigation here. Firstly, APO’s key man clause means it would take the departure of two of the three founders to potentially cease/prevent dry power deployment/redemption. And secondly, as seen with co-founder Marc Rowan’s “semi-sabbatical,” APO has a deep bench equipped to take over in the absence of a founder. Expect 4Q20/1Q21 fundraising activity to be muted as investors await clarity on the investigation results before allocating capital to APO funds.

Source: Investor Presentation (November Deck)

A Free Option on Performance Fee Income

APO doesn’t offer the same quality Blackrock (BLK) and Blackstone do, but the price is far more compelling, in my view. Assuming a ~17x multiple on after-tax fwd FRE (implying ~$41.3/share in value from fees) and ~$1.2bn of balance sheet value (~$2.60/share), this implies the market is assigning no value whatsoever to performance fee contribution (unrealized carry receivable and future carry). At a more realistic ~20x after-tax FRE multiple, this implies investors are getting the FRE stream at a discount as well, with the balance sheet value bundled in for free. Investors willing to sit and wait get a growing ~5-6% dividend yield to boot.

FRE Multiple @ 20x

FRE Multiple @ 17x

Stock Price

43.86

43.86

(-) After-tax FRE/Share (FY22)

48.10

41.30

(-) Balance Sheet Value (Net Cash, Debt, Preferred, Principal Investments)

2.56

2.56

= Implied Performance Fee Income Value

-6.80

0

Source: Company Filings, Author’s Est

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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