It has been a roller coaster ride for Apollo Global Management (NYSE:APO) since I first wrote about them last February. The stock has been up and down throughout the intervening six months, but it sold off considerably after missing on EPS by $0.14 (Q2 EPS of $0.52 vs. $0.66 consensus) and on revenue by $52.6M (Q2 revenues of $572.15M vs. $624.75M). While revenues were up about 15% YOY, economic net income (or ENI) after taxes was actually down from $0.56 in the year earlier period and distributable earnings were well off the year earlier levels at $227.1M (vs. $603.9M) largely on the back of lower net realized carried interest. Management fees for the firm were actually up $16.4M to $82.1M whereas the P-E ENI of $119.1M was down from $175.7M a year ago. With APO likely to see maybe $2.10 in EPS this year, the stock is priced very reasonably, but the question that has to be on shareholders' minds is 'what does the future look like for the company?'
Apollo still maintains many of the structural advantages I first noted back in February. I like the Athene twist in the stock. APO is now managing ~17% of Athene AUM vs. 15% back in February, and Apollo owns 6% of Athene today. This ownership stake will probably reach 10% in time, and I fully expect the partnership to help APO keep growing its AUM probably to the point where APO manages ~1/3 of Athene AUM, but by itself this won't be enough to support the stock. In addition, two other factors are driving the stock here - interest rates and stock market performance/sentiment.
The second factor may seem foolish, after all, returns on all stocks are largely driven by stock market performance and sentiment. But in Apollo and other private equity firms also rely on the stock market valuation for their holdings in portfolio companies. In Apollo's case Athlon and EP Energy both did very well last quarter up 35% and 15% qoq, while names like Sprouts and Norwegian Crusies were less helpful (down 9% and 2% qoq respectively). APO's private equity segment turned the dial up on secondary offerings over the last quarter (Sprouts, Rexnord, etc) and distributed $735M in proceeds. Still the mixed markets only led to $198 in realized carry income, and it looks like valuations in buyouts are getting a bit tougher as Apollo only invested $2B in capital over the last 12 months vs. a $3-4B average. Private equity in general had a great year in 2013 and Apollo was no exception with fund returns of 35%. This is not sustainable going forward of course and so shareholders may need to get used to fund returns in the teens and the associated lower profits this entails. At this point, multiples on buyout deals are basically back to 2007 pre-crisis levels and those valuations simply do not support the kind of returns we have seen in the 2010 to 2013 period.
At the same time though, with APO paying out perhaps $2 a share in dividends on average going forward over the next few years, the stock is certainly a good candidate to own. In particular, the key for real appreciation in Apollo's stock is multiple expansion. Traditional asset managers often trade with multiple north of 20X. APO and other "alternative" asset managers trade at half that level despite that fact that there is an abiding trend towards positive investment inflows into these funds. It is impossible to say whether or not Apollo will ever be able to command this level of multiple, but more time as a public company, earnings consistency, and greater certainty over the ever present possibility of special carried interest taxes being levied on hedge funds and PE funds would all help considerably.
As it regards earnings consistency and growth, Apollo is pretty good actually about generating high-quality (accounting quality) consistent carried interest income this quarter notwithstanding. That said, the company is probably going to be in even a bit better shape going forward. The firm's investment PE portfolio is now only 50% level 1 and 2 vs. 60% in the year ago period, and I see the firm focusing more on certain esoteric debt opportunities in the future, especially if a rapid rise in interest rates (an issue giving the markets heartburn right now) creates dislocations in certain segments of the asset class.
In terms of positioning for the eventual rise of interest rates, Apollo looks like they have been ready for a while now. Co-founder Josh Harris said on the latest conference call that most of the firm's credit securities were in floating rate issues. This is a doubled edged sword. Once rates do start to rise, APO should be sitting pretty as the value of these assets will appreciate quickly. In the meantime though, the rates are pitifully low and there have been a number of false starts and some unwarranted optimism in these issues as anyone holding the various Eaton Vance floating rate CEFs should know (see for example (NYSE:EFR)).
In summary, the situation on Apollo has certainly gotten more complex as equity markets have shot up since February and now appear to be in for a rough patch. The outlook for interest rates has gotten murkier and while the economy looks stronger, there are some distressing points of weakness (homebuilding, the consumer, etc). Because Apollo is so connected through its portfolio to almost every facet of the economy, all of these issues have to be considered by the shareholder. Moreover, until the investing public gets comfortable with a consistently profitable alternative asset management space, multiples are not likely to go anywhere. I thought we would have seen a bit more progress on that issue by now perhaps driven by transformative deals within the space. So far there has been nothing on that front. Nonetheless, with distributions likely to be in the ~$2 range for the next few years and perhaps higher thereafter, Apollo is still worth owning today.
Disclosure: The author is long APO. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.