Apollo Alternative AAA

March 23, 2017 - 12:50pm EST by

straw1023
2017 | 2018 | ||||||

Price: | 42.80 | EPS | 0 | 0 | |||

Shares Out. (in M): | 76 | P/E | 0 | 0 | |||

Market Cap (in $M): | 3,300 | P/FCF | 0 | 0 | |||

Net Debt (in $M): | 0 | EBIT | 0 | 0 | |||

TEV ($): | 3,300 | TEV/EBIT | 0 | 0 |

Trade: Go long 1 unit of AAA.NA at $42.80 and short 0.8894 shr of ATH at $50.65. I just executed at these prices concurrently.

This is an attractive arbitrage idea. +6.35% (versus long $ amount) over the next 7 months with no risk that I can imagine. As well, the arb has a very good chance of closing sooner than 7 months.

The volume on the long side (AAA.NA) is limited although we have been averaging about $200k of buying per day. So it is approproate for smaller funds only.

Basics:

-- The only asset AAA.NA owns is shrs in ATH. Note that the managing partner (Apollo) gets a carry on the shares. This carry is only on a fraction of the shares and is based off a strike price near $10 per Athene shr. The delta is 88.94% ATH shr per AAA.NA shr.

-- AAA.NA's ATH shares are locked up shrs. 1/3 are 225 days. 1/3 are 365 days. 1/3 are 450 days. These lockups are from Dec 9, 2016. As of today, this is an average of 8 months.

-- AAA.NA has stated many times that they will distribute the ATH shrs as the lock-ups expire and then shut down promptly. Note that they need no permission from Athene to do this. This is why the "deal risk" here is almost zero.

-- ATH shares are easy to borrow, and I have found borrow rate as low as 1.3%. The borrow cost is 1.3% * 88.94% * $50.65 * 7/12 = 34 cents.

-- the prices I am using were done with trades conducted concurrently as both Amsterdam and US exchanges open. ATH is fairly non-volatilie, but I adjust the risk accordingly to leg into trade.

-- AAA.NA will freely tell you that they expect ATH will waive the lock-ups and the shrs will be distributed well before an average of 8 months. They are well aware that ATH has traded strongly since its IPO on Dec 9, 2016.

-- And in fact, they have announced the first such acceleration. 22.5% of the ATH shrs (all from the 225 day lock up bucket) will be distributed as part of a Follow-On Offering. If you do not participate in follow-on offering, the ATH shrs you receive are immediately fungible with your ATH short. So this reduces the average time to "deal close" from 8 months to 7 months. I am assuming the Follow-on offering happens, but it could fail.

-- Other than their accelerating the ATH distribution, the only other unknown are admin expenses in running and winding down AAA.NA (and a series of other entities). I have spoken with AAA several times and while they will not give a definitive answer, they have told me the plan is to shut the entity down soon after the final distribution (less than a year from now) and that expenses should not be disproportionate to past admin expenses. I have estimated $15mm of expenses, or about 20 cents per shr until closing the entity.

Valuation:

As of 12/31/16, the FV of AAA.NA unit was $40.58 vs ATH = $44.49. Note that ATH closed at $47.99, but they use a 7.3% discount factor for the lock up.

At a delta of 88.94%, the current ATH price of $50.65 translates to a Dec 31, 2016 FV of $46.06.

But we need to subtract admin costs (20 cents) and borrow costs (34 cents) to arrive at true FV of $45.52.

Versus the actual $42.80 --> +6.35% for an average holding period of 7 months and almost no risk that I can imagine.

Risks:

- If I had to list risks, it would be that borrow in ATH goes away, but there is no shortage of borrow that I have found.

- Some massive fraud: AAA.NA does not actually own shrs of ATH

I do not hold a position with the issuer such as employment, directorship, or consultancy.

I and/or others I advise hold a material investment in the issuer's securities.

I and/or others I advise hold a material investment in the issuer's securities.

There is a built in catalyst as the lock-up periods expire.

Plus, there are possible accelerating catalysts as ATH waives the lock-up periods.

Subject | Re: dumb question |

Entry | 03/23/2017 02:54 PM |

Member | straw1023 |

that is due to the "strike" on the carry. Apollo does not earn carry until ATH above $10-ish (it is not exactly $10).
so just as value of a call option does not equal delta times stock . . . cannot do what you are doing.
make sense? | |

Subject | Re: Re: dumb question |

Entry | 03/23/2017 03:08 PM |

Member | straw1023 |

I will detail the numbers when I get back to office.
Off top of my head, I think about 76mm AAA units; 75mm ATH shrs held. But about 35mm of those ATH shrs subject to 20% carry when they are distributed above a strike of about $10. since ATH much, much higher than $10 . . . the optionality is deep-in-the-money.
delta is about 75mm - 35mm * 20% = 68mm shrs . . . 89%.
but note that value needs to take into account that $10 strike.
so FV is essentially the 68mm shrs plus the 20%*$10*35mm = $70mm so FV of AAA is essentially the 89% of ATH plus another 90 cents for the $10 strike.
But then take out future admin costs and the cost of borrow.
Make sense? | |

Subject | Detailed Numbers |

Entry | 03/23/2017 06:52 PM |

Member | straw1023 |

AAA units = 76,328,950 ATH shrs held as of 12/31/2016 (and present) = 74,639,776 The "strike" of the carry is $10.43. The number of ATH shrs on which carry applies is 33,762,867. Note that they have a tiny amount of assets not ATH shrs. And then do not forget about admin costs from 12/31/16 to total close (about 3/31/2018). I used $15mm. And do not forget about borrow costs on your short. I used 1.3%. I think if you run these numbers, you will tie into the penny on my numbers. | |

Subject | Re: Cost basis |

Entry | 03/24/2017 12:22 PM |

Member | straw1023 |

Leo,
This is a great question. First, I am not a tax expert but have run this by our accountant. 1) AAA.NA distribution of ATH shrs is NOT a taxable event to AAA.NA itself. They have already distributed shrs (in the IPO) with no tax consequences. If this is incorrect, this investment thesis is invalid and I will remove from Board. 2) For non-taxable funds, your question is not relevant so that even if inherit $10 basis, does not matter. Still a valid thesis. If tax basis in $10 AND relevant to non-taxable investors, this investment thesis is invalid for all investors and I will remove from Board. 3) For taxable funds, my understanding is that the partnership tax basis in ATH is not inherited. Instead, the investor's tax basis in the Partnership is the relevant tax basis. If I am wrong here, this investment thesis is invalid for taxable investors.
Please correct where I am wrong. I have gotten incorrect information before on these complex tax matters, but the advice and my reading of Partnership distribution tax law leads me to the above conclusions. | |

Subject | Re: Re: Re: Cost basis |

Entry | 03/24/2017 01:18 PM |

Member | straw1023 |

Leo, I think I understand your point, but I do not think that happens either. The IRS does not let you double dip on the tax basis by essentially adding both your tax basis in the partnership and the partnership tax basis in ATH. You would actually end up with a tax loss even though you have an investment gain. I do not think it works like that. I think the investor basis in the Partnership is the relevant tax basis. Look up Partnership distribution tax laws. Would love a follow-up for what you find, whether or not it agrees.
Thanks | |

Subject | Re: Re: Re: Re: Cost basis |

Entry | 03/25/2017 08:01 PM |

Member | straw1023 |

Leo,
I have a more detailed answer to the tax question. The key question is what distributions are liquidating distributions. I had thought that since all distributions (including December 2016) were part of an explicit and definite plan of liquidation, all distributions would be considered liquidating distributions. However, this might be wrong and only the final distribution may be considered the liquidating distribution. This is still an open question, but below assumes that only final distribution is liquidating. The effect is as follows: Non-liquidating distributions have the inherited tax basis, and your basis in the partnership is adjusted accordingly. But then the final distribution -- the true liquidating distribution -- will get the tax basis in partnership. Let's take an extreme example: the partnership basis in all ATH shrs is 0. And your tax basis in partnership is $100k. And they distribute all your shrs except one shr. Then the tax basis in all those distributed shrs except last one is 0. But then the tax basis in that one last shr when disributed will be $100k. So the result is that it might create capital gains in 2017 (from non-liquidating distributions with low basis) that are offset by capital losses in 2018 (as the final shrs end up with a high basis) because unless they accelerate lock-ups, the final liquidating distribution is scheduled for March 2018. This is still attractive to all investors, but a taxable investor must take into account the time value of money in these offsetting tax effects between 2017 and 2018. As well, I suspect that the final distibution will occur in 2017 as they accelerate the lock-ups.
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Subject | Re: Re: Re: Re: Re: Cost basis |

Entry | 03/27/2017 06:36 AM |

Member | Leo11 |

Thanks Straw. After reading through some law explanations I came to the same conclusion - assuming that ATH shares will not be considered as money due to the fact that AAA acquired these before IPO (so these were not marketable at the time). | |

Subject | Re: Re: Re: Re: Re: Re: Cost basis |

Entry | 03/27/2017 10:46 AM |

Member | straw1023 |

ATH shr distribution is certainly not considered money. It is an Other Distribution. For a taxable investor, the best way to play may be to set up the arb thru Dec 9. At that point, 2/3 of the value will have been distributed. And then close the position so that all the tax effects happen in 2017. Of course, you are then vulnerable as to whether the market has closed the gap of cheapness for that last 1/3 distribution. The company is reporting to me that the distributions before the final distribution will not be deemed liquidation. So it looks like my hypothesis is correct. I am still confused why all these distributions are not considered part of a plan of liquidation and all deemed to be liquidating. I have asked them for clarification and will let you know if they reply with a meaningful answer. One tax issue I am still researching is whether you will get LT cap gains on the shrs where you inherit partnership basis (because partnership has held for years), but then will get a ST cap loss on the final distribution in 2018. In this case, it is always good to generate LT cap gains and offsetting ST cap losses so holding on through the end might make sense even though cap losses in 2018 while cap gains in 2017.
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Subject | Re: Re: Detailed Numbers |

Entry | 03/28/2017 10:40 AM |

Member | straw1023 |

jwilliams,
You are making same error as Azia. See below. You are conflating the value with the hedge ratio.
The easiest way to see this is that the hedge ratio (but not the value) remains the same regardless of the the carry basis . . . the hedge ratio would be the same whether the stock was 5, 10, or 20. So long as the carry basis is significantly below the ATH price, the hedge ratio remains the same.
This is the exact same concept as saying that on a $50 stock, the hedge ratio of $10-strike call option is same as $20-strike call option. Their values are different (by about $10), but their hedge ratio (or delta) is the same.
So here, the proper hedge ratio is the 74.6mm ATH shrs less the 20% * 33.8mm = 67.8mm ATH shrs (versus 76.3mm AAA units) . . . .889 ATH shrs per AAA unit. Note that the "strike" does not enter into the calculation of the hedge ratio (so long as ATH is significantly higher than the strike). But note that strike does enter into calculation of AAA value.
See note 3 for more detail on same question.
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Subject | Re: Re: Re: Detailed Numbers |

Entry | 03/28/2017 11:29 AM |

Member | straw1023 |

error: I said "stock was 5, 10, or 20" . . . I should have said "carry basis was 5, 10, or 20"
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Subject | Re: Re: Re: Re: Re: Re: Re: Cost basis |

Entry | 03/28/2017 06:03 PM |

Member | straw1023 |

AAA has now confirmed that only the final distribution will be considered a liquidating distribution. I think they are making a bad decision and could make them all liquidating distributions, but they have politely declined my advice. | |

Subject | Re: Re: Re: Re: Detailed Numbers |

Entry | 03/28/2017 06:47 PM |

Member | straw1023 |

"As ATH’s share price goes higher, more ATH shares are allocated to AAA’s GP and fewer shares are available to AAA unitholders. So, the hedge ratio does change." Your first statement is correct. Your second statement is incorrect. As I explained in note #3, AAA unit holders will get 0.889 ATH shrs plus 90 cents. So at the current ATH price of about $50, this 90 cents is worth about .02 shrs. But if ATH rose to a trillion dollars . . . then, this 90 cents would be worth .000...0001 shrs. another way to see all this is take the math derivative of .889 ATH + 90 cents with respect to ATH . . . it is equal to .889. Again, I am pretty sure you are confusing hedge ratio with value.
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Subject | Re: ex-distribution today |

Entry | 03/29/2017 10:48 AM |

Member | straw1023 |

For those keeping track of the numbers to the nth decimal point, there are several things to keep track of to explain why the numbers do not tie out exactly. First, they are selling/distributiong shrs to pay for admin expenses. Second, and more importantly, for some reason they do not distribute carry/non-carry shares in strict proportion to the ratio they hold them. In this case, it appears they slightly over-distributed non-carry shrs versus carry shrs. I believe they may be doing this for tax reasons as the carry and non-carry shares have different tax basis to the Partnership. Third, one other issue is on what price do they pay the carry? I believe that here they will pay the carry on $48.50 secondary offering price, which is to our benefit as we get to pay the carry on lower amount. This is a very minor point but it does affect the numbers if you are tieing out exactly.
All this is very minor and you can adjust when they release updated NAV, but this is why the numbers do not tie out exactly. The key is that my valuation is driven off the company NAV (versus ATH) so my errors in the exact ratio of carry/non-carry is only a penny or two. | |

Subject | Re: Re: ex-distribution today |

Entry | 03/29/2017 12:09 PM |

Member | apacs |

Thanks again for the interseting idea. My count FV of AAA shares is ~$36.28 (55.4m ATH sahres + $70.4m in carry) so spread is now ~2%. I may be misunderstanding some of the math here, but pro forma for the distribution, the new hedge ratio is ~72.6%. It has been challenging getting liquidity on AAA, but continue to like this as an off the run and relatively risk free arb even at these levels and leakage from doing this on swap. | |

Subject | Re: Re: Re: ex-distribution today |

Entry | 03/29/2017 01:10 PM |

Member | straw1023 |

apacs,
I assume you are using $49.50 on ATH and that you are counting borrow and admin costs as I do . . . I have FV 10-15 cents higher than you. I believe that some of the admin costs were already subtracted here. Not sure if you took that into account. but generally agree with your assessment. I think it a positive that ATH still trading fairly well in light of the secondary. Makes me think we will see future follow-on offerings that will accelerate the lock-ups.
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Subject | Re: Re: Re: Re: Re: Re: Re: Re: Cost basis |

Entry | 04/05/2017 09:39 AM |

Member | straw1023 |

Leo, Where are you seeing this? Thanks | |

Subject | Re: Re: Re: Re: Re: Re: Re: Re: Re: Cost basis |

Entry | 04/05/2017 09:59 AM |

Member | Leo11 |

Brokerage accounts. Using IB. | |

Subject | Re: Re: Re: Re: Re: Re: Re: Re: Re: Re: Cost basis |

Entry | 04/05/2017 10:41 AM |

Member | straw1023 |

I would not trust your brokerage account treatment. The key will be the K-1, and AAA gave me unambiguous answers.
Also, the 2016 K-1 treatment is consistent with AAA's answers. The Dec 9 distribution was not treated as a liquidating distribution on 2016 K-1's.
I would prefer the treatment you are seeing from broker, of course, but I do not think it is correct. Either way, it still works. | |

Subject | Re: Re: Re: Re: Re: Re: Re: Re: Re: Re: Cost basis |

Entry | 04/05/2017 12:38 PM |

Member | cfavenger |

IB often oesn't get the tax basis on special situations right. If you think it should be something else then challenge them. I warn you from experience it will take daily persistence annoying them to get escalated to the point where they look at it. | |

Subject | Another Distribution Pre Lock Up; Shortening Time of Arb |

Entry | 05/24/2017 11:37 AM |

Member | straw1023 |

http://www.apolloalternativeassets.com/ViewDocument.aspx?f=TTMC_AAA_Investor_QA_5_22_17.pdf
This is good news as it reduces the avergae time for the arbitrage to take effect.
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Subject | Conclusion |

Entry | 03/19/2018 02:21 PM |

Member | straw1023 |

This arb ended up working out slightly better than expected. We received a total return (including cost of borrow on short) of 7%, and due to early distribution, we received the distribution in an average time of 7 months. |