Apollo Global Management, Inc. (APO) Earnings Call Transcript & Summary

Good morning, everyone, and welcome back to the BofA Future of Financials Virtual Conference. I'm Mike Carrier, the research analyst at BofA covering the brokers, asset managers and exchanges. I hope you're all doing well. Our next company up is Apollo Management. And with us today is Josh Harris, Co-Founder. Josh and the team had built Apollo into the leading alternative asset manager and the largest alternative credit manager in the world. Josh runs the day-to-day operations, and he's been responsible for some of the most successful private equity investments at Apollo. So Josh, thanks for being with us today. And before I kick it off, I just want to let the audience know that if you have a question that you would like to ask, just submit it to the portal. And then towards the end, I'll be able to ask those questions as well.

And so Josh, just given your kind of unique perspective across markets and economies, I wanted to first start with a bigger-picture question. So there's been fairly significant divergence from what we're seeing in the public markets and the real economy. Do you think that divergence makes sense, particularly if we're getting closer to a vaccine? Or should there be reasons for concern?

Yes. So first of all, Mike, it's a pleasure to see you virtually. And a pleasure to be here. Thank you for having us. So technicals definitely are driving well ahead of fundamentals. And it actually does make sense when you think about -- if you think about the economy, right, we lost 22 million jobs, we've got 12 million back. Unemployment is still just under 7%. And the COVID-affected industries, even though, obviously, the very welcome news of a possible vaccine has broken, it's going to be a slow grind back as that gets rolled out and so forth and so on. And so you would expect that markets would be below where they are today. The market -- stock market is up 7%. The leverage finance markets have recovered. But what's happened is that the Federal Reserve has leaned in so much that rates are well below historical levels. And so when you look at -- even though you look at a P/E, we'll use the stock market as an example, it's about a 22, 23 P/E. When you -- that seems elevated. But when you look at that relative to 0 rates or 90 -- 70 to 90 basis point treasuries, it's not that elevated. In fact, what we do is we compare the earnings yield on the S&P 500, which is about 6 -- there's about a 6% spread between that and real rates today on the 10-year, and that's pretty average. It's a little bit above average. So even though you see technicals driving fundamentals and it looks like the markets are ahead of fundamentals than they are, unless the Fed and the Bank of China, Bank of Japan, the ECB, unless they change their policies, in the 0 rate environment, it actually makes a lot of sense. And so we're all going to have to deal with 0 rates and what we perceive to be overvaluation, I think, going forward for a while.

Great. That's a good start and good macro color. Just on that front, like since you mentioned what the Fed has done and we've seen a lot of stimulus, whether it's been fiscal or monetary, and right now, we have low rates. But how do you think that eventually transitions, whether it's to inflation, a rate backdrop? And if we start to see more inflation going forward, how does Apollo, whether it's from an investment standpoint or from investors allocating money into alternatives, how do you think that plays out in that environment?

Sure. So first of all, I would say that, look, the Fed added $3 trillion to its balance sheet. That was as much as it added through the entire 10 years around the financial crisis of 2007, 2008, 2009. So you have seen an enormous move by the Fed, and there's -- and they've sort of signaled they're not going away. And so you would expect, right, with fiscal stimulus, with the Federal Reserve, with everything that's going on, you'd start to worry about inflation. But in actuality, there's a lot of slack in the economy. And what drives U.S. inflation and, to a lesser extent, global inflation is labor, generally. I mean there's some energy in there. There's some commodities. But by and large -- and as I mentioned, you still have 7% unemployment, which is roughly double where it was before we went into this. And you have continued -- even with all the trade war talk and other things, you still have globalization and countries where -- that are -- with very low-cost labor forces that are exporting goods into the U.S. And so I don't really believe that inflation is going to be much of an issue. I mean if it were an issue, then it would change everything. You would have a stagflation-type situation. But I feel like I don't believe that's going to happen. So I think we're in this -- the Fed has pretty much a freehand. It's got a dual mandate between unemployment and inflation. So it can continue to lean into lowering unemployment without much worry about inflation. You're still below the Fed's 2% inflation target. And as result, you're going to have 0 rates for a long time. And so what we're doing to combat that, right, is in a world that feels overvalued from a fundamental point of view is continuing to build out our private credit businesses. We're increasingly finding that we can generate a lot of excess return for our insurance company clients, our LP clients, 100, 200, 300, even 400 or 500 basis points of excess return all across the credit spectrum, whether it be a B credit, like we just did with Hertz, or whether it be a AA credit like we did with ADNOC. And so increasingly, our ability to originate private credit will be a huge advantage and something that we offer to our investors. We think there's a lot of tailwind there. I think also in private equity, we've got a two-pronged strategy. One is there is a bit of distress around. Obviously, these COVID-affected industries, and we can talk more about this, are going to have to go through some restructuring, and we're going to participate in that a bit. It's not broad-based. But we're seeing selected distressed opportunities. And even though the public markets are overvalued relative to fundamentals, as we discussed, we're seeing the bottom 25% of the public markets trading around a 10 P/E. So the markets no longer care about cash flow, right? I mean they care about growth, and that's what they're focused on. There used to be about 8,000 public companies. Now there's just over 4,000. There's 35,000 private companies. And so in many cases, the public markets aren't an appropriate home for even larger cash flow-oriented companies that might have -- might not be industry leaders or might have some complexity to their business. They might be in multiple business. They may not be in tech businesses. They may have some cyclicality. And so we see that as a good ground for doing deals. And we would expect our pipeline is building as is others, and we would expect to be announcing some stuff shortly.

All right. Great. And then maybe shift over into the private equity business. How has the portfolio been like operating just in this COVID backdrop, whether it's areas that have been making some headwinds and tailwinds? And as you do get a vaccine, you come out of this, how do you see the outlook starting to shift?

Yes. So our private equity portfolio, I think as we've said before, we're a bit different than some of the other players out there. We created Fund VIII, our sort of last fund that's fully invested at about 6.5x multiple of EBITDA. And that's much lower than the industry standard, which was about 10x. And we had much less leverage on it. The average player had about 6x leverage as a multiple of EBITDA in their portfolio and we had 3.5x. And so we went into the crisis with less financial leverage. And we -- about -- while obviously, in a very small number of cases in energy and retail, we had, like everyone, a problem or 2. We generally have very few companies on what we call our watch list right now. It's less than 3%. And by and large, our companies are weathering the storm well. And so we're definitely shifting to playing offense. And so the fact that we started off the crisis with no -- with very few maturities, no covenants, lots of liquidity, low leverage, allowed us to weather through. And in terms of the performance of the companies, it's as you would expect, which is, on average, GDP is going to be down, depending on who you ask, 3% to 5% this year. And you'll see our companies' revenues trending down in line with GDP. And then -- but you're also seeing that rebound in the third quarter and going into the fourth quarter now. And so we're tracking basically what you would expect in the economy. And so in terms of the vaccine and the outlook, I think that things have clarified a bit, right, in terms of where we are. Like I think that you're going to see cases -- the election is over. The results, which looks to be sort of divided government, are -- that's a very good business climate. We think everything will be pulled to the middle. Some of the more radical things that were being discussed on either side, I think that's going to be harder to get done. And so business confidence is coming back. That part of the equation has sort of been somewhat clarified. And then in COVID, obviously, cases were ticking up. I think we're all girding for the next 6 to 9 months through the warmer weather to be more difficult. And -- but then therapeutics are coming along. And obviously, we had the big announcement on a vaccine. And so every expectation is that, in the second half of '21, that will start to become more widely available. And so as a result, you can start to look at some of these COVID-affected industries and start to try to put base cases, business cases around them as to the slow recovery of those industries. And there is leverage availability out there. And so you're seeing everyone's pipeline building. You are seeing, both in terms of private credit and deal flow, a return to more normalized levels. We would expect to return to more normal -- after levels going -- private equity transactions and credit transactions being down 1/3 to 50%, depending on the area for the first part of the year. Now you're seeing -- I would expect in the fourth quarter, first quarter, you'll start to see people do deals where, ourselves included, where they can handicap the return of these industries in a positive way. And the fact that there's this clarifying base case before Christmas, before the shopping season, particularly as cases were spiking and you had this political uncertainty, that was kind of putting a chill on everything. Now there is this clarification. So obviously, the world is unpredictable. Something could happen to change it all. But I see -- I think people are going to lean in now to a more optimistic approach to getting transactions done.

That's helpful. And then maybe one other question on the private equity side. Technology, if we look across a lot of industries, it had some impact. And in some areas, it's created some value traps and other companies have been able to reposition and move on. So how has Apollo adapted to some of these technology changes and kind of incorporating that knowledge and that skill when either making investments or working with the companies in the portfolio?

Yes. So we're doing a lot of things. I mean, obviously, technology is a massive and growing part of the economy. And so we're all-in in terms of both origination. So the definition of -- Apollo, what we're really good at is creating proprietary origination at arbitrages at discounted prices, whether it be distressed for control, where we're absorbing a process complexity, or whether it be corporate carve-outs, where we're absorbing complexity of carving out a business. But certainly, in a lot of cases, technology businesses are trapped in significant other portfolios. They may not be valued appropriately. We're good at recognizing value where others don't. And so the definition of an Apollo technology investment is one where we're able to create it at a discount to what we think is fair value because some either misunderstanding of a business or some complexity that we have to manage, either process-oriented or in terms of managing. And so whether it be the Rackspace deal that we accomplished, taking West private, there are plenty of examples of Apollo investing in private equity technology transactions. And that's going to be a continuing growth part of our business. In the credit side, we're finding increasingly that, whether it be Airbnb or Expedia or many other companies, that there is an appropriate part of a technology company's capital structure, which is credit or debt. And our ability to move quickly in size and understand these companies has allowed us to -- in the case of the March to June time frame, to get them over the hump completely-wise or, in many cases, kind of help them grow their companies. And so we're also seeing significant possibilities and growth in our origination capability around private credit. And then lastly, we're bringing -- we have [ AC ], Apollo Consulting, and we have a whole force here, a whole group of people that is enabling our companies with technology, led by fellow, Aaron Miller, that we're happy to have. And whether it be -- I mean, the most, whether it be enabling cloud and Internet-based kind of back office or marketing applications or sales applications, like we're bringing technology across our platform. And it's creating a massive amount of opportunity and EBITDA. And so all of that -- and as well as facilitating some of our portfolio companies, like ADT just announced a partnership with Google. So there are plenty of our companies that are also availing themselves of new technology in a way that is very positive for them. And so technology is big, it's important and it's growing and we're all in.

Great. And then just you mentioned on the deployment, some opportunities picking up and pipelines filling up as well. Despite the progress on vaccines, it seems like this environment is probably going to last longer than most people maybe expected or hoped, and that creates some challenges with private companies. So when you look at those opportunities that are starting to emerge and you're able to look out a couple of years and see how it plays out, what are some of the more attractive areas that you guys are spending time on?

Yes. So first of all, I mean, obviously, in summer, the COVID-affected industries, these companies are going to emerge with just too much debt. So whether it be travel or travel-related services or events, it's been public that we're helping with the restructuring of Swissport's debt as an example, that's been out there, certainly Hertz. And there's going to be a lot of examples of us just working with great companies that found themselves with lower EBITDA and probably needing to rightsize their capital structures. And that could be done either through restructurings as the ones I've talked about or more towards capital solutions, getting people over the hump. And so that would be the first thing. I think, secondly, in some of the COVID-affected industries and in private equity, you can now invest -- there's -- you can -- because of the availability of leverage and low-cost leverage, right, we're looking at deals where, okay, even if it's '24, '25, right, in terms of revenues and EBITDA, as long as you get back to that '19 level by '24, '25, you're okay. And so you can give yourself some room, you can give yourself some cushion. You have to set up the capital structure in a nuanced and intricate way. And so -- to make sure that you have the room and if things go wrong and you could see it's all very unpredictable. But if you set it up right, you've got ample room to create real private equity returns. And then lastly, we're now a lender to the middle market and we're seeing the middle market private equity groups come alive. And so we're seeing sort of needing to lend to them in terms of sort of stretched senior secured debt through our MidCap platform and in Europe. And so that would be another area. And then lastly, it's just this origination. We've done this year-to-date, so far, $13 billion of transactions between -- that is like off the run, where it's everything from Albertsons to Cimpress to Expedia to now Hertz, $13 billion. And we calculate that ADNOC, which was a AA oil company that we did a sale-leaseback with, and we're finding that some of the Federal Reserve money doesn't reach into some of these areas. And so they're just too complicated for the markets or what have you. And so we've generated those opportunities at what we think is a 300 basis point spread for our clients and also help these companies get through either raise growth capital, in the case of ADNOC, or get over the hump or do some pre-IPO financing as we did in Albertsons. And so there are tremendous win-wins between private companies or public companies that need private capital and our investors, which are pension funds, teachers, firefighters, government workers that need money for their retirement. I mean one of the effects of 0 rates, right, obviously, is that the pension system needs to generate 6%, 7%, 8% returns to keep up with funding for health care costs and the promises that they have made. And so we're helping with that.

All right. It's good color on the investment side. And then Apollo tends to be a bit more dynamic in terms of the types of investments that you make, depending on where we are in the cycle and this investment backdrop. I know you guys have mentioned in Fund IX focusing more on distressed opportunities versus like traditional private equity. What are some of the pros and cons when you kind of shift to those types of investments versus, say, the more traditional private equity-style investments that investors should know?