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Apollo Global Management (APO) is a leading alternative asset manager. The firm’s earnings are comprised of two income streams: relatively stable fee related earnings and cyclical incentive fees. While Apollo has been rapidly expanding, a cyclical low in incentive fee income has been masking the growth and led to a stagnating bottom line. When the cycle in incentive fee income stream turns, APO’s growth will start showing up in increased earnings and dividend. This should provide a strong tailwind for the share price.

Apollo is sometimes described as a private equity firm, but the company today is much more than a private equity firm. In fact, private equity accounts for only $73 billion of Apollo’s $414 Billion in assets under management (AUM). The bulk of the firm’s AUM comes from the company’s huge credit arm that has amassed $300 billion of AUM. The credit arm has seen phenomenal growth over the last several years underpinned by growth in the insurance sector. The remaining $40 B of AUM are in the real assets business segment. The total AUM has been growing rapidly underpinned by a proliferation of strategies, as shown below in the chart below from Apollo’s August 2020 Investor Presentation.

August 2020 Investor Presentation

Apollo’s ability to pay out almost all of its earnings as dividends without sacrificing growth remains a largely unappreciated differentiator. AUM has grown at a 21% CAGR since it IPO’d in 2008, and the growth hasn’t shown signs of slowing down. As of the most recent earnings report of Q2 2020, AUM grew just over 32% in the last year.

Allocations to alternative assets continue to grow and the assets continue to flow to the largest players, of which Apollo is a part.

Apollo 2019 Investor Day – Page 23

Apollo suggests that distributable earnings (DE) is the best measurement of the firm’s performance, and I agree. The great thing about distributable earnings is that, true to their name, they are earnings that Apollo can distribute to shareholders and distribute they do. Apollo has historically paid out roughly 90% of earnings and appears poised to continue to do so.

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Some companies retain all earnings to provide growth or perhaps grow but don’t produce earnings. REITs and MLPs may pay out significant portions of their cashflow, but require debt to grow. Apollo, along with some of its alternative asset manager peers, is one of the rare companies that grows its business while distributing a large percentage of its earnings while still maintaining a clean balance sheet.

So, Apollo is an alternative asset management juggernaut that is amassing AUM at a break-neck pace while paying out most of its earnings and keeping a clean balance sheet. Everything is great, right? Well, maybe not.

Let’s take a look at Apollo’s historical earnings and distribution/dividend:

AUM (year end)

DE

Distribution/Dividend

2012

$113 B

$1.94/share

2013

$161 B

$4.49/share

$3.98/share

2014

$159.8 B

$3.13/share

$2.89/share

2018

$280 B

$2.15/share

$1.83/share

2019

$331 B

$2.71/share

$2.35/share

2020 (H1)

$414 B (end of Q2)

$0.83/share (H1)

$0.91/share (H1)

Apollo has rapidly grown their AUM. Increased the number of clients and strategies. Diversified their client base geographically. Increased the amount of permanent capital. Yet, the DE and dividend has been stagnant or worse.

What is going on here? To answer that question, you have to look at Apollo’s two sources of DE – fee related income (FRE) and realized performance fees. It is a tale of two income streams. FRE has been a fantastic success story and performance fees have been a disappointment or worse.

In its 2019 Investor Day Presentation, Apollo suggests that performance fees should be worth $11-17 USD/share of value, but are being largely ignored by the market leaving the share price supported by the FRE alone. The situation remains the same today.

Apollo likes to emphasize the FRE which has grown steadily, including at a 16% CAGR over the last 5 years. They have become an increasing percentage of Apollo’s DE, but only partly because of the growth of FRE.

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2012

2013

2014

2015

2016

2017

2018

2019

LTM

(Q2 2020)

FRE (in millions)

$300

$299

$446

$420

$530

$624

$771

$902

$941

FRE as a Percentage of DE

34%

16%

31%

69%

83%

63%

81%

74%

Implied Contribution of Realized Performance Fees as Percentage of DE

66%

84%

69%

31%

17%

37%

19%

26%

In 2012-2014, realized performance fees were a large percentage of Apollo’s earnings. The large distributable earnings and distributions of 2013 and 2014 were driven not by FRE, but by those large performance fee contributions. However, in 2018 and 2019, the performance fee contribution to DE had become relatively small. 2020 has been even worse, as performance fees have been a net drag on the company’s distributable earnings.

The lack of performance fee income has been striking of late. In H1 2020, Apollo has managed $1.11/share of FRE but only $0.83 of DE. That’s right, performance fee income has been a net negative contributor to DE in 2020 so far.

There are several reasons for this performance fee disappointment, some more concerning than others. Apollo has intentionally emphasized growth in FRE rather than performance fee growth. FRE is more stable and more valued by the market and so Apollo has intentionally emphasized growing FRE. Secondly, performance fees are cyclical by their nature. Additionally, the spike in 2013 and 2014 was aided by investments made at depressed prices during and in the wake of the GFC and aggressive realizations by the company. Some may remember that Apollo’s Leon Black said in 2013 – “We’re selling everything that’s not nailed down.”

A pessimist may point to more enduring challenges, chief among them the amount of money looking for private equity deals. Private equity is a key platform for Apollo’s performance fee income. It was likely true at one point that making good returns in private equity only required funds and leverage. That’s no longer the case.

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Private equity is also more capital constrained than some of Apollo’s other strategies. Apollo’s private equity AUM continues to grow and I think it can continue to grow, but not at the pace of some of Apollo’s other strategies.

Apollo’s recent lack of performance fees is a disappointment, but is it a temporary cyclical disappointment or an enduring one? In their 2019 Investor Day, Apollo estimated that Performance Fees would contribute $1.50-$2/share per year in the 2020-2024 timeframe. If that comes to pass, it will be a big boost to earnings compared to the recent minuscule contributions from performance fees.

Apollo 2019 Investor Day

In my opinion, the recent lack of performance fees is more likely a cyclical trough than a permanent decline. Apollo has a tremendous track record of success in private equity and in generating performance fees from its other businesses. There is no reason to believe that Apollo somehow has forgotten how to run private equity or generate performance fee income.

August 2020 Investor Presentation

A rebound in performance fees will make a huge difference to earnings and should make a large difference in the company’s share price. If the roughly $1.75/share average performance fee contribution projected by management is correct, a normalized DE for 2020 would be approximately $3.97/share (annualizing FRE from H1). That would put Apollo at a multiple of just over 11x DE – too cheap for a rapidly growing alt manager.

Unless Apollo has forgotten how to invest in the private equity space and generate performance fees, the lack of performance fee income should be temporary. Once performance fees rebound, the company’s growth should be reflected in the bottom line through an increase in DE and the dividend and provide a tailwind to the stock price.

Disclosure: I am/we are long APO. 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.



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