While Apollo (NYSE: APO) shares have been clubbed so far in 2022, the company’s earnings profile has been largely transformed over the past two years via its acquisition of Athene. Although investors may think of Apollo as a volatile company dependent on successful IPOs, the reality is that the vast majority of Apollo’s revenue comes from stable charges on committed capital and income related to distribution. Considering only these stable revenue streams, Apollo is trading for just 10.5x estimated EPS for 2022. That’s far too cheap for a company with a stable, fast-growing revenue stream. Assuming 15% annual growth for its recurring earnings business, I think Apollo’s stock can double (or better) over the next four years.
Breakdown of winnings
Below is an image of management’s earnings forecast for Apollo. On a pre-tax basis, Apollo expects to generate $5.70 per share ($4.56 after tax at 20%) from its fee-related and broadcast businesses. Fee-related activity includes Apollo’s private markets business (private equity, debt, real estate and infrastructure) – fees here are earned as a percentage of long-term committed capital. The capital is generally blocked for more than 7 years and the fees are collected on the committed capital (not subject to mark-to-market or mark-to-model). As such, it represents a source of stable and recurring revenue for Apollo shareholders.
Similarly, spread income comes primarily from Apollo’s (formerly Athene) insurance business, where Apollo sources liabilities at low cost by selling fixed annuities and invests the proceeds in assets. higher yielding fixed income earns a spread on the difference between the rate paid to annuity holders and the rate it earns on assets. It is important to note that the assets in which Apollo invests are largely investment grade assets (relatively low risk senior debt) which should be resilient even in a difficult economic environment.
In addition to the sustainable revenue streams described above, Apollo earns primary investment income from performance fees in its private markets business. These fees are much more volatile in nature than fee or spread income. These fees depend on the performance of investments which is linked to capital market conditions, i.e. successful investment exits via IPOs or sales to private buyers. These fees will suffer in the current environment as funding conditions are tight and IPO activity is virtually non-existent. Fortunately for shareholders, the core investment segment represents a very small percentage of earnings, so small that it will be ignored for the purposes of this analysis.
Apollo has several levers that should contribute to the long-term structural growth of its commission-based compensation business. Over the past 30 years, private equity has continued to attract huge inflows of funds as investors shun actively managed public stocks and instead allocate capital to leading private equity firms such as Apollo, KKR (KKR) and Blackstone (BX) which generated peak returns. for decades (see below).
In the medium to long term, I expect the trend of increasing allocation to private equity strategies to continue. This will benefit Apollo as it raises capital for new funds in new markets. The company is raising money for Private Equity X, a $25 billion private equity fund. In addition, the company has several other funds, including real estate and private debt, which will help raise new interest-bearing capital and increase the revenue stream of this segment. Additionally, Apollo and other private equity leaders are increasingly targeting retail investors with new products. This could prove to be a tremendous opportunity given that this segment is largely under-penetrated (retail investors invest primarily in public markets).
In addition to the opportunities to grow its commission-related revenue, Apollo’s spreads business is perfectly positioned to generate higher revenue in the future. Apollo’s fixed annuity business (Athene) has been a long-term market share gainer. Rising interest rates tilt in Apollo’s favor as the revaluation of earning assets exceeds the higher rates paid on annuity liabilities. Additionally, with many financial institutions retreating in a tighter economic environment, returns earned on assets are increasingly translating into higher spreads and profits for Apollo’s spread-related businesses.
Conclusion: Putting it all together – nearly $8 in 2026 EPS
Here is a summary of management’s expectations for its business in 2026:
Giving no credit to Apollo’s more volatile core investment segment, management expects after-tax earnings of nearly $8/share in 2026. This implies that today Apollo is trading at just 6x 2026 EPS, which is far too low for a steadily growing company. In addition, Apollo’s management has suggested that the company could use some of its strong cash flow to repurchase shares (the outlook above does not take into account a reduction in the number of shares), which could bring recurring EPS closer to $9/share.
I think a high-quality, fast-growing company like Apollo should trade between 12 and 16 times recurring EPS, which suggests the stock could trade between $95 and $125 per share over four years, which which implies an increase of more than 100% for patient investors. Meanwhile, investors will cut a 3% dividend in the meantime.
1/ Stocks of alternative asset managers have been volatile despite their increasingly stable earnings profile
2/ Institutional allocations may slow their allocation to private markets due to rising interest rates and heightened economic uncertainty