Ready to plunk down some money with a private equity firm? If
you are an accredited high net worth investor with at least $1
million to risk with the firm on whatever their latest deal is,
you have many quality outfits to choose from.
But if you're not in "the 1%," there is another path. Many
private equity (PE) firms are also public companies, including
Blackstone Group (
) and the infamous KKR. As an industry group, together with
traditional investment management firms like BlackRock (
) and Franklin Resources (BEN), the PE "alternative" asset
managers currently rank in the top 10% of Zacks Industries.
Today we are going to focus on the remarkable
Apollo Global Management, L.P.
) , a $3 billion company which grew its total assets under
management (AUM) in 2012 from $75 billion to $113 billion.
What's so remarkable about Apollo? Three things stand out
1) Earnings Surprise After Surprise
Apollo operates in three business segments: private equity,
capital markets and real estate. It raises, invests and manages
funds on behalf of pension and endowment funds, as well as other
institutional and individual investors.
After a rough year following its March 2011 IPO, the firm
started firing on all rockets, boosting fourth-quarter GAAP
earnings an astronomical 1,564% higher than a year earlier. And
this represented a 120% surprise over analyst expectations.
And it gets better: for the last four quarters, Apollo has
beat consensus EPS estimates by an average of 99%. Granted, PE
earnings can be volatile as big investments and turn-arounds can
take many quarters to develop leaving dry patches in between.
But if it's one thing Apollo has shown consistently in the
past year it is their ability to deliver new profits from their
investing harvests as they continue to find attractive deal
values. And this explains the 60% rise in share price in the past
2) A Valuation to Envy
Below is a timeline of annual earnings estimates plotted
against price since the firm's IPO. 2013 estimates are clearly
going in the right direction -- up and to the right -- with first
quarter results due next month lifted from $0.71 to $1.18 since
their Q4 report in February.
Full year 2013 estimates got a lift to $3.22 from $2.85. And
at Tuesday's close of $23.55, that puts Apollo trading below 8
times on a forward basis -- even after the incredible 60%+ rally.
The slower rising slope of 2014 estimates is likely due to the
perceived volatility of private equity earnings going out that
3) Moon-Shot Dividend
Apollo really likes giving cash to shareholders when the going
is good. After their announced fourth quarter earnings, the
company boosted its quarterly dividend 162% to $1.05 per share.
While Apollo's dividend varies every quarter based on earnings,
if it maintains its $1.05 distribution, then it would have an
effective dividend yield of 19%, way above the industry norm.
For PE and other alternative asset management firms, it's all
about raising and deploying capital in diverse markets. Apollo
also specializes in distressed debt and recently launched a $300
million partnership to invest in coal mining properties.
Keeping the "alt" in alternative investments helps them
generate returns outside of traditional LBO deals which are
becoming more competitive (think DELL).
Besides intense competition for deals, another factor pushing
up deal values lately has been persistently low interest rates.
Speaking at the SuperReturn conference in Berlin recently, Apollo
CEO Leon Black said the average price for private equity deals in
the U.S. is 9 times EBITDA.
One of the major assumptions resulting from such high
valuations is that interest rates will continue to be soft over
the next five years, he said. However, Apollo has managed to
strike deals at lower valuations, around 6 times EBITDA.
This has primarily happened by acquiring corporate "hive-offs"
or businesses being offered for sale by a parent company, like
the company's recent purchase of McGraw-Hill's education
Alternatives to Cash are King
Another factor pushing up the cost of deals is that private
equity companies are flush with funds. According to research firm
Preqin, private equity buyout funds focusing on North America
collectively held idle capital to the tune of $189.4 billion as
of Jan 2013.
This is just 12% lower than the amount in December 2011. So, a
large volume of capital has piled up, which private equity either
has to utilize optimally or return to investors. Right now,
Apollo is choosing to hang on to their war chest and reward
shareholders with a chunky dividend.
This appears to display management's continued confidence in
their ability to find good deals around the world while money is
cheap. One might wonder if all this cash forces PE firms to the
edge of the risk envelope.
Since the headier days of LBO transactions, fund managers
today are now seeking out companies with a high intrinsic value,
before even attempting to turn them around. Such a strategy is
aimed at launching a second IPO, the most lucrative outcome of a
private equity deal.
Therefore, deals are evaluated with an increasing focus on
operational feasibility. This is why propositions such as Best
Buy are viewed with skepticism by fund managers. The major
concern in this case is that the company operates in a dying
industry and a turnaround would be highly risky.
It's not that the entire industry has reoriented itself
towards a low risk, conservative approach. Speaking at the
SuperReturn conference, Howard Marks, Chairman of Oaktree
Capital, said the slow recovery in both Europe and the U.S. has
meant investors are moving towards riskier propositions in the
quest for higher returns. Marks said the ratio of debt on
leveraged buyouts is moving back up towards "pre-crisis
So where does that leave the self-directed investor seeking
diversification and yield?
Given the optimism among analysts for the coming quarters --
which gave Apollo a Zacks #1 Rank -- plus the company's valuation
and stellar dividend, investors interested in a managed approach
to the risky world of private equity should have APO on their buy
list for Q2.
Kevin Cook is a Senior Stock Strategist with
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