Turnaround Time Or Split-Up Time At Apollo Investment

| About: Apollo Investment (AINV)

Summary

The fund distributes $.20 per share each quarter.

The losses in the energy investments are probably over and the energy sector will recover sooner or later.

Failed companies are not only reorganized, they often have new management which increases their post bankruptcy prospects.

The management company has replaced some key personnel in an effort to turn things around.

The fund could split into smaller more focused pieces to enhance turnaround prospects.

Apollo Investment (NASDAQ:AINV) is out of favor. There is a considerable discount to book value that will bring out the grumbling in even the most loyal shareholder group.

Click to enlarge

Source: Apollo Investments Fourth Quarter, May 19, 2016, Earnings Presentation Slides

What appears to concern investors the most (Adobe Reader May 19 download) is the constant negative and unrelenting stream of unrealized losses shown above. Such losses, if they continue unabated will endanger the revenue stream and eventually the rather generous distribution. That idea was reinforced when the company reported for the quarter ending in March, 2016, that income barely covered that quarterly distribution. After all, how good is a dividend if the stock price drop (and net asset value decrease) wipe out the dividend benefits?

Click to enlarge Click to enlarge

Source: Apollo Investments Fourth Quarter, May 19, 2016, Earnings Presentation Slides

When the portfolio is mostly debt (May 19, Adobe download), significant capital gains are hard to come by. So evidently the market is paying some extra attention to the continuing stream of losses. It probably does not help that there are a significant number of oil and gas companies on non-accrual status. Most investors will think that those holdings are on their way to a conversion to common (or maybe preferred) equity holdings, although there is a liquidating or buyout possibility.

So the market thinks that the part of the portfolio that is allocated to equity investments, will have an out-sized amount of oil and gas companies. Mr. Market does not favor oil and gas companies, and therefore probably does not assign much of an opportunity to recover those unrealized losses. But the oil and gas industry has been cyclical for a long time. So chances are very good that there will be another complete cycle for the industry in the future which will provide the time for plenty of capital gains for decently run companies. Oil and gas prices are significantly off their lows and there is a good possibility, that the price caused industry carnage is behind us. So a little patience would not hurt. Apollo has the financing to help these companies and has been working with oil and gas companies for a long time. So there is a very good chance that investors will recover their losses in the future.

For example, one of the companies reorganized was Miller Energy Resources (NYSE:MILL). That company now has potentially $35 million in loans. That was far from the situation I wrote about before the company filed for bankruptcy. This company had far more than $100 million in debt and a lot of preferred stock that had dividend in arrears prior to the filing. All of the equity was wiped out in bankruptcy. The loans of Apollo and another were converted to equity. The financial leverage was sharply reduced in bankruptcy. While there may be some shareholder suits to clean up, the company now has a far easier debt load (and no preferred) to deal with. More importantly, key employees started to be replaced before the bankruptcy filing, and that process probably has continued to the extent deemed necessary. The personnel leading Miller Energy now will be far more experienced personnel, than the people that pursued the highly risky strategy of financial leverage. So there really is a good possibility that Miller Energy will not repeat the past. As a result the present Miller Energy Resources could become a far more valuable company in the future.

Those other distressed energy companies will also receive similar review and treatments as needed. Apollo Investments is working hard to get the investments back that were lost when the loans soured. Plus management wants something for the time value of the money tied up like this. While there is no guarantee of success, a lot of effort is being made by management to fix the investments that are not paying and the company is in danger of failing. The market gets very scared about total losses that rarely happen in this business.

Recently, oil and gas prices have rallied, which will give this part of the portfolio some breathing room. That price rally may lead to some positive re-evaluation of these distressed companies or even the ability to liquidate some holdings. After all the markdowns, oil and gas now occupies a much smaller part of the portfolio, so it will be far harder for that oil and gas segment to damage earnings in the future, the way it has in the past. The re-organized companies will be far more efficient competitors with better survival chances and profitability hopes. But right now, as is typical for industry bottoms, the market could care less.

The company has appointed some new senior managers to help with the fund turnaround. The company has repurchased stock at a book value discount and has reduced management fees for a year. Some of the steps that management has taken should make a difference in future returns. Management definitely appears to "get it" that shareholders are not happy with the latest quarterly performance of the fund for some time now.

There are two ways that the discount to book value could close. First is that quarterly results begin to improve. There is a good chance of that as world economies continue to grow and the demand for oil and gas improves. Plus the large write-offs of the last few years are very unlikely to continue.

Second the fund could split up into several smaller funds. Smaller, more focused funds often out-perform their larger brethren and are usually easier for investors to understand. So if the fund cannot improve its performance, then maybe it is time for the fund to split up and see if the pieces do better than the fund itself.

In any event, the future of the fund is brighter than the immediate past. Downward trends rarely continue as long as the market anticipates, so now may be the time for an investor to take a contrarian position in the fund. The exposure to the oil and gas industry has been greatly reduced and the fund is very diversified. The stock closed at $5.51 per share on July 8, 2016. That is an extremely large discount from the $7.28 per share book value shown at the end of the first quarter. The current stock price assigns no value to the whole equity part of the portfolio, so the shares can be purchased for the solid debt business and the rest of the company (where the capital gains are) basically comes for free. There are worse deals out there than this one.

Plus there is a $.20 per share distribution each quarter, that is unlikely to be cut. While it was barely covered during the last earnings report, one quarter does not put the distribution in danger. Should the dividend be cut, the current yield has a sizeable safety factor already built into the stock price. Plus with economic activity increasing as the economy grows, the weaker members of the portfolio will be far more easily liquidated at a profit or at least break-even. Investors do need to monitor the company's debt costs and compare that to the interest income, but right now that margin does not appear in any danger.

Disclaimer: I am not an investment analyst and this article is not a recommendation to buy or sell specific securities. Investors are urged to consult the company filings and read all press releases as well as conduct their own investigation to determine if these securities fit their investment profile.

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.