|Shares Out. (in M):||76||P/E||0.0x||0.0x|
|Market Cap (in $M):||2,443||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||0||EBIT||0||0|
Long AAA NA: AP Alternative Assets (“AAA”) has units that trade OTC in the USA under the symbol APLVF, but the company's units primarily trade in Amsterdam under the symbol AAA NA.
Write-up with graphics is posted in below link:
AP Alternative Assets has been written up before on VIC, but I thought I’d provide my own update, as I think the risk-reward at the moment is particularly attractive. I’ll provide a preliminary overview here, but please refer to the previous write-ups for further context.
AP Alternative Assets (AAA) is an Apollo-managed closed-end fund based in Guernsey which was set up originally as a vehicle enabling retail investors to indirectly participate in Apollo private equity and other alternative asset funds (AAA collects an annual management fee and 20% carry). In late 2009, Apollo hired former SunAmerica President Jim Belardi, and with capital provided by AAA, founded Athene as a fixed annuity permanent capital vehicle. Fixed annuities, which provide long-term, sticky, fee-generating capital, are an ideal source of investable funds (i.e., AUM for Apollo). Jim Belardi is a renowned insurance company executive. While at SunAmerica in the 1990s, the stock was the best performer on the NYSE, appreciating 213x and eventually being sold to AIG for 6.6x book value. In 2011, AAA contributed substantially all of its assets into Athene in exchange for more equity (effectively making AAA a look-through share of Athene, though annoyingly burdened with management fees and carried interest). Since 2010, Athene has acquired four major fixed annuities businesses: Liberty Life (2010), Presidential Life (2011), Investors Insurance (2011) and Aviva USA (2013).
At the time of the previous write-ups, the Aviva acquisition ($45bn in assets, 3x the then-size of Athene) was pending and undergoing various regulatory reviews. The acquisition closed in October 2013 and, since then, Athene has been undergoing a complex integration process. In addition to closing the Aviva acquisition, Athene announced an additional capital raise of $1.3bn that was completed this summer at $26 per Athene share (~$29.50 per AAA share; ~$27.90 per AAA share after APO carry). The proceeds of the offering will be used to shore-up Athene’s capital base in order to obtain a credit rating upgrade, as well as possibly be used as dry power for future M&A.
Athene represents a compelling opportunity on both an absolute and relative valuation basis. The current opportunity exists for a number of reasons including: no research coverage, small and illiquid float, complex situation, and limited financial disclosures. All of these issues will disappear when Athene goes public, likely in 2015.
Based on my estimate of normalized earnings and a below-peers P/E of 10x, I believe that AAA is worth $45.00 per share (~41% appreciation). My upside case (50% of equity raise is used for another acquisition that yields a 20% ROE) and 11x P/E (in-line with comps), AAA is worth $53.50 per share (~67% appreciation from current).
Background / Business Model
A fixed annuity company can be conceptualized as a “net spread” business; it borrows in the form of annuities (either traditional fixed or fixed index) at a very low cost for long durations (protected by surrender charges), and invests the proceeds in primarily investment-grade credit assets. Products are typically marketed to individuals (i.e., retirees) by independent marketing organizations (IMOs) where insurance agents receive hefty commissions. The industry is fairly competitive and through-cycle ROE is in the low teens (~10-13%). In addition, fixed annuity businesses require high amounts of leverage (typically in excess of ~10:1 assets-to-equity).
Athene was founded in 2009, which fortuitously happened to coincide with a global regulatory push, in Europe in particular, where financial institutions were forced to raise capital, which resulted in a lot of companies in the fixed annuity business being sold at the same time (Fidelity & Guaranty sold by Old Mutual plc, Liberty sold by RBC, Aviva USA sold by Aviva plc, EquiTrust sold by FBL). This created an excellent buying opportunity for private equity players like Apollo and Guggenheim, which have been particularly aggressive over the last few years in assembling fixed annuity platforms.
Athene has been very successful in aggregating and consolidating four fixed annuities businesses under a world-class management team and is pursuing a strategy not too dissimilar from Warren Buffett’s Berkshire: find a platform that creates extremely low cost, long-term, sticky liabilities (“float”) and on the asset side, strategically invest in assets with higher yields (typically fixed income with a small alternatives allocation). Because of the long duration and sticky nature of Athene’s liabilities, it does not need to buy assets with CUSIPs (i.e., liquid assets). It is built to handle illiquidity and Athene’s current strategy is to redeploy Aviva’s acquired assets (investment-grade CUSIP bonds), into products that have “more value” such as investment-grade non CUSIP securities (Apollo’s Mark Rowan explains, see below).
“And I'll give you one example, just to capture the imagination on dislocation. We look at -- we have a very good practice in insurance. And we will not surprise you, we're big investors in insurance-linked securities. So you take a typical insurer like Aegon or ING, who are investment-grade issuers whose investment-grade holding company paper trades in the 3s. Their more highly-rated, structurally senior, more complex, less liquid investment-grade securities can yield 6% or 7% in the same issuer. I can earn almost twice the return with less risk by moving down the liquidity spectrum. For an account like Athene, that is an ideal situation. And what I like is, on the one hand, Athene's liabilities are priced relative to investment alternatives available to consumers, think CDs. So rates are very, very low. On the other hand, their assets don't have to be liquid, but they do have to be highly rated. And this bank cycle, this bank rotation that I've been talking about, is a source of tremendous amount of products for the Athene to the world, as well as for our pension fund clients. And I do think that's the biggest opportunity in front of us. It is not the alternative credit opportunity.” – Mark Rowan at the GS Financial Services Conference in December 2013
In addition to strategic asset allocation, Athene is structured to be highly tax efficient (more on that later) and will reap large cost synergies by consolidating headcount and office locations of acquired platforms. To sum it up: Athene has successfully become one of the largest and most profitable players in the fixed annuity industry by acquiring inefficient, undermanaged operators and more opportunistic M&A is almost sure to follow.
For an overview of Athene’s business model, check out the below presentations on AAA’s website:
Original Athene Presentation – contains investment thesis and high-level unit economics
Update post Aviva-closing
AAA Update / Investment Catalyst
The previous VIC write-ups focused on closing the Aviva acquisition as a catalyst. The acquisition closed about a year ago but AAA’s unit price has not moved much (up ~15%). I think the reason why the price has stagnated is due to the primary equity offering that was announced in January 2014 (originally $500mm, but expanded to $1.3bn). This offering was highly dilutive to existing Athene shareholders (AAA in particular), especially if you assume none of the capital will be deployed in a value-enhancing acquisition. Despite this ostensible per-share value destruction, I think Athene (via AAA) represents a compelling investment opportunity. I believe that an IPO is imminent (probably mid 2015) and that the true earnings power of the business will be fully revealed at that time. In addition, although the equity raise was dilutive, the much stronger capital position should provide Athene a more attractive IPO valuation and give the company flexibility should opportunistic M&A arise.
The pre-IPO capital raise (~$1.3bn) was 20% funded in Q2 2014 and will be fully drawn within 12 months of initial closing in April 2014. Management has stated that the capital raise is meant to strengthen the company’s balance sheet, give it flexibility in pursuing additional strategic M&A, and achieve a ratings upgrade. In particular, an AM Best upgrade from B++ to A- (“Good” to “Excellent”) would likely open up new distribution channels that Aviva had access to prior to its acquisition by Athene. Note that Aviva’s closest competitor Fidelity & Guaranty (NASDAQ:FGL) also has a B++ rating.
Delayed Release of Financial Results
Athene typically releases its quarterly financial results to AAA unitholders ~6 weeks after the end of the quarter, but Q2 2014 results have been delayed in order to remediate “material weaknesses in internal controls.” At face value, this sounds really bad, but keep in mind Athene is a private company and Aviva was not a GAAP filer. In the context of a private company in the process of preparing for an IPO and implementing public company, SOX compliant standards, I don’t think this is a huge risk factor. Athene received a clean 2013 audit, but was notified of material weaknesses in controls (all previously disclosed in early 2014), which the company has been addressing. See below commentary from the Q1 ’14 earnings call.
“So we're using this integration as an opportunity to upgrade the combined accounting systems with a goal of being able to meet public company reporting requirements before the end of 2014. We're on track to meet that goal. However, even though Athene received the clean audit opinion for its 2013 statements, did inherit two material weaknesses in control, one for reserves and one for taxes. We do have a plan in place to remediate both of those deficiencies in 2014.”
Athene has made accounting restatements before, so this is nothing new. I think the most likely reason for the delay is to allow for the final closing of the primary equity offering at the (undervalued) current Apollo mark on Athene. If Athene releases good results and provides more color on IPO timing, it could result in a rally in AAA unit price which could potentially complicate its final equity raise closing (which is Athene employees and “affiliates” (i.e., Apollo), so it’s not as if they are incentivized to get the best price). Lastly, I would note that Athene’s investment assets are disclosed in APO’s public filings and AUM was at $61.0bn on June 30, 2014 (up from $59.2bn on March 31, 2014). This is significant since only 20% of the initial closing commitment had been drawn (~$200mm), which implies organic investment asset growth in the quarter of ~$1.6bn (~11% annualized asset growth).
Valuation & Returns
Current Valuation / Apollo Mark
Athene shares are currently marked at $26.00 per share by Apollo (based on the most recent capital raise). This price implies a P/E of 5.7x my normalized earnings estimate, 1.22x P/GAAP BV (ex-AOCI, pro forma for capital raise), and 0.78x P/Stat BV (pro forma for capital raise). P-GAAP life insurance accounting is highly complex. At a very high level, in P-GAAP accounting, both assets and liabilities are marked to FV in an acquisition, whereas in stat accounting, assets are marked to FV, but liabilities are marked at actuarial value. This creates a large, but temporary delta in stat and GAAP book value. Athene management explains, “the gap between statutory capital and GAAP book value is expected to appreciably narrow over time as GAAP book value approaches statutory capital.” Hence, I think it’s important to think about valuation from both a GAAP and stat perspective. I included a deeper discussion of this in the appendix¹.
My base case takes Athene’s latest management-adjusted quarterly results (Q1 2014) and annualizes them to come up with a “run rate” earnings forecast. In addition, I make three normalizing adjustments.
The above adjustments seem reasonable especially in light of commentary on the March 2014 conference call when they stated that Q4 2013 investment income of $663mm was “close to kind of a fixed income run rate going forward.” After making all of the adjustments I highlighted above, my quarterly run-rate figure comes out to only $650mm (and this includes the added benefit of deployment of the equity capital yet to be drawn).
Trading Multiple / Comps
In terms of trading multiple, Athene’s closest comps (in decreasing relevance) are Fidelity & Guaranty (FGL), American Equity (AEL) and Symetra (SYA), which all operate in the fixed annuity space, though SYA has a more diversified business than FGL and AEL. The three companies currently trade at 10.9x and 11.3x, and 12.8x NTM P/E, respectively. Note that multiples in this space are at high levels relative to history (in 2009, AEL traded at average NTM P/E of 4.0x, and pre-crisis AEL traded in 7.5-9.0x NTM P/E range). SYA went public in 2010 and since then its average NTM P/E has been 9.4x. In recent quarters, multiples across the space have increased as the outlook on the retirement services industry has improved. Industry-wide annuity sales are increasing rapidly, ROEs are recovering, and rising rates will increase the appeal of annuity products. The base case assumes a 10.0x NTM P/E for Athene, which is justifiable given the recent capital raise, tax efficient structure, and best-in-class management team.
With the normalizing assumptions I’ve made above, assuming a 10% effective tax rate and a P/E of 10.0x applied to earnings of ~$4.50 per Athene share, AAA will be worth ~$45.00 when the company goes public next year (~41% from current).
[See link for graphic]
I believe there is a reasonable probability that Athene completes another acquisition, especially given this is management’s stated strategy and they just raised $1.3bn (vs. $500mm original target). Assuming the company uses 50% of the equity raise to complete an acquisition with a 20% ROE, and Athene is valued at 11.0x P/E at IPO, AAA shares would be worth ~$53.50 per share (~67% from current).
[See link or graphic]