Apollo Beats KKR to Carlyle After Rally: Riskless Return
Apollo Global Management LLC (APO) is the top-performing stock among publicly traded alternative-asset managers as Chief Executive Officer Leon Black demonstrates that reaping gains from buyout holdings while raising new investment funds is the key to pleasing stockholders.
Shares of New York-based Apollo, the third-biggest private-equity firm in the U.S. by assets, almost tripled in the year ended May 21, giving it a risk-adjusted return of 5.4 percent, the best among 12 global buyout, hedge fund and real-estate investment firms in the BLOOMBERG RISKLESS RETURN RANKING. Carlyle Group LP (CG), the Washington-based buyout firm that went public last year, ranked near the bottom, while 3i Group Plc (III) rose the most after Apollo.
Apollo, founded 23 years ago by Black and two deal makers at Drexel Burnham Lambert Inc., is exiting a series of profitable investments including chemical maker LyondellBasell Industries NV (LYB) and has generated $14 billion in proceeds over the past four quarters from selling holdings in its funds, President Marc Spilker said this month. Apollo is also gathering fresh cash for one of the biggest buyout funds since the U.S. financial crisis, targeting $12 billion.
“Apollo has aggressively entered harvesting mode and you’re seeing shareholders reap the benefits,” said Howard Chen, an analyst at Credit Suisse Group AG who rates the shares “outperform,” an expectation that the stock will rise more than broader markets. Apollo is selling holdings in older as well as newer funds and “that provides us some sense of sustainability,” said Chen.
Shares of all but one of the alternative-investment firms in the ranking beat the U.S. market in the past year as the stock rally lifted the value of fund holdings and increased the portion of investment profits allocated to the firms. The worst performer in the ranking, Brookfield Asset Management Inc., returned 30 percent on an absolute basis in the year ended May 21, matching the gain, including reinvested dividends, of the Standard & Poor’s 500 index of large U.S. stocks.
Alternative-asset manager stocks have been more volatile than those of traditional money managers because earnings from overseeing buyout and hedge funds can be unpredictable and shareholders have struggled to understand their business models. That’s changing as investors are getting a better understanding of the alternatives managers’ businesses and earnings metrics, said Credit Suisse’s Chen.
“It takes time for investor mindshare and knowledge to fully develop,” Chen said. “That’s what we’re going through now.”
The risk-adjusted return, which isn’t annualized, is calculated by dividing total return by volatility, or the degree of daily price variation, giving a measure of income per unit of risk. Higher volatility means the price of an asset can swing dramatically in a short period, increasing the potential for unexpected losses.
The 12 managers in the Bloomberg ranking had average volatility of 28.1, compared with 19.1 for the Standard & Poor’s index of asset managers and custody banks, which includes Franklin Resources Inc., the manager of the Franklin and Templeton mutual funds, and BlackRock Inc., which manages mutual funds, institutional accounts and the iShares exchange-traded funds.
Apollo, which oversees $114 billion in strategies including corporate buyouts, real estate and credit, beat competitors because of its highest absolute return of 167 percent despite having the fifth-highest volatility in the group.
Apollo’s return beat the 126 percent absolute gain by 3i Group, Britain’s biggest publicly traded private-equity firm, which ranked second with a risk-adjusted return of 5.2 percent.
Fortress Investment Group LLC (FIG) ranked third with a risk-adjusted return of 4.4 percent. Blackstone Group LP (BX)’s 4 percent return after adjusting for volatility earned it fourth place in the ranking, and KKR & Co. (KKR) was fifth with a 3.9 percent risk-adjusted return.
Brookfield, the Toronto-based manager with a focus on investing in property and infrastructure deals, was the worst performer with a risk-adjusted return of 1.6 percent. Carlyle, the second-biggest U.S. alternatives manager behind Blackstone, was the second-worst, with a return after volatility of 1.8 percent.
Charles Zehren, a spokesman for Apollo at Rubenstein Associates, declined to comment; as did Gordon Runte, a spokesman for Fortress; Andy Willis, a spokesman for Brookfield; and Randall Whitestone, a spokesman for Carlyle.
Most of the companies in the ranking, including Apollo, Blackstone, Carlyle and KKR, initially formed as pure private-equity firms. Such groups pool money from investors such as pension plans and endowments with a mandate to buy companies within about five to six years, then sell them and return the funds with a profit after about 10 years.
Private-equity and hedge funds typically keep 20 percent of profits from investments as a so-called carried interest, on top of an annual management fee of 1.5 percent to 2 percent to cover expenses. Traditional asset-management firms, which offer products such as mutual funds and exchange-traded funds, get most of their income from management fees, making their earnings more stable.
As the private-equity firms started going public, they diversified their businesses beyond leveraged buyouts, introducing new funds to manage assets that, together, would produce larger and steadier streams of income. Blackstone, the largest alternative-asset manager with $218 billion, completed its initial public offering in 2007. The New York-based firm, led by Stephen Schwarzman, offers funds that invest in LBOs, real estate, hedge funds and credit, as well as pools that use a blend of those strategies.
“All of these firms, including Apollo, have done a lot to diversify their businesses or to position themselves to grow assets on a more sustainable basis,” said Marc Irizarry, an analyst at Goldman Sachs Group Inc. “The market is giving them some credit for that.”
Apollo on May 6 said fee-earning assets under management rose to $81.6 billion in the first quarter, up 37 percent from the year-earlier period. First-quarter economic net income after taxes, a measure of profit excluding some compensation costs tied to the firm’s 2011 IPO, increased 76 percent to $741 million, or $1.89 a share, topping the $1.23 average estimate of 11 analysts in a Bloomberg survey.
Apollo’s cash earnings were driven by the firm’s heavy exit activity, and realized carried interest more than doubled to $345 million. The company in the first quarter sold shares of LyondellBasell and Charter Communications Inc., and took public Norwegian Cruise Line Holdings Ltd. (NCLH) and Countrywide Plc. During the second quarter Apollo has already completed or announced at least three strategic sales, two secondary share sales and three dividend recapitalizations, Spilker said earlier this month.
“We think it’s a fabulous environment to be selling,” Black, also Apollo’s chairman, said at a conference last month in Los Angeles. “We’re selling everything that’s not nailed down in our portfolio. And if it is nailed down, we’re refinancing it.”
Buyout firms’ earnings rarely follow a linear path because they are driven by the lumpy timing of exits as well as the “mark-to-market” valuations of fund holdings, which are vulnerable to market swings and required each quarter under accounting rules. While Apollo last year reported higher profit for three quarters, its second-quarter economic net income after taxes fell 84 percent as its fund returns declined and it collected a lower share of investment gains.
Rallying equity markets and affordable debt have made for an environment conducive to IPOs, sales and refinancings by private-equity firms, said Irizarry of Goldman Sachs. The cash earned from such exits and the distributions they fuel to shareholders is buoying the firms’ public stocks, he said.
“The pig is coming through the python in terms of all the deals that happened at the buyout peak of 2006 to 2007,” said Irizarry. “Because of the financial crisis and the economic backdrop, it’s been a longer cycle. So the distribution cycle is here.”
For Irizarry, who has neutral ratings on shares of Apollo, Oaktree (OAK) Capital Group LLC, Carlyle and Och-Ziff (OZM) Capital Management Group LLC, alternative-asset firms are still proving themselves to public investors because the typical 10 years of a full buyout fund cycle hasn’t yet occurred while the firms have been public. Fortress was the first company in the ranking to hold its IPO, in 2007, followed by Blackstone and Och-Ziff later that year.
Fortress, based in New York, is down 61 percent since its IPO. Blackstone has declined 25 percent since its offering, and Och-Ziff has decreased 64 percent since it sold shares to the public.
KKR, which is traded on the New York Stock Exchange, didn’t hold an IPO, choosing instead to combine with its publicly traded European fund. The firm moved its listing to the U.S. from Amsterdam in 2010, and the shares have almost doubled since then.
Apollo has gained 39 percent since its IPO on March 29, 2011. Carlyle and Los Angeles-based Oaktree have risen 40 percent and 29 percent, respectively, since their offerings last year.
“They’re still ‘show-me’ stories in the eyes of the market,” Irizarry said. “There’s some reluctance on the part of investors to ascribe higher valuations on these managers until they see how sustainable these businesses really are.”
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