Apollo Global (APO)
Athene acquisition creates a differentiated and misunderstood business model
Description: APO is a top 5 alternative asset manager globally with $513bn of AUM as of 1Q22. APO’s AUM is diversified across 73% of AUM in Yield strategies, 17% in Equity strategies, and 10% in Hybrid strategies. APO recently acquired the remaining 65% of Athene (ATH), for $10.4bn (6x ’22 EPS), adding ~$200bn of insurance liabilities to APO’s balance sheet including fixed indexed annuities, fixed annuities, group annuities, and funding agreements. APO operates three business segments: Asset Management which generates fees on AUM, Retirement Services which houses APO’s insurance operations, and Principal Investing which maintains APO’s on balance sheet investments.
Before diving into APO, let’s look at some of the key drivers impacting the alternative asset manager sector (the Alts). Alternative investments are considered financial assets beyond the conventional asset classes such as publicly traded stocks and bonds and related mutual funds/ETF’s. Key alternative investment asset classes include private equity, venture capital, private debt, hedge funds, and real assets (including real estate and infrastructure).
Alternative AUM has grown at a high rate over time, roughly 11%/yr. from 2015-2021, but only makes up ~13% of global AUM as of YE21 at $13tn. Investors have increased their allocation to alternatives driven by strong performance from alternative strategies, low correlation with public markets, and reduced volatility from many alternative strategies focused on private markets. Additionally, the illiquidity of these strategies is a key feature for many institutional investors. Preqin (a leading alternative asset data provider), forecasts alternative AUM to grow at 11.7%/yr. through 2026.
As shown below all investor types are expected to increase their allocation to alternative asset going forward, and allocations to alternatives vary substantially by investor type from 3% Insurance/4% HNW to 27% for Foundations and 19% for Sovereign Wealth Funds.
While the entire industry is expected to grow AUM at a double-digit rate as noted, the larger alternative asset managers (BAM, BX, APO, KKR, etc.) are forecast to grow AUM at an even higher rate as LP’s plan to consolidate their relationships with alternative asset managers. As shown below, the larger alternative asset managers have taken market share and are expected to grow at a higher rate going forward. This top-down industry forecast lines up well with the bottoms up view, with most of the larger Alts forecasting ~15% AUM CAGR’s through 2026.
Retail is viewed as a key growth area across the sector given its under allocation to alternatives compared to other investor groups. BX has already proven success with two retail focused strategies, BREIT ($63BN of AUM) and BCRED ($45bn of AUM), and this is a key focus for APO (discussed further below).
I expect APO to generate attractive returns driven by ~18% annual EPS growth through 2026, a 3% dividend yield, and multiple expansion. Key drivers for EPS growth include a 15% AUM CAGR through 2026, $5bn of share repurchases, substantial growth opportunities in its yield business, and meaningful operating leverage. I believe the market underappreciates the stability of APO’s earnings going forward, given its differentiated business model. Specifically, APO’s spread based Retirement Services business is unique in the sector and will contribute 50% of earnings, with Asset Management contributing an additional 40%, leading to 90% of APO’s earnings from these stable businesses compared to peers in the 30-75% range. Finally, APO’s management team has a strong track record and substantial equity ownership, aligning management with shareholders. In my base case, APO is worth $142/share in 2026, representing a 29% IRR. The key risks are macro related, as a recession would likely lead to portfolio losses and weaker spread based earnings.
Strong EPS growth driven by AUM growth and capital deployment. At its recent investor day management guided to 2026 EPS of $9/share, equating to a 15% EPS CAGR from 2021-2026 driven by 15% AUM growth, operating leverage, and capital deployment. This guidance compares to its 21% AUM CAGR from 2011-2021 and is in-line with expected AUM growth from peers, as well as market research estimates for the sector. As noted above, alternative asset managers benefit from secular tailwinds as investors look to increase their allocation given the lower volatility and strong performance record of many alternative strategies.
Within its Yield business, management guided to AUM increasing from $339bn to $750bn in 2026 as origination volumes increase by 50% to $150bn in 2026. APO has 1,300 employees driving origination volumes, which is a key differentiator relative to its peers. These origination platforms focus on senior secured lending across a variety of asset classes including middle-market lending, aircraft leasing, small fleet vehicle leasing, triple net lease real estate, and recently consumer finance, clean energy real estate, and trade finance. These origination platforms are run as decentralized entities, with compensation based on long term realized losses, and allow APO to generate attractively yielding senior secured fixed income assets. Growing its 3rd party AUM from $93 to $200bn is another growth driver with a focus on HNW/Mass Affluent.
APO expects to increase its Equity AUM from $85bn to $125bn driven by the launch of a new PE fund in 2022 which is expected to raise >$25bn, as well as targeting impact investing and US/Asia Real Estate. APO’s strong returns over time will also be a key driver of AUM growth going forward. Finally, APO has guided to doubling its Hybrid business from $47bn to $100bn by YE26 driven by scaling several sub-scale strategies such as Infrastructure, Hybrid Value, Hybrid Real Estate, etc. Additionally, APO views Hybrid strategies as attractive given many banks pulling out of the market following the Financial Crisis.
However, I believe there is upside to management’s guidance, and I forecast high-teens EPS growth through 2026. The delta is driven by:
$5bn of expected share repurchases through 2026. APO noted at its investor day that it would have capacity to repurchase upwards of $5bn of shares through 2026 but left the impact out of its guidance. Given the recent share price decline, management views repurchases as an attractive use of capital and APO repurchased $325mn of shares in 1Q22, higher than expected and showing willingness for opportunistic repurchases.
$5bn of growth capital deployment. APO’s investor day guidance noted that APO will have access to an additional $5bn of growth capital through 2026 that is not represented in its forecasts. I expect APO to use this capital for platform acquisitions and tuck-in M&A, and stronger growth in Retirement Services (described in more detail below). At a 15% ROE, $5bn of growth capital would generate $750mn of earnings, adding $1.25/share to EPS assuming 600mn shares outstanding.
Clean energy opportunities. Following its investor day, APO recently announced a target to invest $50bn in clean energy and climate capital over the next 5 years, with the opportunity to invest $100bn by 2030. Notably APO has already deployed more than $19bn into energy transition investments over the past five years.
Positive impact from higher rates. Rates have increased meaningfully since APO’s investor day. Management noted its positive rate sensitivity on its 1Q22 earnings call, that every 25bps parallel shift in the curve would drive an additional $30-$40mn of annual SRE. APO also noted that if the forward curve materialized, it would add ~$0.30/share of upside to SRE in 2022. Higher rates should also increase demand for annuities.
Opportunities to expand into retail. APO announced the acquisition of Griffin Capital following its Investor Day which will add $5bn of AUM and expand APO’s product line up to include a retail focused Real Estate Fund and retail focused Credit Fund. Additionally, APO noted on its recent earnings call that it plans to launch two new retail strategies per quarter over the next 18-24 months including its non-traded REIT ARIS, a BDC, and other strategies across the risk/reward spectrum. APO has also expanded its retail headcount from 25 to 145 to focus on the opportunity.
Underappreciated low-cost and permanent capital base. A key differentiator for APO is its Retirement Services business, which provides APO with a large pool of permanent capital allowing APO to generate attractive spread based earnings. APO’s permanent capital base makes up 60% of APO’s AUM compared to 15-35% for its peers. This capital base is comprised of low-cost insurance liabilities with 52% Fixed Indexed Annuities, 18% Fixed Annuities, 12% Group Annuities, and 13% Funding Agreements. These liabilities have a ~9yr. weighted average life with no exposure to mortality/morbidity risks, and less capital markets sensitivity than Variable Annuity and Variable Life Insurance products.
APO then invests this capital in fixed income (95%), and alternative assets (5%), generating stable and attractive spread income. 94% of ATH’s fixed income portfolio is invested in Investment Grade rated securities with the allocation shown below. ATH has a much higher allocation to securitized asset classes driven it asset origination platforms. These originated securities are largely senior-secured debt with a 100-200bps yield advantage over similarly rated publicly traded bonds, allowing ATH/APO to generate higher returns on capital. The additional spread compensation is driven by the fact that these are less liquid securities, as opposed to taking additional credit risk, and ATH can take on the additional liquidity risk given the long dated nature of their liabilities.
Specifically, ATH has a roughly 40bps yield advantage across its portfolio compared to peers, and generated an average 16% ROE (23% excluding excess capital) from 2014-2021, compared to low-teens ROE’s for its life peers.
Retirement Services also serves as a key growth driver, with substantial organic and inorganic growth opportunities. Specifically, ATH’s inflows have increased at a 40% CAGR from 2014-2021, and ATH is the largest writer for pension group annuities, funding agreements, retail fixed index annuities, and flow reinsurance. Going forward APO has guided to roughly $120bn of organic inflows into Retirement Services, and upwards of $150bn in inorganic growth over the next five years.
Additionally, APO owns 27% of Athora, a retirement services platform in Europe which has scaled to $60bn of AUM as of YE21, after launching in 2018. APO also owns 18% of Challenger Ltd., a dominant retirement services provider in Australia catering to the Asian market with $115bn of AUM as of YE21. Both platforms represent attractive growth opportunities to replicate its success with Athene, as APO looks to grow further into Europe and Asia.
Opportunities abound in the U.S. as well with both strong organic growth and inorganic growth expected through acquisitions and block reinsurance. Furthermore, ATH has ~$8bn of excess capital as of YE21 and expects to have an additional $10bn of capital available by 2026 that can be utilized to fund additional origination platforms, capital raising platforms, or capacity to seed funds across APO’s numerous strategies. Given its roughly 12x leverage (assets/equity), this excess capital represents a substantial amount of dry powder that can be utilized over time, leading to substantial EPS growth.
More stable earnings. APO’s earnings should be more stable than peers, as APO expects 90% of earnings to be spread related earnings (SRE) or fee related earnings (FRE) compared to 30-75% for peers. The remaining 10% of earnings is from Principal Investment Income (performance fees and realized/unrealized gains), which is inherently more volatile and less predictable. APO’s more stable earnings base should lead to a higher P/E multiple than peers, but APO trades at a significant discount to peers as discussed below. Of its peers, only KKR has meaningful insurance liabilities on its balance sheet, through its stake in General Atlantic, which only accounts for 12% of its earnings.
While APO’s peers are heavily diversified across asset classes and strategies including PE, Hedge Funds, Infrastructure, etc. they are also much more reliant on principal investment income which commands a lower multiple given its greater volatility because of its capital markets sensitivity. APO’s peers are also more reliant on 3rd party fundraising efforts, while APO’s credit focused strategies allows the company to compete in the much larger Fixed Income replacement market (estimated at $40tn compared to $12tn for alternative assets). APO is effectively taking market share here from large global banks who have pulled back their origination efforts due to the challenging regulatory environment following the Financial Crisis. APO recruits heavily form the large banks and can lift teams out and provide more attractive compensation in a higher growth company.
Strong management team and bench. APO has a strong management team led by co-founder and CEO Marc Rowan, Co-Presidents Jim Zelter and Scott Kleinman, and ATH CEO Jim Belardi. Management’s interests are heavily aligned with shareholders with substantial share ownership as Marc Rowan has a 6% stake in APO, followed by Jim Zelter at 2.4%, Scott Kleinman at 2.2%, and Jim Belardi at 1%. Furthermore, Marc Rowan was the key architect for APO’s Yield business which differentiates APO and makes up the bulk of its AUM. Notably Marc Rowan was behind the acquisition of ATH for 6x EPS, which represented a shift from management’s prior stance on owning all of ATH. Additionally, Marc Rowan has cut the dividend payout ratio and is focused on using the additional capital for growth to generate greater shareholder value. Jim Belardi operated the Retirement Services model at both SunAmerica which he sold to AIG for 6.6x BV, and as CEO of ATH. Importantly, both APO and ATH historically executed extremely well against prior targets, providing increased confidence that the company will beat its recently announced targets. Finally, APO’s one share/one vote governance is unique among its peers and further aligns management and shareholders and makes APO eligible for inclusion in the S&P 500. Given its market cap. I would expect APO to be added to the S&P 500 in the near term, providing substantial fund flows which should boost its valuation.
Risks. The key risk facing most balance sheet financials is weakening macro conditions, including a deteriorating credit cycle or continued equity market decline. Every source of earnings for APO would be impacted by a recession with lower fee-based revenue, credit losses reducing Retirement Services’ earnings, and weaker realized investment income and reduced performance fees.
While APO and ATH have only experienced one recession as a public company (2020), both companies performed extremely well with strong earnings, record fundraising and AUM growth, and minimal credit losses. Specifically, ATH’s portfolio averaged 12bps of credit losses compared to a 15bps average for the life insurance industry overall. Furthermore, while APO’s principal investment income declined from $1.2bn in 2019 to $392mn in 2020, it increased meaningfully to $3.7bn in 2021 as the economy and markets rebounded, more than offsetting weak 2020 results. If the US entered a recession, the same dynamic would likely play out with principal investment income initially declining but fully recovering along with the economy.
Additionally, ATH has substantial excess equity capital of $4bn and additional $3.5bn of debt issuance capacity to maintain ratings.
Shown below are stress test results for ATH on a stand-alone basis, including impacts to earnings and capital from an ordinary recession and deep recession. ATH provides a substantial amount of information regarding the resiliency of its balance sheet in its annual stress test results, which APO has committed to providing going forward. The key takeaways from ATH’s stress test results are the conservative nature of ATH’s balance sheet, and major focus on credit risk management.
Additionally, there may be concerns that a rising interest rate environment is a headwind, as alternative strategies may be less attractive. However, all the alts (including APO) significantly outperformed the S&P 500 during the last rate hike cycle driven by substantial fundraising activity. However, alternative asset managers benefited from converting from partnerships to c. corps during that time, which was clearly a one-time benefit. Nevertheless, the market is likely penalizing the entire sector as a result of higher rates, although I don’t believe higher rates will impede AUM growth given numerous tailwinds.
Valuation. APO trades at ~9x ’22 EPS, and 7.5x ’23 EPS, a significant discount to peers as shown below. With no multiple expansion, I expect APO to generate ~21% IRR’s through 2026 driven by an 18% EPS CAGR and a 3.2% dividend yield. However, based on the modest multiple expansion I assume below, I expect APO to generate a 29% IRR through 2026.
I believe my assumptions are conservative regarding multiples for APO’s FRE, SRE and PII earnings and the value of APO’s investments is based on its reported book value. As mentioned, APO operates a unique business model which introduces complexity, relative to both alternative asset managers and to life insurers. APO’s large Retirement Services business drags down its valuation as most Life Insurers currently trade at 6-10x earnings. However, compared to its Life Insurance peers, APO’s Retirement Services business has generated much higher ROE’s over time, with stronger organic EPS growth, lower leverage, and without the legacy liability issues that plague the sector.
Additionally, APO’s Retirement Services business does not have any directly comparable public peers as most life insurers have highly diversified businesses across Life Insurance, Annuities, Group Insurance, Retirement, and Asset Management. As a result, I don’t believe the market appropriately values the earnings generated by Retirement Services, but ultimately that gap should close as APO generates consistent and stable Retirement Services earnings going forward.
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