Fitch Affirms Apollo's Ratings at 'A-' Following Announced Investment in AR Global; Outlook Stable
Today, Apollo announced its intention to acquire a majority ownership interest in AR Global Investments, LLC, which will own substantially all of the on-going asset management business of AR Capital (ARC), for $378 million, consisting of $200 million of cash and $178 million of equity, along with future performance-related contingency payments. ARC is primarily a manager of yield-oriented funds for retail clients, including non-listed real estate investment trusts (REITs) and business development companies (BDCs) with approximately $19 billion of aggregate assets under management (AUM) as of June 30, 2015.
Concurrently, Apollo announced an agreement to acquire RCS's wholesale distribution business for $15 million in cash. Apollo will also be purchasing $25 million in newly issued preferred stock in RCS. As part of the transaction, Apollo has also entered into a strategic relationship with RCS's retail wealth management business, Cetera Financial Group.
KEY RATING DRIVERS
IDRs AND SENIOR DEBT
The rating affirmations reflect Apollo's strong competitive position as a global alternative investment manager; its experienced management team; solid investment track record; large investor base; predictable management fee stream, given significant fee-earning assets under management (FAUM) and limited exposure to assets that earn fees based on net asset value; incentive income-generating capability; relatively low leverage; solid liquidity; and the subordination of general partner interests to outstanding indebtedness.
Rating constraints include large exposure to affiliate Athene Holding Ltd. (Athene), which accounts for a meaningful percentage of management fees and introduces potential regulatory and reputational risks, and the recentness of Apollo's business achieving scale, which means the sustainability of margins is unproven over time. General rating constraints for the alternative investment management industry include 'key man' risk, which is institutionalized throughout many limited partnership agreements, reputational risk, which can impact the company's ability to raise future funds, and legal and regulatory risk, which could alter the alternative asset space.
While Fitch believes the ARC/RCS investment may provide strategic benefits to Apollo over the longer term, in the near-term, it is expected to introduce execution risk, associated with achieving envisioned business synergies and scale, and potentially, elevated leverage, should the purchase price be funded with borrowings. Fitch also notes that the non-listed REIT space, and ARC in particular, have recently attracted increased regulatory scrutiny which could potentially impact ARC's business model going forward.
The strategic investment in AR Global Investments, LLC is expected to add some scale to Apollo's existing real estate strategy, which had $10.6 billion of AUM at June 30, 2015 and has yet to contribute positively to core operating earnings on a consistent basis, as measured by management business economic net income. The investment will also increase AUM in the form of permanent capital vehicles, as ARC's AUM consist largely of non-listed REITs and BDCs, which Fitch believes can provide enhanced predictability of fees over time and the potential for margin expansion, given the scalability of the permanent capital base. Pro forma for the transaction and based on June 30, 2015 figures, assets managed in permanent capital vehicles would represent more than half of Apollo's AUM.
The investment in RCS is expected to broaden Apollo's distribution capabilities, allowing the firm to more directly access retail investors. This has been an area of focus for alternative investment managers in recent years as defined benefit plans continue to be replaced with defined contribution plans. Direct access to retail investors could allow Apollo to grow its FAUM more quickly, particularly in credit, which accounted for 72% of the firm's FAUM at June 30, 2015. Fitch believes growth in FAUM would yield higher fee revenues and provide an ability to scale certain credit strategies for additional margin expansion. Following the transaction, Apollo estimates that the retail channel will represent about 20% of Apollo's AUM.
Fitch believes Apollo's liquidity profile is sound. Apollo's cash balance amounted to approximately $838 million at June 30, 2015, which is more-than-sufficient to fund the cash investment in the announced acquisitions of approximately $250 million. The firm also had $500 million of availability on its corporate credit facility. Claims on corporate liquidity include unfunded commitments to the various funds, which were approximately $690 million at 2Q15; although Fitch believes the company has significant discretion over the timing of funding commitments. Apollo distributed approximately 90% of its distributable earnings in 1H15, but Fitch believes the firm could reduce its payout ratio to boost its liquidity profile, as necessary.
Apollo's leverage, as measured by corporate debt divided by fee-related EBITDA (FEBITDA), was 2.74x at June 30, 2015 on a trailing 12 month (TTM) basis, which was below the 'A' category average of 3.5x. Assuming the cash portion of the investment ($250 million) is funded with long-term debt, leverage would increase to 3.41x, all else equal. However, the ownership stakes in ARC and RCS would be expected to generate incremental FEBITDA for the firm.
Fitch believes the firm's consolidated leverage ratio will be managed in-line with the agency's general tolerance level for 'A' category firms of 2.5x longer-term. Therefore, leverage would be expected to be reduced, post-acquisition, by incremental earnings from the investment, organic growth in the core business, and the realization of scale and distribution benefits from the investment in ARC and RCS. Were this not to be achieved, ratings could be pressured.
The Stable Outlook reflects Fitch's expectations that management will continue to generate stable management and advisory fees, grow/retain FAUM through the raising of new and expansion of existing funds, albeit at a much more moderate pace near-term, sustain recent operating margins, operate with relatively low leverage, and retain a solid liquidity profile in order to meet near-term debt maturities and co-investment commitments to funds.
RATING SENSITIVITIES
IDRs AND SENIOR DEBT
Declines in investment performance, a key man event, and/or legislative risk which negatively impact the company's ability to raise FAUM and generate fees, sustained increases in leverage, and/or impairment of the liquidity profile could result in negative rating action. Furthermore, ratings could be adversely affected if the relationship between Apollo and Athene were to materially change as a result of regulatory scrutiny, outsized fines/penalties or loss of management or sub-advisory fees.
Conversely, positive rating momentum could develop from a demonstrated ability to operate at the current size, scale and margin level over an extended period of time. An increase in fee diversity, lower leverage, and/or stronger liquidity would also be viewed favorably.
Apollo is a global alternative investment manager specializing in private equity, credit and real estate. FAUM amounted to $128.2 billion at June 30, 2015 and total AUM was $162.5 billion. The company's Class A shares are listed on the NYSE under the ticker 'APO'.
Fitch has affirmed the following ratings:
Apollo Management Holdings, L.P.
Apollo Management, L.P.
Apollo Capital Management, L.P.
Apollo International Management, L.P.
AAA Holdings L.P.
Apollo Principal Holdings I, L.P.
Apollo Principal Holdings II, L.P.
Apollo Principal Holdings III, L.P.
Apollo Principal Holdings IV, L.P.
Apollo Principal Holdings V, L.P.
Apollo Principal Holdings VI, L.P.
Apollo Principal Holdings VII, L.P.
Apollo Principal Holdings VIII, L.P.
Apollo Principal Holdings IX, L.P.
Apollo Principal Holdings X, L.P.
ST Holdings GP, LLC
ST Management Holdings, LLC
--Long-term IDR at 'A-';
--Unsecured debt rating at 'A-'.
AMH Holdings (Cayman), L.P.
--Long-term IDR at 'A-'.
The Rating Outlook is Stable.
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