Apollo Stock Punished For Less Than Stellar Quarter – Nothing To Worry About (APO)

We Are Apollo Global (NYSE:APO) was 7.5% down yesterday upon its Q2 announcement. One may think something terrible has happened. Not at all! The quarter was just less than stellar. I do not remember when it was the last time Apollo did not surprise the market with its quarterly numbers. But here it is as reflected in yesterday’s SA announcement: “Apollo Global Management Non-GAAP EPS of $1.64 misses by $0.11”. As I will show shortly: a) while technically correct, the headline is misleading; b)the quarter was much better than follows purely from non-GAAP EPS. Retirement Services Apollo’s non-GAAP EPS (aka ANI – adjusted net income) consists of Asset Management (aka Fee Related Income or “FRE”), Retirement Services company Athene (aka Spread Related Income or “SRE”), and Principal Investments (“PII”) segments less financing costs and tax. PII is far less valuable, and we will ignore it for most of this post. SRE is the biggest, and it was the culprit for missed non-GAAP EPS. Athene is a type of life insurer that does not write any life insurance. Instead, it only sells annuities and similar contracts, invests premiums at a higher rate, and locks the spread over the contract’s lifetime. Athene’s results depend on its AUM and net spread (investment spread less opex and financing costs). In Q2, its net spread was 1.24%, lower than in Q2 23 (1.52%) or Q1 24 (1.52%). Apollo The development vs the previous quarter is well illustrated in the diagram above. Athene was issuing annuities at a 0.12% higher rate but was investing funds at a 0.16% higher fixed income rate – everything is fine in this regard. The cost of floating rate hedges (0.05%) relates to Athene’s actions to immunize its portfolio from floating rate asset exposure. The company benefited from this exposure for many quarters, but now it expects the floating rate to drop and hedges. This item will persist for one more quarter before going away. The elevated interest costs (0.05%) relate to the fact that Athene issued debt to increase its capital in the previous quarter. This is a positive event as it will allow the company to issue more annuities. However, Athene needs more than one quarter to fully use this capital. This item should disappear in the next quarter. The most serious damage was due to lower alt return (0.17%). Alts represent only about 5% of Athene’s capital (the rest is fixed income) and consist of several uncorrelated investments – a combination of various Apollo strategies (mostly via the so-called AAA fund with third-party investors besides Athene), various debt-origination platforms, and strategic investments in other retirement services or reinsurance companies (Athora, FWD, Catalina, etc.). Some of these companies are private, while others are public. Combined, they have underperformed recently for various reasons, and it was not offset last quarter by the extraordinary performance of other alts. I do not consider alts quarterly performance important. Equity investments, private or public, do fluctuate and this is normal. My audience knows it too well. Meanwhile, Athene gross organic inflows remain high across channels: Apollo The green segment in the diagram represents retail annuities and is the most important. It is on track to beat the outstanding number of 2023 and its run rate is almost twice (!) bigger than two years ago. Net flows have increased Athene’s gross and net investment assets – $302B and $233B vs. $293B and $227B in Q1(the net number represents assets on Athene’s balance sheet while the gross number adds third-party insurance assets – sidecar or so-called ADIP). However, this growth was not sufficient to offset the drop in net spread. Two things would worry me about SRE: either a drastic increase in surrender rates or credit losses in a fixed-income portfolio. Neither has been reported. Everything else All other metrics were exceptionally strong. Let us start with Fee-Generating AUM (“FGAUM”), arguably the most important overall number. Apollo Apollo reported 13% growth in FGAUM concentrated in its most important yield segment which reported 15% growth. It caused a disproportional jump of 17% in FRE as the company enjoyed some operating leverage. Apollo Besides strong growth in management fees (which are proportional to FGAUM), capital solutions fees jumped 50%! This pace is unsustainable but it shows the strength of Apollo’s complex ecosystem and its potential. Capital solutions fees are transactional fees that are triggered by operating activities such as debt and equity originations and placements. Apollo needs strong origination capacity and a lot of different relationships on various levels to generate $200M+ in these fees in a single quarter. FGAUM grows due to inflows from various channels: Apollo The slide shows the healthy levels of these inflows, with emphasis on the Asset Management segment. Besides high inflows from traditional institutional customers, Apollo quickly grows inflows from retail customers such as high-net-worth individuals (the so-called wealth channel). Today the company has several strong offerings in various non-traded funds (AAA, non-traded credit fund, etc.) and the growth is achieved by scaling up distribution via banks, RIAs, and other financial intermediaries, both domestically and internationally. This distribution network is far from being mature, but its input starts being palpable. In the first half of the year, Apollo raised $6B vs. $8B via the wealth channel in all of last year. This is about 15% of all asset management inflows in the first half, and the proportion is growing rapidly. Each quarter, Apollo increases its distribution and comes up with new offerings that produce excellent returns. Based on CEO Marc Rowan, AAA is expected to become Apollo’s biggest vehicle eventually. I have presented all these numbers trying to show how broad-based Apollo’s growth is. And it is purely organic, without any exciting M&As. They are still possible but not needed at the moment. Valuation Apollo’s stock dropped primarily because of lower-than-expected non-GAAP EPS or ANI. This presumes that ANI is the most important metric and that alt managers can be valued by their P/ANI ratios. The last statement is plainly wrong. Apart from alt managers that are driven purely by FRE – such as Blue Owl (OWL) or Brookfield Asset Management (BAM) – this metric in isolation is rather meaningless. For example, in my posts about alt managers, I showed that there is no correlation between P/ANI for Blackstone (BX) and its stock performance in subsequent periods. The same is true about Apollo because its ANI consists primarily of FRE and SRE, which require different multiples. This is not my opinion, this is how the market values them. FRE is valued much higher than SRE. The best comp for Apollo’s FRE is arguably Ares (ARES). It is currently trading at a 2.5% yield. Since Ares pays out almost all of its FRE, it represents a P/FRE multiple of 30+. SRE is an adjusted income of an insurance company. Have you ever seen a big insurer trading at a 30 P/E multiple? So, it is rather meaningless to combine both FRE and SRE and ascribe a single multiple to this combination. I use a simplified valuation method for Apollo: apply 20-25 multiple for TTM FRE, 10-15 multiple for TTM SRE, discard PII and financing costs as the former is always bigger than the latter, and apply 20% normalized tax. It has worked quite well since Apollo merged with Athene, and below are the current calculations: Author At the current $116, APO is trading comfortably within its fair value range. Note that my range for FRE multiples (20-25) is far lower than the market multiple ($30+). If we apply 30 multiple for FRE, the Asset Management segment is worth 2.45*30=$70, and it makes APO worth ~$111-131. Under these assumptions and combined with expected growth, the current price seems very attractive. However, I am against this overly aggressive approach that, in my opinion, is embedded in today’s market. Conclusion After the drop, Apollo is trading close to its fair value. It is not as appealing as it was not so long ago. However, due to its expected growth, the stock remains more attractive than the market in the long term. In October, the company will present its strategic plan for the next 5 years. It will be a good time to assess future returns.

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