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Subject:  Re: Let the Game Begin! Date:  7/8/2013  2:40 PM
Author:  EightTrack3 Number:  17612 of 26128

Large-cap, US, one biz segment, diverse customers, predictable w/high barriers to entry.

What's your pick?

Apollo Global Management (APO). A bit less than $10 billion market cap; please note that APO is a publicly-traded partnership that issues K-1 to its limited partners (shareholders). Due to its production of UBTI (unrelated business taxable income) this is not a suitable investment for tax-deferred vehicles.

APO is currently trading at $23.34 per share.

What does it do?

APO is an alternative asset manager. It has three lines of business: private equity investment, credit products, and real estate. Approximately $114 billion in AUM.

What's the difference between your plain-vanilla asset manager and alternative asset managers?

At the risk of oversimplification, plain vanilla asset managers receive a set percentage on their assets under management. Alt asset managers receive a set fee (1-2%) and "carry" on certain products above a hurdle rate (for example, 20% above a 8% return).

APO management has stated that they intend to pay out "available cash flow" which is all cash flow generated after the needs of the business.


Owner-operator management that owns 60+ percent of the business. Three founding partners: Leon Black (not Leon Kass), Josh Harris, and Mark Rowan. Started in 1990; partners came from Drexel Burnham, which explains value-orientation and credit focus.

The three partners receive base salary of $100,000 each and most of their compensation comes from distributions from their AOG units. AOG units have additional voting powers than the publicly traded Class A units but the economic rewards are similar (exception are some tax implications, particularly if Apollo is forced to covert from partnership to corporate status).

End result is that you have an engaged management with incentives largely aligned with small shareholders in a normal world. Besides tax implications, upper management would not have to personally repay much of their 'carry' income in the case of a massive reversal. As APO adopts Method 2 accounting (OAK uses Method 1), this is a potential downside in a 2008-2009 meltdown. FIG had to reverse carry income and the stock collapsed.

Where's the value?

Alternative asset managers, imho, are not being properly valued by the market. Perhaps because the same analysts that cover traditional asset managers cover alt managers, there is a tendency to use the same metrics. Also, due to slight differences in reporting standards: Method 1 versus Method 2, "European waterfalls" for carry income distribution determination, there is a complexity discount - at the moment.

Alt managers have two income streams. Analysts want to slap a multiple of the fee income (example 15x) and a much smaller multiple on the carry income. Because the carry income is a) variable as the market moves up and down, b) difficult if not impossible to predict when it will be distributed, c) a new form of income for analysts to deal (few public cycles to compare with) it is being heavily discounted to the level of 4x or so.

My argument is that fee income should receive a HIGHER multiple than traditional asset managers because in most cases AUM is locked up for years or permanent in minor cases. Secondly, since alt managers control the buy-and-sell timing, and because we have long-term management with a history of success, we should not discount carry income so drastically.

Indeed, APO is in the process of liquidating some of its private equity investments so distributions may be strong in the near-term if the market stays at this level.

APO is growing assets in its credit segment nicely, and that segment and real estate offer good opportunity for AUM growth. Private equity does not scale as well although the carry income is substantially dependent on private equity returns.

APO tries to invest at 6x EBITDA and sell at 9x EBITDA and capture additional gains from improvements to the business while under ownership. Timing of the sales, and therefore distributions, is up to APO partners.

Joshua Harris (one of the founding partners) believes that APO can generate $3-4 per share in cash distributions annually over the economic cycle. Some years less, some years more. I think we're entering a 'more' time period now and the combination of additional asset growth, powerful distributions, and an analyst reevaluation of the alt manager model is going to create nice upside.

Of course, do your own due diligence and my APO position may change at any time.

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