Apollo Investment began as the first business development company backed by a brand-name private equity group. It was first to market, soaking up over $900 million at its IPO, effectively stopping competitors in their tracks.
It performed well, for a time. But going into the 2008 financial crisis Apollo was highly levered in real estate investments that would later go bust. Its $1.5 billion buyout of Innkeepers USA Trust in 2007 proved a massive miscalculation that would ultimately result in more than $273 million in losses, as Apollo held on to the highly leveraged equity component in the deal.
Today, Apollo Investment is no longer managed by the same crew that made those disastrous moves. The housecleaning of senior managers began in 2012 as the company was realizing losses from its pre-financial crisis investments. In a sign of just how bad the downturn was, its external manager bought a slug of stock at book value in 2012 — a double-digit premium to Apollo’s market price — to restore confidence in its future.
A road map for 2015
New leadership is speaking a different language. Where Apollo Investment ballooned on equity investments at the top of the cycle in 2007, it’s looking to take profits in 2015. One of its chief goals this year is to reduce its equity investments to redeploy the capital in safer, income-generating debt investments.
Assets slated for sale have only been broadly defined. On a recent conference call, management said it wanted to harvest some older private equity investments and redeploy capital into income-producing assets. Virtually all of its largest equity investments were tagged with a footnote that they were non-income producing as of Dec. 31, 2014.
Excluding its Merx Aviation unit — a wholly owned aircraft leasing company — equity investments made up nearly 10% of the portfolio at fair value. This is a significant chunk of the company’s portfolio, equal to one-sixth of book value when accounting for leverage.
Constructing a safer portfolio
If investors can judge Apollo Investment’s performance by any single action in 2015, it will be the company’s ability to sell its nonyielding equity investments at or above their most recent fair values.
Harvesting its equity investments today, when we are probably closer to a peak in valuation than a trough, will help it derisk its balance sheet for the next cycle. No one can perfectly time the market’s ups and downs, but Apollo can broadly manage its risks. Equity investments are inherently riskier than debt investments in a downturn.
Cashing in seems even more prudent when you consider its larger-than-average energy exposure. The company recently reported that 13.6% of its investment portfolio is dedicated to energy companies, nearly twice the industry average. Stable for now with hedges in place, its oil investments could be a sore spot should petroleum prices remain depressed for a prolonged period.
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Jordan Wathen has no position in any stocks mentioned.