March 12 (Bloomberg) -- Apollo Management LP adapted to the leveraged-buyout freeze by investing $1 billion in distressed securities, including the debt of companies it already owns, founder Leon Black told investors.

``We are doing exactly what you would expect of us in this market -- using our distressed expertise and appetite for complexity to find investments in good companies that are available at significantly discounted levels,'' Black wrote in a Feb. 29 letter to clients of the New York-based firm.

Apollo's most recent funds are ``in very good shape,'' Black wrote, even though the buyout of real-estate services firm Realogy Corp. has been hurt by the worst housing market in a quarter century and its Linens 'n Things Inc. and Claire's Stores Inc. are struggling as retail sales growth slows. Fund V, a $3.8 billion pool started in 2001, has returned 3.5 times invested capital, according to Black. Holdings of the $10.1 billion Fund VI were valued at $1.5 billion above cost as of Dec. 31.

Black, 56, is a former Drexel Burnham Lambert Inc. banker who since forming Apollo in 1990 has made his name investing in industries such as chemicals, metals and satellite communications when they were out of favor. He noted the company's first two funds were started amid the LBO slump of 1990-1992 and returned 37 percent annually, while Fund V, started as the economy slowed in 2001-2002, has returned 57 percent.

Apollo spokesman Steven Anreder declined to comment.

LBO financing began to dry up in July, a casualty of rising subprime-mortgage delinquencies that soured investors on anything but the safest government debt. The value of deals announced in the second half of 2007 declined by two-thirds to $204 billion from the first six months, according to data compiled by Bloomberg.

Schwarzman's View

Two rate cuts by the Federal Reserve in January that lowered the benchmark fed funds to 3 percent haven't helped to bring investors back to the corporate bond and loan markets.

Black's view on distressed investing was echoed by Blackstone Group LP founder Stephen Schwarzman, who told investors on a March 10 conference call that his New York-based firm is eyeing leveraged loans it considers unfairly discounted by investors amid broader credit-market worries.

``Leveraged loans is a very interesting area and getting more interesting,'' Schwarzman, 61, said. ``Some of it is trading at distressed debt levels and it happens not to be distressed. It's a distressed market.''

Distressed debt typically yields 1,000 basis points over Treasuries because investors believe the company may be default on their obligations. A basis point is 0.01 percentage point.

Intelsat Gain

Black said the firm was buying distressed securities of companies in the transportation, media, financial and packaging industries.

Apollo's fifth fund realized $2 billion in gains since the beginning of 2008 by selling Intelsat Ltd., the world's biggest commercial satellite operator, and Goodman Global Inc., the Houston-based maker of heating and air-conditioning units, according to the letter, a copy of which was obtained by Bloomberg News.

Pembroke, Bermuda-based Intelsat, sold to BC Partners and Silver Lake Partners, made Apollo 10 times invested capital and Goodman Global's sale to Hellman & Friedman LLC made Apollo three times its money, according to the letter.

Apollo completed its $6.6 billion purchase of Realogy, the biggest residential real estate broker in the U.S., last year, ahead of a collapse in the housing market.

``We factored a substantial downturn into our original investment thesis,'' Black wrote.

He noted that Realogy, based in Parsippany, New Jersey, has yet to access a $750 million credit line and has ``significant breathing room in its only meaningful covenant.''

Bonds Fall

Realogy's 12.375 percent bonds due in 2015 are trading at 51 cents on the dollar to yield 29 percent, compared with about 80 cents five months ago, according to Trace and Bloomberg data.

Claire's Stores' 10.5 percent bonds due in 2017 have lost half their value since the Pembroke Pines, Florida-based chain sold them in May, falling to 47 cents on the dollar to yield 25.66 percent.

Bonds of Linens 'n Things, based in Clifton, New Jersey, have plunged 70 percent over the past year to 30.5 cents on the dollar to yield 39.25 percent.

``Linens 'n Things remains the sole challenged portfolio company in Fund V,'' Black wrote, noting that Chief Executive Officer Robert DiNicola is heading the turnaround. ``While Bob has made significant inroads on the operational side, financial results remain challenged in this tough retailing environment.''

Still, Black remained upbeat in the three-page letter about Apollo's prospects.

``We recognize that current bond prices are not necessarily an indicator of long-term underlying value,'' Black wrote.

That extends to its own funds. Apollo yesterday said it bought $23 million of shares in its publicly traded fund in Europe after shares of AP Alternative Assets LP dropped 30 percent from its initial public offering in August 2006. The stock dropped 10 cents to $12.50 today in Amsterdam trading.

To contact the reporter on this story: Jason Kelly in New York at jkelly14@bloomberg.net

Last Updated: March 12, 2008 17:27 EDT