Apollo Investment Corporation (AINV), one of the largest Business Development Companies (“BDCs”), is getting bigger. Yesterday the company announced its intention to issue 17.25mn shares (including the almost always exercised over-allotment by the underwriters). That’s equal to about 10% of the existing share count.
Before the news the stock was trading above $13.6 a share, which was a substantial premium to the last reported NAV of $10.3. The stock has dropped over a dollar to $12.40 on the news. We had a brief look at the prospectus to get some additional color about the proposed equity offering and to muse about the likely impact on AINV’s dividend.
Apollo admitted NAV has dropped since the end of the last quarter, due mostly to the likely Innkeepers write-down , which we reported on a few days ago. Here is what the prospectus said:
We currently estimate that our March 31, 2010 net asset value per share was between $10.00 and $10.10 per share, which represents a decrease of approximately 3 to 4% from our net asset value per share as of December 31, 2009. The estimated change in our net asset value per share from December 31, 2009 to March 31, 2010 is primarily due to the net change in unrealized appreciation/depreciation on our investment portfolio, which currently includes significant unrealized depreciation in Grand Prix Holdings LLC and RSA Holdings Corp. of Delaware (American Safety Razor).
Even at the current market price, this suggests Apollo will be selling stock at a significant premium to NAV and reflects the heady state of the BDC market at the moment.
Apollo anticipates receiving $194mn (or $223mn when the over-allotment is included) in cash from the equity proceeds. Add that to the $508mn in cash already on the balance sheet and AINV will have $731mn in cash versus debt of $948mn at year-end. That makes for a strong balance sheet and lots of capacity to rebuild an investment portfolio battered by the Great Recession. AINV has already recognized $374mn in losses through December 2010, and has $556mn in Unrealized Losses.
Some of the latter will become Realized Losses with the Innkeepers and American Safety Razor news. By the time all the chickens come home to roost Apollo may have to face Realized Losses of $600mn or more. That’s about a quarter of the company’s initial capital at March 2009. Not surprisingly, Net Investment Income Per Share has dropped from $1.60 a year annualized as of the fourth quarter of 2007 to $1.20 two years later, a 25% drop.
We mention this to explain that we don’t see all of this capital raising and unused investment capacity will ever cause earnings to return to their historic levels.
Looking forward, when we calculate pro-forma earnings down the road, we don’t foresee much of a change in Net Investment Income Per Share even a year or two from now. (We should point out that we seem to be more conservative than the analyst consensus which is for $1.33 in EPS for FY 2011). As Apollo deploys its unused cash and borrows more on the Revolver Investment Assets will surely grow, but so will management fees, incentive fees (20% of profits if the hurdle is met, which it will be), interest expense and the dividend liability with another 15mn plus shares to pay off.
As of IVQ 2009, AINV was earning $0.30 in Net Investment Income Per Share, and paying out $0.28 a quarter in dividends. Earnings may go temporarily above that level as new loans will mean higher fee income, and because the new loan market is still paying a relatively high yield (we’re assuming 12%).
However, both fees and yields will shortly be reduced by increasing competition, as the lending environment is healing fast. Moreover, higher LIBOR will hurt borrowing costs down the road, and as whatever proportion of Unrealized Depreciation turns positive, management fees will increase thereon. Once all the dust has settled we don’t see Apollo earning any more than in the IVQ of 2009 on a per share basis, or about $1.20. (The only exception to that is if the company makes any capital gains from its equity investments.
So far that’s been a bust for Apollo but the improving economic environment could help. However that will not help recurring income such as Net Investment Income Per Share).
However, we’re more bullish on AINV’s ability to defend its dividend level. The company has been earning above the dividend as discussed before, and does has substantial amounts of undistributed Net Investment Income ($115mn at December 2009) to serve as a piggy bank.
We don’t know if the company will raise its dividend (which would be bold but unwarranted), but there’s every reason to expect the current $1.12 a year is sustainable for the foreseeable future. At $12.40, that’s a 9.0% yield. Good enough?
Disclosure: Author holds a long position in AINV