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 ( BX - Analyst Report ) and
the infamous KKR. As an industry group, together with traditional
investment management firms like BlackRock ( BLK - Analyst Report ) 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. ( APO - Snapshot Report ) , 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 right away.
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
six months.
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.
![](http://staticzacks.net/images/zacks/blogs/1364935865_scaled_425.jpg)
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
far.
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 segment.
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 highs."
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
Zacks.com
APOLLO GLOBAL-A (APO): Free Stock Analysis Report
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