AP Alternative Assets L.P. AAA NA
September 02, 2014 - 9:35am EST by
sas7
2014 2015
Price: 31.99 EPS $0.00 $0.00
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
TEV: 0 TEV/EBIT 0.0x 0.0x

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  • Private Equity (PE)
  • Reinsurance
  • Life Insurance
  • Listing
  • Retail Shareholder Base
  • Transformation
  • Rollup
  • Tax Inversion
  • Great management
  • Discount to Peers
  • Regulatory Downside Risks
  • Special Situation
  • Underfollowed
  • Potential IPO
  • Compounder
  • secular tailwinds
 

Description

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:

https://drive.google.com/file/d/0ByBNCkJEkQSDZUZqRmd6LTZQTFE/edit?usp=sharing

 

Situation Overview

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

http://www.apolloalternativeassets.com/ViewDocument.aspx?f=MHAR_AAA_Presentation_2_6_13.pdf

Update post Aviva-closing

http://www.apolloalternativeassets.com/ViewDocument.aspx?f=TLJU_Information_for_AAA_Investors_on_Athene_(March%202014).pdf

Latest

http://www.apolloalternativeassets.com/ViewDocument.aspx?f=GOVC_Information_for_AAA_Investors_on_Athene_(June2014).pdf

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).

Investment Thesis

  • World-class management team.  Jim Belardi led Sun America through the 1990s and built one of the most successful retirement services companies in the US (in 1998 Sun America was acquired by AIG and is currently part of AIG Retirement Services). Athene’s management team is highly focused on risk management (they duration and maturity match, unlike some competitors) and they take no foreign currency risk. The following comment from Jim Belardi in November 2013 summarizes the company’s philosophy: “We are not volume driven. We will only add business if it meets our return objectives, whether that’s in the retail space, in the institutional space or in M&A activity. If we can’t make our returns, we won’t do it.” This comment is consistent with the company’s track record.  Annuity sales are down vs. pre-Aviva peak, but profitability (as measured by ROE) is by far the highest in the industry.
  • Athene is a tax inversion play.  I have not seen this mentioned in other write-ups or by Athene’s management team (other than very high level “our corporate structure brings efficiency on tax”), but I believe one of Athene’s largest advantages is its tax structure. Because Athene Holding Ltd is domiciled in Bermuda and a Bermuda subsidiary (Athene Life Re) reinsures a substantial portion (~80%) of all in-force and new business, Athene’s effective tax rate is much lower than its US-based competitors (2013 tax rate: 5.8%; 2012 tax rate: -3.7%).  The favorable tax position will support the above industry average ROE target in the management presentation, as well as provide the company a cost advantage in writing new business. In my base case, I’ve assumed a 10% effective tax rate (which implies 25% of pre-tax income is US-based and taxed at a 40% rate; Bermuda has no income tax). Assuming US peers generate a through-cycle ROE of ~11.5% (consistent with history), the pre-tax industry ROE would be ~19.2% and Athene’s through-cycle ROE (at 10% tax rate) would be ~17.3%, consistent with “high teens run-rate ROE” commentary from management. Athene is a highly attractive investment due to its ability to sustainably compound capital at mid-teens returns due to its structural tax efficiency relative to the industry.  Athene has not provided guidance on its future tax rate, but has stated that “Over time, the business mix between Athene’s U.S. subsidiaries and Athene’s Bermuda subsidiary will determine the blended tax rate reported in Athene’s financials.”
  • No research coverage. Limited liquidity.  The opportunity exists because (i) limited liquidity suppresses hedge fund involvement, (ii) no research coverage results in limited retail investor interest and (iii) the situation is complex, the life insurance industry is characterized by arcane accounting policies and management has been non-transparent in its investor disclosures.
  • IPO as catalyst.  There is a high likelihood that Athene will IPO in 12-18 months. The company has stated its intent to IPO many times, including in disclosures to regulators. Upon IPO, there will be a lock-up on AAA shares for 7.5 months, after which AAA will commence a wind-up tender offer. Unitholders that do not tender will receive a distribution of their pro rata portion of common shares of Athene as such shares are released from contractual lock-up over a period of 7.5-15 months following Athene’s IPO. It is important to note that AAA will remain a publicly-traded vehicle after the IPO (and until wind-up), so AAA investors will continue to have liquidity despite the lock-up.
  • Favorable demographic trend.  Demographics and macroeconomic factors are increasing the demand for FIA products, for which demand is large and growing: over 10,000 people will turn 65 each day in the United States over the next 15 years. According to the U.S. Census Bureau, the proportion of the U.S. population over the age of 65 is expected to grow from 14.8% in 2015 to 20.3% in 2030. Due to turbulence in the stock market in 2007 and 2008, many middle-income Americans have grown to appreciate the security these indexed products afford. As a result, the FIA market grew from nearly $12 billion of sales in 2002 to $34 billion of sales in 2012.
  • Long-term compounder.  Athene’s management team is positioning Athene to be one of the largest and most profitable retirement services companies in the US.  Management is in the process of redeploying the ~$45bn of assets acquired from Aviva into higher-yielding assets and increasing portfolio yield (which flows directly to the bottom line; I have assumed no additional redeployment in the base case, other than investment of excess cash). In addition, Athene is growing its reserves through issuance of new annuity policies (target is ~$3bn of annuity sales this year), and sales will rise further if Athene receives a ratings upgrade, which provides access to additional distribution channels. Prior to the Aviva acquisition, Aviva USA was writing ~$4bn of FIAs per year with #2 market share in 2012 and 2011 (vs. #5 currently). The most recent data is highly encouraging: industry-wide FIA sales were up 37% YoY in Q2 2014 (and up ~9% vs. the previous record quarter which was Q4 2013). Increasing annuity sales provide Athene the opportunity to compound internally generated cash flow at attractive high-teens returns.  Although I anticipate Athene’s ROE to gradually decline from low 20s currently (largely a result of attractive acquisitions) to mid-to-high teens (run-rate on new business), this will happen over the course of several years and the growth in Athene’s book value will more than offset the decline in P/BV multiple that results from lower ROE over time. Jim Belardi summarized the long-term thesis well in Athene’s Q3 2013 conference call: “We do now have in place the infrastructure, the cost structure, [and] the man power to take advantage of exactly how this business was designed, which is to add significant amount of additional business with little incremental variable cost.”
  • Management and Apollo are investing heavily near current price.  Management and Apollo have participated heavily in the latest equity raise for Athene investing a combined $230mm (18% of $1.3bn total). At the per share value of Athene of $26, on a look-through basis to AAA the value is $29.46 ($27.87 net of carry) per unit compared to a trading price of $31.99 currently.  This means that investors in AAA are paying a 8.6% premium (15% net) to insiders, but the premium implicit in AAA units is partially justifiable given the enhanced liquidity profile. In addition, I think the $26 price per Athene share is far too cheap, as it implies only 5.7x my normalized earnings estimate of ~$4.50 per Athene share.

Investment Risks

  • Monoline business. Athene’s lack of diversification (heavily concentrated in fixed index annuities) is a risk as it exposes the company to adverse legislation or regulatory developments around the FIA space (which has had a history of controversy). The Harkin Amendment (passed in 2010) bans the SEC from regulating FIAs, which largely mitigates this risk.
  • Credit risk.  Given Athene’s high leverage level at 15.5x investments/equity (ex-AOCI), the company is particularly sensitive to credit events. Notwithstanding, Athene’s leverage is not crazy in comparison to its closest publically-traded comps (FGL at 14.1x and AEL at 24.4x investment assets /equity (ex-AOCI)).  Although Athene has a relatively aggressive asset allocation (with 7% of assets invested in alternatives), its RBC was 478% at year-end 2013 vs. 501% for FGL, 344% for AEL, and 458% for SYA.
  • Adverse tax ruling / legislation.  If the IRS or congress were to challenge Athene’s current structure, the pro forma tax rate would be significantly higher than today’s. Although there have been recent legislative proposals to close this “loophole”, I think it’s unlikely anything gets done outside the context of overall corporate tax reform. Looking at statistics on the percentage of bills that go from introduction to passage, the record is about ~2-3%. Of the ~9,700 bills introduced in the 113thCongress, only about 1.75% became law.  Of the~170 bills that became law, only 2 of those involved taxation (both introduced by Republicans).
  • Athene Asset Management (AAM) is not owned by Athene.  AAM which manages 100% of Athene’s assets is owned and consolidated by Apollo (including Athene management).  AAM charges an annual fee of 40bps on all AUM it manages, which in this industry is an enormous sum and represents a drag on ROE of 5.4% annually (40bps*(1-10% tax rate)*assets/equity of ~15x).  AAM also allocates a portion of AUM to Apollo funds (as of 6/30/14, 17% was sub-advised by Apollo), and from which additional fees are levied.  Perhaps after the IPO, Athene’s shareholder base will broaden and investors will demand better terms from Apollo.  Notwithstanding, it’s hard to argue that AAM and Apollo have not added significant value to Athene, despite the high fees.  The best managers are never cheap but often worth paying for. 

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.

Normalized Earnings

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.

  1. As of Q1 2014, AAA disclosed a 7% allocation to “Alternatives” with a target yield of 13% (for total exposure of ~$4bn). During the Q1 2014 conference call, management stated that their recurring / non-alternatives investment income for the quarter was $512mm (implying $67mm of investment income from alternatives, or an annualized rate of 6.5% on the $4bn allocation).  Assuming through-cycle Athene can generate a 10% return on its alternatives allocation (vs. 13% target), normalized annual alternatives investment income would be ~$410mm (vs. the $270mm implied by the Q1 ’14 figure).
  2. As of Q1 2014, Athene disclosed a cash & equivalents allocation of 5% (~$2.9bn). My base case assumes that $2bn of that cash is deployed into higher yielding assets, consistent with management commentary: “In addition to selling down over time some of the investment grade corporates that we hold, we started the year intentionally with higher than normal cash and we will deploy that cash as well.  So if you look at where the portfolio is on March 31, across time you should see the cash and equivalents continue to get redeployed into our preferred structures and also the investment grade corporates.” I assume that $2bn is redeployed at a 3.5% incremental yield (vs. 3.9% overall portfolio yield) resulting in incremental annual earnings of $70mm.
  3. Athene is raising $1,278mm of primary equity (none of which was drawn at March 31, 2014).  Athene will use this capital to achieve a ratings upgrade, and perhaps use a portion of it to fund opportunistic M&A.  In my base case, I have assumed that Athene deploys 80% of the equity raise in its traditional fixed income portfolio and 20% into alternatives (for an all-in yield of 5.2%), resulting in incremental investment income of $66mm. I think this is conservative, as it does not assume that Athene can find an M&A opportunity, despite management’s assertion that one of the purposes of raising the capital is M&A. 

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.

Base Case

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]

Upside Case

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]

 

 

I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

AAA is basically a look-through share of Athene (non-public Apollo insurance company). At $32 per AAA unit, Athene is only valued at ~6x normalized earnings. When Athene IPOs in 2015, shares will rerate toward a more typical ~10x P/E multiple with considerable earnings upside as the company looks to deploy the ~$1.3bn of primary equity raised in H1 2014.
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    Description

    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:

    https://drive.google.com/file/d/0ByBNCkJEkQSDZUZqRmd6LTZQTFE/edit?usp=sharing

     

    Situation Overview

    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

    http://www.apolloalternativeassets.com/ViewDocument.aspx?f=MHAR_AAA_Presentation_2_6_13.pdf

    Update post Aviva-closing

    http://www.apolloalternativeassets.com/ViewDocument.aspx?f=TLJU_Information_for_AAA_Investors_on_Athene_(March%202014).pdf

    Latest

    http://www.apolloalternativeassets.com/ViewDocument.aspx?f=GOVC_Information_for_AAA_Investors_on_Athene_(June2014).pdf

    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).

    Investment Thesis

    Investment Risks

    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.

    Normalized Earnings

    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.

    1. As of Q1 2014, AAA disclosed a 7% allocation to “Alternatives” with a target yield of 13% (for total exposure of ~$4bn). During the Q1 2014 conference call, management stated that their recurring / non-alternatives investment income for the quarter was $512mm (implying $67mm of investment income from alternatives, or an annualized rate of 6.5% on the $4bn allocation).  Assuming through-cycle Athene can generate a 10% return on its alternatives allocation (vs. 13% target), normalized annual alternatives investment income would be ~$410mm (vs. the $270mm implied by the Q1 ’14 figure).
    2. As of Q1 2014, Athene disclosed a cash & equivalents allocation of 5% (~$2.9bn). My base case assumes that $2bn of that cash is deployed into higher yielding assets, consistent with management commentary: “In addition to selling down over time some of the investment grade corporates that we hold, we started the year intentionally with higher than normal cash and we will deploy that cash as well.  So if you look at where the portfolio is on March 31, across time you should see the cash and equivalents continue to get redeployed into our preferred structures and also the investment grade corporates.” I assume that $2bn is redeployed at a 3.5% incremental yield (vs. 3.9% overall portfolio yield) resulting in incremental annual earnings of $70mm.
    3. Athene is raising $1,278mm of primary equity (none of which was drawn at March 31, 2014).  Athene will use this capital to achieve a ratings upgrade, and perhaps use a portion of it to fund opportunistic M&A.  In my base case, I have assumed that Athene deploys 80% of the equity raise in its traditional fixed income portfolio and 20% into alternatives (for an all-in yield of 5.2%), resulting in incremental investment income of $66mm. I think this is conservative, as it does not assume that Athene can find an M&A opportunity, despite management’s assertion that one of the purposes of raising the capital is M&A. 

    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.

    Base Case

    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]

    Upside Case

    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]

     

     

    I do not hold a position of employment, directorship, or consultancy with the issuer.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    AAA is basically a look-through share of Athene (non-public Apollo insurance company). At $32 per AAA unit, Athene is only valued at ~6x normalized earnings. When Athene IPOs in 2015, shares will rerate toward a more typical ~10x P/E multiple with considerable earnings upside as the company looks to deploy the ~$1.3bn of primary equity raised in H1 2014.

    Messages


    SubjectAthene ipo
    Entry10/13/2015 12:35 PM
    Memberblaueskobalt

    Seems like an interesting time to revisit this one.  Athene now has their post-Aviva GAAP financials in order and they are tracking for an S1 filing in early 2016.  AAA shares trading at ~6.9x LTM adj. earnings per share. 


    SubjectRe: Re: Athene ipo
    Entry10/13/2015 03:35 PM
    Memberblaueskobalt

     

    Sure.  Pulling the #s from some recent Athene statements:

     

    http://www.athene.bm/financial-statements/ 

     

     

     

    Earnings:

     

    2014 Operating Income after tax--$771m

     

    Less 1H 2014 Op income after tax--$368m

     

    Plus 1H 2015 Op Income after tax--$277m

     

    Equals LTM 6/30 Op Income after tax --$680m

     

     

     

    Average Shares:

     

    (133m shs 6/30/14 + 141m shs 12/31/14) / 2 = 136.95m avg 2H’14

     

    (164.3m avg shs 1H’15 + 136.9m avg shs 2H’14) / 2 = 150.6m avg shs LTM

     

     

     

    $680mm Op Income after tax / 150.6mm avg shares = $4.51 adj earnings per Athene share

     

    86.1mm Athene shares owned by AAA / 76.3 AAA units outstanding = 1.1284 Athene per AAA

     

    $4.51 x 1.1284 =  $5.09 of adj Athene earnings per AAA share

     

    $35 AAA price / $5.09 look through earnings per share = ~6.9x earnings multiple

     


    SubjectCap Raise
    Entry11/02/2015 01:40 PM
    Memberstraw1023

    blaueskobalt,

     

    Was the April 2015 draw on the April 2014 capital commitment raise done to acquire Delta Lloyd? Or was it done to strengthen balance sheet for existing business? Or some combination?

     

    I am trying to figure out what the true share count (or capital) is for the LTM business. You simply take the average, but if capital used for acquisition, it was pretty much dead capital and so should not be counted. However, it was done to strengthen balance sheet for existing busines, then it should pretty much fully count.

    Thoughts on this issue?

     

    Thanks

     

     


    SubjectRe: Cap Raise
    Entry11/02/2015 07:14 PM
    Memberblaueskobalt

    As I understand it, the capital draw was primarily to pay for the acquisition. 

    This is consistent with the overall timing of each step.  In the private placement, they said they were raising capital to fund pre-IPO growth opportunities.  They raised the money in 2014, but didn't draw it.  They announced the German deal in Q1 2015, drew down the capital in Q2 and closed the deal at the end of Q3.

    So, while they got some ratings benefit from having done the private placement, I think it was primarily there for dealmaking. 

     


    SubjectCarry and Post-IPO Dynamics
    Entry11/03/2015 01:07 PM
    Memberstraw1023

    blaueskobalt,

     

    Thanks for your answer regarding the Capital Raise. I agree, and if we are correct, the share count you used is actually too high as that capital is dead until the acquisition.

     

    So now my question relates to the fairly complicated dynamics surrounding Apollo, AAA, and Athene IPO. 

     

    If I understand the docs correctly, AAA no longer pays Apollo a mgmt fee. That ended on Dec 31, 2014. However, a 20% carry is still in effect. Correct?

    And then I am very confused by the 8% hurdle. Is there an 8% hurdle (with a catch-up provision) on the carry? And is that 8% hurdle applied off the $19 price in June 2006? Where are we with respect to the carry and the 8% hurdle? The current NAV is just below the 8% hurdle (if I am calculating correctly). Is there a huge catch-up provision about to kick in?

     

    Upon an Athene IPO, I am reading about a Wind-Up Tender offer but confused as to exactly how this plays out in terms of timing and value. I assume that this will result in the eventual unwind of the AAA structure and AAA unitholders will receive Athene shares, correct?

     

    So perhaps we can just use a simple example . . . Let's say Athene IPOs and trades next year at $44.31 . . . which translates to $50.00 per AAA share based on your 1.1284 fraction.

     

    It seems to me that after the fees and carry, AAA shares will not receive the full 1.1284 shrs due to fees and the carry, but I admit I am confused by the language.

     

    When it is all said and done, assuming my Athene shr price, how many shares of Athene will each share of AAA receive?

     

    Thanks 

     

     

     

     

     

     


    SubjectRe: Carry and Post-IPO Dynamics
    Entry11/03/2015 07:25 PM
    Memberblaueskobalt

    I'm glad you asked, because the fee situation is one that is not as bad as many people seem to think. 

    For starters, as you point out, there is no longer a management fee. 

    The GP is entitled to carried interest on the realized returns of AAA.  However, that does not apply to "Excluded Athene Shares".  The "Excluded" shares are the 48.3mm shares AAA received in the Nov 2012 transaction.  So, AAA pays the GP a 20% carry on ~37.8mm shares.  (That is the 86.1mm Athene shares held by AAA less the 48.3mm "excluded" shares.)

    The carried interest is paid in Athene shares.  So if Athene is worth $44.31 per share, and cost basis for the 37.3mm shares is roughly $15 (my best guess) then the GP will be granted roughly 4.9mm shares of Athene stock.  That will lower the ratio to ~1.064. 

    Once the IPO happens, AAA shareholders will receive distributions of Athene shares between 7.5 months and 15 months later.  That is it. (Because this won't happen until 2016, there are no longer any unwind fees payable.)

    The 8% hurdle applies to the voluntary "wind up tender offer".  I wouldn't worry about that.  It looks like a bad deal for AAA holders and they won't go through with it if less than 25% of AAA units participate.

     


    SubjectRe: Re: Carry and Post-IPO Dynamics
    Entry11/03/2015 08:30 PM
    Memberstraw1023

    blaueskobalt,

    Very helpful. Thank you for taking me through that. With that understanding, I am guessing you are getting fair value in low 50s and we have catalysts in the IPO (6 months) and the actual distribution of Athene shares (let's say 18 months).

    Seems compelling.

     

    Thanks


    Subjectupdated financials
    Entry12/17/2015 08:57 AM
    Memberblaueskobalt

    Athene released updated GAAP #s through Sept 30.

    Athene LTM after tax operating earnings of $722mm translates to $4.70 per AAA share (diluted).  Book value per AAA is $32.94. 

    So the shares are trading at 6.7x trailing earnings and 0.96x book value ex AOCI

    Balance sheet remains overcapitalized.  CEO commented that their portfolio has held up well and they see themselves as positioned to take advantage of market dislocations.

    IPO remains on track for 1H 2016. 

    Seems cheap.

     


    SubjectRe: updated financials
    Entry11/10/2016 06:51 PM
    Memberstraw1023

    blaueskobalt,

     

    Are you still involved with the IPO on tap?

    Any updated thoughts on valuation? Book value (ex AOCI) is higher but op profit has fallen a bit. 

     

    thanks


    SubjectRe: Re: updated financials
    Entry11/11/2016 03:59 PM
    Memberblaueskobalt

    Still like it. 

    Athene should be a 15-20% ROE business over time, with that goal made easier by the recent move up in rates.

    The company has lots of excess capital to grow organically or through M&A, demographic tailwinds, good management. All available at an attractive price. 


    SubjectRe: Re: Re: updated financials
    Entry11/11/2016 04:35 PM
    Memberstraw1023

    How are they going to enforce the lock-up on the 12.5% distribution at the time of the IPO? I do not believe I have seen a lock-up applied to ordinary public shareholders.

     


    SubjectCongrats
    Entry12/09/2016 11:44 AM
    Memberstraw1023

    blaueskobalt,

    Congrats. It has finally worked. The ATH valuation right where you had it (about 6 months late).

     

    It is still cheap, but going to be a discount for the lockup.

     

    Thanks

    Straw

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