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Apollo Investment: Earnings Analysis

INTRODUCTION: Earnings season is kicking off with Apollo Investment’s Fiscal 2017 IIIQ results, for the period ended December 2016. The BDC Reporter reviewed the BDC’s earnings press release, 10-Q filing and listened to the Conference Call held Monday morning February 6, 2017 at 10:00 a.m. EST. We also updated the BDC Credit Reporter’s database of Watch List companies, using Advantage Data’s immediately updated records on each portfolio company, and comparing against our own database.

BACKGROUND:  Apollo Investment (AINV) is the public Business Development Company of well-known private equity group and asset manager Apollo Global, one of whose subsidiaries serves as the external Investment Advisor. AINV has been public since 2004, and issuing stock at $15.0. AINV is one of the larger BDCs, but has not fared well over its near 13 year history. At December 31, 2016 the BDC reported Net Asset Value of $6.86, down 54% from the IPO price, and 15% off the NAV 5 years ago, which we use as a consistent measuring stick for longer lived BDCs. Distributions, too, have dropped by about half from their post 2011 highest point. Compared to the 2008 distribution peak in 2008, AINV currently pays only 29% as much in distributions, having recently cut its quarterly pay-out to $0.15. As the 5 year chart shows, the BDC’s stock price has dropped 17% at the current stock price, but was 37% behind at the lowest point in February 2016 or $4.52. The stock’s highest point was in November 2013 at $9.03, and is currently trading at around $6 a share.

Analysis of AINV: IVQ 2016

IF AT FIRST YOU DON’T SUCCEED…

Apollo Global has twice in the past 5 years sought to revitalize its BDC. A new CEO and CFO were brought in during 2012, and AINV launched a number of new “vertical” lending specialties. The parent invested a modest amount of new capital into AINV and waived some fees as a sign of support. At the time, AINV’s NAV was $8.45, as discussed in an article we published at the time. Unfortunately one of the “verticals” which AINV launched into in 2012 was energy. That worked out for a couple of years but when the oil price began declining in mid-2014, the BDC began to suffer a series of credit losses. Between June 2014 and the just announced December 2016 results, Realized and Unrealized Losses increased from $1.1bn to $1.55bn. NAV per share dropped from $8.74 to $6.86. Again, APO decided to implement a strategic shift. Again, equity investments were made in AINV’s stock and fees were temporarily waived in the first calendar quarter of 2016. Managerial changes were made in mid 2016, and the BDC announced that commodity and CLO investments would be jettisoned or greatly reduced and there would be a much greater emphasis on investing alongside other Apollo Global funds in the future.

In the past 3 months AINV’s stock price has been in a mostly wait-and-see mode in a generally positive market for BDC stocks. As the chart shows, the stock has traded in a 6% range from the level 3 months ago, and was just over 3% up before the earnings release, well below the BDC sector, which is close to 9% up in the period.  At January 31, 2017, AINV was trading at $5.86, or just over a dollar below NAV and a 15% discount to book. With the annualized distribution at $0.60, the yield was just over 10.0%. Net Investment Income in the quarter ended September 2016 was annualizing at $0.72, which implies that at $5.86, the price to recurring earnings was 8.1x.

RESULTS: Judging by the numbers alone, there was very little change quarter-to quarter between September and December 2016.  Net Investment Income Per Share dropped a penny to $0.17, Net Asset Value Per Share dropped by $0.09, Debt to Equity moved up slightly from 0.69 to 0.66x and the distribution was unchanged. Management made the case that much had been done to remake the BDC as promised in 2016:

Mr. James Zelter, Apollo Investment’s Chief Executive Officer, commented, “We believe that we have made considerable progress repositioning the portfolio, consistent with the strategy that we outlined last year. We have meaningfully reduced our exposure to structured credit and renewables. In addition, we funded three transactions entered into pursuant to our co-investment exemptive order during the quarter. Since receiving the order, we have entered into eight transactions including several in the March quarter.”

In the Company Presentation that accompanied the earnings, AINV pointed out that its exposure to “Renewables” (aka Energy) had dropped from 11.3% to 7.3% of total portfolio assets when a post quarter repayment of a loan is considered. Structured credits have dropped from 7.8% of the portfolio to 4.9% as several CLO investments were sold off.

DIVIDEND SUSTAINABILITY

We’re going to have a look at the earnings  and distribution outlook for the BDC in light of this new strategic direction.

There’s no doubt that “getting out” of so-called Renewables and CLO investments is going to reduce risk and volatility in the portfolio, even though there’s an element of closing the barn door after the horse/cow has already departed.

CONSEQUENCES

However, the other consequence is that the portfolio yield is going to trend lower as well.

After all, the attraction of both Renewables and CLOs was the fat, juicy yield that is involved.

For example, the GAAP yield on the MCF CLO III (see page 10 of the Q) is 20.4%.

The SHD Oil & Gas Tranche C Note is yielding 12.0%. Tranche A is at 14.00% (8% Cash and 6% PIK). See page 12 of the Q.

TRADE-OFF

Those sorts of assets are going to be replaced with Apollo Global platform generated asset based loans and slivers of bigger loans with yields of 9% or so.

Management is not hiding the fact that they expect-as a trade-off for seeking out a “safer” portfolio-new loan yields and the overall AINV portfolio yields are headed lower.

We expect-based on what management is saying and knowing the yields of the kind  of debt the BDC is targeting, that the gross yield on AINV’s portfolio will drop by as much as 10%.

As of December 2016, the portfolio yield was 10.9% and could drop to 9.8% in a year (or two).

THE HIT QUANTIFIED

That could reduce interest income running at a $223mn annual pace in the latest quarter to drop by $22mn.

TEMPORARY

Moreover, should Apollo Global’s temporary fee waivers not be renewed,  another $21mn of boost to earnings could melt away.

IT ALL ADDS UP

Put those two numbers together and you’ve got over $40mn in potentially lower Net Investment Income for shareholders.

With 220mn shares outstanding, that’s $0.18 a share that’s at risk for shareholders versus a “running rate” Net Investment Income Per Share at December 2016 of $0.68.

That would bring down the annual Net Investment Income Per Share to $0.50 versus a distribution of $0.60.

OFFSETS

To their credit AINV is undertaking massive stock buy-backs, although we’d argue the money would be better used paying off expensive Baby Bond debt.

That will reduce the number of shares that need to be paid a distribution.

Moreover, there is some room to increase leverage on the balance sheet (everybody else is doing it !) and so boost earnings.

As discussed on the Conference Call, materially higher LIBOR rates might also boost earnings down the road.

OTHER DIRECTION

On the other hand, there are still many Watch List borrowers in AINV’s portfolio that could yet go from paying currently to non accrual.

We will review the subject in greater detail when we undertake a “credit snapshot” of the latest portfolio.

CONCLUSION

Although AINV only recently reduced its distribution from $0.20 to $0.15 a quarter (back in September 2016), we have doubts about its sustainability in the short term (i.e. the next 12 months).

The next distribution has already been fixed for the current quarter:

On February 3, 2017, the Board of Directors declared a distribution of $0.15 per share, payable on April 6, 2017 to shareholders of record as of March 21, 2017.

Our analysis suggests, though, that a year from now (or even before) AINV might have to cut the distribution to $0.125 a quarter or lower, a 17% or greater cut.

If that should happen, the stock price might follow, dropping to $5.0 or below.